The Economic Times
English EditionEnglish Editionहिन्दीગુજરાતી
| E-Paper

    Small and mid caps have only given up their gains: Rajeev Thakkar of PPFAS MF

    Story outline

    • Small and midcaps have been beaten down severely.
    • Real-estate linked clean-up is yet to happen.
    • Auto still has a role to play in Indian economy.
    There was a huge outperformance by small, midcap stocks until 2017. They gave up those gains in last 18-20 months, says Rajeev Thakkar, CIO, PPFAS MF. Excerpts from an interview with ETNOW.

    We are looking at two markets -- a global market which refuses to go down and a smallcap market in India which refuses to go higher. You have global mega companies and you have Indian smallcaps. Are you happy about holding the smallcap end or are you feeling great about owning a lot of mega caps?
    You do not have too many small and midcaps in India which are in…

    Let me put it this way, the midcaps have become small caps, and large caps have become midcaps.
    That is correct. We had been crying ourselves hoarse saying small and midcaps have done exceedingly well. But this was true in 2017. If we just look at end 2017 to today, then you are absolutely right that small and midcaps have been beaten down very severely. But if you zoom out a little, let us say to a five or six-year period, then in the two comparative charts you will actually see a huge outperformance by small and midcap stocks until 2017. They have only given up those gains in the last 18-20 months. So, it is not that something exceptional is happening around here. Sure, with a steep fall there will be pockets with great valuations, but a lot of them deserve to fall. You have seen a lot of fraudulent cases coming out where the books of accounts were completely cooked or there were no underlying business, just a paper tiger as it were. So yes, it is partly deserved and partly an opportunity going forward.

    Things You should consider
    • Annualized Return
      for 3 year: 8.6%
    • Suggested Investment
      Horizon: >3 years
    • Time taken to double
      money: 7.0 Years
    Global markets, given the trillions of dollars and ample liquidity, are trading at negative yields; the cost of capital has gone down dramatically and given that kind of environment. Let us say you are a pension fund or a university endowment, and you have the choice of buying a zero-coupon German bond at a premium -- not at par with premium -- versus buying any of these companies at 25 times earnings with 4% earnings yield. I think the choice is a no-brainer for most people.

    Given where the world is now moving, everybody is talking about less than 1% of the world population owning 99% of the total wealth. Is that a big disruptive threat which could be coming for the Amazons, Facebooks and Googles of the world?
    Every individual has one vote that is not weighed by their wealth. So, every democratic country has this urge to get into populism and that is what is happening.

    You do not own IndusInd Bank?
    We do not.

    But you do own a whole host of other banks like HDFC Bank, Axis Bank and ICICI?
    Rajeev Thakkar: Yes.

    What is your view on banks right now?
    Some clean-up has happened, but real estate or financials-linked pain could come to the fore. For example, we have one large developer from India whose bonds trade at 30% in dollar yield on a one year….

    You are saying that they are looking at selling some stuff in London?
    You have those kinds of things now. Where we are sitting right now, in the studio in our neighbourhood, you have these flats at close to a million dollars each. And tens of thousands of them are lying unsold across various developers. The real estate linked clean-up is yet to happen. The balance sheets could still throw up some pain. So, for two or three years now we have been saying most of the cleanup is done, which is true as far as large industrials go. But there is a final bit of financials and real estate that could still have some room to play out.

    Let us talk about auto because you have got a quite a few holdings there. Are you also assuming that what we are seeing in the sectors is cyclical or are you worried about this entire transition?
    There is also a fair bit of structural change coming in the future -- electrification, ride hailing, ride sharing, autonomy, connected vehicles. All these are a reality and they will have some impact. But a lot of the pain is cyclical in nature. When the growth was good, we almost looked at the Marutis and the Eichers of the world -- the quasi FMCG kind of names where growth will keep happening in a linear fashion, which is never true of consumer discretionary things like autos. Whenever people are pinched on their earnings, that expenditure can be postponed anytime. So, you need not buy a vehicle today, you can buy it six months later or one year later. So, a lot of the pain is cyclical in nature. Electrification and those kind of things will be a reality. Public transportation is a reality. Urban congestion is a reality. But still, the penetration which is there in India is at very low levels. I think auto still has a role to play in the Indian economy and that we will rebound from the lows that we are seeing right now.

    When it comes to IT, there are names like Persistent, Mphasis, etc. Clearly you are going for some of the midcap names. What is driving this conviction?
    Some of these companies have focussed on specific niches. Again, only time will tell whether it plays out as we envisage. For example, Persistent is playing in AI, machine learning, Cloud, mobility, and social media -- upcoming areas -- rather than going for traditional application development and maintenance kind of businesses. Furthermore, they have a lot of product work behind them rather than just services. They have also recently appointed a new CEO. So, let us see how it pans out. It is mainly a call on the business model and what they are focussing on.

    We were earlier talking about the FAANG stocks. What are you tracking in terms of regulatory hurdles? There are also concerns of them having topped out in terms of valuations as well?
    Ironically, people keep asking me about valuations. Whereas I would say companies like Facebook, Alphabet and Apple are cheap in terms of conventional metrics that we...

    Do people think that just because the market caps are higher, the valuations would be higher too? In Alphabet's case at least, the valuations are lower than lot of midcap stocks and even the market cap is high, right?
    Correct. In terms of traditional metrics, let us say if you look at the price-to-sales or price-to-earnings, they are close to where we are -- close to the index levels. Also in many cases it is not excessively valued. One could argue things like Amazon being very expensive, or that Netflix being a loss-making company. Netflix we do not own. I do not have a particularly strong view on that. But Amazon’s headline numbers would be close to 80 times the earnings. In Amazon what happens is that it a collection of businesses, it is not just a retail play. A big portion of the valuation comes from their Cloud computing business, which is a 40-45% CAGR, 30% margin kind of business and a very significant portion of the Amazon’s market cap. I think that has to be taken out and valued separately. On the retailing side of things, the earnings are actually suppressed because they enter into new geographies and loss-making categories. So, the profits get suppressed by the new investments that they are making. I would argue that the price-to-earning ratio would not be very reflective of the underlying business' profitability. But one can argue that on Amazon, Facebook and Alphabet even conventional numbers are not that expensive.

    Also Read

    The Economic Times