Sunil Subramaniam is sticking to these 3 sectors in uncertain times
A reasonable three-year bet would be the capital good cyclicals play.
First it was banks, then NBFCs, now pharma. Sector after sector, everything is on the butcher’s block.
So, what is the question?
Question is that when will this winter end? Will the darkest hour before the dawn get over?
The market has a lot of uncertainties ahead of it for the next three to four months. In addition to Brexit and the Trump impeachment in the US plus the trade war, the data for the festival season, the quarterly earnings are yet to come out and the next big bang day will be the budget on 1st February. Honestly speaking, for the next three to four months, the market is going to be cautious and moving sideways because all these are key data for future projections.
I do not think it is correct to take any strong view but banks remain my pick because whichever way the cookie crumbles, whether there is a demand side pick up, followed by a surplus side pick up over the medium term or vice versa, it is the banks which are going to be the lubricating vehicle. As NBFCs and public sector banks are going to be fairly less active, to me the one safe play is the private sector banks because they have a healthy mix of retail and corporate book. Year-on year, their earnings should still show decent growth because last year there was the NPA crisis and that was depressing the numbers.
Apart from banks, it is best to hedge your bets and stay fairly distributed across sectors. But from medium term perspective, cyclicals make sense. If anything, the government’s action in terms of the corporate tax cut and whatever else they are doing, is going to have an impact. It is going to be on fresh FDI flows coming into newly set up corporate entities to shift manufacturing from China to India from foreign players. That is one clear-cut direction which should play out over the next few months and the ones to benefit from that is going to be the small and midcap capital goods suppliers.
The reason I am focusing on this is because this is A) one thing which is not dependent on demand revival in India. B) It is the most important thing from employment generation view which is the government’s key focus given our demographic situation. C) The tariff wars beneficiary is going to be Samsung, Apple. All are attempting to shift production out of China and this is the space for India to make its play. A reasonable three-year bet would be the capital good cyclicals play. Though today and in the next three months they may not give you any great returns. This is the way we are playing our stock and sector selection in our mutual fund schemes.
Nobody knows what happens next but in case another NBFC or private bank goes belly up, are markets prepared for this or is that going to create a systemic risk?
I would separate the private banks from the NBFCs. I would say that NBFC damage will get contained, even if there is a big NBFC going belly up, we still are contained within the financial sector, but a private bank collapse has far reaching implications and if that was the case, the market has not factored in the complete belly up or the fact that such an event could actually happen. I do not think the market believes that yet.
On the private sector banks side, the past track record of various governments since independence has been that no bank in public sector or private sector has been allowed to go belly up so there has been a forced merger -- be it Global Trust Bank, the New Bank of India, the Bank of Cochin, such banks which have had impaired balance sheets and have screwed up their operations have been merged into public sector banks.
Given the far-reaching implications of a private sector bank going belly up on the depositors and on the wider sentiment, I do not think the government will allow that to happen but if indeed it happens, the market has not factored in that risk.
On the NBFC side, I do not think there will be either a big bailout or that the government will step in to merge a NBFC into a bank. That is a quite a bit of challenge but I still feel that the NBFC sector does not have that much of a retail exposure in terms of borrowings from the retail public. They may be lending a lot of loans out there, but not the other way. But markets are better prepared for an NBFC to go belly up because they have seen such a wide variety of NBFCs in stress.
You have been tracking Aurobindo, Glenmark Pharma, but overall, when it comes to the pack, we have seen some very subdued sentiment given those constant concerns around the US FDA and its observations. Would you still continue to look at some of these names?
Our consistent view over the last many months, probably more than a year has been that we are bearish and underweight on the pharma sector, especially the export- oriented sector. Those factors have only got further strengthened because in a slowdown, pharma’s orderbook gets hurt. Also, in an election year, in the US, prices of pharma products for their local consumers will be a sensitive matter. There is also the risk in terms of the FDA, in terms of the plants meeting the safety standards etc. There are quite a lot of concerns around the export oriented pharma space and we have been consistently underweight.
Coming to cyclicals, while you are positive on cement, capital goods, auto, given that we are again seeing pain and that the festive season may not actually kick into those earnings yet for another quarter or so, what is a better bet within the auto pack?
We would broadly split the auto pack into three segments; the commercial vehicle (CV) segment, the urban vehicle segment and the third is the rural demand for vehicles. I split it in this way because three distinctly different factors drive the demand in these segments. If you take the urban segment, there are the low-end and high-end cars and clearly there was pain in the low-end cars.
In the rural segment, two-wheelers are a key product. We have seen pain there and tractors is the other heavy vehicle there. That is also because of the monsoon situation and all of that had been subdued in the past. In the commercial vehicle segment, however, it is more related to general industrial activity.
Clearly in commercial vehicles, there is a cyclical slowdown whereas in the other two, that is a structural issue. What I mean by structural issue is that there has been excess production built up by the auto companies in anticipation of a huge burst in demand which did not come through and all are saddled with excess capacities and the problem has got compounded from there.
Second, the auto sector is suffering due to two trigger points. One was the NBFC crisis. A far more deeper crisis in the rural demand is the persistently low inflation. In India as an economy and as an industrial sector, we all welcome low inflation. The government welcomes it as a populist measure to win elections, but such a deep low inflation is hurting the rural consumer because those who are reliant on selling farm produce for their livelihood, their income has been stagnant or even fallen. Hence consumer confidence is down and that’s why FMCG is also suffering.
The clear-cut thing is that this low inflation has had a very negative impact on consumer demand and that is a structural thing because low inflation is a product of the fact that oil prices have been very low. Demonetisation sucked out liquidity from the rural shadow banking and the non-structured economy there, has to resolve itself over a period as food prices rise and rural confidence comes back. So, that is a structural issue.
But in commercial vehicles, it has been a case of cyclicality driven by two-three things. a)Introduction of GST means that a vehicle going from Chennai to Delhi, used to take seven days earlier. It takes only three days now and they do not have stop for octroi and other taxes on the way. The road quality has improved and that also means that heavy overloading is happening on these vehicles as multi axle trucks are coming up. So, that is a typical cyclical environment. In the next 12 to 18 months, we would definitely see a turnaround because it is linked to industrial activity and if capex picks up on the back of freight and movement of cement trucks, steel trucks and jelly stones, all of those would pick up.
Within the auto pack, we are less bearish on the commercial vehicle space because we see it is a cyclical thing the industry goes through every four to five years. This cycle has started 12-18 months ago and I think the next year to year-and-a-half, that cycle will turn around. It is part of a cyclical pick.
Do you sense that consumption as a basket will be able to do the heavy lifting this quarter or do you think the sentiment will be soured because of the overall demand slowdown?
Factors negative to the consumption story have to be countered by the fact that Amazon and Flipkart have seen record sales this festival season. Consumers are spending money on products of their choice. So, let us wait, Diwali is still a few weeks away, at the end of the month. The initial news on Flipkart and Amazon is heartening. It is early days yet on the consumption story.
Within cyclicals, you are positive on certain pockets. If not names, give the specific segments where you feel there could be a potential for returns.
The big trigger is going to be infrastructure spend and when I talk about infrastructure spend, I am talking in a wider sense. The corporate tax cuts are definitely going to lead to some pockets of new companies being floated to take advantage of the 15% tax cut. The second aspect is that I expect FDI flows to pick up because at 15% tax rate for new unit and India’s low labour cost, a China to India shift is possible. The key driver is the per capita income of China which is 5x of India. While other Asian countries could compete with us, the sheer supply of labour from India in addition to the wages being low, would see over the next three to six months, a significant announcements of FDI and some level of ground level activity.
The third factor is a 1st February budget factor. This year, the government is not likely to do much infrastructure spending because to contain the fiscal deficit because of revenue shortfall due to the corporate tax cut. So, infrastructure is the easiest thing to cut down.
But come the Budget, there will be an announcement because it is a new year, a new balance sheet, new sources of funding and new plans laid out. I would expect government spending to bounce back in the next fiscal. Given the government spending picking up, pockets in the private sector starting to spend on infra plus the FDI coming in, over the next 12 to 18 months I would expect companies which are going to help set up these factories, build these roads, build new ports and airports, is all going to be boiling down to our long-term favourite cement, to some extent steel, EPC contractors, building materials, capital goods suppliers -- the whole range.
Mind you, as a mutual fund, I am always looking to create value over three to five years. We should not forget that this is a process of accumulation of these sectors over the next few months so that over a three to five-year we will be able to deliver value to the investors.