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Which sectors will benefit from global economic recovery? Manish Gunwani explains

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Last Updated: May 28, 2020, 02.28 PM IST
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Summary ‘The emerging market currencies seem to be stabilising’

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Manish Gunwani-Reliance MF-1200
While the FMCG stocks have corrected, the free cash flow yield does not look that exciting.
The global markets seem to be pointing that there are some signs of recovery building up, says CIO - Equity Investments, Nippon India MF.

I can easily divide the world into two: the optimists who believe the economy will recover in the second half, a vaccine will be discovered and India will benefit because of crude prices, and the realists, who feel that the economy is in a long slow but painful patch. Nothing will come this year on the vaccine front and despite the odds, markets currently do not offer great value. Which camp are you in?
I do not know about the economy and at what pace it will return but the ask rate of a lot of stocks is not very high. You are asking whether the economy will come back in one year or not. I am saying if you start from the other perspective on say what the auto stocks building in or what the retailing stocks or bank stocks building in, or cement stocks are building in; even if the economy comes back in two-three years, you will get 50% to 100% return.

There will have to be a structural change in consumer behaviour because of this crisis, which to my mind can only happen in some very niche segments. You can debate that multiplexes may get disrupted but clearly in cements or commercial vehicles or retailing, I do not think anything structural is going to change. So the next six months, twelve months, maybe even eighteen months may look very tricky and pessimistic on the economy but stocks are building a discounted cash flow of 20-30 years; so one or two years really should not affect the intrinsic value of stock as long as we can survive now.

Which is why my view has been that the easier call is to buy operating leverage. The trickier call is the banks and the financial leverage stocks because obviously you will make much more money on them if you get it right but there you have to just calibrate and see how the global economy is doing, how virus cases in India and then maybe you buy them when you see some clarity. But where you have debt-free balance sheet in lot of these cyclical sectors like cement and auto, you can afford not to wait for good news assuming that if the economic activity two years down the line will be the same which was there in FY20 pre-Covid, you can still maybe get 40-50-70% returns.

Why do you have a slightly nuanced view on banks because if the economy comes back, the leverage economy has to come back and credit has to start as there are only few banks left which will have to do all the heavy lifting now?
You are correct. The relative call again in banks to my mind is quite clear. Just like what is happening in many other sectors, the large private banks will get market share from most of the NBFCs and regional banks. The only thing about banks is that they are leveraged. Now you could see a lot of capital raising because despite whether the asset quality goes bad or not, people are concerned and we are seeing a fair amount of capital raising.

Say there is a second wave of virus somewhere down the line, then any leveraged balance sheet is what you will be a bit more concerned about. So my point is that you can take a three-four-five-year view much more easily on an operating company without debt and they are also quite cheap. Banks are the relative call as they are easier. The absolute call might be a bit trickier but if you have a very long-term view, the large private banks are good places to be.

You mean the big give, right? That is what one should stick to by just getting a clarity on it?
The way things have panned out, the ones with slightly higher corporate exposure may be better off because the personal credit, especially unsecured credit, is much more open to question after this crisis and that is where the valuations have been higher or you have a three-four-five time book. While these stocks also have corrected, there obviously are large private banks with half corporate, half personal which are at one-time book, maybe adjusted. So to me, the latter is probably the easier call at this point of time.

How does one approach FMCG because many debate that life has come to basic essentials and FMCG is not going anywhere? The other angle is some of the stocks are still trading at 60 PE multiples but at the same time you even have names like ITC which are getting badgered because of what may come by in terms of higher taxes when it comes to cigarettes. With the entire debate about rural India leading the recovery, do companies like Dabur, Godrej Consumer Products stand to gain?
Whenever this crisis fades, even FMCG fundamentals will improve in terms of growth and profitability. They also have a tailwind in terms of lower commodity prices because almost every FMCG company is procuring packaging materials and all that. But the challenge is that India is a place where you have very high fixed income rates relative to the West; so the argument in the West typically is that the dividend yields on a Nestle or a lot of the big pharma names is more than what you get paid in the bank. Here also, with the bank FD rates coming down, you can look at the bond markets and get some really good bonds at 8-9-10%.

While the FMCG stocks have corrected, the free cash flow yield does not look that exciting to me because you are starting with 1-2% free cash flow yield and where in an economy your state government bond is probably yielding you 8%. Given that the topline growth of these companies is probably going to remain 9-10-11-12%, it is difficult to be very excited. Obviously over the next one year, where there is a lot of uncertainty, some of them will be good places to hide and the terminal value of these companies is unquestionable but in the long term, you will make some steady returns. But I think the core theme at this point I would look for is higher operating leverage rather than pure staples.

What is the rationale behind the exposure to cyclicals, particularly power and energy?
At this point, it does look like the global economy is recovering faster versus the expectations than the Indian economy. Clearly, our lockdown period has been longer than what we thought two months back. The amount of activities which are restricted is much more than in a lot of countries in the West and the cases are not coming down to the level we would have hoped for. On the second side, given the fiscal situation we had before entering the crisis, obviously the stimulus is something which has been less than what people hoped for.

Given all that, I am quite positive on a lot of these global facing sectors like global auto or energy or IT because the US definitely seems to be coming back quite strongly. China has already come back quite strongly. A lot of these stocks also had gotten beaten up quite a lot. So if you see the price action of the global markets, you can look at a lot of the cyclical bellwethers in industrials and commodities; all of them have come back 30-40% from their lows. The commodity prices have come back and crude has come back all the way from zero to $30, aluminium and copper seem to be stabilising with an upward bias and the emerging market currencies seem to be stabilising. They have started appreciating a bit although yuan looks a bit dodgy.

The global markets generally seem to be pointing to the fact that there are some signs of recovery building up because obviously as the economies relax the lockdown, economic activity will go up. So commodity consumption and prices should trend upwards. At this point, I feel some of the exposures to IT, energy, global auto is a good place to be in.



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