The markets have gone a bit nervous with profit-taking emerging ahead of the Budget and the expiry. We had a good run but purely from the positioning and expectation standpoint how are you looking at this event?
While everyone has expectations and anticipations from the Budget, unless there is something very substantial in nature that affects the cash flows of the companies in a meaningful manner over a longer term, the market would move just intraday on the day of the Budget and then that event would be behind us. Unless there are major changes on corporate taxes like the positive ones that were announced in September 2019, I do not think there would be any material expectation built in so that the market would be disappointed if those are not delivered.
The market has been in a selloff/profit-taking mode over the last three-four days. This is the second quarter in a row when the numbers have been higher than estimated. Do you think markets have baked in a recovery in earnings for next two, three, four quarters?
The high on BSE 500 was 19,200 and today it is 18,541. So, it is roughly 650 or 3% off the top. We have been all spoiled over the last nine months with a unidirectional upwards slope and even a 3% sounds like a sell off.
As for whether the earnings are baked in, the market being a discounting mechanism, recognises well ahead of any of market participants or macro gurus or fund managers that the pandemic is not going to have a lasting impact on company or corporate cash flows. The market is factoring in that the economy would have a very sharp rebound which already it has but continues to have a sharp rebound. This year might be down high single digit or so for the economy. Next year, expectations are for a double digit economic growth. Corporate earnings are not turning out to be as bad as were expected. Third quarter earnings are in fact coming out to be very strong and year to date or for the year now, most expectations are for high single digit or double digit earnings growth.
With the economy down, still the corporate world is expected to deliver almost double digit earnings growth and on top of that, next year expectations are for another 25% plus earnings growth. The market built in some of those expectations at current market levels or during the whole of last year as the market regained its lost ground.
How are your portfolio companies coping with this recovery? While the earnings and demand outlook have improved, raw material/input prices are up. What kind of conversations are you having with your portfolio companies?
One has to look at sector by sector. Let us start with IT services companies. They are seeing very strong demand trends from around the world. One thing that every company and any company that is worth its name has realised during the pandemic is that technology is very core to all kinds of businesses and post pandemic, they must prepare for a dual or a parallel network that allows work to be conducted as a normal business from home as well.
This has entailed a tremendous ramp-up or acceleration of technology spend worldwide and that is certainly benefitting Indian IT services companies because they are in the midst of multi-year, multi decade trends which are getting accelerated now. I am sure you have seen the performances and numbers because most of the IT services companies’ results are already out and despite the Q3 December quarter being a seasonally weak quarter due to furloughs and what not, these companies have shown amongst the best quarter on quarter trends in a long time.
In banking, which is the other very large sector, the numbers that have been reported by some of the private banks, are showing very solid numbers while the NPA numbers are artificially suppressed right now because of the NPA directive from RBI where the NPAs are not recognised. But even on a pro forma basis, just about nine, 10 months ago, there were serious question marks about the survival of a lot of financial services companies, including some of the largest banks. People had started talking about who will be the last man standing.
So the financial sector of the country has come through the worst possible crisis of our lifetime more or less unscathed, in contrast to the magnitude of the crisis that the pandemic has unleashed. There has been a minor bump in NPLs from 1% to 2% and credit costs of similar magnitude. That is nothing. It shows the robustness of the model and how well managed the companies and banks are. So their numbers have been far ahead of expectations just a few months ago. These two sectors and the consumer sector — paints or consumer durables companies are showing very strong growth and it is not just pent up demand. That is just part of the mix and part of the demand driver. But beyond that, there is the fact that the underlying economy in rural as well as urban areas has picked up very well. The shift from unorganised to organised has been a multi-year phenomenon and it will accelerate further.
Let us talk about consumer companies like Asian Paints and the paints industry. How do you see the pricing ability of the leader as well as the challenger?
If we talk about the paint sector in general, it has very attractive dynamics. From a growth perspective, it is a structurally growing segment of the economy. Besides the demand growth, there are elements of unorganised-to-organised sector movement with about four major players in the organised sector. It is well behaved in terms of pricing and the overall competitive environment. Unlike in most parts of the world, India has an emotional connect with consumers and hence it is a brand. People do value brands in paints quite substantially.
As for new entrants, I done right it is possible that considerable headway can be made by new entrants. But ne has to have the patience and commitment to pursue it for many years and it is possible that given the announcement that is in place, I do not see a major upheaval that would destroy the fundamentals or profitability of the sector any time over the next three to five years or even longer term. It will be one new player. It remains to be seen how the industry adjusts from four to five players or other players who might come in. But at this point, you cannot write off the new competitor nor can you assign a very high probability of success either. You have to wait and watch how this unfolds over the coming few years.
You wore many hats. You have been an FII, then a PMS and now turning into a DII also. What is the outlook of your friends from the FII community? Will we be beneficiaries of foreign fund flows for a reasonable period of time?
Look at the market levels and the market direction and trends are the primary drivers of flows. Everywhere in the world that is omni present truth, even in India if markets remain elevated and continue to move higher, you would see eventually the flows turn positive and turn into a torrent and offshore as well.
The concerns were very high during mid-year June-July timeframe, During the May-June-July timeframe, the migrant crisis and India’s poor healthcare system and how we would handle the infection — all those questions have been put to rest. The market put those concerns to rest before the actual reality and hence the sentiment also starts turning globally for investors.
So as long as the market remains directionally in a positive mood, I do not see the appetite subsiding or appetite disappearing amongst foreign investors. Of late what we have seen is increased interest from foreign investors who had at some point in time over the last couple or three years stopped or paused looking at India as an individual country for investment destination. They were invested in India but through GAM fund or Asia fund and were not that keen on a country dedicated allocation. Now we are seeing increased appetite amongst those investors to have India as a specific country dedicated allocation which is a very positive and heartening sign.
