Why Sameer Narayan finds value in midcap power utilities

Even the government is trying to get in place a discom policy where they will be looking at getting the letter of credit first and then ensure that the discoms are solvent and they are in a position to pay up for the PPAs that they have signed up. That kind of revenue visibility will give a lot of comfort and confidence to the street, says Sameer Narayan, Market Expert. Excerpts from an interview with ETNOW.

We are in the middle of the earnings season. Yes Bank is the one we are watching out for today. There is a possibility of fundraising and that could be the pivot for the counter. We saw the way it moved yesterday, what are you expecting?
First, people would look the earnings getting troughed. How does NII look, what is the loan growth, how is it doing sequentially and that would give you an indication that yes now they are across the turn.

Secondly, the type of fundraise. For example, if there is just a financial investor or somebody is coming with a possible strategic intent, that will probably give the street a larger measure of confidence about things quickly turning around for Yes Bank.

It will probably be in the rate of change that people want to play here because the stock has corrected a fair bit. Right now, one does not know at what price I want to buy, is it 0.5 times book, 0.7 times or 1? The moment you get a sense that there is a due diligence done, there is a financial investor with a probable strategic intent coming on board and is providing capital, that is when the whole growth story can start building up.

What are you making of Wipro? We are going in with very tempered expectations and the management had made it fairly clear the last time around in terms of their guidance as well. What is the pecking order in IT and what are you expecting from Wipro?
We have got the numbers coming out from Infosys and TCS. Infosys was a very clear beat on the revenue line, TCS was probably a bit lower relative to expectation. In Wipro, the expectations have anyway been muted and they have not guided too strongly also.

Given the fact that it is probably Premji’s swan song as chairman, you could see some amount of forward looking directions being set because a flat quarter-on-quarter growth on the IT services revenue line is perhaps just par for course.

It is not as if this quarter has been anything great but if you look at what has been happening in Infosys or TCS, the amount of TCVs that they won means there is a fair bit of deal bids that is happening. Maybe, Wipro will be probed more as to how do they want to fix the front-end and that is what the analysts would be wanting to get a commentary on from the management.

Do you think investors will make more money by buying HDFC Mutual Funds or buying HDFC AMC stock?
HDFC AMC stock has done fairly well in this quarter because post the Sebi changes that were coming out into the commission structure, given their size and their relevant dominance in the space, they have been able to pass through the entire thing to the distributors.

Therefore they have been able to at least maintain margins. That is the reason why people will look for that kind of confidence. It is a very fortified profit mode that is available in businesses like this, where you have say a profit run rate of Rs 1,200 crore.

I think 30 times multiple is a very easy going thing for the simple reason that at these numbers, you will continue to get growth. As you rightly said, for them, growth is there for the asking because the moment penetration increases, savings go up. These people will get a disproportionate share of the incremental business but at what valuation would you want to buy? HDFC Bank is always trading expensive and chances are, so will this from the AMC.

Can one just make a portfolio of HDFC Bank, HDFC AMC, HDFC Life and just sit on it for the next five years?
Absolutely. If you are looking for a 10-12%, 10-15% kind of a CAGR, these are fantastic stocks and rather than doing passive investing, it is better that you take direct exposure to these kind of marquee names. But the problem is that when you are looking for a distress situation turnaround, which probably a larger portion of the economy right now is in, then you need to see the operating leverage kick in and you will not get those advantages here.

You will probably get in some outsized stock where you have not been pricing for the growth and there is a huge amount of leverage not unleashed yet. Here, you may get a 2x, 3x kind of a return.

If you are putting your hard earned money in midcaps, maybe the perception needs to change for retail investors. They cannot expect astronomical returns, at least for now?
Today, the recent returns have been probably high single digits but if one was to look at a roaring bull market or an economy where we aspire to touch $5-trillion in size, you will need a lot of things to fire. From that perspective, you will see certain sectors getting that kind of push where you have to be clear as to what kind of midcaps you want to play in. Is it in the sub $500 million companies or is it in the Rs 15,000-40,000 crore ($2-5 billion)? That is where you will get enough business models which have been proven and where you will see that when growth comes, there is a large amount of operating leverage that can get unleashed which right now is not getting priced.

You were talking about looking at opportunities within the midcap universe where there is a strong operating leverage. Is there some sort of a sector or a pocket where you would find that comfort?
Power utilities is a very good sector where a lot of things are happening from the regulatory side. We are seeing that even the government is trying to get in place a discom policy where they will be looking at getting the letter of credit first and then those things which will ensure that the discoms are solvent and they are in a position to pay up for the PPAs that they have signed up.

That kind of revenue visibility and the fact that you will actually get money for your power supply will give a lot of comfort and confidence to the street to be able to see how growth will play out in utility stocks.

If interest rates come down, affordability goes up. If three things come together; ability, availability and affordability, then we could be staring at a strong demand revival. Do you agree with me?
Absolutely. There is a fair amount of optimism built in because today the 10-year yield is also signalling that people do not want to put as much money into the private bonds because there is some amount of risk aversion. People are not very sure about the credit risk and that is the reason why anybody who has to deploy funds, wants to rather buy G-Secs that is the reason why you are suddenly seeing that those bond prices are rallying, the yields coming off and hence the spreads between corporate bonds is widening.

Now that RBI has ensured that liquidity starts turning surplus, there is money available but that money is not chasing the private issuers they are going straight to the sovereign bonds, Now the government is making all the right noises. There is talk of raising external borrowing or a sovereign bond issue of $10 billion. That amount is not something which is too large in the Indian context. Earlier, we used to have Resurgent India Bonds. During Raghuram Rajan’s time, we have taken overseas borrowings and so that is not a problem. Once liquidity is available, you will find that people will start putting it at decent yielding assets. That is what kick starts the spiral and let us hope that it builds momentum.

Is there merit in buying commodity consumers now? We are going through a cycle where copper, oil, cotton, coco, soya everything is coming down?
China is typically the region from where the commodity pricing take its leap. In China, over the last two months, even though the growth has been soft, the data on commodities has been fairly strong. Their fixed assets investment is maintaining at the same rate. At the same time, most of the inventory of all finished goods is actually running fairly high. That means China has not taken the paddle off in terms of the production of these industrial materials. The way the trade war spat is going on, one would probably be wondering that China is also now looking at ways to make the economy more domestic looking. They are basically pump priming and do a lot of more fixed asset investment because they have done a fair amount of consumerisation.

Consumption has become a decent share of their GDP. But now when they know that there is going to be some slack and exports are not going to be there for the asking, maybe they will come back. It could be a signal for all commodities to start trending up. They have been soft in the recent past but the future may not be that amenable to the commodity users.

Have you read into the commentary on auto? There appears to be a positive sentiment building up for the festive season. Has the Street really unnecessarily punished these stocks? Is there going to be a prolonged slowdown or has there been too much pessimism?
Probably a combination of all. It is a cyclical industry but all the stocks were primed for growth, that 15-20% growth is going to be continuous. Therefore they all were being given 25-30 multiples. Now you face a situation where there is BS-VI changeover, which means investments have to be made, costs will go up to the end user and then there is the whole EV investment thrust. Both these factors are together combining and the NBFC crisis further accentuated the entire availability of credit which was probably the last leg standing.

As a result of all these factors, some amount of demand has stepped back. In case the monsoon starts picking up, that will be a big sentiment driver. So the moment you start seeing the number starts coming up and the monsoon starts getting more widespread throughout the country, the mood in auto will pick up -- at least on the passenger cars, on the two-wheeler side.. On the CV side, there is a fair amount of inventory and a a fair amount of slowdown because freight is not visible, people are not in a position to make those investments up front. So, CVs may take a bit of time to recover but I think come may be a quarter down the line we should see some pickup.

What is your take on infrastructure? Are we going to see orders picking up and is there any sort of sub sector within the infra space that you like?
Infra has been given a lot of focus even in the Budget and we are looking at the leg of Pradhan Mantri Gram Sadak Yojana kicking in post budget, that Rs 80,000 crore allocation. Roads will incrementally see a lot more money coming in and within infrastructure, even power and power utilities and capital goods.

The moment you start seeing some amount of capex or some amount of optimism on the part of corporates looking to expand capacity, you will see that getting translated into your order book. As of now, it is not visible but going forward, it is possible.

It is an extremely long term and full of regulatory risk kind of scenario. I completely agree and high burden, I take you rationale for it that is the upside but the downside also is fairly steep.
That is the reason why now you see the availability of funding is not what now government is looking at. There is a savings shortfall in India. So you need to start getting capital from outside. Somebody who wants to build these assets needs access to cheaper capital and because demand is there, the idea is in what time frame can you execute it and what is your capital structure? If those two metrics are there, there is enough tailwind for the sector because demand is definitely not a constraint.

As of now, power utilities and power sector things are falling in place. I think the government will take up one sector at a time.

The other pocket that we have been looking at is pharma. Are you looking at it as a defensive bet or just as an opportunity and if so would there be specific names or strategy you look at?
Pharma has seen a massive underperformance over the last two-three years. Today, most of these stocks relative to the benchmark are quoting at substantial discount. One is trying to see if there is some growth that can probably start getting priced in, but the near term visibility there is not much. A Sun Pharma is still 20 times FY20 and if growth comes back, it will probably be in FY21. So, as of now, it is a leap of faith but yes because the sector has seen a large bout of underperformance and there is a fair amount of under ownership.

Everything is happening due to a stronger rupee I do not think the large companies with export driven models will have a lot of tailwind or support from the export earnings. The near term earnings may not be as robust as even today current valuations are at discount. But 20 times is not exactly cheap, it is probably in line with the market multiple.