Given the current valuation, any market upswing due to the election outcome must be taken as an opportunity for investors to book profit, according to Quest Investment Advisors' Aniruddha Sarkar.
Sarkar currently maintains around 8–10% in cash, though he is not very negative on the market. "Valuations at current levels are not giving many investable ideas," he told NDTV Profit's Niraj Shah in an interview.
Sharp moves near election results might be a good time to take some profits, he said. After the election results, the discussion will go back to sectors, companies, and valuations, he said.
The recent rally is due to the FII money coming back, as we saw a massive upmove in a day, Sarkar added.
Investors need to be in some companies where growth visibility is strong while also keeping in mind the valuation, Sarkar said. "Companies without alternatives, such as capital goods and defence companies may continue to trade at high valuations."
In the recent valuation shift, the historic 40 price-to-earnings ratio is equivalent to the current 60 P/E, he said. "As long as growth continues to surpass past trends, valuation multiples may remain inflated."
The valuation gap between private banks and their public sector peers has continued to decrease, Sarkar noted. "The PSU banks continue to do well both on the valuation and operational fronts." From here on, both private and public should do well, as the banking sector valuation looks attractive considering that they have underperformed for the past year, he said.
Watch The Full Conversation Here:
Edited Excerpts From The Interview:
The markets have staged a pullback from the 22,000 odd levels, Aniruddha. Is this part of the pre-election rally or is it due to RBI’s move?
Aniruddha Sarkar: Basically, the market is kind of, you know, depending on what comes from the different phases.
We have elections phased out over the last six phases. I think that the market is being a bit worried about the numbers that the ruling government will get. I think that is what is leading to the FIIs exiting in huge numbers.
When we look at the FII numbers for the whole month of May, I think it has been one of the highest exit numbers. The recent rally, I would say, to a large extent is some amount of FII money coming back.
We saw a massive up move on the Nifty within a day when we saw the FII numbers which were very, very positive. So I would say it is more about the pre-election kind of, you know, optimism mixed with the pessimism which is leading to the sharp movements in the market.
RBI, I think, to some extent definitely has been contributing to the huge number of the dividend which they have given to the government. I think that also is a big factor, which is kind of increasing the optimism in the market.
Are you fully invested currently, or are you waiting for the verdict to be out? Some people are saying that you should be careful about the valuations. What do you think?
Aniruddha Sarkar: As an investor or as a portfolio manager, as of now, I'm keeping around 8–10% cash.
It's not that I'm very negative on the outcome or on the market. But I think, as you rightly mentioned, the valuations are something which is not giving you many investable ideas at this point of time.
Having said that, I would say that if the markets give you a kind of sharp upmove around the time when the election results happen, I think that it would be a good time to take some profits off the counters where the valuations have become very expensive.
Now, I would say that not everything is expensive. I think that after the election results will be out, I think the whole discussion would go back to sectors, companies, and the valuations where earnings growth is there, where valuations are comfortable, that is where the money will start flowing.
Definitely, looking for ideas in this type of market where everything is quoting at very, very high valuations, both on an absolute basis and on a relative basis is something. Keeping a 10% cash is not a bad idea.
You said that valuations look expensive in a few pockets. Cochin Shipyard, Garden Reach Shipbuilders, HAL, etc, have been throwing up phenomenal results. Did you have exposure to these stocks? They've run up so much, but they're posting strong results as well. What do you do?
Aniruddha Sarkar: That's a very big issue with you know, being a value investor and looking at the numbers also every quarter which have been coming out.
So I have been an early investor in some of the defence companies, but I would say looking at the numbers where the stocks have zoomed in the last one year I would say that you know, I exited a bit early.
But having said that, it would be difficult to justify the valuations at which most of these defence PSU companies are. So, definitely, the numbers are coming excellently well but I think the next 4–8 quarters have already been priced in. Now that's where the big concern is—what is priced in and what the market is not pricing in.
Now the big issue is that many of these companies are underowned also, in many of the portfolios. When you see the numbers coming from these companies and compared to other pockets, which were typically overweight in the portfolio, which are not reporting a good set of numbers, that is where I would say the investors are having a big issue to decide that do you continue holding the companies, which have historically been a large part of your portfolio and the numbers are not coming so good, compared to those companies where valuations are looking rich like the defence PSUs, but numbers are coming excellently well? You keep hearing about the order books and you keep hearing about the type of opportunity which is coming for Indian defence companies.
So I think that is where there is a big kind of a confusion of both portfolio managers and investors alike.
But to be honest, it's not that I would be completely away from it. I would say that you know, we need to be in some companies where the growth looks very strong, where I would say that the replacement or rather the alternative opportunities are not there like you know, some good capital goods companies, some good defence companies where I would say there are no alternatives and these companies might continue to trade at a high valuation for a long time.
So some amount of allocation can be done there, but I wouldn’t say it should be a very large part of your portfolio.
A lot of people talk about the ABBs, the Siemens and maybe the Cummins and the expertise that they bring to the table. Do you think that if a business or company has that kind of moat, they might continue to trade at these, "egregious valuations"?
Aniruddha Sarkar: Absolutely. I think you know, companies like which you mentioned, and also along with that, there are many other MNC companies which are there in that whole capital goods and engineering space, where I would say that historically they have always quoted at anywhere between 40–60 P/E.
When I look at one year forward or two years forward, compared to that 60 P/E, some of them are quoting at 70–80 P/E. Now, the issue is that, you know, historically they have not shown this type of growth and so I would say that historic 40–60 P/E is now the new 60–80P/E. So that is the valuation shift which has happened. We can't compare this 80 P/E with the broader index, because historically they have always quoted at a high valuation.
Now these high valuations come from the fact that you know, they have a strong parentage, they have a strong R&D expertise which they bring on the table, and in fact, there are some companies who are the only suppliers of a particular type of a product in the market and demand for those products are going up.
So I think, you know, you will find these MNC capital goods companies, energy EPC companies doing exceptionally well. Valuation is a big question. Is 60 the right multiple or 80 or 100? But I think as long as the growth continues to do better than what we have been doing in the past, they will continue to quote at a higher multiple.
The other aspect is what could happen to PSU banks, for example, post this whole RBI dividend, which a lot of people believe will bring down yields.
The JP Morgan Bond inclusion might also have that impact on bond markets and that, to a few people, means that there'll be MTM gains in PSU banks portfolio. The results haven't been so bad either. Are you constructive on that bucket?
Aniruddha Sarkar: Yes, I think PSU banks have definitely come of age, you know, since those days when they used to be a hated lot.
I think, what we have seen over the last 24–36 months is a massive kind of the multiple gap between private and PSUs decreasing drastically, wherein on one end, you had the private banks quoting at full price-to-book and you had the PSUs quoting at 0.5 price-to-book. I think that the massive valuation gap has decreased.
Having said that, I would say that where they stand today, PSU banks continue to do well, both on the operational front and also valuation-wise. I think they're not expensive.
Along with that I would also say that some of the private banks, which have seen a massive multiple contraction, are at those levels where valuations are now getting into that zone wherein you don't mind allocating some money to the private banks also.
I would say, from here on both PSU and private banks should do well. Overall, the banking sector valuation is looking attractive, considering they have underperformed for the last one year. So in my portfolio, I have decent allocation to PSU banks also.
Aniruddha, one brokerage believes that companies catering to the urban consumers or high-end consumption pockets could witness Ebitda increasing by three times in five years. For the last two years, we've seen such stocks benefitting. Will these kind of stocks continue to do well, or will rural spending focused companies come to the fore?
Aniruddha Sarkar: Talking about urban consumption I think, you know, it's a very interesting part because it's very close to my heart and I have been bullish on this whole urban consumption theme for the last almost eight quarters and almost 40% of my portfolio is allocated into urban consumption.
When it comes to the urban consumer, I would say that demand and income has been very, very strong. It has been resilient to whatever has been happening in Europe, America, agri side not doing well. This urban consumer is one part where the demand and the income growth has been very, very strong.
Now, the idea of being bullish on urban consumers and as an investor you know, what needs to be seen is that where do people like you and me spend our money and as you mentioned about the airports, I think the holidays are a large part, both for business and for leisure. I think this whole aviation part, along with airports is definitely going to continue to be a good kind of growth story.
Along with that, I would say hotels, which we have been very bullish on, continue to do very well and I would say along with that consumer discretionary. Basically, where do we spend our money—eating out, going out to the malls, the movies. I think this is where a lot of growth is going to be there.
We have been negative on the whole agri consumption for almost the last eight quarters. So I've been bullish on urban consumption, but I would say in this quarter, we are seeing some signs of the revival of agri demand and if, as per the IMD, the monsoons remain good this year, I think we should see the agri side of our economy also picking up on the demand side.
We have seen the bikes and scooters’s demand doing very well. I think that FMCG companies should also start reporting a good set of numbers. We have seen the margins improving there but I think the volume growth is the real thing which I'll be looking out for.
In the recent past, the Bank Nifty’s performance has not been right up there. Valuations are not that expensive, but many sceptics say now that corporates don't have to rely only on private banks, credit growth of banks will not necessarily equal the capex growth that India does. So why should I buy into banks? How are you looking at this? What's in store over the next 12 months?
Aniruddha Sarkar: No, I think I agree with your point which you mentioned about these experts, with regard to what historically valuations in Indian private banks used to be there.
I think that was kind of an aberration and I think that was a period when it was kind of a very high growth phase where you didn't have multiple options of getting the funding from.
Having said that, I think, those old multiples that the private banks used to enjoy might be a thing of the past and you might not see those multiples coming back.
Having said that, I would say that within the private banks, you had the pecking order completely reversed. There used to be a time when on the valuation front, you had Kotak, HDFC, Axis and ICICI. The entire pecking order has turned upside down.
So I would say that within the private banks, there could be some amount of catching up by the ones which are better valued, because I think some of the concerns with some of these private banks have been addressed to a large extent and now the management has also understood that should be the focus area with regard to the growth versus profitability.
So I think you could see some amount of catch up happening within the private banks. But I would say it should not be a discussion between private versus PSU banks, because both will go hand in hand.
Having said that, as you rightly mentioned, there are many good NBFCs which are being very active these days with regard to the lending, but I think RBI has been trying to keep a tight leash on the unsecured lending to ensure that, you know, you don't have too much of the underlying asset risk.
In fact, just recently, the RBI came out with a guideline for the banks to ensure that NBFCs who were co-lending with them, should try to assess the risk of the underlying assets over there. So I think eventually we will see some sort of a control even on the NBFC lending and that needs to be at par with what the bank will be doing.
A clutch of the pharma names have actually given some fairly decent quarterly performance to end the year and the commentary from some isn't that bad either.
Do you track healthcare closely? Do you like any of the healthcare pharma companies focused on US generics, the India-exposed ones, or the CDMO companies?
Aniruddha Sarkar: I would say, after almost 18 months of being negative on pharma, over the last six months, we have been adding some of the pharma companies.
I think, the rationale for that was exactly what we are seeing in this quarter in most of the pharma companies. It is that there will be a massive improvement in the margins and margin improvement is what is getting reflected in the numbers if you see. This is mainly because the raw metal prices have improved. You know, they were at very high levels and that has gone down drastically.
Several investments which they have made in the new markets are now yielding results. If you look at the kind of growth which has happened not just in America or domestic, even the rest of the world market, I think that is where the growth is coming from. In some cases, the new launches are also contributing, which were all in kind of the capex mode for the last 1–1.5 years, wherein all those things are now yielding.
So I would say the whole pharma space, both CDMO and the generics is what we are betting on and valuation along with margin improvement is the main factor because I think this whole space has underperformed the market massively.
You saw massive contraction in multiples in all the pharma companies. At the same time, margin improvement drastically along with a top line growth is aiding bottom line growth at a much faster pace and I think the valuations will start looking much better.
The numbers for the diagnostics hospitals were very strong. Fortis, Metropolis, etc., not bad. Do you like this bucket or are there better places in the market?
Aniruddha Sarkar: As a concept I definitely like hospitals... We need multiple more hospitals compared to what we have today. The only thing that keeps me away from hospitals is the valuations and I think if I have to look at the end of the day, you know between the number of stocks which are there in the market, I have to pick up only a handful of them.
So the hospital does not become the top pecking order to enter the portfolio mainly because of the valuations. But I would say, definitely it's a concept that will continue to do well. The only issue there is that whenever you know the realisations go higher, you know, government control might come in place.
The same thing that we saw in the case of the diagnostics, wherein the government control on the pricing happened and that also kind of sometimes hurts your valuations.
So I think both diagnostic and hospital are good as concept stocks, but valuations will keep me away.
You are sitting on 5–10% cash. Will the deployment of cash depend on the markets correcting a bit and valuations becoming reasonable? What are the pockets that you've shortlisted to deploy this capital in?
Aniruddha Sarkar: The whole idea of keeping 8–10% cash is that, in case around the election results, we see some kind of wild swings in the market. We don't know. The elections can always give you a very big surprise both on the positive and on the negative side.
So I would say that depending on how the outcome happens and depending on how the markets move, the idea is to get deployed into some of the cyclical companies because I think, you know, the whole power EPC space, energy space, power space where I would say, we are evaluating a couple of names. That is one area where I would say we are very bullish considering the type of power demand which the country is seeing and which we'll see in the next 5–10 years.
So this whole power sector, the whole value chain of the power sector, is what I'm looking to add in the portfolio.
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