Markets Could See 'Bumper' Foreign Inflows After Lok Sabha Election: Saurabh Mukherjea

Saurabh Mukherjea: Part of the rally, I think that Indian large caps are very realistically priced. I mean, we haven't seen a blazing rally in Indian large caps over the last couple of years. So valuations are very reasonable on large caps.

Secondly, you are seeing clear signs of economic growth stretching out over the next couple of years. Corporate balance sheets are underleveraged, banking system balance sheets are in the best shape they have been in 20 years. So the combination of very reasonable valuations in the large caps, strong corporate balance sheets, and strong banking system balance sheets are early signs of a private sector capex cycle.

I think those are the core drivers of the rally. I'm not sure elections are front and centre in driving the large-cap rally here.

Saurabh Mukherjea: So it's clear from talking to FIIs that they are getting their thoughts together. They're probably getting the corpus together as well because of the combination of economic stability, financial stability, banking system stability, and political stability, that's very rare to find in the world today.

So when we look at the other large economies, whether it's America, or indeed China, the combination of economic, financial and political stability is very rare to find. So I think it's relatively clear that if there is a showing in the elections, where it will result in more than 350 seats for the ruling party, we will see very strong FII flows. Even anywhere north of 300, I think, we will see healthy FII flows. So that is something to be clear.

Again, I hark back to a very reasonable valuation on large-cap stocks. I don't think they have seen Indian large caps at this juncture of an economic recovery as reasonably priced as we are seeing today.

So this combination is, I think, beautiful for foreign investors. Hence, I would suspect that through June, July, August, we should see bumper FII flows.

Saurabh Mukherjea: There are private sector data providers such as the CMI and they are giving pretty credible data. Both, project starts and project completions—non-government project starts and non government project completions—have hit record highs in the last three months. So I think the last time we saw this degree of private sector capex is all the way back in 2007, early 2008.

The second thing is talking to our investee companies. For example, we are investors in RHI Magnesita. They provide ancillaries for the steel industry. Talking to our investee companies, which are part of the capital goods capex ecosystem, it's clear that order books, business activities are really revving up quite nicely.

And again, combining that with the health of the banking system and the health of the corporate India balance sheet, I don't think I have that much doubt that we are seeing the early stages of a private sector capex recovery.

So far, post Covid, it has largely been about government capex, but I think the signs are clear in the last three months. The private sector pieces are clicking into place and hopefully will kick into high gear after the elections.

Just a quick disclaimer, all those stocks that I mentioned, are part of all our portfolios and hence I am an investor in them by RPMS. So are my parents and so are our 9,000 clients.

Saurabh Mukherjea: On rural consumption there are two layers of the story.

I think, the first is the current bout of optimism running around that hey look, the monsoons are likely to be good. It's going to be a good rabi crop. Hence, let's load up on rural India plays… Auto sales in rural India are picking up and hence in anticipation of a good monsoon, let's load up on rural India.

This is a typical annual cycle. I've seen this in India for a long time. Somewhere at the beginning of the summer, it's kind of habitual for people to start talking about the monsoon. I'm not so sure how much money investors like Marsellus can make from that.

What I think is more interesting to dwell on is post elections, the July budget especially. I think, there will be lots of announcements focused on reviving rural India. So, both on the farming piece and on the employment generation piece, I suspect there's going to be a big focus by the government post elections on rural India.

I think, we will try to do some more work on that and see if there is that potential that much like the government's focused on capex to FY21, FY22 and FY23 and engineered a colossal capex boom, is there potential the government engineer has a bigger role in the boom over the next three years. I think that's a really interesting piece to focus on, as we look at the post-election world.

Saurabh Mukherjea: Look at HDFC Bank. We are large shareholders and have been for a long time.

We increased the position when the stock came off through January–February and are obviously delighted to see that deposit growth number. We believe they can sustain stronger deposit growth as most of the banks in our country.

Given the strength of the liability franchise, given the aggressive branch rollout, they are now rolling out 1,300–1,400 branches a year, which in the context of Indian banking is an astonishing figure. So hopefully the combination of the strong deposit franchise and their legendary underwriting skills will give us the returns that we aspire to see in HDFC Bank.

The stock obviously had a tough time over the last three years. But given the growth of the business, we remain optimistic that they will do well over the next two to three years.

But beyond that, as you mentioned, generally the banking sector is looking in good shape. Overall, the lending sector looks in good shape, asset quality is under control. If the lenders, banks and non-banks can combine strong asset quality with financing the private sector capex piece and I think the next 12 months potentially will be the best 12 months for the banking sector this cycle.

Remember, so far the main lending engine has been retail. The corporate lending engine hasn't yet fired into high gear. That will only happen when the capex cycles for the private sector begin and as signs of that emerge, I think we will be looking to stay heavily invested in banks and NBFCs in Marcellus’s portfolios.

But beyond that, I think the other sector we are very optimistic on is IT. If you see, Naukri.com numbers, IT recruitment is picking up and that's typically a lead indicator that the IT companies are getting greater visibility on execution. IT companies are pretty smart. They build the order book, but until they see that the client has signed on the dotted line saying “execute karo”, they don't go and hire staff.

So the fact that Naukri.com’s data suggests that IT recruitment has picked up, I think is indicative of the fact that the IT companies are seeing a degree of better visibility on project execution on their client side.

That again makes sense. If you look at the scorching pace of American economic growth, it does make sense that the big American corporates are telling the companies whose names you are flashing on the screen. The big American companies are telling the Indian IT services providers, boys and girls, begin the execution.

So we are optimistic there. We have got a large position for a long time in TCS and then in engineering R&D. We have been invested in Tata Elxsi and LTTS for a while.

Saurabh Mukherjea: I don't think ‘dekha maine kaha tha’ is ever a wise thing to say in the stock market. All we did was, we looked at the data. The main data point, which stuck in my mind through that whole melee in January was net interest margins.

So, the market's concern was ‘Boss uska deposit nahi aa raha hai funding kaise karenge HDFC Limited ke book ka’. So, we looked at net interest margins. HDFC Bank and Kotak Bank were the only large banks at the end of Q3 whose NIMs were intact. Barring them, every other bank shed net interest margins quite aggressively—anywhere between 10–30 bips NIM reduction for every other bank.

So I found that very interesting that the market has worked up about the liability franchise of HDFC Bank, and yet this and Kotak are the only banks where the NIM is holding up, which suggests that they've got the two sides of the balance sheet relatively even-keeled up.

Hence, keeping our nerve and in fact increasing the position as the shares came off wasn't too difficult. I think, both from HDFC Bank’s perspective and from the perspective of our large position there is a long way to go.

To get out of the woods, in terms of funding, I think HDFC Bank will need at least three or four more quarters of strong deposit growth to get that book funded. And once they fund that, then we as shareholders have what we need. We've got a big housing finance book, which rather than getting funded by wholesale market liabilities at 7.5% is being funded by CASA at 4.5– 5% and that's the best place to be in Indian banking.

Saurabh Mukherjea: It depends on this capex rally piece. If the private sector capex rally begins which I'm pretty optimistic about, it will.

If the public sector banks take a very aggressive stance in financing the private capex and if the private sector banks you know, perhaps scarred by the memories of 2011-12-13, stay back and hold back, then, the PSU banks could continue to outperform the private sector banks.

Given the strong position that Axis, Kotak, HDFC Bank and ICICI Bank find themselves in, I'm hoping that all of these banks get on the front foot in terms of funding private sector capex. Discussions with the banks over the last few months does suggest a degree of hesitancy given the traumas and the sort of, you know, tragic memories of 2008 to 2014.

But again, banks are run by smart people and I'm hoping that they'll grasp the initiative and we will see the company's balance sheets, the corporate lending activities of the private sector banks will step up over the next three quarters.

Saurabh Mukherjea: From what we're hearing in our discussions, AI and Gen AI is a massive priority for western CEOs. It's a colossal priority.

And roughly, what we're hearing is, for every dollar that the Fortune 500 companies are spending on cloud storage, their AI spend is going to be almost 10 times that.

So in an order of magnitude, this sounds to me to be the beginning of a 4–5 year burst in IT services activity, where the Fortune 500 companies first shift to cloud. Remember, 70% of Fortune 500 is yet to shift to cloud. So first they shift to the cloud. Then, they start moving to AI, which in turn necessitates a whole new wave of spending on software as a service.

So it looks to be the beginning of a big wave of work for Indian IT. While that happens, I'm sure there are mid-cap IT companies, which will benefit from bits and bobs of this colossal wave of IT spend that is coming towards India.

Our preference would be to stay invested in the big names and capitalise on the totality of the search, like almost every aspect of the Fortune 500 IT companies’ spend will have to be revved up as they transition from legacy systems to first cloud and then cloud with AI-enabled inside it.

So, the outlook looks good. We are loaded up. As I said, Naukri.com’s data yesterday suggested the recruitment engine is also revved into high gear. I am also hearing from friends in the industry that TCS' recruitment is stepping up. As I said, that's one of our largest investments in the sector.

Saurabh Mukherjea: Specifically, for Godrej, I think Pirojsha and team have done a wonderful job at building not just the brand but a reputation for great build, reputation for timely delivery and my reading is that standing them in great stead in key markets like Mumbai and Delhi are their enormous fan following and which is why I think you are seeing these bumper numbers.

More generally on real estate though, my concern has always been that do we really have pricing power in real estate anywhere in the country, because barriers to entry into the sector are relatively low? It tends to be difficult to generate a high return on capital because you can't generate strong return on capital. Your surplus cash flows with which you can drive your future growth tend to be relatively modest.

So, applying that to our key markets again in Mumbai suburbs, I'm hearing of enormous supply coming on stream over the next couple of years. And I'm not so sure the amount of supply that's coming on stream, whether there's going to be commensurate demand.

I suspect, Mumbai real estate once again has gone into a situation where optimism on the developers' part is bringing plenty of supply. The age old cycle in the real estate cycle is all right provided that through the cycle you're able to generate surplus cash flows.

I've always had question marks around Indian real estate and their ability to generate surplus cash flows through the cross cycle because without surplus cash flows, you cannot finance future growth.

So our preference has been to play this epic real estate boom through building materials. So investments like Pidilite, Astral Polymer, Asian Paints and Cera Sanitary Ware have been part of Marcellus’ portfolio for a long time and we are hoping that they will have good Q1 and a good FY25 as the real estate boom continues.

Saurabh Mukherjea: On government capex, I don't think the FM could have been clearer, in her vote on account on 1st February.

She said very clearly that in the last three years, government capex grew at around 30–31%. In the vote on account, she said that in FY25, it's likely to grow at 11–12%. So you're going to see a step drop in the growth in government capex and that's only justified. Remember, post-Covid when the private sector capex was really not going to happen, the government stepped up and revived the economy.

Now that the private sector capex piece is firing into life, it makes sense for the government to take a step back. So in that context, how sustainable the rally in many of the PSU capex players is, I'm not so sure. In that context, defence as well features in that.

Clearly, there is an imperative for us to spend on defence given the situation with China specifically, but how sustainable the last three years of 30–35% growth in defence capex every year is from a fiscal standpoint, I'm also sure.

My preference has been to focus on private sector capex and at long last, it seems that private sector capex is turning the corner.

Saurabh Mukherjea: FY24, ironically for our large-cap product was alright. FY24 for our large-cap products CCP gave around 24% net of fees.

Our small-cap product, FY24 gave 0% net of fees. So from that perspective, it is difficult for FY25 to be worse. Jokes apart, the small-cap product has revved into life over the last few months. The mid-cap product is also doing well.

Large-cap product by design is meant to be consistent. It's called consisting compounders for a reason. Its returns are meant to be in the high teens, low 20s area. And they have been like that.

FY23 was tough but FY24 things have turned the corner. And similarly, in the similar vein, we have our all cap portfolio called Meritor Q, which has been gunning out high teens, low 20s returns.

But I think that's our job. If we can keep returns in the high teens, low 20s when people oscillate between 30% and 10%, Marcellus stays in the middle, we should be all right.