Clipped from: https://economictimes.indiatimes.com
‘The impact on wages is significant and auto is a discretionary product’
Expect income to be disrupted in the most vulnerable sections of the society, says ED & CIO, HDFC AMC.
You are a classic value investor. That explains why you have NTPC or an ITC or HPCL and other oil marketing stocks in your portfolio. But in the post-Covid crisis, given how Nasdaq has moved up and how a stock like Nestle or Britannia has made a comeback, are you getting challenged on your thesis of buying cheap and value investing because in this new normal, will the classic old way of value investing?
You are right. I do have a value bias and you could say I have been one on a few occasions earlier than one would have liked to be. But what is value investing? It is simply saying that I want to buy a business that is strong, that is well-managed and at a price which I believe is lower than the fair value. The discovery of fair value at times is a function of the environment in the market and this time around value investing has struggled for longer than what we had anticipated.
Initially, it was driven by the elongation of the corporate NPA cycle and the delay in resolutions in the IBC. When we made good progress around that, we were hit with this. Look at what has happened to many NBFCs and small banks. They have lost 70-80% value and in many cases, the permanent damage to those values is more than in the large banks which will come back pretty strong. So I think it is returns delayed and not returns denied and clearly this tests the patience of our investors or people like me and this is one of the difficulties in investing, especially in a benchmark situation.
Let us go back 10 or 12 years and think about what were the hot sectors and what were the most preferred or the least preferred sectors? Utilities 10-12 years back was the most preferred sector and surprisingly, FMCG and pharmaceuticals which were the least preferred sectors. People willingly and happily bought these utilities at two times, three times price to book and they did not want to participate in FMCG and pharmaceutical companies in low double digit or high double digit multiples. That is when my funds did the opposite. We bypassed the whole infra boom and the subsequent pain and we were significantly overweight consumers, pharma etc. It caused a lot of pain in 2007 but the next few years were extremely strong. Today what is happening is, you have just the opposite situation. We have seen these FMCG companies go up from 12 to 20 PEs to all the way up to 70-80 PEs and on the other hand, the utilities have steadily moved down from two times or three times price to book to below book and the dividend yields on the utility space are now in many cases one time bond yields and in a few cases two times and in some cases possibly 2.5-3 times the dividend yields.
Let us not forget that the environment that we are facing; one, it is of low interest rates and both the government and the RBI will keep on trying to push interest rates lower because it will make life easier for the borrowers, for the companies, for consumption and for the government itself. When interest rates move that low, it is supportive of high dividend yield stocks and these dividend yields are growing. So if you look at the per capita power consumption in India, it is a fraction of the world. So I think power in India represents a growing business and it is not a typical utility that they will not grow. If you look at the growth rates of these companies in the past and the future, they are quite respectable.
On the other hand, what is the real impact of wages and on livelihoods? One is of course corporate profits and stock markets but the bigger issue here is that the share of the bottom half of Indian households in India have a 15% share of the GDP; that is it. So what that means is the monthly income of these people is Rs 25,000 a month. Now just imagine what is happening to retail, construction, service sectors, to SMEs and MSMEs. There will be a significant social impact. Incomes will be disrupted in the most vulnerable sections of the society. And unfortunately, over the last two decades because of the easy availability of small ticket retail loans and because of the propensity to consume, the savings with the lower income groups is much lower compared to what they used to be 10 or 20 years back.
So I think because of the real impact on incomes, because of the fear of the uncertain environment and also because you may have EMIs to service, there will be a sharp cutback on consumption. And I think some people feel that FMCG is just basic; it is not discretionary at all. I do not think that is entirely true. To spend a few hundred rupees on an expensive chocolate or a biscuit or a juice or shampoo or deo or a skin whitening cream. These may not be discretionary for the middle and the high income groups but remember these are mass market products. There are tens of crores of customers consuming these and the incomes of many of them are going to be impacted. So these products become discretionary for those income groups especially at times like these. My view is let us see how things play out. I am also very keenly watching this. I think the growth in this space will be disappointing compared to what the expectations are and it does not justify the very rich multiples that this sector is trading at. But I would again like to revisit this with you after six or nine months. By then I think we will have greater clarity on this issue.
Auto stocks have fallen. Are you tempted to buy this discretionary end of the market?
If you see the last few years, the growth itself was in single digits. If you look at the two-wheeler sales growth or the four wheeler sales growth in the best of economic conditions, it was in single digits. And I think for some of these companies, a fair part of the earnings are also coming from other income. In fact in some cases, it could be as much as 30-40%. As you rightly said, they have cash on the balance sheets.
I think this sector will feel the maximum pain in the current year. One, as you got into the current year itself, the sales were weak for the last few years and quarters. Number two, this a high fixed cost business at least in pockets and I am clubbing the auto ancillaries also in this space. So when volumes drop 20-30-40%, I do not think anyone has a clear sense on how much volumes will drop but they will drop quite sharply. While the other income component is very good for the balance sheet, at least for the larger companies, what will also happen is while you were earning 8-9% return on that cash, it is likely to fall to 4%. So the other income component will also take a hit. If you build in these kinds of numbers and even if you build in reasonable recovery, let us assume that next year life moves back to where it was in FY 20; even then the valuations are reasonable and are not screaming buys.
However, the risks are considerable because it is a very big assumption that the volume comes back to where we were last year. Please understand the impact on wages is real and I do not think once companies get used to lower costs, they will let go of those costs. And when I speak with companies, the impact on wages is significant and auto at the end of the day is a discretionary product. There would be a very small section of people who can afford to buy an automobile; a two wheeler or four wheeler but who do not have one and because of the need to keep social distance, that demand may be there and in next few months, those who were contemplating to buy have not been able to buy. So in the next few months, we could see a surge in sales. Current indications are not that but it is possible. But I would like to wait for some more time before I can take a view on the likely revival in automobiles.