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Hanging By A Thread
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In recent times Agrawal has been investing primarily in annuity businesses with high internal cash generating capacity and delivering returns higher than economy growth rates. Personally 90 per cent of his money is tied up in equity and real estate and he is investing the incremental fresh inflows into high yielding debt to readjust his portfolio and create an annuity income stream.
Excerpts from the conversation:
Indian equity market has gained nearly 17 per cent since the beginning of the year. Do you think the market can maintain this momentum even if liquidity drives and why? Will you be a buyer in this market and why?
Strong infusion of liquidity in the Euro Zone has had its spill-over effect on the Indian equity markets and we have seen a sharp rally in January. This has corrected the undervaluation that Indian equities had faced towards the end of last year. However, even at this juncture, the market still offers some amount of valuation comfort. We project an index level of around 20,000 during FY13 based on expectations of Sensex earning per share (EPS) of around 1,330 and an average multiple of around 15.5X.
While liquidity has been the prime mover of Indian markets, reforms, primarily in the power sector have also played a role. While power sector players have distinctly benefited, lending institutions have also benefited. Incidentally, these were one of the cheapest parts of the market. While we have seen a significant rally in these parts, we believe the market still offers upside.
Besides, RBI is expected to embark on liquidity enhancement measures and rate cuts could commence sooner than later. This again is beneficial to a large part of the leveraged market. While we still want to remain away from highly leveraged companies, we are not averse to looking at companies with free cash flow generation which would result in lowering of leverage in the forseeable future.
We believe that markets may offer positive returns from here on mainly on account of following reasons:
a) Continued infusion of liquidity on a global basis. Liquidity would help all asset prices, including equities.
b) Initiation of reform process. Power sector has seen some reforms. Coal block auctions are beginning and that is a positive. Enactment of cable digitization act has been another positive. The ordering of road projects has again gained momentum.
The second half of FY13 would have the benefit of low base of FY12 and Indian corporates should be able to register good results. Markets being forward looking may have already started discounting the same. Rate cut cycle by RBI is around the corner and should benefit rate sensitives
On the fiscal side, concerns remain. However, while earlier we were looking at a figure of more than a lakh crores for food security bill, the expectation now is that it would be a fraction of that at least in the first year. Hence, while the budget maths may not present a pretty picture especially given the subsidies burden, it would probably be better than expectations. Lastly, the FY13 could be start of better times for the Indian economy. FY14 should see important fiscal measures like direct tax code (DTC) and goods and service tax (GST) getting implemented. After two years of sub-par growth, FY14 could promise a growth acceleration and hence markets could actually consolidate gains and aim for higher levels in FY14.
Even in a bad year like last year, we had remained nearly fully invested. We continue to be focused on quality. We still do not like businesses which require to raise external capital. However, we have booked profits in sectors like FMCG which did exceptionally well last year and have taken some exposure to metals, gas distribution and engineering companies. Most of our portfolio remains unchanged versus last year. The infusion of liquidity just changes the momentum of price discovery and we believe we would need to make only small changes in case liquidity dries up.
Do you see RBI cutting rates in the upcoming monetary policy and why?
Currently the banking system suffers from very tight liquidity. Given the fact that advance tax period is just around the corner, the liquidity in the system would only worsen. Given this scenario, we do expect the Reserve Bank of India (RBI) to have some liquidity enhancing measures soon. The measures could take the form of open market operations (OMO), a cash reserve ratio (CRR) or a statutory liquidity ratio (SLR) cut.
As far as interest rate cuts go, there is a good possibility that they start in March versus the expectation of first cut in April. The policy makers were divided in the last policy meeting itself to the requirement of a rate cut and since then the economic parameters in terms of growth has worsened while inflation has come down. While there is a view that the RBI may want to wait till budget is tabled to see fiscal consolidation and also wait for some more time to see if oil flares up or not, fact of the matter is that the economy is already slowing down quite sharply and sooner the rate cuts start the better.
The other driver for rate cuts is the fact that projects which have borrowed money are not able to service interest at such high rates and the incidence of non-performing assets (NPAs) has already shot up in bank books as per last quarter results. Hence, unless rate cuts are affected sooner than later, banks may see further incidence of NPAs.
What are your concerns for the Indian equity market?
There is still a wall of worries that the market has to climb. The budget is around the corner. We would like to see fiscal consolidation in the budget as large deficits may derail the India story. The fear is that given the populist pressures, the fiscal deficit may remain high. The revenue base should be broad based. For a long time measures like DTC and GST have been delayed and need to be implemented for fiscal consolidation. Rural incomes which are largely outside of tax net should be brought under the tax net, above a certain level.
The reform process has to gain momentum. Land acquisition rules and mine allocation rules have to be practical and be framed in a finite period of time.
Stresses on the fiscal and inflation pressures have forced public sector to shoulder a lot of burden. This results in undervaluation. If listed public sector enterprises, particularly in the areas of mineral and mining, are allowed to charge market related prices, their full potential may be realised.
There is a stress on the current account situation in the country as our exports are slowing and imports growing, on a larger base, faster than exports. Stress on the INR can cause overseas investors to change directions quickly. This year several companies have to refinance their foreign currency convertible bonds (FCCBs). Inability to do so would present a further stress on the banking system.
This is a liquidity driven rally and we have seen certain stocks of companies, where there seems to be survival issues, show sharp returns in a short period of time. While it could be on account of short covering, fact is that a section of investors may get suckered into the space and the market may get hurt as a consequence, when the music stops. In any liquidity driven rally, commodities like oil also spike up. Indian economy which is a large importer of oil hence gets impacted negatively. The strange phenomenon is that while the stock market may be rising on account of liquidity, actually the fundamentals of the economy gets weakened and the fall after may hence be quite bad.
Supply of paper may catch up rapidly to incoming liquidity. Government has restarted its disinvestment programme. Companies with more than 75 per cent promoter holdings are also looking to raise money. We have already seen several large ticket exits by PEs in stocks like HDFC and Kotak.
Do you think the time bomb is ticking in the global financial market with central banks across the globe pumping money in their respective economy? What is your view on the overall financial market? Do you think crisis in Europe as well as US behind us and why?
The problems in the western world are long term in nature and we do not believe that they are behind us. However, we also believe that till interest rates can be maintained at low levels, the problem recognition can be postponed. Once, policy makers have time, they should be able to address various parts of the problems in a systematic manner. The key is the sustenance of low level of interest rates and we have to look put for signs of stress leading to a loss of confidence of the credit providing nations. However, a freeze of financial markets is not a high frequency event. The fear in the minds of investors is whether Lehman kind of a scenario can be repeated. We believe that kind of a scenario is still fresh in the minds of policymakers. We believe that since the cost of recovery after a Lehman kind of scenario is significantly higher than otherwise, policymakers would try to avoid such a scenario. A freeze in the financial system is a low probability event to our minds.
In current market condition where are you advising investors to invest? And why? As a fund manager what call will you take on the overall portfolio of the fund? What will be your short-term strategy in the current market condition?
We continue to be focused on quality growth business which implies annuity businesses with good return ratios, steady free cash flows, good dividend payouts and pricing power. Last year, we had shunned risk and had cut exposure to sectors like metals, engineering, banking and capital goods. Some of these businesses present upsides and we are selectively buying them, selecting them over some FMCG businesses that have become expensive.
We are long-term investors and the churn ratios in our schemes are some of the lowest in the industry. We typically run concentrated portfolios with strong conviction in our stocks and are not swayed by short term factors.
Currently where are you investing your own money? And why?
Most of my money continues to be invested into equities with small portion in real estate and debt. Personally I like the infrastructure sector and I am focused on companies which have large coal assets abroad. Coal is a valuable asset and can result in multifold gains for companies which can bring the coal to the market. I also like high dividend yielding banking stocks with a return on assets (ROA) of over 1.2 per cent. This is to afford some regular income and also make sure that the banks do not loose valuation multiples as Basel III norms are enforced and high leverage does not remain a possibility. I also like gold financing businesses. This business offers high ROAs and one of the highest growth trajectories in India. However, the skepticism of the investing community has kept valuations still very attractive. Incrementally though, I am investing my fresh inflows primarily into high yielding debt. This is to take into account the imbalance in my portfolio and create an annuity income stream.
What has been your advice to offshore clients? What are their expectations from Indian equities?
Offshore investors look at various asset classes and India story is at best a high beta play for them at this juncture. We continue to have faith in the India growth story and advise the same to the offshore clients. The offshore clients have been hurt by the INR depreciation and is expected to return only when there is a semblance of stability in the currency market. We are devising products with dynamic hedging for our global investors.
In your view what will be the next trigger for the Indian equity market? And why? And when do you see it coming such that we break the 18K levels?
We have discussed the positives that the market would encounter over the next 12 months in a previous question. While there are a lot of concerns primarily related to export-import and fiscal deficit, to my mind, the next positive trigger for the equity markets would be the liquidity infusion and drop in interest rates by the RBI. It is a widely anticipated move. If it happens in March as we debated, it would be better. The fourth quarter results could be the next trigger. Advance tax payouts would provide an indication of the same. Corporate results should benefit from relatively stable currency markets and low resultant forex related losses as compared to previous two quarters. We remain positive on the India growth story and believe that over the next three years the market offers significant upsides. In the short term, the state election results and the Budget could provide market volatility.