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  • Sentiment has changed, but ground reality remains the same

    Mr. Rajeev Thakkar's interview by The Economic Times, April 2, 2016

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    Sentiment has changed, but ground reality remains the same
    "Private banks' growth will contribute to the sector growth because public sector banks will have a very flattish kind of numbers in their loan books."

    In a chat with Nikunj Dalmia of ET Now, Rajeev Thakkar, CIO, Parag Parikh Financial Advisory Services, says private banks' growth will contribute to the sector growth because public sector banks will have a very flattish kind of numbers in their loan books.

    Nikunj Dalmia: We have seen hell and then we have seen heaven, what is the reality?

    Rajeev Thakkar: At our end it is as boring as watching grass grow. Our investments in January when all hell was breaking loose was more or less the same as now, three months later. Nothing much has changed.

    Nikunj Dalmia: You have not changed anything even though we have seen so called 180 degree turn?

    Rajeev Thakkar: Yes, our portfolio has hardly changed through the turmoil.

    Nikunj Dalmia: Is that not boring? Is it not saying that you do not like the milk when opportunity is great?

    Rajeev Thakkar: Well, if you are waiting with bated breath to see the next fact sheet and see what are the dramatic changes that are going to happen, is it absolutely boring? The most exciting thing that happens at our end is when we read a new annual report or we read a new biography or we discuss a business, that is all the excitement there is. Other than that, the easiest job in our office is that of the equity dealer who probably on 17 days out of 20 working days in a month does not have anything to do in the dealing room.

    Nikunj Dalmia: We will talk about that exciting part but right now let me address a) the big picture and specifics of the big picture are again global in nature. For the moment, it appears that central bankers are unlikely to increase rates, (b), the China concern is behind us and now we have a bottom in place for commodities. So the OCD syndrome which we were talking about oil, China and then debt -- all these concerns have got addressed?

    Rajeev Thakkar: People are looking beyond those. I would not say they are completely addressed. So the shale gas companies which were distressed three months back are not completely out of the woods. Their old hedges are expiring. They will have to sell incremental energy produce at the current market price and they have debt. So they will be distressed. Excess capacity in metals still prevails. So it is not that on the ground, things have completely changed. What it seems is for once, the free fall kind of scenario where people were saying oil is now at $35, now at $30, now $25, $20, $15 -- that kind of a thing has stopped. People are saying okay, it would not go to zero. There will be some price at which oil will sell or at which iron ore will sell. Also, people have stopped asking whether it is 2008 again.

    Nikunj Dalmia: That conversation is over.

    Rajeev Thakkar: That conversation is over. So people are saying PSU banks have NPA problems but how long will it take, one year, two years to clean up, how will the recovery process happen?

    Nikunj Dalmia: That is a glass half full approach now?

    Rajeev Thakkar: Yes. Sentiment has changed. Ground reality is more or less where it was. People are trying to unclog the system be it asset sales happening all around or are some of the defaulters trying to work out a mechanisms to resolve their debt issues?

    Nikunj Dalmia: The half glass full approach is that the worst of the economic print at least for the moment, is behind us and global concerns for the moment have got addressed. Let me pour in rest of the drink and the environment around us, both locally and globally -- is that interest rates surely and steadily are coming down. Growth will not be as great as what we have seen in the last five years. Growth will come down and there is a challenge and even the central bankers are likely to print more money. The effectiveness of that is drying up. So are we in an environment where growth will be precious and liquidity will be surplus?

    Rajeev Thakkar: We are in a low growth, low interest rate, low inflation environment. I think in such a scenario, nominal earnings growth will not be as great as we have seen in the past. But even a 10-12 per cent kind of earnings growth for a couple of years is not that bad. Of course, the last financial year has been a washout more or less in terms of earnings growth for the indices but I think 2016-2017 should be better than the year gone by.

    Nikunj Dalmia: Your largest holding for the longest time has been Google and the challenge for the internet stocks is that valuations are coming down and the so-called fashionable stock, the FANG stocks -- Facebook has taken a knock of more than 20 per cent, Amazon is out, Netflix is down more than 40-50 per cent from the recent high; Google is the only one which is holding forte and remains to be your core holding. So if other internet stocks in the world are correcting, some would argue that it is a matter of time Google will also fall down like there is no tomorrow?

    Rajeev Thakkar: Sure. So Amazon is a wonderful business in terms of very charismatic leader, someone who is passionate and so on. Facebook is again dominating in the social media space but the starting valuations for both the companies were excessive, Netflix again is very high valuations. So Google headline price-earning ratio would seem to be 30. if you remove cash it would be about 25 times earnings. Even at 25 times earnings, you have $3-3.5 billion going into their other bet, so called other bets, a huge amount of R&D spend which happens, a business growing at a very rapid rates, so 25 times kind of earnings even before adjusting for all these expenses is not that high a valuation. So, even after the fall, among FANGs Google is the cheapest.

    Nikunj Dalmia: And when we say Google you are talking about Alphabet.

    Rajeev Thakkar: Alphabet, yes.

    Nikunj Dalmia: So you are happy to keep Alphabet or Google as your top holding for another two, three years?

    Rajeev Thakkar: Longer maybe.

    Nikunj Dalmia: Okay. So you are convinced that Google as a structural business is here to stay. I am going to step down and talk about some of your other key holdings. You like private banks and I think there is a very strong case for private banks. But given the kind of environment we are in where credit growth is expected to remain low, private sector still lacks the ability to commit fresh capital. Some would argue that private banks are only relying on one pony and that one pony is retail?

    Rajeev Thakkar: Corporate loan demand will be a constraint. In a scenario, where there is excess capacity, people will try and fill up the existing capacity before venturing out to borrow more, so that is true. However, if we look at the overall scenario where maybe 70 per cent of the banking sector is with the public sector players and where the public sector banks are constrained in terms of their existing lending, capital adequacy and so on, they are not going to be aggressive in terms of competing for fresh loans. So whatever credit demand is there, private sector banks have a possibility of growing at far in excess of the sector growth.

    Nikunj Dalmia: But do they have the ability to grow in an environment where the growth otherwise is going to be challenging?

    Rajeev Thakkar: So overall loan growth may be lower than what we have seen in the hay days but still they would notch up a very decent growth rate and, in fact, their growth will contribute to the sector growth because public sector banks will have a very flattish kind of growth numbers in terms of the loan book.

    Nikunj Dalmia: HDFC Bank is an expensive bank, as is Axis Bank. So what is the meat in buying a good business at a price when it is not traditionally cheap, that is my definition?

    Rajeev Thakkar: If you look at what Buffett has said with regard to banks and what various player have said is that in banks you surely do not want to go with the cheapest bank, you want to buy the best quality bank and if you look at his holdings, Wells Fargo again is a big position for Berkshire. Wells Fargo is not the cheapest bank around, it is the best quality bank. So in fact he said that you can pay a expensive looking price for the best quality bank and get a good result whereas if you buy the cheapest bank and where there is leverage and your lending may go bad. So, you may end up with a very bad result. In 2008 we have seen where people with huge number of years where they had a good track record of outperformance in a single year they had excess weightage to some of the poorer credit names and they lost everything.

    Nikunj Dalmia: So why have you decided to go ahead with HDFC Bank and not a Kotak Mahindra Bank or IndusInd Bank because Kotak Mahindra Bank and IndusInd Bank also they pretty much have the same flavour so to speak?

    Rajeev Thakkar: Sure. So I think it is a matter of individual judgement preferences and so on and nothing against Kotak Bank or IndusInd Bank> We like the private sector banks in general. These are the three we have chosen but maybe others also will do well.

    Nikunj Dalmia: Your comfort level is very high with them?

    Rajeev Thakkar: Yes.

    Nikunj Dalmia: Now as we rollover from FY16 to FY17, one key factor or driving factor for the markets and for the economy will be how the pay commission dollops would be implemented and the benefits which will come to the defence personnel so we are looking at about 1,30,000-1,40,000 crores straightaway coming in the hands of consumer, which automatically will have a multiplier effect in some of the discretionary spending power. So how are you planning to capture that?

    Rajeev Thakkar: So the fact is well known and I am sure it will play out in some fashion. Predicting what the consumer will do with that extra money in the bank account is difficult...

    Nikunj Dalmia: But you will have to make assumptions?

    Rajeev Thakkar: One has to make assumptions. It is difficult to predict exactly what will happen and secondly in many cases the starting valuations are not comfortable. So one obvious thing would be to let us say go out and buy FMCG stocks...

    Nikunj Dalmia: Which you are not doing?

    Rajeev Thakkar: But so called Black Swan has happened. Do you have a company like or organisation like Patanjali coming and disrupting a lot of the players? You have this whole e-commerce thing going on where a lot of consumers are going out and buying gadgets and various other things so people are not spending so much in malls and spending money online. So a lot of changes in patterns are happening as to where the spend is going and we are watching the space. In a lot of cases, the starting valuations are not giving comfort. We have Zydus Wellness in the consumption space not linked to OROP or Pay Commission but we feel they are well placed in their own artificial sweetener space. We have something like Mahindra Holidays which would possibly benefit from more discretionary demand.

    Nikunj Dalmia: There is outright fear in pharmaceuticals. A couple of months ago everyone thought nothing could go wrong, now everyone is of the view that nothing could go right. You have a position in Ipca and I am sure that has been a painful position for you. Is the current market environment and the news flow forcing you to revisit pharma stocks? Is your conviction getting challenged?

    Rajeev Thakkar: In pharma, our stance is to buy after the pain rather than before the pain so...

    Nikunj Dalmia: How do you judge that?

    Rajeev Thakkar: We buy once the warnings letters come in.

    Nikunj Dalmia: So you bought Ipca after the warning letter.

    Rajeev Thakkar: Yes and it is still above our purchase price in that sense. So if you look at the US market which is the biggest export market for most pharmaceutical companies, there are two factors playing out over there. At one end, you have companies like Valeant and Turing and all that which are getting a lot of bad press and because of hiking up drug prices and all that. Even in the presidential election campaign, high drug prices are a campaign issue and people are figuring out how to curb drug prices. So there is this big push towards generics. Lot of drugs will go off patent that is at one end. At the other end, FDA has become very vigilant in terms of quality controls and processes that the Indian companies follow. So I think this is a phase where the men will be separated from the boys in the pharma space.

    Nikunj Dalmia: So what is so unique about Ipca? If I look at Ipca's business model, their margins are not the best in the industry. Their main stay is Paracetamol APIs which again is a high volume but a low margin business. They do not have excellent value added products where they are right up in the supply chain. So at a time when just about every pharma stock has fallen 15-20, even 50 per cent, why have you decided to settle with Ipca?

    Rajeev Thakkar: We are closely looking at lot of pharma companies. Ipca is only about less than 2 per cent of the overall portfolio. We are looking to create a basket of pharma stocks. This is not one stock with the large weightage and...

    Nikunj Dalmia: So pharma is there on your radar?

    Rajeev Thakkar: Pharma is there on our radar and we are looking at businesses which go through these huge price corrections because of warning letters and where we see that as a non-fatal problem and where recovery should come in a year or two so we are looking at those kind of opportunities.

    Nikunj Dalmia: The school of thought which you represent is largely centred around buying monopolies, moat investing, buying companies which have great businesses and those businesses cannot be displaced. Aclassic example here would be something like Page Industries or an Eicher Motors or an Asian Paints. Whereas moat investing has worked in the past and it may work in the future, my only challenge with moat investing currently is that these stocks are very expensive; these businesses are ridiculously priced. So what are your thoughts there?

    Rajeev Thakkar: So we have stayed away from very high quality businesses where the valuation is priced to perfection or even higher than that.

    Nikunj Dalmia: So give me an example of a business which you want to buy but you are not able to buy because of valuations?

    Rajeev Thakkar: You have mentioned some of those...Eicher Motors, Page Industries. A lot of those businesses are there where valuations are not comfortable and at a different valuation one would look at those.

    Nikunj Dalmia: A naysayer would say that there is deep value in infrastructure. Nothing is going right everything is going wrong, the problem is so scary now bankers are sitting on the boards and companies are being forced to liquidate some of their good assets. Is that an opportunity or that is a realisation of how hard the headlines are, how tough it is for some of the infra companies?

    Rajeev Thakkar: I would be looking at people who are buying distressed assets rather than the sellers of distressed assets. So recently we have seen deals in the power space, airport space, cement space where leveraged groups were forced to sell assets to other groups to create liquidity. So obviously where one seller is a distressed seller the buyer is getting the assets at a low cost so those buyers of assets would be in a better position whereas some of the sellers even though the starting valuation is low in terms of the nominal share price or the share price may be far lower than the all time highs but most of the money that is realised from asset sales will go to the bankers, ultimately shareholders will not get anything significant. I would rather look at those buyers of assets who do have that much...

    Nikunj Dalmia: That is an interesting logic. Do do not buy companies which are selling good assets to reduce their debt because they are selling good businesses, in fact buy those companies which are getting these assets cheap because good assets once they get transferred they will benefit someone else?

    Rajeev Thakkar: True.

    Nikunj Dalmia: Where to your mind markets are still mispricing growth?

    Rajeev Thakkar: I think in the FMCG space where we discussed, I think people are still pricing in very growth numbers so in a scenario where inflation is low I think a lot of pricing power may not be there as it used to be in the past. So I do not think markets are pricing in a 10-12% kind of growth, people are still looking at a 20% kind of growth and if growth numbers were to be lower then what market expects you could see some disappointment coming in over there.

    Nikunj Dalmia: And to flip it around, where are markets slightly nervous about earnings recovery and where do you think earnings recovery could surprise us?

    Rajeev Thakkar: In pharma, wherever there are these issues, people tend to write off the companies or people tend to become too pessimistic. So in pharma, maybe you could see opportunities coming in, especially companies which have had issues with FDA.

    In IT space. selectively you could see companies benefitting from the overall recovery as and when it plays out in the developed countries. I think these two sectors one would...

    Nikunj Dalmia: So what is the right way to look at IT, you have got Cognizant which has issued a profit warning, you have got Accenture which has upgraded their guidance, they both are great companies they both are big companies, so should one lean more towards what Cognizant has indicated or should one buy into what Accenture has guided?

    Rajeev Thakkar: In IT space there is a churn going on. Cloud is a big thing, social media is big, analytics, so there is a churn going on, the traditional application development, maintenance space is not that high growth area anymore. So you have to look at people who will benefit from the shifts and trends so Persistent is something that we know where we think they could benefit from the...

    Nikunj Dalmia: What do you make of the Persistent-IBM deal?

    Rajeev Thakkar: I think it is a transformational deal for the Indian company obviously because they get experience of working with such a big partner giving them ability to breakthrough with some of the larger corporates down the line.

    Nikunj Dalmia: So you think that Persistent has got all the basic processes in place and they can scale up on the SMAC vertical?

    Rajeev Thakkar: I think so, yes.

    Nikunj Dalmia: What about the traditional business? On one side, their SMAC business is growing, traditional business seems to be slowing down and which is hurting them now. If I look at the trajectory of Persistent, numbers have been slightly volatile, whereas I am with you when you say that SMAC and digital is a great opportunity and that is opportunity which is an exploding opportunity somehow the business or the earnings trajectory for Persistent has been slightly volatile?

    Rajeev Thakkar: So we are fine with lumpy earnings and the model is such that you cannot have smooth earnings coming quarter on quarter and we are fine with that, essentially you have to look at it as business unfolding movie over the years rather than look at it quarter to quarter.

    Nikunj Dalmia: So typically you are a very patient investor, when you buy a stock you have three to five year timeframe minimum in your mind?

    Rajeev Thakkar: Yes.

    Nikunj Dalmia: When you look back in your investing career which is one stock you regret selling early?

    Rajeev Thakkar: Selling early, I think Pidilite. Pidilite, Asian Paints I think lot of the high quality names one was uncomfortable with valuations which were reached, they kept going up earnings kept following so...

    Nikunj Dalmia: And which is one stock you regret selling late?

    Rajeev Thakkar: Selling late, I do not think there is something which I held on for a long time so obviously there are many investment mistakes but those were essentially things which did not work out as planned so for example, many years back we used to own oil marketing companies when the oil prices were going up and...

    Nikunj Dalmia: Yes, a couple of years they were dirt cheap trading below book?

    Rajeev Thakkar: True. So we were lucky to exit them at our cost price although we would have sold even lower than cost price if things were not going as per plan so I think the mistakes essentially have been in places where government is involved either in dictating the price or in terms of policies and so on and so forth.

    Nikunj Dalmia: You typically do not like businesses which are dependent on government?

    Rajeev Thakkar: Yes.

    Nikunj Dalmia: So you will not take a venture and you will not take a deep dive in a defence or in a railways or for that matter any of the businesses which currently markets are excited about because there is a huge government push?

    Rajeev Thakkar: I would be very weary.

    Nikunj Dalmia: So you will not buy road companies, you will not buy infra companies which are making roads or are running BOT projects?

    Rajeev Thakkar: We own one road company which in terms of financials is doing well but in terms of headlines it scares over the years.

    Nikunj Dalmia: There is no government domination there, Noida Toll Bridge, right, there is no government domination there?

    Rajeev Thakkar: So periodically you have political parities wanting to make the road toll free and you have agitations and things like that so it scares you in the morning to read those headlines in the papers. It is making profits, it is paying our cash flow to the shareholders but you keep having these things so I think one is enough for us, do not want too many of those.

    Nikunj Dalmia: So how would FY17 be different from FY16 from a market standpoint? FY16 frankly has been a lost year for long-term investors and medium-term investors because we started the year with lot of hope and hype and we are about to close the year on a dismal note?

    Rajeev Thakkar: I think people have got adjusted to the scenario that the times are tough, growth rates will not be 20% kind of thing but at the same time people are looking out one year, two years from now, people are willing to maybe see through the weak earnings in maybe one or two quarters but the grounds for recovery are being laid whether it is deleveraging, whether it is banks cleaning up their act, whether it is more purchasing power being placed in the hands of consumer through pay commission or OROP, whether it is capacity gradually filling up for people, government's spend on infrastructure coming in. I think all the ground work has been laid we just have to wait for things to play out.

    The original article could be seen here.

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