Investors lapping up consumer, insurance, pharma & telecom stocks due to earnings certainty: ASK Investment

The world is looking to diversify away from China and we could gain from that, says CIO Prateek Agarwal.

What is your current market view? Do you think markets have run slightly ahead of themselves?
Our view is that valuations on PE, which is the most followed valuation parameter generally followed, on a one-year forward basis is fairly priced assuming zero growth in earnings in FY21 over FY20; sub-500 kind of EPS on Nifty. However, on other valuation parameters, particularly asset-based valuation, the marketcap to GDP and price to book are decidedly cheap. So our sense is that uncertainties remain high. The outlook on earnings remains uncertain and hence the idea is to focus on the best of companies and be with them for the foreseeable future. Invest gradually so that in case uncertainties arise, the market gives a chance on first quarter earnings, which are going to be nothing like we have seen before. We can make use of the cash on the sidelines.

When you see a large deal in a stock like HUL and where sophisticated institutional investors lap up whatever is available in the market, is that a clear endorsement that consumer staples may be expensive and that is why everybody wants to migrate and they will continue to outperform?
That is the space where certainty on earnings is higher than other spaces. There are very few such spaces; consumer being one, insurance being another, pharmaceutical being the third and telecom maybe the fourth. So there are very few spaces where one can say with some amount of certainty that earnings might be down but down only 5-10% and not much more. So for people who are focused on predictability, sustainability and better quality businesses will want to position here rather than elsewhere.

What is your view on Reliance? It almost seems like it is immaterial now whether or not the Aramco deal actually goes through because they have almost covered 80% of the debt that was to be reduced with the Aramco deal.
RIL is a business with three large parts: refining and petchem, retail and telecom. The telecom vertical does seem to have a large value sustainable; maybe increasing at this point in time given the deals that are happening. Retail is promised to do well over medium to long term but in the immediate term, given that we are in a lockdown situation in large parts of the country which are economically relevant, let us see how this business fairs. Refine and petchem is where we could see stagnation in value if not decline given the margins where they are today.

As we go forward, there is a move away from fossil fuel. So the amount of value that resides there may not increase; it could actually decrease and that is something that is grappling us. So overall, the growth in value will occur for Reliance. We are very hopeful of that but there will be one leg which pulls it down and one leg which will be trying to pull it up. On telecom, we do believe they are very nicely positioned at the moment.

What is the view coming in on paints as a segment because a lot of people in the market are also debating whether the RM cost reduction would be beneficial and if so, then how much? Do you believe that the valuation and the kind of earnings that they will deliver are not really talking to each other and thereby there will be that impending correction in paints as a sector which is going to play out eventually?
Yes, it is something that we are aware of. This is not the peak time for getting the house painted. It starts after the rainy season into the fourth quarter. You are right that at this point in time, not too many people will want a person in the house for painting. But then, it can change very quickly and we need to keep a watch on that.

If you look at the numbers district-wise or city-wise, then large parts of the country are actually Covid-free. It is a few large metros where the concentration of cases is very high. If the current trends are to be taken, except for Tamil Nadu, the whole of south maybe Covid-free. Goa and Kerala are already Covid-free, Odisha has a great chance of being free and Northeast is free. In UP, except for Noida and maybe Lucknow, everything seems to be under control. So there it should be business as usual. Yes, in metros where the fear factor is more, it may take more time to come back and that needs to be watched.

Even if we take some amount of volume cut because of margin expansions, we do believe this is a space which can deliver earnings growth in FY21 over FY20. However, the scene will change if lockdowns continue for longer and the fear factor continues for longer. My sense is if people get more normal by rains, the space will sustain and do very well; if not, the view will change.

In terms of the recovery period, do you see a consistent up move given the kind of liquidity we currently have or do you still see chances of further uncertainty given that we still do not have a package and we still do not know exactly when the lockdown will be lifted?
We could have a very sharp recovery. That is in the realm of possibility. While there are businesses which will be impaired for longer -- travel, tourism-related, airlines, hotels, malls etc -- hopefully they will get addressed over the next six months to a year though not immediately. So it would not be a V but a sharp U is completely possible because demand is there and assets are there. What needs to be provided is finance and the amount of finance that may be actually required is not too great.

My sense is, for a capex-intensive business one month to two months of working capital accumulation should be enough; 10% increase in gross debt. For a working capital-intensive business, maybe 15-16% of an increase in gross debt. With that kind of a scenario, give a 20% increase in gross debt per entity unless that entity in any which ways is in dire straits should be manageable. Now the sense is that it requires some amount of confidence building. We do hope that we see that in the form of a package sooner than later and if that happens then a lot of the fears will be taken care of. We do understand that financials would need some amount of a helping hand given the fact that recently we had a large increase in auto fuel prices. The ability of the government to hand out the package has increased significantly. So we stay very hopeful.

What are the other areas of opportunity? Are you looking at consumption, pharma or IT stocks?
Let us do it in our tick box approach. We focus on the highest quality space which will still be able to grow at least before the Covid hit. So cash on book is the first tick. We are looking at cash on book businesses. They will be able to gain in the market today after the normalcy returns. This is important. If you look at two large examples in the space; look at what happened to Bharti when the third company had issues in the marketplace. The survivors and the stronger entity gets rewarded in the marketplace. Look at what happened to or is happening in the airline industry where Indigo is behaving very differently from the others. So if your position in the marketplace improves or seems to be improving, the stock prices would be rewarded for that versus immediate-term earnings. So I think cash on book will be a great strength with companies.

Again, the tick box is branded versus commodity. We do believe commodity prices will stay soft for longer. In commodities, you can cut up to a particular point after that volume cut into balance supply which was very very difficult. Many countries are participants in the commodity businesses; they cannot cut volumes beyond a point for their own fiscal. So it starts to get difficult. We have seen oil crack out; oil cracks, gas cracks and coal will not have an upside while the usage may be different. The petchem change in the chain and the vegetable chemical chains do meet in the marketplace through the ethanol chain. So we do believe chances of wide spectrum commodities remaining soft for longer is high, which means that users of commodities with pricing power will have a very large gross margin advantage. So yes, there may be some down trading but the branded space may be better versus the unbranded space.

Third tick box is domestic versus exports. We do believe India has done vastly better than the West. We are very hopeful that our final numbers will be much much better. The world is looking to diversify away from China and we could gain from that as well.

What has been a large entry into your portfolio and exit of your portfolio post the crisis?
I shared with you three tick boxes: cash on books, focus on branded business versus commodities, domestic-focussed except for maybe chemicals and pharmaceuticals. If you look at our portfolios before Covid, they were positioned in the same manner. Our conversation for the last several months has been that way. We have rebalanced our portfolios; our chemical and pharmaceutical exposure did very well in this period, but financials did not do as well.

In financials again, we were focussed more versus the index on the fee-based financials; be it life and general insurance and mutual funds which have done considerably better than the corporate banks and today even retail financials.

So neither have we gotten out of anything substantial or gotten into anything substantial. Yes, we have increased weightage to pharmaceuticals a tad bit due to market action and have some bit of new exposure into diagnostic chains.