Investors in India cannot afford to bypass equity

By Morningstar |  02-02-17 | 

Sailesh Bhan is Deputy Chief Investment Officer - Equities & Senior VP, Reliance Capital AMC. At the Morningstar Investment Conference he was a panelist on a panel moderated by Madhusudan Kela, the chief investment strategist and Reliance Capital. Below is an excerpt from this panel.  

You have been holding a lot of good quality names. Today, quality is not at a premium, but it's at a super-premium; 30 to 50 P/E multiples. What gives you the conviction to keep holding these stocks? At what point of time do you decide that a 40P/E or 50 P/E or 60 P/E is not worth holding?

Wherever there are high P/E companies being bought, the basic case is: Is the growth possibility there much higher than what is imputed? So when we buy growth or expectations of growth, it is only where the current earnings are 5-year or 6-year lows. We are not focused on buying high P/E companies where growth has already come about.

For me to sell, I have to see if the hypothesis on which the investment has been created has changed. Say growth expectations are driven by possibly lower interest rates, better ordering or by changes in the environment relevant to the business. If they change, you have sell out. Then P/E multiples don't matter.

The expensiveness is a function of what is possible because it's a forward-looking mechanism. The minute you look back last 5 or 6 years, earnings have been very inferior. So, can you have the next 3 to 5 years earnings of 14% to 15% compounding for larger companies? It's a possibility. And on that, if you find businesses which are going to do 4% to 5% higher than that, that is the space which can command a little bit of premium.

There is no point being in businesses where there are multiples just because there is liquidity, momentum. Three years back FMCG companies were so expensively valued at 40-50 multiples. Now they are delivering only 4% 5% revenue growth.

You have taken few outsized bets in your funds. And I know that currently some of it is hurting you. Let's say, you bought 8% of Indian Hotels. What kind of thought process actually went into creating that position?

These deviations or specific sectors calls are at any point of time taken on 2 or 3, out of 10 sectors. And we take a 3-year kind of view.

Let’s talk about the hospitality sector.

This is one sector where the leaders in this actually were a part of the indices 20 years back. This was an established sector with a lot of prominence at one point of time. For various reasons, it went completely out of favour. But when look at some of these businesses over 3 to 4 years, do they have an optionality in them where growth can be far superior to what today numbers are telling you about?

In 2007, all these same properties which we are sitting on actually were making much more money than they are today. The profits were double of what they are today.

Today at $100-120 you get to stay in a 5-star hotel in India, which will be among the cheapest now globally. The cheapest Ritz-Carlton is in India. The cheapest Four Seasons is in India. So, any global brand, which is actually the best, is cheaper today because of what the (2008) crisis has been. And that risk comes in prices much, much below replacement cost, strong earning power, models are correcting. And the whole 5-4 year earnings cycle ahead to be played out for.

The minute you do analysis in these areas, you will find that earnings growth will never be that 15% CAGR, it will be for the economy. But there will be businesses which can do 30% compounding. And I think you will have to choose those sets of business…..

How long will you hold?

When buying itself, the margin of safety factor comes in. So, you are buying at a price where it is distressed. It is a most hated sector today. The same thing is happening in corporate banks. Nobody wants to touch it today. So, these are the most hated sectors where there is value lying. Like, oil and gas sector was a traditional sector three years back where value was lying.

Buying at a right price and keeping a proportion which is relevant from a 3-4 year point of view.

Then evaluate whether the market is are turning the way you wish to or the way you want to see it to turn, I am referring to the business environment itself for them, only then you follow it. And if valuations run ahead of earnings expectations based on our framework itself, we exit.

What is the key message to investors to encourage them to invest in equity?

Higher interest rates are not there in India today. The relative asset attractiveness is clearly there for equity.

We are at earnings lows. In many, many sectors we are earnings lows. So, valuing a business or valuing a market only on the basis of a P/E multiple for next year is a little bit of a narrow way of looking at it. A sizable economy like India can compound earnings at 15% for the next five years. Without growth in the last 3-4 years, the world has started looking at India very differently. With growth, the kind of opportunities which will emerge here are tremendous. There is confidence in the long-term India story. Growth has not disappeared from India. It will come back.

India has some extraordinary businesses, the kind of universe and the diversity of businesses you have to buy today is amazing. There are established companies and very young industries, whether it is say a diagnostic industry, just being virtually born in the stock market. Penetration levels are too low in hospitality, media or entertainment sector. So many young sectors can actually outshine. Opportunity exists because India is so underpenetrated.

But please come in with a 10% risk in your mind. There is no line which says that the market cannot go below this or above this. There is no P/E multiple band which the market will like to be in. Come in with a view that if it is a Rs 10 asset you are investing in, you are investing at a Rs 9 level itself. That keeps you invested for a timeframe. And only when the client gets that that he is going to buy from the underlying returns which will come from businesses, only then he will stay longer. I think the first experience of the client will matter here.

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Aravind Sankeerth
Feb 2 2017 07:30 PM
Amazing interview. Simply amazing. I feel that, the question on few outsized bets and the example of Hotels was entertaining to listen. Infact I feel that all hotel stocks are in that phase where they were in 2007-08 and I guess the person was referring to that here, when he said that margins are low now(in comparison)
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