‘Competition 'toh India mein hai hi nahi’'

Some of the biggest business houses in India are looking to diversify into sectors they have never been into before. “We have an economy, which is growing at 13-14% nominal growth rate, to that extent existing large companies, which are incumbents are benefiting big time and throwing up lots of free cash flow,” says Anand Shah, head — equity, Canara Robeco Mutual Fund, explaining this phenomenon. In this interview he speaks to DNA. Excerpts:

How are markets looking?
When you are looking at the market at an overall price to earnings (PE) ratio of 18+, overall, margin of error is little. You are talking about a very certain GDP growth rate with sustained margin expansion, and robust profit growth, which may or may not happen. So today, you don’t have margin of error for various stocks including the large companies.

However, we are looking at markets where tailwinds are still strong. You have sectors such as banking, pharma, FMCG, auto where you have a benefit of the industry itself growing very fast. So we are still focused on the domestic consumption story, where valuations might be a little rich, but then you don’t have issues on earnings.

So are you relatively bearish?
No. We are cautious. To be bearish on India would be actually very difficult given the secular growth phase we are in.

You said you are positive on the FMCG sector. Can you explain the rationale?
When we are talking about FMCG, the entire new growth driver has been Bharat. The metro markets have not been growing very fast. We have 85%+ penetration in metros and thus growth rates are not very high. That is why if you see between 2002 and 2006, practically this sector grew in low single digits. It was only 2008 onwards that we started to see double-digit growth rates for FMCG companies. And that’s entirely a phenomenon of Bharat, which is semi-urban and rural India.

But what has happened in Bharat that has changed the game for FMCG?
FMCG is the beneficiary of this entire transfer of wealth from urban to rural areas through the NREGA and through soft commodity (essentially agri) prices going up. That is showing up as inflation in urban India, but inflation in urban India through food prices is beneficiary to rural India. They are now able to afford FMCG products. And that is somewhere showing up in textiles as well.

That is a very interesting point you make, does this growth benefit the larger FMCG players or smaller ones?
It is helping the companies that were forward looking, innovative and who have launched products for Bharat. If you ask me, the FMCG firms which are focused on urban India, have actually not been the fastest-growing. It is FMCG companies, which invested in distribution in rural India and also innovated in packaging (small sachets etc) who are the biggest beneficiaries. And some of the more aggressive FMCG companies have gone to Egypt, Africa, Bangladesh, Middle East, Argentina, Sri Lanka, South Africa etc, who also have been growing pretty fast.

What is your bet on the banking sector, with interest rates are set to rise in the next few months?
Banking has various issues that will come or are likely to come in the short term. But one has to look from a longer term perspective. If you see the middle class population, the fastest growing part of their wallet is actually savings. If you see the impact of that on the size of the banking industry, it has the potential to double every four years, because our savings are growing at the rate.

We had $100 billion of gross domestic savings in FY2002, and that has almost quadrupled in a matter of seven-eight years. You have this big plus for the banking industry that even larger banks in our country can double in size, in the next four years. The smaller banks and the faster growing banks can actually double every three years. That is a big positive and that takes care of lot of negatives.

When you have that kind of growth you can take care of smaller problems like hike in interest rates. The only issue with rising interest rates is treasury losses. Otherwise if you see banks which have a higher current and savings accounts are likely to benefit with higher interest rates because net interest margins will expand.

What about a sector like telecom?
If you see gradually with all the players having launched their plans, now that the sensitivity to pricing has gone. If you see, incrementally, mobile plans are not sold on rates. Nobody is flashing that 50 paisa per minute or 1 paisa per second like before. That has become less. On top of it, with the money that has been paid for 3G, their ability to compete more has reduced further.

And to that extent, whether in 3G everybody will lose money in the initial years is a given, but in the existing voice market, the 2G , there is a feeling that it has bottomed out, the rates will not fall further. And that in itself is big news. So you see last two quarters you had 10%+ quarter on quarter growth in minutes of usage. And if your pricing stops falling, that’s equal to their revenue growth rate.

So you are actually talking about a double-digit sequential growth rate in revenue, going forward. The users in rural India, who have bought phones in the last two to three years, will mature over eighteen months and the minutes of usage will go up there. You have the tailwind of all the subscriber growth that has happened in the last 3-4 years, which will actually start consuming in large quantities.

What’s your new fund Large Cap Plus fund all about?
It’s a large cap product which will invest 100% of the money in the top 150 stocks of the country, by market cap. And it would have benefit of our bottom up stock picking and our research capabilities. The added plus is the capability of Robeco that we have imported. Robeco is an 80-year-old mutual fund and one of early adopters of quant strategies in Europe. Over years they have developed quantitative models which help fund managers identify the stocks with superior valuations, superior earnings momentum and superior price momentum. 

Every month it will run quant strategies on our stock universe and give the fund manager the relative ranking within the universe. The relative ranking is in turn used by fund manager as ‘idea generator’ and as ‘second opinion’ to its fundamental research. Thus, it’s a large cap product from Canara Robeco driven by fundamental research, but you have a quant ranking for the fundamental research team to look upto, as second opinion.

Lately there has been a lot of news about some of the bigger listed companies wanting to get into totally different areas of business from their core area.

How do you explain that?
We have an economy which is growing at 13-14% nominal growth rate, to that extent existing large companies which are incumbents are benefiting big time and throwing lots of free cash flow. The incumbents are benefiting big time kyon ki competition toh India mein hai hi nahi, also due to lower capital intensity and limited competitive intensity within their own business now they are looking for newer growth opportunities.

At the same time, in India due to changing demographics and whole lot of reforms process/ liberalisation we are seeing many more emerging sectors which are throwing up multi year growth opportunities. To that extent they are diversifying their cash flow from stable business into new emerging sectors. Whether it will work, not work, remains to be seen. It is management capabilities of those companies which are diversifying, which will be put to test.  It has failed in the 1990s when many big business houses went into unrelated sectors and have burnt their fingers. So it may or may not work.