Psu Stocks: PSU rerating maybe on, but remember consensus trades never work: Krishna Kumar Karwa

“It is the largecap indices which have reached the all-time highs but smallcap and midcap indices are a fair bit away. My sense is as confidence levels improve, one more quarter of results from corporate India should give confidence to investors to invest in the smallcap, midcap segment because the environment is very volatile globally,” says Krishna Kumar Karwa, MD, .

The ring of all-time high is almost there. It looks like we are likely to go beyond that given that December is still left for the year?
Yes, certainly. We have seen the resilience of the domestic flows. It has been the crowning glory for the year which has seen massive selloffs by the FPIs in between. But the domestic investors continued to keep their faith in the market and now we are at all time high or closer to all time high.

It is the largecap indices which have reached the all-time highs but smallcap and midcap indices are a fair bit away. The rally has not been so broad-based in the last few months but my sense is that as confidence levels improve, one more quarter of results from corporate India should give confidence to investors to invest in the smallcap, midcap segment because the environment is very volatile globally.

Whether it is interest rates hardening, recession, hard landing, soft landing and China having its own issues. In such an environment, it is natural for investors to gravitate towards the largecaps where the ability of these companies to manage the environment and survive and grow it much better. Many of the smallcap companies may struggle and we have also seen in the quarter gone by that margin pressure effect was very much evident. At the ground level also, we are getting a feeling that there is a slowdown etc.

Investors are behaving very rationally while putting their faith in the largecap segment and taking a breather as far as the small and midcap segments are considered.

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Exactly a year ago there was a mad rush for new age tech stocks. Everybody called it the new tech rush. I am talking about fintech; nobody wanted to sell , , , and today nobody wants to buy them. The same guys who bought at 80-90% higher, are selling at distress levels. So was last year’s price action more like a mirage or is this year’s selling the ugly reality?
We are hardcore public market investors and many of the names that you mentioned basically were driven by private equity and new technology, new money and basically all digital driven businesses had liquidity driving valuations. These companies went for IPOs at the peak of the sentiment and at a time when liquidity was at the peak.

Thus the sentiment was also extremely positive. It was greed that took over all of us as far as the public market investors were concerned. If you look at the investor profile, many of the veteran investors in the domestic ecosystem kept away from many of these overvalued issues. There were some pop ups which were available in some of the stocks and smart investors were able to take some money off the table.

Now when the lock-ins etc are being released, all the investors who were invested, are willing to sell stocks at maybe 25%, 30%, 40% off from their peaks. There are two reasons I believe; one is obviously many of them are invested in so many other investments and the global environment turning difficult, they would like to take money off the table.

Second is the reality that there was a huge push to many of these internet driven companies during Covid in terms of growth. Now things are becoming much more normal and the growth that was expected to continue for many more years is getting more adjusted.

Having said that, do these businesses have a right to grow? They are disruptive companies and possibly some of them will get further disrupted by new entrants but now at least, with some of them having a decent amount of cash on their balance sheets, all of them have started talking the language that public market investors understand, which is the path to profitability.

Last year, when these companies went public, I do not think they even wanted to talk about profitability. It was only about growth and new segments and new geographies that they would like to enter. But now reality has sunk in and they are talking about the path to profitability. So some of these businesses are becoming attractive for investors to look at. I think there is a herd mentality and today when these companies are available at attractive valuations, investors are still not willing to bite the bullet.

There were sensible merchant bankers who took them public. There were big pension funds who talked about years and decades they have invested in them and the same names are selling. So for folks who are known for long-term investing, how has the template gone wrong so badly? A stock may fall 10%, 15% but yahan to ganga ulti beh rahi hai (but here things have turned upside down).
I would not blame the investors who invested in those companies in the earlier years or the merchant bankers who took them public. I do not think any investor who invested in the stock at the company’s IPO or subsequently have any rights to blame any of those investors or the merchant bankers. It is a free market. All public information is available to you. You are buying because you believe that you will be able to sell tomorrow at a higher price or after one year.

Now if you have not evaluated the business properly, you as an investor are to be blamed for it. It is all about greed. It was about the bigger fool theory. Subsequently, if your bets have gone wrong, it would be wrong to blame anybody but yourself. It is best that investors always consider whatever the valuation is. If they do not understand the business, do not invest but if you have got it wrong, don’t blame others.

What is the outlook when it comes to the inflationary concerns? Do you think one needs to be a little bit cautious in the consumption space as a whole?
I definitely think the global environment is very challenging in terms of inflation, interest rates, China, etc, and it is going to be very volatile. Every day, some new data point will come in and you will have to revisit earlier hypothesis.

I would think that domestic India investors who are investing in Indian companies should be more completely focussed on domestic fundamentals and based on that, they should be taking investment decisions. Now as far as consumer space is concerned, yes there were headwinds in terms of high raw material input prices and which was reflected in the margin pressures, etc, and there is a view that there is some slowdown currently also.

One has to be very vigilant but the raw material pressure at least seems to be going off and so maybe, we will see margin improvement going forward. Between staples and discretionary, for staples companies at least, most of the valuations are rich and investors will also have to consider about the valuations in terms of when they invest. But during inflationary times, generally it has been seen that they would be able to pass on maybe with a lag or two in terms of the raw material input prices moving up. So their profitability should be intact.

They are basically cash generating companies and in an inflationary environment or high interest rate environment, typically these companies tend to do well from an investor’s perspective. So yes, we have to be very cognisant of the global headwinds but more focussed on domestic fundamentals and look to invest in these companies as part of the portfolio because of the inherently strength of the businesses.

Opinion seems to be very divided on PSU banks. Of late, they have caught everyone’s eye but you seem to be of the view that the balance sheets are fairly robust.
In the last three-four years, the public sector banks have cleaned up balance sheets and currently there are tailwinds in the business, credit growth is robust and most of the public sector banks should be able to participate in the credit growth cycle for the next few years.

Generally the investor community and even the analyst community have been burnt by the underperformance of the public sector banks in the last seven-eight years and so their ability to thump their desk does not seem to be there. There are very few contra investors who are willing to take the bet and invest in the public sector banks, some of which have delivered substantially higher returns on a 12-18 months’ basis.

For the next two years, do you think that public sector banks will give you better returns? I would say the odds were very high because while there is a lot of scepticism, they have all the wherewithal to be able to deliver at par with the private banks. So yes we are very positive on public sector banks.

Private sector banks have already seen returns of 15% plus. In the case of public sector banks, it is upwards of 30-40%. Despite this and the delta that exists, should one stay invested or accumulate and prefer the public sector banks?
Definitely the valuations are still very attractive for the public sector banks and there is no reason that on a two-year basis, most of them are still quoting at 0.5-0.6 price to book and many of them seem to be capable of at least reaching to 13% to 15% ROE in the next two years.

Our take is that as consistently as every quarter, they deliver good quality growth with minimal credit cost. There is no reason why most of these banks should start quoting at closer to one-time price to book and one can expect a 25-30% or maybe more compounded returns on many of these public sector banks for the next two years.

A larger theme is playing out, a big PSU rerating seems to be taking place. Is the market seeing that outside of energy, everything in PSUs is safe and may be used for making money?
One should look at the various government initiatives across the industry. Not only the private sector, even the public sector businesses will benefit out of them. Whether one talks of defence or railways, one can see government initiatives for growing those sectors and specific initiatives as far as Make In India is concerned. Many of the defence and railways focussed companies should benefit and the market has recognised the opportunity.

So, yes there can be challenges and flip-flops from the government. Investors understand but investors recognise the sheer valuations at which many of these companies were quoting 12 to 18 months ago, the initiatives that the Government of India announced and then the numbers that many of these companies are delivering.

We will need to appreciate the fact that consensus trades never work. So six -nine months ago, many of these were non-consensus trades where investor ownership was limited and as people got more and more comfortable, they started investing and now these companies should deliver decent returns. But if you look at it, the maximum gains have been made in many of these companies. But yes, going forward also, on a macro basis, the opportunity seems to be very strong, be it for the banking sector or defence or railways. One should be looking to hold on to these stocks to decent returns even next year.

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