Not many can boast of having such long and varied experience, to be precise more than 33 years, in the field of Equity & Market and Knowledge Management. Albert Einstein’s famous quote “The only source of knowledge is experience,” suits G Chokkalingam perfectly. Right from his days at Institute of Economic Growth, where he assisted eminent economists, to the day he moved to market research, as Econometrician in 1992, he has been constantly drawing attention for his matter of fact and blunt opinions. For a long time he was head of research at Enam Group and later moved to Barclays Wealth, India, as Director & Head (Research and Strategy). His last stint was at Centrum Wealth Management as Chief Investment Officer when he decided to pursue own initiative in equity research.
In such a volatile and unpredictable economic scenario the pressure to make the right calls is very intense and challenging. One has to have a deep and historical understanding of the industries and stocks. With his vast hands on experience G Chokkalingam has mastered the art of picking big compounders. Today clients with serious money are looking to him for direction because he is certainly the best around.
Here he shares his views on macro as well as micro part of the markets in a free-wheeling chat with Indian Economy & Market.
FPIs are net sellers in last nine trading sessions continuously; do you think they are perturbed by the budget proposal?
To some extent yes, but the actual outflow of around $1.5 billion in July is not enormous to worry as compared to their cumulative inflows into the domestic equity markets. A large number of FPIs have successful stories of making substantial wealth from the Indian equity markets by being long-term investors. So such investors are here to stay for long-term.
How the FPIs outflow will impact the Indian equity market and how much our market is dependent upon the inflows from FPIs?
Unfortunately the Indian market doesn’t have required appetite to withstand any major outflows by the FPIs. Even $10 billion outflows could cause a massive fall in the domestic equity markets. At the same time, FPIs also have a limitation – they are not in a position to take out more than $10- 15 billion from the Indian equity markets at this juncture. Any such move would lead to a massive fall in their stock values and also in rupee exchange rates. Hence, any major destabilization to the markets and economy on account of massive outflows from the FPIs is quite impossible.
The finance minister has asked SEBI to consider increasing the minimum public shareholding to 35%; how is it going to impact the secondary and primary capital market?
“Do not anticipate making money within one year in the Indian stock markets; rather extend your investment horizon to 3 to 5 years. Most successful smart investors made equity wealth not by expecting to make returns within a year or so!”
The objectives of minimum public shareholding (MPS) of 35% are noble, no doubt. But the timing is not appropriate in my view. Perceived benefits of this proposal are possible higher allocation by the foreign investors to the Indian equity markets and reduction in speculative activities in the stocks with very low retail float. However, both the equity markets and the economy are going through the problem of liquidity and also by the rising deflationary signs. Resource mobilization through public issues and QIPs have fallen quite badly; resolutions through NCLTs need significant amount of liquidity; the government needs to mobilize more than a `1 trillion through the divestment of stakes in the PSUs from the markets; some of NBFCs are going through liquidity crisis; some of PSU banks need larger support for capitalization; and most crucially, the individual investors are going through major losses in the stock markets due to the dichotomy in the performance between the just 15 NIFTY stocks and rest of the broader markets.
Enforcing MPS in the short to medium terms would call for a demand of around `4 trillion from the secondary markets. Such a move at this point in time would aggravate the problem of liquidity and also suppress the stock prices of many SMC stocks, which are already beaten down quite badly. Hence, postponing this proposal by 4 to 5 years would give a substantial relief to the markets.If we leave out top 15 NIFTY/SENSEX stocks, the remaining listed stocks have collectively lost around `26 trillion of market caps from their peak market caps in January 2018. The individual investors especially the retail investors are highly concentrated in these small and mid cap (SMC) stocks of broader markets. However, these 15 top large cap stocks have added over `10 trillion of market caps in the same period. There are over 600 actively traded stocks, which have promoters’ stakes of more than 65%. On the other hand, there are only a couple of these 15 large cap stocks having promoters’ stakes more than 65%. While the institutional investors are highly concentrated in the large index stocks, it is the retail investors, who are focused heavily on the stocks of broader markets.
How do you see the trajectory of key interest rates in India and globally?
We are slowly going back to the situation of early 2016 – deflationary pressures are rising across the globe. While some of major metals are down around 16%, oil is down over 26% from their respective 52-week highs. The US benchmark 10-year yields fell to its lowest since September 2017, while China’s benchmark overnight repo rate fell to a 4-year low of nearly 1%. German bond yields fell deep in negative territory while the French 10-year yields turned negative for the first time. Indian benchmark bond yields also touched 20-month low. Share of global government bonds trading with a negative yield has risen to 29%, its highest level since October 2016. Thus rising deflationary signs across the world are likely to moderate interest rates further down across the world including India. However, India, though would have adverse impact on account of slowdown in the aggregate demand, would gain substantially out of global pain in terms of huge savings in oil import bill. At the peak of deflationary pressures in early 2016, it is worth noting that crude oil price hit 13-year lows. This possible saving of resources could partly compensate for the overall slowdown in the aggregate demand.
How much probability you ascribe to India becoming USD 5 trillion economies by 2024 and which are the sectors you believe will give opportunities to investors?
I feel it is possible to achieve this $5-trillion target – we were already growing at 11% our GDP in current prices. This target calls for 12% annual growth, which is quite possible if the government improves the investment cycles. Banking and financials, telecom and FMCG could be the key major sectors, which could benefit in the event of this target being achieved. In the mid cap space, companies which have good land bank and lease models, and engaged in the production of tyre, formulations for the domestic markets, etc would benefit.
The Middle East is again on the boil, how is it going to impact the world economy and especially India?
Geopolitical tensions would crop up quite frequently but the financial markets need not worry much. All major nations hold bombs, which would ultimately act as a war- deterrent and finally moderate the tensions. Good example is recent tension between North Korea and the US.
My advice is:
• focus on time-tested managements
• avoid over-leveraged or where promoters’ pledging is more than 1/3rd of holdings
• evaluate whether the timing of stock purchase is wrong or the selection of stock itself wrong
• do not exceed the exposure to the individual stocks at 10% of total portfolio values.
• if stock selection itself is wrong (in terms of leverage, pledging, valuation multiple, quality of management, etc.) then just exit the stocks.
Do you see now stability in NBFC sector or believe some skeletons are still hiding in the closet?
Absolutely there is no doubt that the stability would emerge soon for the NBFCs for number of reasons. Over the last two decades, the RBI has done a good job of controlling the access to public deposits by the NBFCs. The outstanding net NPA is roughly half of what it is for the PSU banks and hence, the bad asset issue is manageable. Largely it is issue of liquidity rather than losing out core assets by the NBFCs. Therefore, in my view, with the active support from the government and RBI, this issue would be resolved soon and stability would come back in this sector.
Auto sector is going through one of the worst demand crisis in recent years. How long do you see it to continue or is it going to be new normal with the government’s drive towards reducing reliance on fossil fuels?
This time the pain for the automobile sector could last much longer. Now the overall slowdown in the aggregate demand is impacting the automobile sector. By the time the economy starts improving the growth this sector would get impacted by disruptions anticipated from the shift to electric vehicles. Hence, it is better to have limited exposures to the stocks of the automobile producers, which have diversified across geographies and also in terms of product profiles. However, investors should be too cautious on the two-wheeler space. The two-wheeler stocks did too well in the last ten years mainly due to strong growth but partly also due to the oligopolistic nature of the industry with just about 4 players dominating the whole market. However, the disruption anticipated from the shift to EVs in the two-wheeler space would change the market structure itself substantially. We have already seen too many regional players showing interests in electric two-wheelers with help of private equities. It is quite certain to see the current oligopolistic market structure giving way to more of perfect competitive market structure, which would obviously bring down the growth and margins for the existing players in my firm view.
When do you see the pain in small and mid-cap companies come to
This could end within 6 to maximum 12 months. Small and mid cap (SMC) space has lost more than `20 trillion from their peaks in January 2018. This kind of fall in absolute term is unprecedented. Many quality stocks in the SMC space are available even at 4 PE and 5% to 7.5% dividend yields. These are the signs of SMC stocks bottoming out. There are instances where the downfall in the SMC indices continued even 3 to 4 years. But my contention is that what damage (in terms of overall market cap erosion) happens in 3 to 4 years has already happened in just last 18 months alone. Roughly 45% of SMC stocks are down 45% to 90%.
Do you see a pattern in wealth-destroying companies? If yes, what are those that an investor should avoid now?
Absolutely YES. Just 140 top losers, mostly from the SMC segment, alone have lost nearly `5 trillion of market values from their respective peak values in January 2018. There is a clear pattern – a vast majority of them had problems of huge leverage, very high percentage of promoters’ shares being pledged, bubbles in valuation multiples and many of them were not time-tested managements in the stock markets. Some of those companies also had severe pressures from the working capital management – some companies had inventories and receivables together exceeding annual revenues. These are the five crucial variables, which the investors should consider before investing in the stocks. Of late, it has become very important to see the existence of long duration in the secondary markets, not just hearing few words about the quality of the managements. Proven history in the secondary stock markets helps the investors to understand the quality of managements. As the markets are well-regulated, it is important to evaluate: how long the stocks were listed; how they actually delivered in comparison with what they promised to the shareholders through AGMs, investors presentations, media conferences, etc; how they rewarded the investors through dividends and buybacks (mere bonus shares or splitting of shares immaterial unless the companies deliver strong consistent growth over a period of time); whether the stocks were suspended ever from the exchanges in the past for failing to fulfill the norms of exchanges or regulators; even the frequency of wealth destruction in the stock markets; etc.
There is one stock from the food segment which is known for periodically destroying the investors’ wealth to the extent of 70% to 80% once in 3 to 5 years and again multiplying several folds before once again destroying the market caps by more than 90%. However, the stocks of time-tested managements, which also fulfill other parameters mentioned here, may also fall in the bear markets, but the history repeatedly proves that most of them recover completely and also end up in giving decent equity wealth in the medium to long terms.
How do you rate the sectoral performances based on the quarterly results?
One sector which has promising outlook is the mobile telecom. However, one has to be choosy in selecting the stocks. This industry is basically oligopolistic in nature and therefore, it cannot continue to lose money in the business. Recent results also indicate stabilization of margins. Latest quarterly results also give some comfort in the sectors like large IT and engineering companies. However, in my view, big alpha would come from the mid cap stocks going forward as they have been crashed in a big way while top 15 index stocks have added more than `10 trillion of market values since January 2018.
Cyclical stocks such as corporate banks and infrastructure companies have led the last rally. How sustainable are these, especially looking after their recent results?
“It would be better for the investors to avoid stocks of real estate and construction, two-wheeler segment of automobiles, agri-related and steel sector in the short-term.”
While the banking sector could continue to do well, the infrastructure sector could take a backseat in terms of performance in the short to medium terms as the investment cycle is yet to pick up. While the aggregate demand has slowed down which has led to lower capex by the private sector, the government’s allocation to the capital expenditure is also not significant enough to boost the public investment. However, the banking sector as a whole could do well for the next one year at least. However, the performance within the banking sector could possibly tilt towards large and relatively better performing public sector banks (PSBs). Few PSBs are on the verge of moderating their NPAs and come back to growth path, thanks to consolidation, speedy resolutions through NCLT and continued strong credit growth of over 13% yoy.
It would be better for the investors to avoid stocks of real estate and construction, two-wheeler segment of automobiles, agri-related (as only 50% of 36 sub-divisions received normal or excess rainfall as on July 27th) and steel sector in the short-term.
Which sector, you believe will give investors new multi baggers and how to identify them?
Multi-bagger opportunities mostly evolve from the small and mid cap (SMC) space. Since the SMC space lost more than `20 lakh crore of market value since January 2018 and nearly 50% of them trade at nearly 50% to 70% lower than their respective peak prices seen in 2018, once again this space could give multi-bagger opportunities. Beaten down cash-rich PSUs, select tyre stocks, attractive holding companies, mid-sized IT companies (which trade close to 10 PE or around 1 time Enterprise Value to annual revenues), land bank-rich companies engaged in leasing real estate business, mid-sized pharma companies (engaged largely in the domestic pharma business with least exposure to US markets), etc. could emerge as multi-baggers once again. Also old private sector banking segment is worth looking at – this OPSB segment also got beaten down and some of the banks with 8 to 10 decades of proven successful existence trade at steep discount to their adjusted book values. While some of the new mid-sized private sector banks with less than `1 trillion of business trade at over `50,000 crore of market caps, some OPSBs, which managed to contain the Net NPAs over the last 6 to 8 quarters and still keeps growing their business and managed to hit more than `1 trillion of business size are trading at mere `3000 to `4000 crore of market cap. In my firm view, this kind of dichotomy between the market rewards cannot continue for long.
Frontline equity indices are still trading at PE of 28. What is your expectation of equity returns in the next one year?
The scope for the frontline index stocks would be, on an average, around maximum 10% only in the next one year. While successful frontline stocks were rewarded in terms of huge valuation multiples, the underperformers were punished quite badly. Outperforming frontline stocks are given as high as 8 times book value in case of financials or over 50 to 60 trailing PEs for non-financial stocks. However, the earnings growth for most producers is not in strong double-digits. At the same time, for these companies, it is difficult to expect significant expansion in business while the aggregate demand in the system has come down significantly. Hence, the scope for expansion of valuation multiples is limited. Also possible disruptions from shift to electric vehicles, execution of MPS, global trade wars, etc would cause a lot more uncertainties for some of the frontline stocks.
What are your filters to select the right sector at the current juncture?
Growth, disruptions, trade wars and global deflationary conditions are the four key parameters, which should guide anyone to select the sectoral themes. Is the sector suffering from de-growth? For example, the automobiles – it is not clear whether it would soon come back to growth. In case, it returns to growth path, say by end of current fiscal, whether this sector (especially the two-wheelers) would be subject to another setback on account of disruption to emerge on account of forced shift to EVs. A trade war initiated by the US is causing both opportunities and threats – the investors need to be still cautious on the consequences of ongoing global trade wars. For examples, the margins of steel industry are impacted heavily by trade wars and by consequent deflationary conditions. Fall in aggregate demand consequent to the rising deflationary conditions have led to slowdown in the domestic consumption of steel and demand for real estate. It is quite interesting to note that most frontline large cap stocks are associated with large sectors while there are other SMC companies, which are engaged in diverse or unique services or manufacturing, which still manage to grow. Therefore, apart from massive crash, the SMC segment looks promising for the future considering many unique themes. Examples are: M&A opportunities in the mid-sized IT companies, attractive holding companies, very high dividend yield stories, cash-rich small PSUs, etc. These companies may not form part of the broad sectors or even if they belong to broad sectors, their optimism may differ from their respective large allies.
What is your advice to investors?
The biggest problem, which I learned in the last 3 decades from the retail investors, is that all cycles of stock markets (whether at the peak of the boom or bottom of the markets), many of them excessively focus on absolute prices and their movements, rather than on the underlying fundamentals and valuation multiples. This approach stops them from selling the stocks at the peak of the valuations and accumulating the quality stocks at the bottom of their valuation – giving away the opportunity only to the “smart” investors. Second issue is that many investors start aggressively averaging down the buying cost of stocks way down the path of deceleration without checking the credentials of the fundamentals and managements of the stocks. Many innocent investors aggressively averaged way down many stocks, which had governance issues without evaluating the management quality or the business outlook and finally ended up in losing 80% to 90% of the values in the stocks.
My advice is: focus on time-tested managements in the stock markets; avoid over-leveraged or stocks in which promoters’ pledging is more than 1/3rd of holdings (of course, in few cases, there could be exceptions). Evaluate whether the timing of stock purchase is wrong or the selection of stock itself wrong – if fundamentals are sound, only timing is wrong (in the sense current prices are significantly down), then do not panic and sell. Rather accumulate more and stay tight on your holding. However, normally do not exceed the exposure to the individual stocks at 10% of total portfolio values. If stock selection itself is wrong (in terms of leverage, pledging, valuation multiple, quality of management, etc) then just exit the stocks whatever is the loss.
Don’t act on rumors or tips received on social media without checking the fundamental implications of the developments. Remember there are no NGOs in the stock market, which is engaged in the business of money-making and also there is zero-sum game as far as investible surplus available collectively in the hands of investors. While gullible investors gain, the smart investors keep growing their wealth substantially over the decades.
Last but most important, do not anticipate to make money within one year in the Indian stock markets, rather extend your investment horizon to 3 to 5 years. Most successful smart investors made equity wealth not by expecting to make returns within a year or so!