Prashant Jain lists 4 reasons behind the downfall of bank stocks
At the beginning of the year, your portfolio positioning was tilted towards value. It is still tilted towards value and there were two arguments; a), value stocks had underperformed, they were cheap and the mean would revert; b)we are at the beginning of an economic cycle. Value stocks have come back. Now what is in store for utilities or corporate banks or PSU stocks? Does mean reversion in terms of the underperformance over?
Honestly I do not know and I was surprised by the valuations where some of these companies were trading. But we have seen a reasonable correction in the corporate banks’ valuations. In the next leg of corrections in banks in general and some of the banks which are still cheaper compared to their peers,we have to watch out for credit growth. This is one indicator which continues to be quite low in India.
I think the last data point on credit growth was around 7%. As economy normalises; as capex, industrial capex, infra capex pick up steam and retail credit comes back to normalcy, credit growth should pick up and that will be supportive of good prospects for the banking sector. The only other piece where there is really good value is the utility space or sectors that have been impacted by ESG concerns. This may vary from individual to individual, but clearly this has impacted the valuations in power producers as well as tobacco companies.
This should probably be short-lived and that is what I have felt for some time. Thus far, it has not played out and time is the best judge of how long these low valuations can remain. But I for one believe that the current thermal power producers are extremely well placed to transition to renewable power. They will play a very meaningful role because in renewable power, the main competitive advantage or disadvantage is the cost of borrowing.
Some of the large companies have the finest cost of borrowing and so over time, I do not see any reason why they will not become more ESG compliant or acceptable to a wider set. Meanwhile, the power demand in India continues to grow. One big question with not just India but probably the world is an answer to whether the ESG concerns over time will impact demand first or will they impact supply first.
In the global context, the investments into the oil and gas space have been quite low compared to what they used to be and the population of fossil fuel vehicles will continue to grow for the next at least five years and probably the next 10 years despite good EV adoption. If there has not been enough investment in fossil fuels for the last three-five years because of obvious reasons and demand actually grows, then what happens to oil prices, what happens to the price of power? I will be keenly watching this space over the next few years.
You have a large exposure to corporate banks, within the financials. Why is the entire financial space suffering? Is it because the fear of fintechs is overdone?
We are coming to a stage where this divide between corporate and retail banks has disappeared. Some of these banks have done extremely well if you take a slightly longer period but yes in the last few quarters, there has been some underperformance. It could be for a variety of reasons. a), It is always hard to forecast near-term. b)The up move was very sharp and that again leads to some periods of consolidation. c)Credit growth in India continues to be weak and so there is lower provisioning costs. Now the market would wait for credit growth to improve before taking a fresh look. d)Some reallocation of portfolios must be taking place as space was created for some of these new-age or fintech companies.
I for one believe that the current environment where the adoption of digital banking is extremely rapid will play to the advantage the large banks and these banks will be able to serve a lot more number of customers, far larger suite of products and they will be able to service even very small customers and very small ticket loans which they can disburse, because it will all be technology driven.
It will also lead to lower cost for the banks. Actually the current environment is very supportive of large banks and they should again share even faster than what they have done in the past. Clearly banks that do not adopt digital will not do well but I feel there is very little that the fintechs can do which the banks cannot do, at least over a time. I feel the large banks especially are quite sustainable and actually are well placed to benefit from the current environment.
Are markets overpricing this EV rerating?
EV is a theme that has very serious implications for the incumbents and over the medium term also for the country. Clearly the government is extremely supportive of this transition to EVs and that is evident in the way the traditional vehicles are being taxed and the way there is taxation on fossil fuels. Today you can literally buy an EV and a roughly similar sized ICE vehicle for roughly the same price. The ex factory prices are very different, the on road price is the same because of taxation. So for the consumer, cost parity is being reached. It has probably already reached three-wheelers; we are getting there in two-wheelers and in the foreseeable future, it will happen even in the passenger vehicle segment.
This is a transition that will happen. There will no doubt be challenges and many false starts but it is a transition which is reasonably in sight. We can discuss, debate how much, how fast but the direction is very clear. This has implications for the incumbents, companies that do not believe in this transition are at risk of ceding the leadership to the new companies.
Once they cede leadership, they cede market share, consumer mind share. It is very hard and very expensive to get back customer mindshare. To that extent, one should be cautious. Hopefully in five or 10 years, as the population of EVs in India grows significantly and our fossil fuel imports start coming down, the dependence on fossil fuel imports could reduce and that will be a structural positive for India.
As and when we manage to curb or reduce our fossil fuel imports. India has a chance of becoming a structurally current account surplus country. That can do wonders and that is what I am saying that it has some very positive implications for the country over the medium to long term.
We had a conversation in 2018 and you said you do not like NBFC stocks, they have mispriced their asset-liability completely. As we roll into the next year, a lot of NBFCs have become cheap and some of them with the exception of are trading at record lows. Is the market pricing in extreme pessimism there?
I think the operating space for NBFCs is getting severely constrained. In fact, it is reducing as we go along because in the past the banks were constrained by either the physical reach or by high operating costs or lack of transparent data or inability to collect or do collections in cash. All of that is changing.
In the data driven digital world, the role of cash is reducing. There is very little space left where banks would not compete with the NBFCs except in places where they say I do not want to underwrite the credit risk but clearly will come with their own set of costs. The current environment is very supportive of the large banks. I do not think it is so favourable for the small banks and even for the NBFCs unless these NBFCs have some unique niches still available where the banks are hesitating to go or are not in a position to go.
For example, the second hand CV market had its own unique operating style. That is a space where NBFCs still have relatively less competition. But generally speaking, I would be cautious of the increasing intensity by large banks in many of the spaces where NBFCs operate. So I would be slightly more structurally cautious on that space.
IT has been crowned as the best performing sector. Though large companies are growing at a reasonable rate, midcap IT is where the PE multiple expansion has happened. Why do we have such polarity? If I compare PE multiple of Infosys versus L&T Infotech and KPIT versus TCS there is a sharp divergence. Shouldn’t midcaps be trading cheaper than large caps?
You are right and this is the view I also used to have but I think one thing has changed in this last cycle; unlike the previous years where large caps were growing in line or actually faster than the small midcaps or smaller companies in this space, in the last few years, some of the midcap companies have actually grown materially and sustainably higher than the large caps and this is something that even I was not expecting.
While valuations no doubt are quite expensive, the answer to that will depend on how long and how much they can grow faster for how many years. No one really knows the answer but over time as you grow, the growth rates moderate and to that extent, the growth the large caps are experiencing has less downside to that than the downside to reduction in growth rates for some of the small and midcaps. I would be slightly cautious here.