Sanju Verma, Chief Executive Officer, Institutional Business, Proactive Universal Group, feels the global rally was not just a result of ample liquidity. She sees corporate earnings catching up with valuations. “Now, you have a classic case where earnings will actually catch up with valuations. That will drive the next phase of the rally.”
October, historically has been a very bad month for Indian markets but this rally has broken a lot of earlier myths, she said. She believes that till now the markets have run up on liquidity. "Going forward, a healthy mix of earnings and valuations will drive markets higher."
Here is a verbatim transcript of the exclusive interview with Sanju Verma on CNBC-TV18. Also watch the accompanying video.
Q: What do you think, another leg of momentum is opening up globally with the Dow above 10,000 and what you have seen on the Nifty this week?
A: Certainly, I think earlier we spent the better part of the last few months pointing out that liquidity was the sole driver of the rally, both globally and domestically. But I think it is not just liquidity alone, which has led to an almost 60% rise in the Dow from the lows that it hit in October 2008. I think more importantly earnings now seem to be catching up with valuations. You look at the results of be it a JP Morgan and Intel or even for that matter Alcoa after three consecutive quarters of losses, it reported for the last quarter profit beating even the most optimistic expectations on the street. I don’t think good numbers are coming out only from the US alone. I think more importantly the benchmark has already been set with a stellar set of numbers from Phillips in the euro zone. Again every analyst on the street was expecting Phillips to post a loss and it actually posted handsome profits. So my sense is that now you have that classic case where earnings will actually catch up with valuations and I think that will drive the next phase of the rally.
As I have always said, earlier it was a problem of plenty, there was huge liquidity. So every asset class in the last one year has moved up from gold and soya beans to equities in both emerging markets and developed markets and what have you. I think in the next phase of the rally there will be a differentiation between asset classes. It is very rare to see gold, treasury bonds and equities moving in tandem. So somewhere that correlation has to certainly breakdown and I think in the third phase of the rally, you will see a differentiation within an asset class between geographies. So within equities as an asset class, you will see differentiation between emerging markets, frontier markets and developed markets.
I think we are still in the first stage of the bull rally of what I believe will be a multi-year bull rally for sure as happened in 1982 i.e. not to say we will continue hitting new highs every second fortnight. I think we will take a breather if you look at what happened in 1958 globally and then again globally what happened in 1974-1975 after a stellar run in both these years, markets moved horizontally for the next year or so. But if fundamentals do sustain then I think we will certainly see what happened classically in 1982.
Let us not forget that October historically has been a very bad month for Indian markets if you strip out data for the last two decades or so barring 2004 and 2007 when we saw the BSE going up by 10% and 14% respectively. Every year in October for the last ten years or so, we have actually gone down. So I think this rally has broken a lot of earlier myths and my sense is that till now it was liquidity going forward it will be a good and a healthy mix of earnings, valuations, liquidity what have you.
At the end of the day, let us not forget that most analysts are still working with an EPS number of Rs 1,000 or 1,100 for FY11 and if we actually do Rs 1,200 - and there is a good possibility of that happening - then you are actually talking of 33% earnings growth in FY11 over FY10 assuming that we do something like Rs 900 or 910 EPS for FY10. At FY11, assuming a Sensex of 17,000 or thereabouts currently you are actually talking that the Indian markets are trading at just about 14.5 times which is not expensive by any stretch of imagination, we have never peaked out in any bull rally in the past before hitting those highs of 22 or 25 times. So my sense is that there is still a lot of steam left to this rally.
Q: You track infrastructure, what would you be comfortable buying from the whole infra pack?
A: From the infrastructure pack, JP Associates continues to be a favourite because I think it is a proxy to everything that one can take an exposure to within the infrastructure space be it cement, real estate, construction, power. Coming specifically to power, I would now certainly after the developments of the last twenty-four to forty-eight hours I would like to place my bets on GVK Power, the stock closed at Rs 47, I won’t be surprised if you see another 20-25% upside from current levels for a simple reason that the Andhra Pradesh government has given the nod to both GMR and GVK to sell atleast 20% of their power by way of merchant power sales for the next fifteen years and I think that is a huge positive.
Let us not forget that in terms of the power that they sell by way of the power purchase agreement (PPA), they only get about Rs 2.6-2.7 a unit and if they do manage to sell 20% of their power at anywhere between Rs 4-10 a unit, the upside to earnings can be tremendous. The stock has not performed as much as it should have possibly because FY09 and FY10 will see an EPS degrowth. We are barely talking of something like 0.70 paisa EPS for FY10 but FY11 the EPS number suddenly notches up to something like Rs 1.50 and that is without giving them credit for merchant power sales. So I think a lot of earnings upgrades are certainly in the reckoning and my sense is that the key drivers for this company will also be the monetization of real estate assets in Mumbai. Let us not forget they have 197 acres of land in prime areas in the western suburbs and that alone translates to something like Rs 17 a share and also the airport business which currently translates into something like Rs 12-13 a share. So my sense is that you are getting Rs 29-30 simply from the airport and the real estate businesses and now the key drivers going forward will be the kind of rerating that you see from the power business also because the availability of the gas from KG basin, which was earlier a big problem for companies like GMR and GVK that obviously has now become a thing of the past. So that also should help drive the fortunes of the power business. So I think GVK looks like an excellent play within the power space moreso given the fact that you have so many companies coming out with IPOs in the power space and it becomes that much more difficult to differentiate between the men and the boys.
Q: Any thoughts on Bajaj Auto? Aside from the earnings today there has been talk about how it is slowly beginning to steal a march over Hero Honda?
A: Bajaj seems to be getting its act together. More so if the management noises with respect to 50,000 to 70,000 units on an average which they intent selling of the Discover model is anything to go by. Having said that let us not forget that a large chunk of the 60% plus growth in earnings last quarter year on year came from forex gains, other income the 800 point basis improvement in margins that too was driven more by raw material, cost having come down rather than sheer product development or price differentiation having worked for the company.
I mean from being a strong contender to snatch the crown from Hero Honda to actually having been pushed to the wall was fighting to regain even an 18-20% market share. I think it will take a while before Bajaj becomes a serious threat to Hero Honda. That said I would still place my bets on Hero Honda because I think the September quarter numbers will be a mirror image of what we saw in the June quarter. We are expecting actually a 22-25% volume growth which means that you are talking again of a 30% topline growth and 90% earnings growth. I think here again while FY10 is something that most analyst more or less seem to have got it right because everyone is talking of a 50% or a 60% earnings growth in FY10 I think FY11 again earnings needs to be upgraded because even the most optimistic analyst on the street is talking of barely a 16-17% earnings growth. I think that is where the surprise will come in from.
If you are talking of a 25% earnings growth even for FY11 then the stock is available to you at less than 14 times which makes it dirt cheap. So while Bajaj is getting its act together I think from a purely momentum perspective and the fact that you will have a heady mix of earnings and great valuations in the case of Hero Honda I will still go with it and perhaps Maruti second down the run and may be the third pick would be a Bajaj or a Mhindra & Mahindra
Q: Your thoughts on Pipavav which is just struggling below its issue price and the one which closes today Indiabulls Power, would you be queueing up to buy that one?
A: I think in the case of Indiabulls Power, the fact is that at Rs 45 - the higher end of the band -15% of the company’s equity is on offer giving it a marketcap of 9,000 crore not a single megawatt is operational forget about comparing it with Adani. The fact of the matter is that if you were to actually take a 75:25 debt to equity ratio then for the 6,600 megawatt (MW) odd power capacity which they expect to commence in the next four-five years, you are actually talking of the need to raise close to 8,000 crore by equity issuances alone, which means huge equity dilution is on the cards. Let us not forget that after this issue, the post equity dilution will be something like 19%.
I think the reason why people are queueing up to buy Indiabulls is because the government has given them a coal block of 350 million tonne but people forget that the cost of transportation is going to be extremely stiff because this coal block is about 500 kilometers away from Amravati phase I and about 900 kilometers from Nasik. So I think people who are getting excited about the coal block seem to have perhaps bit more than they can chew. The other interesting thing is that the Engineer-Procure-Construct (EPC) contract for Nasik has not yet been awarded. Even for Amravati phase I, it has not got the fuel linkages in place. There is an assurance that fuel linkages will be in place, so in the absence of EPC contracts having not been awarded for the Nasik project, fuel linkage still in question for the Amravati project, the fact of the matter is that the weighted average EPS of Indiabulls is just 56 paise over the last two years. So you cannot even talk of a P/E because there is hardly any E. So you are only paying a price, you are not sure of the value that you are getting and assuming that it gets listed at Rs 45 which is where anchor investors have put in the money, you are basically saying that the stock is trading at a ridiculous 80 times. Why would I buy Indiabulls Power at 80 times when Adani is still available on FY11 numbers given that there has been so much of comparison between the two at less than 30 times. Not that I am particularly gang-ho about Adani, but I think if you are talking of new listings then Adani certainly steals a march. More importantly National Thermal Power Corporation (NTPC) is coming out with an follow-on public offer (FPO), Rural Electrification Corporation (REC) should hit the street in the next two months. So I think there will be a lot on the plate from the initial public offering (IPO) space and one needs to be very discerning.
As for Pipavav, I am not very surprised by the lukewarm listing. I think the two great things going for it were the fact that Punj Lloyd has more than 20% stake and has an excellent record, the parentage is certainly A+ given that skill has also had experience in the past in developing the Mumbai special economic zone (SEZ). But I think the key question in the case of Pipavav is why would I pay marketcap to book of one time plus which is the best way of evaluating the stock like Pipavav when Bharati Shipyard and ABG Shipyard are available at 0.3 and 0.5 times on marketcap to book. Again in the case of Pipavav, it is all great to say that it will be one of the biggest dry docks but earnings will kick off only in Q3 or Q4 of FY11. What happens to Pipavav if the government decides to tamper around with the export-oriented unit (EOU) status, if the government decides to take away the tax concessions that are available to it by virtue of being declared in SEZ? So I think these are some of the questions that need to be answered. The management has also been quiet on the fact that 2,500 crore of their 5,000 crore order book is in litigation. So I think perhaps the stock has run up ahead of fundamentals and my sense is that there is no need to plunge in and buy a company where the earnings momentum will pick up only two years hence you are better off buying Bharati Shipyard and ABG Shipyard in that order.
