Do you believe that the softness that we have seen in demand when it comes to the revenue growth in Q2 is likely to percolate into the coming quarters or are you expecting some sort of reprieve in Q3?
Our belief is that this result season has been a polarised one, based on results particularly. What we do see is that there are certain companies where results have been very robust both on revenues as well as on margins. But there has been a large chunk of the market where results have disappointed. Take for example Hindustan UnileverNSE -0.07 %. Their results have been better than expected but there have been a whole pack of FMCG players where results have actually disappointed. It is the same with the infrastructure sector, banking space, etc.
What is more pertinent to note than just one quarter’s numbers is whether the earning power of these companies has contracted permanently or if it is just a temporary phenomenon, where because of pertinent reasons, you are seeing margins contract or revenues not coming to the extent that one would expect.
If it is a temporary phenomenon and earning power remains constant, then one has to look beyond the next one or two quarters and maybe look into the next year to take calls on many of these names. This contraction in revenues as also margins is already reflecting in prices in many instances. Stocks are down 50-60-70% and it is in anticipation of contraction revenues and earnings that this has happened.
If there was to be a reversal in the coming year, then there is room for stocks to move up. Looking at results just on a quarterly basis as also in absolute terms may not be the right way to assess opportunities. To do that, one has to look at a slightly longer term perspective and then take calls.
We have been looking at the move in telecom. Do you believe that should there be some relief from the government on those rulings and/or kind of fee structure, it is still worth relooking, if not at Vodafone, then at least Bharti even at these levels in the current environment. Or would you completely stay steer clear?
I believe that the telecom sector is a very interesting space at this time. In the long term, 2-4 years down the line, this will be a case study for future generations as also for current investors. This is a space which had 10-15 names till about three to five years ago and that number has consolidated now to three. Amongst those three, one is under tremendous stress on the balance sheet and there are two which have reasonable strength on their balance sheets. Now the way to look at the situation just now is that what is bad for the sector, will actually stress that one stressed player even further and there could be a possibility that that player goes out of business and if that happens, 30% revenue that that player today commands will be split between the top two players.
On the other hand, if there are measures taken by the government which will be good for the sector and will make this player sustain in the space going ahead, it will still remain a fringe player and these benefits that the government gives to this sector will also go to the other players. So one thing is a given. This is a consolidated market now.
Second, I believe that in this space, the top two players are going to go from strength to strength in the years ahead. We are looking at recent periods of uncertainty and stress in this space. But looking ahead, I do see that this consolidated space is going to offer immense opportunity. Bear in mind that India is moving towards the broadband market. The broadband of 4G is a high margin, high revenue play. In terms of revenue mix, it is going to move towards higher margin mix going ahead. I am contrary to many views. I am constructive on this space.
The balance sheet of some of these firms are so bad that if tariffs do not change, if AGR issues are not sorted out, you could have a situation like the power sector in India. We need power, we cannot live without power but power companies never make money?
You are very right except that we have to keep a few things in mind; one is that this sector used to have ARPUs of between Rs 180 and Rs 200 till about three years ago, when a deep pocketed player entered the space.
Since then, ARPUs corrected all the way down to Rs 100 and in the recent past ARPUs are again up to Rs 120-125. That tells us two things; one is that downsides on ARPUs maybe a thing of the past. They may not go up from here, but at least on the downside, ARPUs may have bottomed in the recent past.
The second is that even three years ago the Indian consumer was willing to pay Rs 180-200 o get telecom services and we are still down to between Rs 120-125. Three years have passed, inflation has picked up and still we are down from Rs 180 to Rs 120. That tells us that there is room for ARPUs to go up further.
Third and more importantly, what is happening is that while on the 3G, 2G services, you have ARPUs of around Rs 100 and thereabouts, on 4G services the ARPUs are of the range of Rs 200 plus. More and more consumers are shifting from 2G, 3G to 4G because 4G offers them fast internet and as well know TV is being replaced by telephone for a lot of multimedia activity. All these things tell is that in the mix, you will see margin expansion because of ARPU change positively and on the downside maybe we have already seen downsides capped on ARPUs.
Balance sheet is the most critical thing here. Whoever has a reasonably strong balance sheet will be able to invest behind the business and get customers on board. Whoever has a strained balance sheet will at the margin either have a status quo business or will become weaker in terms of competitive intensity. Given this scenario, I see this sector remaining highly consolidated and in fact consolidating even further over the next two to three years.
The risk reward here is quite interesting for someone who does not have the next two, three months in terms of time horizon. Investing in a longer term time horizon offers a very interesting risk reward here.
I thought markets follow earnings and macros. How come they are not following it right now?
Markets work with a telescope and telescopes look ahead. For that reason, in 2018 you witnessed one of the biggest small and midcap carnages that I have seen in my 20-year-long career. That sort of pain continued in 2019 but the economy was doing far better in 2018 while markets were going down. Economy started turning adverse in 2019. So, it was the market telescope which was at work, it was looking far and taking calls in advance.
Similarly, sitting here you and I who have relatively more myopic vision as compared to the markets and we do not have telescopic vision. We cannot look six months, one year, two years down the line while the markets being telescopic will look six months, one year, two years down the line. If the markets see green rather than the red that we see today sitting here, then markets will react to that.
It is in that context that we see that the frontline index is holding up strong and it is in that context that we see that there are pockets of the small and midcap space which have started getting new life. I know of many names, which were most disregarded last year and which have rallied 40-50% in the last two to three months. If the same trend continues and the markets believe that the government action as also the general macro trend of low inflation, low interest rates, taxes being favourable, monetary policy being favourable is going to enhance consumption six months down the line, then markets will anticipate that and move to play that trend which will play out six months down the line.
As we stand, things are not looking as rosy as we would want them to look, but if they start looking rosy, then these prices will not be available. The prices are available because things do not look rosy. Six months down the line things will look very different. We have to understand the opportunity that India presents. Speak to any foreign institutional investor and he will go gaga over India but since we are too close to the ground we see thorns rather than roses. But there are roses and roses will play out six months to 12 months down the line.
Markets work with a telescope and telescopes look ahead. For that reason, in 2018 we witnessed one of the biggest small and midcap carnages that I have seen in my entire career.-Anshul Saigal
I will divide the market into three parts: Evergreen companies which both of us know would be financials and some consumption names; then buy companies which essentially are getting priced down because of sentiment or business downturn; and third category is catch them young and see them grow. Give me one name from the second and third categories each.
Please pardon me for not talking about individual companies but I can give you some hints. There is tremendous consolidation happening in the real estate space. There are players in that space which offer extremely robust balance sheets and managements who are fully clued in to the business and who are in the same boat as the minority shareholders. They want to create wealth through their business of real estate.
Some of these players are north based. They may be relatively small companies with Rs 1,000-2,000 crore market cap trading at book value and very healthy balance sheets, no debt, cash on the balance sheet and their business is starting to grow over the last two odd years. This space looks very interesting and one should definitely look at plays in this space and this is a space where you are seeing a cyclical slowdown just now which is why you are getting the valuations that these companies are trading at.
But that cyclical slowdown is bound to turn. Whether it turns in the next year or two is a matter of perception but it is bound to turn. In the space where you have really small companies and where there is substantial possible upside but you have to take a call on that small business actually becoming very big.
Then there are chemical businesses and chemicals is a space which is looking very interesting just now. But in that space, there are very interesting businesses which are trading today at 25% of the valuation they were trading at till about a year and a half, two years ago. So very interesting plays even in that space.