India Bulls Get Together

CIO INVESTORS & FUND MANAGERS: ROUND-TABLE

With the Sensex crossing 5,000 last week, there couldn't have been a more opportune time to have the best money managers assemble together to share their views on the stock markets and their favourite picks.

Thanks to Capitalideasonline.com, a jam-packed audience at the BSE Convention Hall had the privilege of listening to them. The pros on Dalal Street unanimously feel that the Indian equity markets have just entered a secular bull run.

In veteran investor Rakesh Jhunjhunwala's words, "what we have seen is just the trailer."

Though everybody agrees that we have just started one of the longest bull markets in history, nobody rules out the possibility of interim corrections. Read on to sense the pulse of the markets and pros' best picks.

RAMESH DAMANI (Moderator): Rakesh, you are often described as the man who saw tomorrow. What is in tomorrow for equity markets?

RAKESH JHUNJHUNWALA: I would like to distinguish between what the economic fundamentals of this country will be and what the equity markets could be. We have had such a ferocious rise, the pace and the depth of which have surprised me.

As far as growth in this country is concerned, I think we have just seen the trailer. As far as equity markets are concerned, after such a ferocious rise, we need to be cautious.

However, on the whole, equity returns in India are going to outbeat returns in various asset classes like gold, property and so on.

DAMANI: How long could this secular bull run last?

JHUNJHUNWALA: Every bull market is born with a set of fundamentals which are initially not recognised. Instead, they are condemned or ignored. We have gone through that process in India.

The change in India has come about through a democratic process. I see no reversal of India's economic fundamentals. We have grown at 5.5 per cent annually during the last decade, we are the second fastest growing economy in the world.

And all the growth had been ignored by the markets. People lost money in equities and it became the most hated asset class.

I would like to draw a parallel here between the Indian and American equity markets. The American market was 1,000 one day in 1965 and 1,000 on one day in 1981.

And after that it went into a 19-year bull run. It is my personal prognosis that India will go into that kind of a bull run. One cannot rule out deep-rooted corrections, though.

Consider this: there is Rs 13,00,000 crore in bank deposits in India and just about Rs 11,000 crore is available to equity mutual funds in India. Imagine the kind of local money that is still to flow into equity markets.

Valuations today are about one-third of what it was during the 1992 peak. Interest rates are one-third. In some ways, I can say at the present index level of 5,000, valuations are at 10-11 per cent of the levels they were during the 1992 peak.

The market can go down about 500-700 points, but I am a bull. I think we have just started one of the longest bull markets in history.

DAMANI: What sector would you recommend now?

JHUNJHUNWALA: I think over the next 24-36 months mid-cap pharma will outperform.

DAMANI: Sanjeev, what's the outlook over the next year?

SANJEEV DUGGAL: The outlook for the economy is good. We don't really follow the markets per se because the Sensex does not fully represent the underlying stories available in the markets.

For instance, middle-line pharma that Rakesh talked about is not represented. But generally the broad markets look good and returns should be reasonable going forward.

DAMANI: People say that the current bull market is nothing but a liquidity driven rally. What's your call?

DUGGAL: Liquidity would not come in if outlook is not positive. The recent rally is basically to catch up with reality.

Going forward, it will depends on how fundamentals pan out, which, I think, will be positive.

DAMANI: How much more can come in from FIIs and how big a threat is FIIs pulling out of the market (they hold 40 per cent of free-float Sensex)?

DUGGAL: If you look at FII ownership in India, it is about 10-12 per cent of the overall market in India. If you look at countries like Taiwan and Korea it is about 40 per cent.

In Malaysia and China it is 20 per cent. In that sense, India is under-owned. Again, my biggest disappointment is that domestic investors have not come in a big way.

The markets are fixated about FII money moving in and out of the country. I think local money is more important. Unless outlook changes fundamentally, there is no reason for money to flow out.

DAMANI: How does the rupee appreciation transform the economy? Does dollar depreciation worry you?

DUGGAL: May be the Chinese currency is more important. The Indian rupee is overvalued relative to the Chinese currency.

If the Chinese currency appreciates, which some people expect, it will be a big positive for India assuming the rupee does not appreciate by an equivalent amount.

Also, currency is an uncontrollable factor. So we tend to disregard the impact of currency for our analysis.

DAMANI: Sukumar, can you look an year ahead and tell us what you see?

SUKUMAR: I would generally agree that we are in a bull market. In 1994, we had 25 per cent of the country's savings coming into equities directly or indirectly.

Last year, it was less than 2 per cent. It can't go much lower than that. There has to be a shift in asset allocation. And that will happen when interest rates have bottomed out.

Because as long as interest rates are falling, people are not looking at the accruals in bonds, but capital gains. Once that stops, bond as a class will become less attractive.

Then there will be a big shift towards equities. And potentially the markets could go up substantially.

DAMANI: Sanjoy, what worries you most about capital markets today and how do you see markets an year ahead?

SANJOY BHATTACHARYA: Everybody has said that GDP will grow and the government will adopt sound economic policies as a result of which corporate prosperity will be enhanced. Two things worry me.

As a country we have a large fiscal deficit. The effects of that, if not controlled, can be very troublesome. Even a country as powerful as the US in economic terms is now finding it a tough fight.

How does a country sustain higher levels of growth? China has managed to lift a lot of people below the poverty line to respectable levels because GDP has grown at some 7.5-8 per cent compounded for the last 15 years. You can have sustainable GDP growth only if you put infrastructure growth before that.

This government has so far managed to present a reasonably pretty picture to the rest of the world by cutting out what they should have done into infrastructure. That's not very healthy.

DAMANI: Bharat bhai, would you worry about the dollar depreciation as an Indian investor?

BHARAT SHAH: For most of us here the investment opportunity is only in this country. Today, there are a couple of dozen companies which are truly world-class. Either they are cost leaders or size leaders or both.

These companies will not be affected too much by the dollar-rupee issue. To my mind, that is not central to the investment thinking in stocks. If at all, it can be a minor irritant.

DAMANI: Raamdeo, can you give us some insights from your wealth creation study? What do you think markets value most?

RAAMDEO AGARWAL: I read a book by Philip Fisher which said that everybody knows the price, but not the value. In the last study, we found that there is a huge gap between price and value.

Market values corporate earnings, corporate earnings growth and interest rates. And one should keep a margin of safety while purchasing a stock. If you understand these four things, you need not worry about anything else.

In 1992 when Sensex touched 4,500, the P/E was 70 and interest rate was 22 per cent.

Today, when it has touched 4,500 again, the P/E is 14 and interest rate is 5 per cent. If you consider Sensex as a scrip, it has earnings of Rs 350 for 2003-04.

At 5,000 level, the P/E is 14 times. Based on 2005 estimated earnings of Rs 400, Sensex trades at 12.5 times earnings. There could be a potential loss of 20-30 per cent because of FIIs pulling out, etc. but otherwise the market looks well-poised to leap if we assume that earnings will continue to grow at 15 per cent over the next few years.

SUKUMAR: I would like to add a point here. The dominant factor behind India optimism is the demographic transition around the world. Output has to be produced in the world.

So which are the countries that have the hands to produce it? Japan and Europe have an aging population. US will also join the club soon. That's why India and China are important.

DAMANI: Yes. 51 per cent of Indian population is below 21 years of age. Because they are going to be consumers and producers. Part of the euphoria in Asia is because of this demographic transition. Now, let me ask something everyone here would be curious to know. Even though our country may be doing well, a bear phase will eventually follow the bull phase. So, what are the signs investors should be looking for on whether the markets have topped out?

DUGGAL: Look at when valuations get to crazy levels and at the greed versus fear factor.

So, when you see valuations going out of sync with the picture on the ground, that will probably be the sign where you should cut back. Exit when you see P/Es stretched and do not reflect what is really happening.

SUKUMAR: One other important factor is over and under-ownership of a particular class of assets. Equity as a class of assets is under-owned. But time and again, equity is that class which can create wealth.

A terrorist threat may delay the cycle, but if valuations are reasonable and the class of assets is under-owned then there has to be a build up of momentum sooner or later.

BHATTACHARYA: For me a simple test that a bull market is about to get over is when there is a rush of weak companies wanting to do an IPO and are subscribed to heavily and quoted at a big premium.

Another signal is when cats and dogs reach five-year highs. Also when people talk of replacement cost as a valuation measure, it's time to get out.

SHAH: The classic difference between price and value is the key. Most people are busy valuing price than pricing value. More than looking around, I think it's important to look within.

AGARWAL: Signals will be different every time and that's how you always get fooled. In 1992 and 2000, I got fooled in bank stocks and IT stocks respectively. And if you haven't got fooled, markets haven't peaked.

JHUNJHUNWALA: The warnings signs are when earnings peak or expectations from future earnings are irrational combined with an extreme participation in the markets.

Statutory warning: All the persons in the panel are in the business of buying and selling equities for a living. They may have holdings in the stocks they recommend and also have vested interests in what they speak.

It is also possible that they may change their view expressed or act contrary to what they have said either on account of change in fundamentals of the stocks they talk about or their personal situation. Investors are requested to consult their financial advisors before acting on these suggestions.

RAAMDEO AGARWAL

BIRLA JUTE: This company is the fifth or sixth largest cement manufacturer in the country with a turnover of Rs 1,200 crore, 5 million tonnes of capacity right now and 6 million under construction.

At the current price of Rs 60, the company is valued at $25-$26 per tonne in terms of market-cap which is around Rs 150 crore and $30-35 in terms of enterprise value (EV). I bought this stock at Rs 30 when the valuations was going at some $10-15 per tonne.

Compare the company's valuation with the Grasim-L&T deal which valued L&T's cement division at about $80-$85 per tonne. There is enough margin of safety. Beside, if the so-called cement boom happens over the next three-five years, the stock could see a rise to Rs 300.

ASIAN HOTELS: This is part of the Hyatt Regency group. In 1997 there was a hotel boom in India and hotels became really profitable. But post 9/11 there are no new properties coming in. The unique feature of this industry is that if you have 500 rooms, you can't accommodate 501 people.

Also, India is emerging and if one wants to do business in India, he has to be here. Now, the issue is that there are very limited rooms available; you can't put new rooms in two-three years. There are also huge entry barriers. This business is booming without getting noticed.

In India, leisure is invariably week-end outings. And if a hotel incurs costs all seven days and generates revenue only two days a week, it will be hurt badly, particularly in bad times.

Also, trade and business are already booming in India. Asian Hotels has 1,000 business rooms across three properties in Delhi, Bombay and Calcutta.

By rule of thumb, one five-star business room is valued at Rs 1 crore. That makes the property worth Rs 1,000 crore. The company has a debt of about Rs 200 crore. The current market-cap is Rs 300 crore. So, the downside is limited and the upside for the stock could be double or triple over the next two-three years.

HERO HONDA: Here I am not betting on the company's growth which was the reason when I picked up the stock earlier. Right now, I think that the company's current earnings and the modest growth ahead are not being valued properly.

I think money is made not because of the growth, but because of under-valuation. And I see a perceptible under-valuation at current price of 10 times earnings. We differ with some analysts in terms of earnings itself.

The skepticism about the stock is also to do with the general pessimism about the two-wheeler segment. At $400-500 per capita, people have no option but to opt for two wheelers. Two-wheeler penetration in India is just about 35 per thousand, while it is about 250 per thousand in Thailand.

Motorcycle penetration is about 18-20 per thousand or 2 per cent which is absurdly low. With the liquidity reach of finance, this should definitely improve. People worry about competition, but with three major players - Honda, Bajaj and TVS Suzuki - it's not too much to be concerned about.

BHARAT SHAH

IOC: It is one of the most undervalued ideas. If you strip off IOC's holdings in Gail and ONGC which is about Rs 110 a share, the stock is available at Rs 260 (4.5 times earnings) based on current price of Rs 370.

To my mind, petrol and diesel is a growth business in India. Also, while most people recognise Gail as a pipeline company, they fail to recognise IOC. The biggest pipeline in the country belongs to IOC; it's double the size of Gail. That make the undervaluation even more pronounced.

There is one more point which demonstrates the earnings power of the company. Last year it faced an inventory gain of Rs 1,750 crore and in the first half of this year it recorded an inventory loss of Rs 750 crore, a total swing of Rs 2,500 crore during the period.

The company also had to bear additional subsidy which was imposed in April. Despite this, IOC managed to more or less produce the same bottomline as last year.

IOC has a return on investment of 28 per cent, return on equity of 33 per cent apart from all the surplus assets which are yet to be monetised.

At current multiple, the stock is quoting at a substantial discount to the market P/E. And if we are talking of a genuine bull market, then large companies (IOC is second biggest in terms of market-cap and profits) must have P/Es somewhat similar to at least the market P/E.

MOSER BAER: This is the third biggest CDR and DVDR manufacturer in the world and lowest-cost manufacturer of both CDRs and DVDRs in the world. It has proved a number of times that it can sell to the best names in the world and has been growing consistently.

People worry that the business requires money constantly. That is a fact, but the incremental return on capital is consistent at around 27-28 per cent.

So the new money deployed for growth is productive. At current price of around Rs 555, it is quoting at less than eight times. With solid return on investment and a good return on equity, I believe there will be significant sustained growth rate.

KIRLOSKAR OIL: This stock is quoting around Rs 250. If you take off the value of its external investments (Cummins and some more), even at a nominal discount to current market price, you get Rs 100 knocked off from the share price.

In effect, you are getting the remainder of the business at about Rs 150 which is less than six times earnings. It's a very large-sized company and yet the market-cap is not even a meaningful fraction of the turnover.

It may come as a bit of an oddity, but the company is bigger than any of the multinationals in its areas of business. It's a full tax paying company with zero debt.

SANJOY BHATTACHARYA

KARUR VYSYA BANK: The fact that Rakesh Jhunjhunwala, India's most highly regarded investor, owns it for the last nine years and is its single largest owner is testimony to the quality of the stock. The bank has a balancesheet size of Rs 7,000 crore.

This year it will produce net profits of Rs 160 to 165 crore. It produced Rs 76 crore in the first half. It's a bank which is focussed on lending to certain sectors (particularly textile) which is doing much better now.

This is reflected in lower NPAs, partly due to provisioning and partly due to change in fortunes of the industry. The bank has two other things going for it which is fairly important in banking. It doesn't have a capital adequacy problem (close to 20 per cent), which means it can continue to grow for a long time without having to dilute its shareholdings.

The second thing is that the bank has adopted technology in a big way. From zero ATMs two years ago, it is likely to have 150 of them by March 2004.

If the bank earns Rs 160 crore this year, it will have an EPS of Rs 90. The stock is currently quoting at Rs 303. Its adjusted book value (if you strip off all the NPA provision completely without taking any credit for unrealised treasury gains) is about Rs 250. So it's trading at 1.2 times price to analysts' book value. To me it's cheap.

The icing on the cake is that it could be taken-over. The fact that Rakesh owns it is enough for me!

TATA TELECOM: Very simple idea. The company makes the equipment. It has a tie up with a company called Avaya which is a leader in high-end equipment for what are called contact centres or call centres.

Roughly 48 per cent of the business comes in from this segment and another 12 per cent from maintenance contracts with companies which buy their equipment.

So that's an ongoing form of revenue and it is going to increase that as it gets more and more of its equipment in place. Imports won't be a threat to this business because for a call-centre, if the equipment has any down time, it's complete loss of revenue.

So having a service sort of a team or a service network on the ground is absolutely critical to getting clients in.

Tata Telecom has moved away from old low-margin capital-intensive business like EPABXs to selling high-margin equipment which it doesn't actually manufacture. And that's why it's much less vulnerable to the reduction of tariffs or duties.

Also, as high-margin business comes into place, the services business will automatically grow as it is a function of the price of the equipment.

Tata Telecom has come out with stunning results in the first and the second quarter of this year. If the first and second quarters are any indication, it should earn close to Rs 24-25 for the year.

If it gets BPO coming its way and gains repeat orders from existing clients as it grows, SG&A expenses will be lower and March 2005 earnings could be Rs 35.

At current price of Rs 165, it's trading at roughly 4.25 times March 2005 earnings and 6.5 times March 2004 earnings.

MONSANTO: It's a low IQ stock! Requires no intelligence! The company has two businesses. Roughly one fourth of revenues comes from seeds and the rest from herbicides. It has the right to distribute and sell seeds made by a joint-venture company called Monsanto-Mahyco.

Monsanto is a company which has proprietary technology in the seeds business which is unique. There are only five or six companies in the world of the scale and depth that Monsanto has in agro-chemicals and agri-inputs.

So the seeds business is something that is very high-margin and immediately improves productivity for the farmer and has immediate payoff, both in terms of revenue and lower fertilizer and herbicide usage. Monsanto is the market leader here in terms of sales.

And it is focussed on seeds for maize and sunflower which are cash crops. The growth opportunities in the seeds business is probably 20 per cent for the next 10 years in India. Because we are still a large agricultural economy.

In the herbicide business, it focusses on rice and maize and have very strong brands. Currently, there is a lot of manual weeding because labour is cheap, but eventually it will turn to herbicides as labour moves out of agriculture.

Monsanto should earn Rs 70 this year. It trades at Rs 975.

So it's not cheap. It has a return on equity of 22-23 per cent. It has great commitment from the parent which owns 72 per cent and sees India as a big market.

It gave Monsanto the technology in seeds by merging Monsanto Enterprises into Monsanto Chemicals. And this is a stock which, if the power of compounding works, will in five years make a 'hazaria' a 'dus hazaria'

SUNDARAM CLAYTON: Sundram Clayton owns 60 per cent of TVS Motors. The interesting thing is that Sundram Clayton has a market-cap of Rs 750 crore, but the value of its share holding in TVS Motors is Rs 1,000 crore. Yet no one wants to buy Sundram Clayton. So you are getting Rs 250 crore and two businesses free!

I wonder why. It is quite tricky because Indian investors tend to be very skeptical about valuing and controlling investment interests of the promoters.

R SUKUMAR

I cannot recommend stocks because of compliance issues. But I will tell what kind of companies we like. I am not commenting on whether one should be buying these stocks at current prices or not.

Essentially, we need a management with integrity, a set of skills that enable them to use opportunities in a meaningful manner. The environment should be conducive to create wealth in the next few years.

In this sense, I think the maximum opportunity seems to be in the pharmaceutical sector, essentially the companies which are looking at the global markets as well as the Indian markets. These are companies like Reddy's, Pharmaceuticals and Ranbaxy.

Why can they create much more wealth? Firstly, because the amount of capital you need to invest in order to create a lot of profits is low. I am very comfortable with Reddy's and Sun in their ability to generate wealth for the shareholders in terms of EVA.

I don't want to comment on their stock prices and whether they are a buy. But I think the chances of these companies generating a very high EVA compared to the current market-cap is extremely high.

Similarly, I think HDFC Bank has ability to create a lot of EVA in proportion to today's market-cap. If it has competitiveness in cost structure and in creating certain things which make its customer stick, then it can have margins in excess of competition for a long period of time and still grow substantially.

Both the factors put together can enable it to generate a lot of wealth for investors.

SANJEEV DUGGAL

PHARMA: We like the pharma sector and it's something we have been overweight on. We have been overweight in Indian pharmaceutical stock, not MNCs. Stocks like Reddy's and Lupin would be among the top few holdings in our local fund.

The other thing we like is consumer discretionary stuff. People talk about a lot of wealth to be made in the markets. There is a lot of money lying in bank accounts which people are not putting into our mutual funds. They will, hopefully, spend it and we are looking for companies that would benefit from the growth of India going forward.

There is something else that we have been in for a few years - IT enabled services. In our portfolio Mphasis BFL has been a top holding since we launched our fund locally. Those are the sort of sectors that we are interested in.

RAKESH JHUNJHUNWALA

TATA INFOMEDIA: This is a stock in which I never made any money. In this business, the capital intensity is very low, and, hence, high return on assets and capital. It has negative working capital. It's the leader in Indian yellow pages and the largest publisher of specialty publications in India.

Its market-cap today is Rs 180 crore and it has got Rs 80-90 crore of liquid assets. If the economic scenario is good, the advertising for yellow pages should be very good.

GEOMETRIC SOFTWARE: I believe that unlike other small soft ware companies, Geometric is in a space in which there can be no encroachment. It's in the PLM (product lifecycle management) space. There is going to be vertical and horizontal increase in Geometric's market.

Geometric until a year-and-a-half ago was working only for companies which created this software. Now it is going to work in the implementation and the servicing of the software, which is a much larger market than the creation and selling of the software. The (PLM) space going to be the biggest element of enterprise software.

TITAN: If India is going to grow at 7 and 8 per cent, which I believe it will over the next five years, I think FMCG and consumer durables demand will go through the roof. Titan has 55 to 60 per cent of India's organised watch market.

It also has a jewellery business. The size of the Indian jewellery market is roughly Rs 45,000 crore. I think there will be an explosion in growth.

The only problem is it has a very difficult balance sheet; it's highly leveraged. There is some element of risk. One should be very careful when you buy it. Also, I think one should buy it only if one has a three-five year perspective.