The rural recovery theme has already played out to some extent. It is a relative play and it is not as if the rural is doing meaningfully better compared to the pre-Covid situation, says MD & Co-head, Kotak Institutional Equities.


The go-to space for markets right now is pharma. Why are pharma stocks rallying? Are pharma stocks and pharma earnings on a clear upward trajectory?
They have rallied very strongly due to two reasons. One is that going into Covid, they were somewhat undervalued. Most of them were trading in the range of 16 to 18 times March 22 EPS. We have seen a rerating in most cases to north of 20 times but now, they are trading at about 22 to 23 times. What has changed over here is the reinforcement of the fact that because business will continue to do well and somewhere the market was probably underestimating the value in the domestic business. These are businesses which will continue to grow at about high single digit low double digit for a fairly long period of time and not very different from the FMCG type of companies.

The second thing is these are complex companies which have revenue avenues in the US. The market is getting more confidence about the numbers at least for March 2022 and March 2023. Looking at the reasonably good performance of the company as also the news flow which is positive particularly for Cipla and Lupin, all that is resulting in a positive sentiment for the sector which had resulted in a multiple rerating. It is not as if the earnings numbers have gone up a lot. Just in case of Cipla, we have increased earnings numbers but otherwise, there are minor increases only which would not entirely explain the big run up in prices. It has more to do with a better understanding of the dynamics of these companies by the market over the last three-four months.

For the longest time markets have been obsessed with what is happening to the US generic market. What is your understanding of the US generic market pricing as that still is like the mother market?
That is true but only partly. As I was explaining earlier, these companies have a fairly good domestic business particularly the likes of Cipla and Sun which probably are not getting valued correctly. Coming to US generics, there is a base business where over time, the profitability will get eroded. But thankfully, companies have been positioned to launch more products.

Over the last two-three quarters, you have seen bottoming of the revenues in the US and at least product pipelines look reasonably strong until FY23. Even after that, depending on whether some companies should be able to launch the products even up till ‘25, the product pipeline is actually looking pretty decent. There is a reasonable amount of visibility on the numbers for FY22 and FY23.

Do you sense there is still opportunity for a headroom within the IT universe?
The stocks have run up and in a way, the near term upside will be somewhat limited. It looks like even in case of IT, the March 22 numbers are getting discounted which is pretty much a case for even the pharma names now. But what again has changed for the IT sector was in March, April and even May. The market was concerned that there would be a decline in revenues in March 21 and then the recovery may take time, given the negative impact of Covid or a break in the BFSI sectors revenues.

But it looks like there are a lot of foot forward avenues happening elsewhere in the sense that companies are being forced to invest a lot more. Digital offering has happened as a result of Covid. Every company, which was going slow on a digital strategy, has no option but to invest there whether it is in respect of customer acquisition, customer fulfilment or delivery

The companies are being forced to ramp up on the digital sides. That is where Indian companies are standing to benefit and to some extent, earnings numbers or the top line growth of these companies will continue to be on the higher side for a slightly longer period of time to whatever they have built in earlier. That explains why the market is now comfortable giving somewhat higher multiples compared to what the stocks were trading at before the Covid outbreak.

What is the best way of playing the rural recovery theme in your view? Is it through tractors, is it via the agri theme or should one stick to staples irrespective of the valuation they are quoting at?
The names do not change. The universe has spread to agrochemicals, two-wheelers, motorcycles, tractors and FMCG companies. You have to keep in mind the fact that the recovery theme has already played out to some extent and it is the relative play between the rural and urban, it is not as if the rural is doing meaningfully better compared to the pre-Covid situation.

It is just that it is doing better than urban but do remember that there is a large part of rural India which is dependent on services sector which will struggle and also the fact that you have started to see Covid outbreak in some of the more rural oriented districts compared to earlier when only the urban districts were impacted by Covid. That will also result in some impact on demand in rural India.

I would be a bit careful about extrapolating the trends which we saw in March, April and May over there. We have had obviously a good rabi crop and we had a bumper procurement by the government and it looks like the kharif crop will also be fine. But beyond that, I do not know what the story really will be in rural India.

Ultimately you have to create jobs in urban India which will result in migration of people from rural to urban because the salary differential is massive between rural and urban. Ultimately, urban India has to perform for rural economy to continue to grow on an absolute basis.

One of the big drivers of rural India is also the repatriation of money from urban to rural India. Rural India by itself will not sustain beyond a certain point in time and agriculture in its current form. We have written a lot on this. Fundamentally, it is not very viable. About 200 million people are dependent on agriculture given the average farm sizes of 1.1 hectare which is simply not viable beyond a certain point.

If India has to grow, we will have to move people out of agriculture to services. That is what the real story is and it is not so much growing, rural India continues to grow to do well.

There has been some amount of polarisation within the financial basket . How do you see things evolving from here on?
We have a very wide range of valuations currently. Some PSU banks are at about 0.5 times to book. You have better quality banks and NBFCs north of three times. Bajaj Finance is at 4.5 times to book. We have an extremely wide range of valuations.

It looks like at this point in time, the market is taking a call based on historical underwriting abilities of banks and NBFCs and disclosures of the banks and NBFCs on moratorium value as also on the collection efficiency. It is baased on a very simple assumption that moratorium value is good and high collection efficiency is good but that is a very simplistic way of looking at things. What also will matter is the loan books, the nature of lending secured versus unsecured etc, etc.

The current way we are looking at is the banking sector given the huge amount of uncertainty with respect to the trajectory of Covid in India and that is going to be critical. I do not think the current numbers really matter, what will matter is the how the economic recovery takes shape if it is fine then probably every bank and NBFC will get rerated and obviously the tier-2 and tier-3 banks will get rerated a lot more given where they are trading but if things continue to worsen in India in respect of COVID which would also have a greater impact on the economy and given the fact that banks are leverage plays on economy their credit costs and NPLs could be much higher than what the market is building currently if things deteriorate.

In that case tier-2, tier-3 banks and NBFCs would struggle but obviously the tier-1 banks will also come off in terms valuations recent positive news on decline in moratorium value and increased collection efficiency. I do not that is the end game over here we will have to wait and see how the situation pans out. It is only in December or March quarter that we will have a better handle on the level of NPLs and credit cost and then only you can take a call as to how we have got over this pandemic and how the books of the banks are holding in that case.

As of now, based on historical underwriting abilities and nature of loan book and the valuations, you have to take a call on how to play this on a more top down basis because the bottom up numbers will become clear much later.

ET Now: Certain changes have been made to the portfolio as well and so are there certain pockets of the market that you would prefer to exit on the basis of feeling that they are going to be out of favour or is this purely just on where you are seeing returns having topped out possibly. For example, I am noticing a PVR and I know you would not want to talk about specific names but just trying to understand if there is anything that you would like to stay away from currently.

Sanjeev Prasad: The way we are playing this whole Covid situation for the last four-five months is basically just dividing the market into three buckets. The ones which have not got that much impacted by lockdown and the second bucket was where demand got impacted significantly during lockdown but things recovered reasonably fast. The third bucket was where demand was impacted significantly during lockdown but also post lockdown you would see a very-very gradual recovery over there.

Bucket one has done very well which is essentially consumer staples, IT, pharma, telecom and Reliance. They did not get much impacted by the lockdown and the post lockdown situation is fine. Bucket two was essentially some rural plays, to some extent banking and financial services where you are seeing reasonable recoveries. As far as the banks are concerned, rural demand has come back pretty fast.

On that basis, we played this whole lockdown story and this gradual economic recovery that we are looking at. Is it time to look at the bucket – -three names which are essentially high ticket consumer discretionary items or investment names? It is too early to do that. It looks like because things have got impacted. Corporate balance sheets have worsened and unfortunately the government’s fiscal deficit number will cross 11%. They said that is not because the government is giving a stimulus, it is just because revenues have collapsed. The government and more importantly public debt to GDP will reach upper 85%. So the ability of any of these three segments to really spend goes down dramatically.

By the way, it is households in terms of buying essential real estate or private sector putting manufacturing capacity or the government setting up infrastructure capacity. Remember going into Covid, this part of the market or the economy was anyway looking very fragile. You had three quarters of decline in gross fixed capital formation and given the weaker financial position of all the three major players in the investment bucket.

I guess recovery will be a lot more delayed now. Unfortunately, it does not look like we will have an investment cycle very soon. You must stay away from the names for the time being unless two-three year valuations are really supportive.

Companies which have really strong balance sheets and which can tide over the likely downturn at best for next one year or so, is fine. The bucket one stocks are pretty fully valued at March ‘22 discount rates. Even March ‘23 gets discounted in some cases. Bucket two could go either way, especially the financial names, depending on how the Covid situation pans out. In bucket three, there is still some time with respect to a more structural recovery in demand over there.

ET Now: Do you think this time around the recovery is not going to be broad based? The reason why I am asking you this is because unlike the last recovery where everything which was asset heavy, any company which was sitting on high debt, any company which had high operating leverage have benefitted. Do you think it is going to be a very niche and a very specific recovery?

Sanjeev Prasad: I assume you are talking about 2008-09 which was the last time we saw a similar situation. Remember at that time, the fiscal deficit of India — between centre and state — was 4.1%. Going into Covid, we are at about 7% plus and the government at that time had the financial wherewithal to cut excise duty sharply.

If I remember correctly that went down from 14% at the start of the global financial crisis to 8% by April 2009, that was a huge amount of fiscal stimulus which the government could provide at that time which resulted in a pretty quick rebound in both the consumption as also investment demand.

So obviously, the lower excise duty, etc, supported consumption demand and the quick rebound in the economy did not result in the private sector holding back investment. Remember, at that time, you had a very aggressive private sector, ready to invest in all sorts of basic infrastructure. We have a very different situation, in fact 180 degrees different.

We have a situation where the government is in absolutely no position to provide any fiscal stimulus. So, even if our fiscal deficit will grow north of 11% this year, it is not happening because the government is providing a stimulus.

It is happening because the revenues will collapse and the private sector is clearly not in a position to invest currently, both the ability and investment problems are there. If you settle down for a very uneven economic recovery and my bigger worry is this very simple premise which everybody has when it comes to investment in India is that no matter what, India will continue to do at 6-7% GDP growth.

That will need to be looked at because without investment, we struggle to get to 5% real GDP growth on a more structural basis. But beyond that, if you do not get the investment engine to fire and do not create jobs, I do not know how you are seeing real GDP growth getting back to a much higher level on a sustainable basis and that has been the fundamental problem in this cycle.

Things were slowing down going into COVID, economies simply do not have the financial wherewithal to fight this slowdown. RBI is doing whatever it can do on the monetary side. But the ability and willingness to consume and invest both have to compromise pretty significantly.