NBFCs Stand To Gain More Than Banks As Rate Cut Cycle Nears, Says Trust MF's Mihir Vora
Markets are rewarding lenders who have a predominantly fixed rate book, which happen to be NBFCs, he said.
Non-banking financial companies are tactically better placed in the short term than banks as a likely interest rate easing cycle nears, according to Trust Mutual Fund's Chief Investment Officer Mihir Vora.
"Within lenders, we are positive on NBFCs as they have fixed-rate loan books, and when rate cuts come, liabilities get repriced downwards immediately," Vora told NDTV Profit.
Markets are rewarding lenders who have a predominantly fixed rate book, which happen to be NBFCs, he said. Conversely, for banks, the majority of their loan book features floating rates, leading to a faster repricing of assets.
The RBI, in its August meeting, kept its benchmark lending rate unchanged at 6.5%. India's retail inflation dropped to a five-year low of 3.54% in July, below the central bank's key target of 4%. The easing price pressure comes as the US Federal Reserve prepares to turn dovish in its meeting next week, a key trigger for most global monetary policy decisions.
Vora is also bullish on the non-lending financials space, saying financialisation of savings and premiumisation will continue to trend further to benefit insurance and asset management companies.
Vora stated that a Fed rate move next week will affect commodities and general trade flow for the global economy, but Indian IT companies will benefit as US client tech spending rises.
Furthermore, if the pace of rate cuts in the US outstrips that in other regions, the dollar can undergo gradual depreciation, which would be beneficial for risky assets, he said.
While the US economy slows down, Vora said India will continue to perform better than peers as the outlook for domestic consumption improves.
"We are incrementally seeing some positive commentary from rural-focused companies. There is a feeling that the worst of the slowdown in rural consumption is now past us," he said, further noting that a good monsoon will bode well for rural even as urban India disappoints.
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Mihir, and just such a perfect day to get you, we've seen the non-farm payroll data come out, and the interesting thing is that maybe earlier the market wanted weak data to lead to some heavy central banking action for the markets to do well. Now the market seems to be worrying that, yes, there will be central banking action, but growth seems to be a problem, and therefore there is a worry out there too. How do you look at this curious set of events?
Mihir Vora: So, the market always wants Goldilocks, right? But you may not get Goldilocks all the time. So, the market wants the US economy to slow down just enough so that there is a justification for the rate cuts, but not too much that it goes into a recession or something like that. So that's something that you know, is wishful thinking.
My base case is that the US continues to slow down because if you look at the overall macro picture in the US, the excess savings of the households has actually been depleted, the excess savings that we saw because of the Covid stimulus, that is depleted. So you can't continue to expect the same kind of fraction in retail sales, in services, etc, that we have seen in the last two, three years, and the farm rolls data and other data points in the last few days that we have seen, especially on the job creation side, there is a distinct sign of slowdown. So, I think my base case is that the US continues to slow down, as far as the retail consumption, etc, is concerned. So, you may see some downgrades on that space.
On the flip side, that may not immediately lead to technology spending, because corporates have made a lot of money. You are seeing earnings resilience in the tech sector, at least so far. So you may not see the immediate impact for Indian IT services, but for the global economy, as far as commodities are concerned, as far as you know, general goods and services trade is concerned, you can see some slow down.
Okay, there are a slew of central banking decisions. I think we have ECB this week, and the Fed may be following some of the European Central Banks based on your base case of the US continue to slow down, but we are also looking at Fed action... What is your stance on risk assets in general? Will come to India valuation specifically, but I remember you telling me that central banks have been the driving force behind market moves ever since Covid lows. Does that continue to be the case or would you be sceptical on risk assets?
Mihir Vora: I would be a little circumspect, but not necessarily, for say flows to emerging markets, because what we are, what the banks are trying to do is make sure that the dollar does not appreciate too much or depreciate too much. But if the pace of rate cuts in the US is faster than the rest of the world, then you might see a gradual depreciation of the dollar against the major currencies, which can lead to a little bit of positivity for the risk assets.
But my observation of the years is that ultimately, it's the growth that matters and if the rate cuts are happening in a slowdown cycle, then it does not necessarily have a salutary impact on the risk flows. I think the base, the fundamental requirement, is growth and if growth is slowing down, then you can see some volatility and some uncertainty, for sure.
Now, just trying to figure out what happens sectorally, and I'll come to individual themes or individual ideas in a bit, because I see some of the changes that you presumably have made to your portfolios too. So, we'd have some questions there. But before that, is it a turn for some of the lesser performing names which are trading at better valuations to make a bit of a comeback, cyclically, and for some of the ones which have done really well in the last 12 to 18 months, to take a bit of a breather, or maybe even correct. Could there be a barbell strategy of sorts?
Mihir Vora: I think the base cases and the themes will remain the same. You know, we've discussed this in the past, that we are more bullish on the domestic economy compared to the rest of the world. So that base case remains. Within that we are still of the view that, you know, the financialisation of savings and premium consumption will structurally continue to do better and a physical asset creation, which includes infrastructure, manufacturing, real estate, will continue to be the focus area for the markets.
The other one is, of course, that new business models will continue to get involved. We see a lot more companies with these, new age, new tech companies, which will, you know, be an interesting space to watch out for. So, these three, four themes, I think nothing has changed in the last four-five months, performance that for us, that remains.
Within that what has happened is that while, say, one year ago, two years ago, some of the manufacturing themes, defence, etc. even railways were relatively unknown and underowned in the institutional portfolios. So of course, they had a dream run. We saw many multibaggers in that space. But now I think we probably overshot a little bit and typically when you have too many thematic funds in the particular segment coming in, which means that the sector is now well discovered.
So, to the extent, the last two five months, we have seen a slew of funds in this physical asset creation, manufacturing defence, etc. and stocks, of course, didn't run up and make a peak. So, I think, for the time being, while we are very, very bullish on these segments in the medium term, for a three-to-five-year view, probably stocks had overshot and deserved correction/traction.
So, in the last couple of months, we have reduced allocation purely based on valuations. I don't see too much threat to earnings, but purely because of valuation overshoot, you know, we have reduced space in some of these segments. Over the last two, three months what has also happened is that we are incrementally seeing some positive commentary from the companies which deal in the rural markets.
So it's not like all gangbusters and you know, things did very well, but if you look at some of the data points, like, you know, apparel consumption in tier two, tier three, tier four towns, commentary from some of the FMCG companies, there is a feeling that probably the worst of the slowdown in the rural consumption is probably past it, and on a basis of good monsoon, we should start seeing some pickup.
So rural consumption was something that we were negative on, but probably we are getting incrementally more positive, and we kind of added a little bit of exposure to this theme. So that's one thing to look for. I think rural versus urban consumption wise, rural incrementally may work a bit better.
Urban consumption is a mixed bag. You know, cars are not doing that well. Two-wheelers, which are rural, are doing well. I think rural versus urban, rural begins to look a little bit better.
The other big one, actually is financials, where we do see a theme where the market is expecting rate cuts, but the impact of rate cuts will not be uniform in the short term. So to that extent, the markets are kind of rewarding lenders which have a predominantly fixed rate book, and that happens to be, typically the NBFCs, the lenders and non-lenders. So, for lenders, we have Banks and NBFCs, for non-lenders, we have a host of companies in the capital markets, Insurance, wealth management, and broking asset management space. So, the non-lenders, we are more positive non-lenders to start with, because it fits in with the financialisation of savings theme for us.
So, we have more bullish on that and within lenders, within banks, at least for the medium term, not medium term with a short term, we are a little bit more positive on the NBFCs, because lot of the NBFCs have a fixed rate book, and when interest rates come, the liability will get repriced downwards and immediately, assets will take a little bit of time. For the banks, most of the book is floating there, so the assets will get repriced faster. So, you might see a little bit of compression for the short term for banks. So technically, I will be more positive of the NBFCs within the lending space.
Mihir, I heard you say that you believe more in the domestic themes and less on the global facing themes. But I do see and correct me if I'm wrong, but relative to June, in July, your exposure to IT has increased from what sub-6% to maybe around 9% is that true and if so, why is that a bet when you are more focused or more constructive on domestic?
Mihir Vora: Sure. So that's more based on the profit booking that we did with some of the cyclicals that I mentioned. So for example, while we continue to be very positive on defence, infrastructure, manufacturing, we had a huge exposure to that segment, which we have dreamed about dramatically, we almost had about over 20% exposure, which we have in the last couple of months till now, to about 10%. So that reallocation of the 10-12% that we do, some of obviously, some of it obviously went to IT were significantly underweight. So, you can say we are not, like, very positive on IT, but we significantly reduced the underweight position that we had.
Okay, but you're not too constructive on IT. This is just a reduction, Okay, before I come to Pharma, what about some of, I mean, within IT pack, IT services, ER&D, and we have some of the tech plays which are more domestic focused and we've seen the kind of gains that the Zomato, PB FinTech, now even a Paytm is reviving, etc. and then there's some of the others too. Within this bucket, I mean, and I'm presuming that even the domestic take place from a part of this 9%, correct me, if I'm wrong again, where is it that you're more constructive within these buckets?
Mihir Vora: I don't really treat these new business model companies as I.T. companies because they are more consumer companies, in my view, because they face the consumer, and use technology, of course, to reach the consumer. But for me, they are more consumer companies. So we are very constructive. That's one of the things that we are definitely playing on those new business models. So that's definitely a plus for us, yes, for us, overweight.
Within IT services, I would say it's a stock picker market. But in general, if I were to look at the top four, five companies, we are talking about at best, single digit kind of growth. My view of the large IT services companies is that we will revert back to pre-2019 growth rates, which is again single digits for the medium term. The spike that we saw because of Covid spending on IT by U.S. corporates is past us. So on that basis, I don't think we are.
They're not, let's face it, they're not doing the business model dramatically to give us the confidence that they are going to grow faster than what they did in the past. So to the extent it will be a good, predictable, medium growth, medium expectations, kind of sector. But if you expect the Indian economy to outperform the rest of the world, then you probably don't want to be very overweight on the large IT companies.
In the mid and small cap IT services space, there are companies which have different target segments, as you mentioned, ER&D, there are companies which focus more on BFSI. So, my guess is that you might see some more attraction on the BFSI spending space in the US after a long time, AI probably will give some opportunities for some of those companies.
So, I would say that IT will more for us be a stock pickers market where we would like to pick stocks in the mid cap space, rather than go anywhere in the larger IT companies.
Mihir, Pharmaceuticals, the price action seems to suggest that there is a bit of flow into some of the specific pockets, but the US generic makers have already had a rally in 2023 too. Are you constructive or are you part constructive, would love to know?
Mihir Vora: Pharmaceuticals, we are constructive now, compared to four months ago, a couple of things, structuring the sector did both with ups and downs in the last four or five years. But I think the worst of the generic pricing pressures are most likely past us. So that's one good thing for the generic companies.
But I think post-Covid, what has also happened is that a lot of companies are now looking for the CDMO opportunity for India, the CRO opportunity for India, because, like it or not, people have realised that we need to, for the sake of security, diversify away from China, and China is really big on CDMO. So, I think apart from the generic opportunity, the CDMO opportunities have also opened up for Indian pharma companies, and that's the reason why we do think that in the next three to five years, this sector should do quite well.
The good thing about the sector is that you also have companies with a predominantly domestic exposure. So, there's a right basket to choose from. You can choose companies which are more like FMCG companies, because they do the local markets. You can choose the generic companies, or you can choose companies which are in the research and CDMO space. So, there's a whole gamut of companies to choose from, which makes it a, you know, interesting sector.
Okay, and again because it may be a very bottom-up theme here in pharma, but also sectorally divvied up, right? Healthcare, very divvied up, CDMO, as you said, or pure pharma, or even other facets of healthcare. Is there a first among sequels there? Is there a theme within pharmaceuticals that you like more versus some of the others?
Mihir Vora: If you look at the incremental target markets which are opening up, I would say it's the CRO and the CDMO space, because that's something that not many Indian companies were focusing on and you know, this is something that's opened up in the last two, three years, because the multitasking companies, are actively looking to outsource from India. So that's one space we get where we can see incremental action.
By the way, just one quick follow up there. I don't want to make this entirely pharma discussion. One last question on China, but one quick question is a lot of talk of the Biosecurity Act being passed in the U.S. this week, and the impact that could have on CRO, CDMO. Is that something which is very big, or is it something that is difficult to analyse right now?
Mihir Vora: It is a significant move. You may not see the impact of it in the top lines of companies for one or two years, but structurally, it will open up a whole new opportunity. The target market, incrementally, can be quite large.
Mihir, one final word and I'm starting with macro, I'm ending with macro. The only difference is, I started off with the Fed and central banks, and I'm ending with China. You look at these correlations very, very closely, I would love to know I mean China deflating the way it is, and the impact that it has on growth globally, because it's such a large portion of the global economy, and the impact that it has on commodities per se as well, because such a huge guzzler of commodities, until it started deflating. What is the slightly medium-term impact that you foresee if China continues to deflate the way it is currently?
Mihir Vora: Specifically, commodities, you are asking?
In general and in commodities both, I would love to pick your brains on everything that you think about when you think of China?
Mihir Vora: Sure. So, first of all, I don't believe that China's GDP growth is going to come back for a long period of time, just because they have peaked up in terms of working up its population four years ago. Second is they have also created all the infrastructure and real estate that they need. So, there is a huge oversupply of infrastructure. There is a huge over supply of, you know, real estate in China and those, of course, are used because there are some commodities.
So, it's not a very good scenario for Chinese consumption of commodities and China happens to be half the market, or 70%, 80% of the market, in certain commodities globally. So, I think commodity price inflation is not going to come back in a hurry. That's my base case.
The other risk that you actually pointed out is that, because China needs to keep supporting its growth, and if you can't build more infrastructure, you can't build more real estate, what do you do? So they are ramping up manufacturing, and they are ramping up manufacturing, not only on the commodity place like, you know, say, your luggage and all and stuff like that. But they are actually going high tech also, so that, I think in terms of deflation will continue structurally, and you will see China becoming, you know, more dominant.
The hope is that, of course, in companies like India, Vietnam will come of it as an alternate manufacturing base to China. But China is not going to let that go easily, because they also need to keep going. So, it's going to be a race, and you know, when we are very positive on Indian manufacturing, it's not like it's going to fall in our laps without us doing anything. You really have to work hard towards it.
So Mihir, therefore, okay, just final quick 30 seconds or 60 seconds, if China does expand this manufacturing capacities the way it did in the past, or maybe more than that, and even if there are duties, if goods which are cheaper, land, in other in neighbouring countries, in a much lower cost, then it has an impact on product price inflation for manufactured products, even in India, right? Even if there are duties on Chinese imports, does that therefore make the attractiveness of the Make in India story slightly lower?
Mihir Vora: I think the government also realises it. You have, you know, for example, of course, duty is there. We then have to be smarter about the Free Trade Agreements that we are signing. For example, you can't, you know, let other countries act as a conduit and third is that there are non-tariff barriers that also, what we've seen from time to time that the government uses like, like BIS Hallmarking, which kind of is not, you know, it makes it a bit difficult for Chinese companies to import.
So, I think there is awareness within the system and PLI is another company, you know, so it can so on one hand you have tariffs, and on the other hand you have kind of PLI incentives for manufacturing, which makes it cheaper. So, I think we are trying to go about it, you know, from all sides, and we have seen good progress/promise, at least the last two, three, four years, have been very heartening in terms of electronics and a lot of sectors. But as I said, you know, you can't be sleeping at the wheel. You have to be continuously vigilant and proactive.
