Nirav Sheth, Who Called PSU Bank Rally, Is Bullish Even After Twofold Surge
Sheth is optimistic about PSUs and believes in the growth potential of India's lending sector.
Shares of public sector banks have nearly doubled in the past year and tripled over three years, outperforming private peers. According to Nirav Sheth of Emkay Global, the rally may not be done yet.
"I am very constructive on PSUs in general. And let's look at it. So have they rallied? Of course, they have rallied. The question is why they have rallied," Sheth, chief executive officer at the brokerage, told NDTV Profit's Niraj Shah.
With more investment opportunities and growth prospects visible in India, lending through PSU banks will increase as private banks may be a little more cautious about getting into project lending, said Sheth, who predicted the PSU bank stock rally early.
Talking about the recent regulatory actions against Paytm, Sheth said the Reserve Bank of India is just "trying to send across a message that rules are rules" and these need to be adhered to. He also said that it is an isolated case and people may overanalyse the situation.
On MNCs, Sheth said that a diversified portfolio is the way forward. He also said that it is important to have lots of stocks so that they are not tilted towards one side. "The growth in the larger, broader markets will be significantly higher than in the top 50 companies and eventually the market prices are driven by earnings growth rate."
Sheth said he is a great believer in manufacturing. He expects the capital goods sector to play a good role for the next several years. He also said that he would be zero-weight on commodities.
"I want to play the India Story over the next several years," Seth said.
Watch the full interview here:
Edited Excerpts From The Interview:
Let me start off with whether you are sceptical about the valuations—as a lot of people on the street are—or do you believe that the strong Indian growth, policy continuity, etc., etc., etc., will keep valuations higher?
Nirav Sheth: So, do you want to buy good stories cheaply? You want to buy that. Do you get that on a platter? It usually doesn't happen. All of us want corrections, but when corrections come they will come with a specific reason and a serious doubt which means that you may not be necessarily able to pull the plug then.
I mean, the markets were down to 30%, the stock were down 50-60% after the pandemic. None of us had a template in terms of how to things will play out. Right? How many of us actually went and bought anything over there?
So, I am still of the view that we are obsessively focused about valuation which is important and a key determinant of your long-term returns. But I think we are not giving enough emphasis to very strong economic momentum and what I would also call very strong political momentum. I have not seen you know, 70-80 basis point upgrades in GDP in a long, long time. Your income-tax returns are compounding at about 26-27%. Your indirect taxes are about 15-16%. The leading indicators—the PMI for services is above 60, for manufacturing close to about 85. And this is when you know the entire global world seems to be sort of slowing.
Don’t look at just India. The U.S. is making global highs, Europe has made global highs, Japan is at an all-time high, after 1989, because economic momentum globally has been better than expectations. We are at the fag end of your interest rate cycles. So I am very constructive on the markets. That doesn't mean that markets can deliver another 10%. They can, we don't know. But if you dig deeper, harder, there are enough ideas around in the large-cap space and also in the mid and small-cap space. And I reiterate, that for the next several years, I expect the broader markets to outperform the narrow markets. I would call it democratisation of earnings. A large part of the economic companies are getting deep benefits out of what is happening in the country.
In fact, some of the themes that have come up in the last 2-3 years are all themes which are not present by necessity in the market cap, in the top 100 companies. In the last two years, your conferences have had a slew of these mid-cap companies, which are promising earnings growth and which are very promising stories. Maybe valuations won't be expensive currently, but look very attractive from a growth perspective in the next few years.
What is it that stands as first among equals or as first among equals within this mid-cap universe for you, in terms of earnings growth or promise?
Nirav Sheth: I think you have big surprises in the capital goods sector. For example, there is a very high degree of visibility when you look at the investments that will happen in power and I'm talking about thermal power, renewables and stuff like that. None of the capacities have come up in the last 10-15 years. So the transformer companies, the boiler companies, the EPC companies, there's a big chain over there.
Likewise, you know, I am struggling to figure out. You know what is happening in data centres. Right? One megawatt will cost you around Rs 40 crore and we are talking about some serious amount of capacity that is coming up.
We are talking about investment that is happening in the smart meters. You know, 250 million smart meters over the next three years, each one will cost about Rs 10,000. So there are big numbers we are talking about. The interesting thing is, when we usually talk about capital goods 5-10 years back, it was largely old economy.
So a lot of infrastructure is going in, you know including in digital infrastructure, in data centres, in stuff like that. So e-commerce, electrification, and therefore, it's important that you try and analyse how this ecosystem is going to spread.
Think about semiconductors. You're not talking about small numbers. You are talking about almost about 1.4 trillion now which has been officially conveyed to three guys, you know, who are going to set up capacities in Feb.
So I see this phase to be very, very interesting going forward. And I believe, a lot of the companies will get listed. So today, you have got L&T, you have got BHEL, and then there is a big tail. And then, you do your work and try and figure out where you want to be. But I am a great believer of manufacturing, you know, comeback to India and I believe that capital goods will have a role for the next several years.
Okay. You reckon here that the story is the same—that earnings growth will make up for valuations. When I look at the MNC cap good companies, they were priced to perfection. ABB, for example, was priced to perfection at 4,200. But then come the results, then come the commentary. And the market suddenly realises that hey, a stock at 80 P/E or whatever the P/E may have been then, is also okay because of the earnings growth in the commentary and the stock bumps up 15-20%. So, it's not that the market didn't know it was expensive and yet good results are making up for it even in one quarter.
So how are you playing this? Are you buying the cheaper, second-tier, non-MNC cap goods, or are you comfortable even with the MNC cap good companies, which have got the technology advantage?
Nirav Sheth: It's a very good question. This is a conversation that I have with a lot of my clients.
It's not very easy to see 10 years ahead. So while I'm very confident about what's going to happen in terms of the capex recovery and stuff like that, I think the way to go forward is by having a very diversified portfolio. So I would create a portfolio, which will have probably an equal weight in Siemens, an equal weight in ABB, maybe an even underweight, but I will create a long tail, which is like owning a lot many stocks, and which is not coming back to my point that I made earlier. I would expect BSE 500 to outperform Nifty 200, Nifty 200 to outperform Nifty 50, over the next several years, because I see earnings going away and I'm talking about the growth, not necessarily absolute growth. The growth in the larger broader markets will be significantly higher than in the top 50 companies. And eventually, the market prices are driven by earnings growth rate.
So to answer your question, I would have a diversified portfolio. For example, you know, if you just look at the largest small cap mutual fund in the country—Nippon small cap—they would have close to 250-260 odd companies. And I think, that's the way forward. I think, given the equity diversification that the economy offers, you can today actually create a portfolio of 300 companies and do very well.
The other thing is the kind of changes that are coming, on the regulatory side, for some spaces. Last week, this whole conversation around the change in the bidding process for renewable energy or wind energy brought about a serious correction in some of those names as well as related names. And the companies are coming out and saying, hey, look at the targets, look at the things that have already been given out and we are fine for the next 3-4-5 years.
When you look at such things, how do you react to them?
Nirav Sheth: For people like us, who are great believers in free market capitalism, lazy-fair approach. And now, with the benefit of hindsight, we also appreciate that there are market failures that tend to happen. So you can't leave everything to markets. To that extent, I have become far more accommodative about regulatory interventions, if you want to call that. We have seen that with RBI. You know, we tend to again focus very much on the negative impact while we completely forget that they are systematically taking risks away. They have done a wonderful job. For example, you know, the fact that SEBI’s intervention in terms of the leverage that you have against the small-cap stocks. Now just think of it, every time you got corrections in the broader market, you know, your mid caps tend to fairly hold on to their own. So there is no collateral damage. Earlier, we used to leverage the small-cap stocks and buy the futures and stuff like that.
So, over a period of time, you realise that there is an element to it. In some of the cases, you may give away some basis points of growth. For example, if RBI is very conscious about the growth in unsecured loans and you are raising the risk weight, maybe you will grow a bit slower, but you will grow longer as well. So you will not have big peaks and big troughs. That, incidentally should improve your valuations as well.
My colleague Anushi says that Bernstein has downgraded SBI to "market perform" rating, emphasising that it's time that we switch back to private banks instead of PSUs now.
Nirav, somebody from your peer sets has downgraded PSU banks, somebody said that oh, is the PSU rally overdone, etc. Are you of the same belief that the runup is too fast, too soon? Last week too, a lot of the PSU stocks came under pressure.
Nirav Sheth: I am very constructive on PSUs in general. And let's look at it. So, have they rallied? Of course, they have rallied. The question is why they have rallied.
So now let's look at SBI, for example. SBI—if you look at consensus estimates—is likely to grow at about 15% CAGR over next two years. I am talking about earnings. Average ROE over the next two years will be 17%. Now this earnings growth rate is higher than ICICI, it is higher than HDFC and I think it is higher than Kotak. And ROEs are similar. So the fact of the matter is that when I look at the next two years, and if I just forget that it is a PSU balance sheet, and if I just look at the colour of the dollar, which is always green, then SBI seems to be outperforming. I think Axis is slightly ahead of SBI Bank. So the markets have rewarded a big evolution in ROE and the fact that your earning CAGR is similar to other larger peers and you're getting at a discount.
None of these are happening in isolation. You can make a case that PSUs will grow slower than private sector banks and therefore I can downgrade. And it is a call that you can take. I am not of that belief, number one.
Secondly, when we look at the consensus earnings right now, people are looking at the credit growth rate... We're looking at about an almost 14-15% growth rate in earnings. If you look at the last 10 years, India's credit good growth rate has been in line with nominal GDP growth. Therefore, your credit-to-GDP ratio has essentially been flat which is a disaster for a developing country like India. So I believe that you are going to get serious surprises. And I reiterate again that you're going to get serious surprises when the credit growth comes back, especially from capex recovery, which I just alluded to a while back.
For example, we’re talking about $1.5 billion of investment in the semiconductor (sector). The guys, who are going to write a cheque for Rs 10,000 crore or Rs 30,000 crore will be largely PSU banks. And I would expect private sector banks to be slightly more cautious about getting into project lending. We have not even see that—infrastructure lending. We're not even seeing the real participation that is going to happen. So if my assumption is right, then we're likely to see earnings upgrade happening in PSU banks.
Now let us look at energy sector, not only PSU banks. What happened in OMCs? You got earnings upgrade by 100% in fiscal ’24. And in the first half, the stock price was going down because analysts were refusing to believe that OMCs will not cut the prices pre-election. Suddenly, there was a big realisation and the stocks rallied. And they rallied furiously. But there was a catch-up that had to happen. You cannot expect this company to trade at two or three P/E, at the end of the day. Likewise, just for reflection, even today, OMCs trade at 10% free cash flow weight. Why would you not buy that? So I would keep my eye and focus on earnings, ROE, and the valuation context. I see no reason to be outside the PSU (pack). And I think, they are governed far, far better than they were a decade back. You have to make some adjustments for that as well.
The other thing is this whole regulatory action that is turning up the heat on select pockets of the market. Recently, one financial services institution, the other an NBFC, before that, Paytm. There’s a lot happening. I mean is this something that might make people a bit cautious on the valuations in that bucket or are these isolated cases?
Nirav Sheth: I would like to believe that they are isolated cases. This is what we just got in public domain. So there were some lapses on the operational side. And you have seen some interviews happening today that those are being corrected. In all the cases, the RBI has been extremely clear that we will come back and do a reaudit and if things are in order, it will be business as usual. So in a way, you're trying to send across a message that rules are rules, which need to be adhered to. And in a way, I think it's good. So it could lead to people overanalysing the situation and stuff like that. My sense is that our regulators in India have become far, far more agile. I also believe that a part of this could also be driven by the fact that you are into pre-election mood right now and you want to be very, very clear and agile about the fact that you don't want any risk generating for anywhere that can create some sort of political chaos. Therefore, you will probably try to err on the side of caution. I have not seen anything that would force me to have a look at you know, structural impediments to growth. Nothing on those lines so far.
On PSU banks or PSUs in selected pockets, you were way ahead of the street when the street did not factor in. Where is it that you are completely anti-consensus with the street?
Nirav Sheth: I would stay away from metals. That is something that I don't like. China is deflating, 9-10 months of deflation. They just had a marginal positive print. Excess capital is being set up over there for the world. And the world is not ready to receive that. So a lot of chaos. So I don't want to look at commodities. And that actually makes me very bullish on India because we are generally a net importer of commodities, and therefore inflation.
Second thing is consumers. So a lot of these companies started trading at 60-70-80 times without much improvement in growth in free cash flows. So while their net margins have doubled in the last 10 years, it has not led to a corresponding increase in the growth in cash flows. And I think, the competition is hotting up. So, let's say I'm running an extreme portfolio without any respect for benchmarks, I will be zero-weight on all the consumer companies, I'll be zero-weight on the commodities. I want to play the India story, over the next several years.
