Rising Per Capita Income To Benefit Two Sectors, Says Dalal & Broacha's Milind Karmarkar
Optimism remains regarding the performance of the consumption sector, despite the diminished allure of FMCGs. he says.
Short-term corrections are not a concern as companies are assessed with an expectation that profit and turnover can double in a five-year period, according to Milind Karmarkar of Dalal & Broacha Stock Broking Pvt.
If the strategy is selling the stocks over a short-term, then "we do not follow this", the senior fund manager told NDTV Profit's Niraj Shah in an interview.
Karmarkar said that consumption constitutes around 50% of the gross domestic product. "If India's GDP doubles, then consumption will also increase."
Optimism remains regarding the performance of the consumption sector, despite the diminished allure of fast-moving consumer goods companies, according to him.
A comprehensive approach to consumption, spanning sectors like banking and finance, insurance, healthcare, retail and FMCG is needed, according to him.
Here are the sectors that can flourish from rising per capita income, according to him:
Banking & Finance
Karmarkar said banking and finance are poised to excel. In the context of consumption-driven growth, the need for loans is expected to increase.
Retail segment banks are particularly expected to thrive, with a projected annual growth of 18–20% over the next five years, he said. "If (the) economy does better, banking and finance will do better."
Healthcare
As per capita income increases, there is a possibility that the domestic pharmaceutical industry will do "very well", Karmarkar said.
People may have more financial resources to allocate towards spending on medicines and healthcare services, he said. "We are focused on Indian pharma companies."
Watch The Full Interview Here:
Edited excerpts from the interview:
Do you worry that there is a correction imminent and let's sit on cash?
Minind Karmarkar: So, you know me. Basically, our focus is long-term and frankly, we don't bother about short-term corrections, so whether the fourth quarter is going to be slow, so we should move to cash, no, this is not the way we look at companies.
We look at companies with the view that in five years’ time, it is possible that the company will more than double, I mean its turnover and profit, and if the answer to it is yes, we don't mind small short-term bets. In fact, we may add, so, we always have 4-5% cash and whenever these types of opportunities come in, we would like to add to the portfolio. So, selling because there is a short-term issue is not the strategy which we follow.
Is there a short-term issue?
Milind Karmarkar: So, yes because some of the FMCG companies have shown kind of slower growth. There are people who are saying that rural is slowing down but if you believe that India is at a cusp of the next growth phase, where if you'll see most of the neighbouring countries whether it's Singapore, Thailand, Malaysia, China or even for that matter Japan, and so on and so forth… Once a country crosses $2,000 per capita income, the move from $2,000 to $6,200 or $6,000 is very rapid and if that is what we believe in and forget about tripling, but if the per capita GDP is going to even double in next five years, then what will happen is that what the GDP is today, we will be consuming in about five years’ time. So, there is a massive opportunity. That is the reason we are not so worried about it.
Consumption normally is around 50% of the GDP. So, if GDP doubles, whatever is today's GDP will be consumed after five years or so, then the opportunity seems to be very large. But if I look at the U.S., there was a time from probably late 60s to early 70s, when we had most of the FMCG companies who were the top performing companies in the U.S., but in 20 years, it was predominantly the retail companies which were the top performing companies because the baton of pricing power moves from FMCG companies to retailing.
I do see that happening in India as well. So, that is the reason, probably FMCG companies may not have that kind of glamour, which was there earlier, but at the same time, consumption will do well. That is not an issue.
One of the most talked about corporate comments was the quote from Baba Kalyani about how they see imminent slowdown both in domestic and export markets. When you look at the landscape, when you look at consumption very closely, when you look at the macro, do you fear an imminent slowdown or do you reckon it could be transitory in nature?
Milind Karmarkar: So, our portfolios are predominantly focused on India. So, that is one thing. But yes, when it comes to the global situation, there could be a slowdown … India could be impacted to some extent. So, let me go back to 2003, when prior to that, we had 9/11 and a lot of issues and I remember Reserve Bank's comments on April 1 for the next financial year and they said that though India is one of the fastest growing economies, there is a distinct slowdown, which we can see globally. It is possible that some of the large economies in the West may go into a recession and there is a Iraq War. So, despite all this, we do expect India to do well. But, we will be cautiously optimistic, so that is what they said. Come 2024, I think the commentary is going to be exactly the same.
Let's start off with consumption. Is the portfolio bent towards taking advantage of the K-shaped consumption that we are seeing in India and are across the upper crest or not necessarily?
Milind Karmarkar: So, let me just clarify here that again, first of all, I need to clarify that whatever stock-specific we discuss, there is a possibility that we may own the stock. In fact, it's more likely that we may own the stock and I may own the stock myself as well. So, this is not a recommendation and it is only for discussion purposes. So, coming to the way we look at consumption, we look at all the sectors which benefit from rising per capita income. So, whether … it's finance, insurance, healthcare including hospitals and pharmaceuticals, and of course, retail and FMCG and travel, we do believe that all these sectors will benefit significantly.
So, our sort of map of consumption is much larger rather than only focusing on a certain aspect. We continue to believe that in this sector as a whole, there could be some which may not do so well, and some which will do very well. But this sector as a whole will deliver very good returns or in fact, I can say market-beating returns in the next five years.
Let's talk about the ones which you believe will do well.
Milind Karmarkar: Okay, so what will do well, I think finance, banking and finance should do well… We do expect that retail-centric banks are likely to do very well. In fact, I wouldn't be surprised if they deliver 18% to 20% year-on-year growth for the next five years. Albeit currently, they have not done so well, but at the same time, I do believe that over a longer period, banking and finance. If the economy does well, banking and finance has to do well. Period. There are no two ways about it. So, that's why banking and finance is one.
Hospitals I think I've talked about earlier also. When I met Dr Devi Shetty long back and then I asked him, what will drive growth of hospitals, they had just listed at that time. So, he had told me that it's predominantly insurance penetration and rising per capita income.
Same thing Dr. Reddy of Dr. Reddys Labs told me way back in ‘95 when they were focusing more on exports rather than domestic because he said that in India, people don't have money to spend on medicines or hospitals and that is the reason why our focus is exports.
But as your per capita income goes up, there is a very distinct possibility that Indian pharma will do very well. So, I missed out on pharma some time back. So, pharma also constitutes a consumption story for us.
So, there is pharmaceutical, there is BFSI and lenders, private banks, not necessarily PSU banks?
Milind Karmarkar: We have a couple of PSU in our portfolio and again, there is a reason for that, like we have Jammu and Kashmir Bank in our portfolio. So, in August, I went to Kashmir. I saw that the valley had come back almost to normal and in most of the places, there was a J&K Bank presence, while other banks were not there. It's not that over a period, other banks will not come in. The management had changed completely and J&K Bank is likely to be the biggest beneficiary of peace returning to the valley where people will have more spending power. So, that's why J&K Bank and SBI even because I think that even technologically, they are doing something very nice and they will benefit. So, these are the two PSU banks which we have in the portfolio. The others are predominantly retail-centric banks.
Do you reckon that this valuation will catch up, that PSU banks have done better than the private banks as an index. Do you think this valuation catch up still has room to go? J&K or an SBI, whatever else, will it benefit both from earnings growth as well as further valuation rerating as well or is the story over?
Milind Karmarkar: I doubt whether they will be. They will benefit from their income growth. They may not be the ones that if you go to a PSU bank, you realise that the attitude still needs to change. So, that is the issue.
There has been a valuation rerating, you don't think there is further rerating?
Milind Karmarkar: No, I don't think so.
You mentioned the thesis around pharma, hospitals, etc. Are you present across the chain or are you present within specific parts of the chain today?
Milind Karmarkar: So, we are present in pharma, India-focused pharma companies… Hospitals we do have, but it's India-focused pharma companies that we would like to bet on more than pure export-driven companies. We also have a sort of pharma distribution company in our portfolio, but that is purely as a concept stock. It is a kind of a startup but it's listed.
We are looking at a couple of more hospitals. No diagnostic companies, we have avoided them.
So, with hospitals, there is a question about them getting more branded players and therefore more pricing power. Or is it purely a question of earnings coming through better over a period of time and spending?
Milind Karmarkar: They are into an expansion mode. So, they are something similar to retail, so they will have a number of stores added and same-store sales growth. So, it's a combination of the two.
I understand you look at consumption across a variety of buckets. I am drilling it down to pure consumption. Is there merit in betting heavily on things which are focused on premiumisation?
Milind Karmarkar: So, I was reading a book which talked about conspicuous consumption and in conspicuous consumption, they defined it as that consumption like when people's per capita income increases, for them going to a large-format store like a Zudio or Reliance Trends or others, that itself is a big thing. That is the reason if your masses or a large population is basically coming out of this $2,500… those will be the companies which will grow significantly. In terms of conspicuous consumption or in conspicuous consumption, which is predominantly at the higher end, the consumption changes from showing off your consumption to more towards, like hiring nannies that type of consumption. So, because of that, though people are saying that high-end consumption will do well, I think it's still the base-level consumption, which is likely to do very well...
This was more about retail, but within particular consumption, take for example, the larger companies like Hindustan Lever or any of them, they're fully penetrated… Now, if you go to a small village also, you will have Surf, you will have shampoo sachets. So, it's fully penetrated. So, there is unlikely to be a volume growth there, whether there will be upscaling, that will happen only when the per capita GDP goes beyond $5,000. So as of now, these types of companies which are into personal consumption or not exactly FMCG personal care products, let me put it that way. There, the growth may not be significant, but food is something which I see a big growth which can come in.
So, if I look at Q3, I mean staples largely sustained to similar demand trends as was in Q2. Very few companies, except for maybe a Dabur or Pidilite, came out with some commentary around this as well. So, I suffer from recency bias. Are these pockets of isolation growth— maybe building materials, specialised pharma or consumption products like Dabur— does it look like a low volume growth kind of a piece on the FMCG side?
Milind Karmarkar: No, I think growth will improve. But it may not be immediately, it will take time and if your GDP is growing at say 6-6.5% and you have a 5% inflation, at best they will grow at about 12%, not more than that, 12 to 13%. So, that is the issue which I have with these, but food is something where direct benefit comes in as your per capita income goes up. So, food and clothes, or food and apparel, that is where maximum growth will come in, rather than personal care.
What about foods, how do you play that within this Indian ecosystem?
Milind Karmarkar: You will have to look at larger companies like maybe a Nestle, maybe a Tata Consumer or these types of companies, though I don't have them in my portfolio. But these are the companies which can deliver and then maybe many others…
So, we are playing with food through one of the food companies. We are looking at a food company as well. …but when you say fast-moving consumer goods, I'm talking about a company which focuses on food and not on personal care.
Another aspect of consumption in two pockets. One of them was QSR. Everybody believed that QSR will have growth for the foreseeable future; somehow this quarter, the previous ones are a roadblock despite ICC World Cup and so on and so forth. What's happening here?
Milind Karmarkar: So, my view is that our focus is predominantly on food tech companies because they encompass what is represented by QSR, they're indifferent to what is their service. So, that is why I think food tech companies have started coming in profit similar to Policybazaar and these types of companies which have started coming in cash profits. These types of companies probably are a good source of representative of external food consumption.
There was a CLSA note yesterday which said that— I'm using this as an example— Zomato could clock in profits. So, because they are looking at profit, now they're changing the valuation methodology to a P/E multiple, and therefore obviously, the target prices could vary materially. If indeed P/E becomes the metric, the P/E could be high and the earnings could be disproportionate. How would you value foodtech? How do you value a company like this?
Milind Karmarkar: We hold Zomato. No, I would value it at earnings after considering growth. It's as simple as that.
If a particular stock is quoting at Rs 100, and let's say, the earning is only Re 1. So, that means you're looking at it 100 times. But if you think that … the earnings will double every 2.5 years. So, rough growth of about 45% or 40%. Then, it is very clear that in about five years’ time, your P/E will contract, either the P will contract or the P/E will contract because the earnings will increase. The second is that if they continue to grow at this level, and at that point in time, if you consider that this growth is likely to continue, the P/E will not contract. So that in fact is how we first looked at Trent also. So, that is how we are looking at these companies, which is we always say value after considering growth.
You've been spot on, on Trent. How do you look at a business like that now, that has rallied so much? There is a bit of growth behind it already, the base is higher and the valuation leaves hardly any room for execution risk.
Milind Karmarkar: …When people say that they have grown so much or rather when my analyst comes to me and says, “Sir, yeh bada base hai iss liye grow nahi hua...” I said that is not an answer. For the simple reason that when you are talking of doubling your per capita income, there is no chance that you can take this as a respite from saying that they didn't grow because there was a large base.
Of course, they have a large base and because if you look globally, a country having said $30,000 per capita income, in that country, this will be nothing. A billion-dollar turnover is nothing. So, that is how one should look at. So, if you think that Trent or any other company is likely to grow at 40, you have to look at is there any scope. I remember long back when I used to meet Mr. Tata, I used to ask him— at that time, they had two stores— as to how large they will become and he used to say that, “I can visualise 90 stores across India in a span of 15 years”. I used to say, “Wow, that's 45 times growth.” Today, they're adding 150 stores everywhere. So, in between when I had met them, it was an analyst meet, so I'd asked them, "What is your strategy?” So, they said now increasing density is the strategy because earlier if we thought that a city like Mumbai can have only two stores, now we realise that it can comfortably have 10 stores. …This is just an example. I don't know how many stores there are in Mumbai.
But so, that is the kind of opportunity which is there as your per capita income grows, your consumption grows disproportionately.
