Indian stock markets are making new highs in quick succession. At this moment, investors are preferring quality over quantity. With a raft of cases coming to the fore, where established companies have been found flouting corporate governance norms, this has meant investors are not ready to compromise. In times of turmoil, people generally turn to safer and known stocks and that is the primary reason that benchmark indices have outperformed mid-cap and small-cap space in the last two years where the economy has been in a dire state, Pankaj Bobade, Head of Fundamental Research, Axis Securities tells Kumar Shankar Roy in this week's Finapolis Conversation. The stock expert also shares his views on metals, PSU banks, NBFCs, auto, and telecom stocks.
How is Axis Securities' investment philosophy and stock selection process different from others? What are your stock selection criteria?
Axis Securities' investment philosophy is rooted in identifying fundamentally good stocks with strong management and high standards of governance shown in the past. We select stocks based on strong fundamental parameters. Some of them are superior return profiles on its equity and capital, consistent growth shown in the past with a clear view of the medium-term future growth drivers, adequate leverage, competitive advantages over its peers and whether they have a sustainable moat, growth outlook of the sector itself, from a long term perspective, etc.
We also focus on governance standards by meeting company officials and board members to assimilate as much information about the top executive management and look at any past deviations. Even if all the fundamental financial parameters are excellent, in case there is serious doubt about governance standards, we prefer to stay away from such stocks.
The Indian markets have lately been hit by a series of corporate governance crises. How do you assess the corporate governance and 'quality' of investible stocks? Are there indicators that serve the purpose?
Assessing corporate governance and ‘quality’ of investible stocks is not as straight forward as say assessing the financials of a company as it involves a lot of qualitative assessment. The most important factor to consider is to assess the Board structure of the company.
Typically, any corporate governance failure is due to a lack of ethical decision making right at the top. Some pointers to evaluate corporate governance issues are:
* Does the board have sufficient relevant experience to address the main challenges that the company may face. In this, it is particularly important to look at independent directors and whether they have complementary and relevant skill sets and track record of ethical decision making, keeping in mind the minority shareholder interests. Whether their power to voice their opinions is dwarfed by promoters and executive directors or there are guidelines to stop excessive risk-taking that could jeopardize long-term growth, etc.
* Another important pointer is to look at the fact that, are the board getting all the relevant information on time and are not blindsided by the executive management.
This can be gauged by board meeting minutes released for public although it’s difficult to judge on this point. One very recent example was of a company where an insider complaint got leaked at a public forum and the board got the information much later. Such indicators point at a lack of effective controls at the board level itself.
* Another important parameter to look at is related party transaction and structure of the corporate entity. Typically, complex corporate structures that have multiple subsidiaries and associates with a lot of related party transactions are more likely to be indulging in bad corporate governance.
* A more difficult indicator is to look at the auditor of the firm and whether they have vested interests in overlooking important data points. For example, if an audit firm also has substantial consultancy business there is a greater risk of audit reports being biased.
The benchmark indices are at new highs. Yet, mid and small-cap stocks are at lows. What is your take on large-cap stocks going forward? Will large-caps be able to sustain their performance, or will reversion of mean happen?
In times of turmoil, people generally turn to safer and known stocks and that is the primary reason why benchmark indices have outperformed mid-cap and small-cap space in the last two years where the economy has been in a dire state. We believe that with concrete policy reforms to drive growth and investments along with expectations of more reforms to come in the next budget, mid-cap space looks poised to outperform the large-caps. If you look at the mid and small-cap space they were down by 40-60 per cent in July-September 2019 when the benchmark indices were down by 12-15 per cent. So, the more likely scenario that we feel is a larger upward mean reversion for mid and small-cap space and a slight downward reversion of large-cap should play out in the medium-term.
How do you view do you metals, PSU banks, NBFCs, auto, and telecom?
All these sectors have been faced by challenges that have led to dismal performance in stock markets but the challenges are significantly different for all these sectors.
Metals have faced challenges due to soft commodity prices and the US trade war with China. Metals have a cyclical structure and have been in a downfall for more than a year now but have recently shown recovery.
PSU banks have been mired in operational and governance challenges of rising NPAs, lack of quality management and frauds. Some large PSU banks have successfully navigated the challenges helped by bailouts from the government. However, the larger issues of bad management and lack of operational controls still remain.
NBFCs have been hit again by frauds and giving out cheap loans without effective credit review and monitoring. It has been aggravated by the economic downturn and lack of supply of credit to these companies. While some good quality NBFCs have navigated these times successfully, a lot of churn has happened (for good) in this industry. It is on a slow recovery path.
The auto industry has been faced with an unprecedented demand slowdown but they do not have management and governance issues. The issues in the auto industry have been aggravated by a lack of liquidity due to the NBFC crisis, major changes in norms increasing the uncertainty of demand and economic slowdown. With clear policy initiatives coming in and availability of credit at lower rates, this industry should revive in the medium-term.
The telecom industry again was hit by a price war with a new entrant disrupting the incumbents. It is also faced by regulatory challenges and highly leveraged, capital intensive nature of its business. This sector is critical for the government (and as a nation). Regulatory and policy changes are required to promote sustainable and healthy competition in this sector.
How does the Q2 earnings picture look so far? Have the earnings met street expectations? Will Nifty/Sensex earnings downgrades continue?
The Q2 earnings picture has been a mixed bag. While private banks reported good growth in their loan books, slippages look to be contained; if a final decision on pending NCLT cases is taken, the profitability of these banks would witness a big jump, going ahead. The volumes in the FMCG sector were slightly better than expected esp. on the back of the high base and the pain in the rural segment. Discretionary consumption plays were a mixed bag with paints and QSR segment reporting better than expected growth. Near-term consumer demand is likely to be subdued and company managements remain cautiously optimistic over the rest of the year.