In short, medium & long term, be cautious on auto stocks: Dipan Mehta

Although the entire paints industry is delivering positive growth, the valuations are capturing many years of earnings going forward. That means they could underperform for many quarters going ahead. So, we are negative on Asian Paints and on the other paint companies as well, says Dipan Mehta, Founder & Director, Elixir Equities. Excerpts from an interview with ETNOW.

On Asian Paints

The biggest aspect is the Asian Paints valuation at about 60 times plus trailing 12 months with 8% PBT growth. These kind of PE multiples are just not sustainable and from time to time, the base effect will come into play for Asian Paints which is what has happened this time around as well. The long-term trajectory for growth is high single digit to low double digit, given the base and given the maturity of the markets and the competitive intensity.

It is not just Asian Paints, although the entire paints industry is delivering positive growth, the valuations are capturing many years of earnings going forward. That means they could underperform for many quarters going ahead. So, we are negative on Asian Paints and on the other paint companies as well.

On Insurance Companies & SBI Life
It is very confusing to analyse insurance companies. On what basis will you value them? Traditional ratios for valuation which are there globally, somehow are not working in India and on that basis, they are extremely expensive. The entire flow from premium to net profit consists of several assumptions and accounting practices which are a bit difficult to get a handle on.

Intuitively one feels that insurance companies should do well in an underpenetrated country like India,and may be they will do well, but in last one year they have run up significantly and are quite expensive at these levels. While they may be market performers, going forward, one cannot expect a high degree of outperformance as was the case earlier. They are good companies and it comes to risk-off trade happening in the market where investors want to just protect their capital and want earnings visibility and good corporate governance.

All those aspects of insurance companies do come into play but the tide certainly is turning over here and we are seeing greater appetite for risk. At least the next two-three years or so, you could see good returns coming in from midcap companies with stretched balance sheets or companies with various issues with their businesses or even overall slowdown in the industry. Those are the businesses one should focus on which are available at attractive valuations and there is where there is a scope for earnings to move up and PEs to get rerated higher.

On ELSS Fund Scheme

Mutual funds have done exceedingly well given positive returns. Many mutual funds have shown outperformance versus the Sensex and Nifty and that is why we are seeing so much interest amongst investors. The entire financialisation of savings is a very powerful theme and from even an investment perspective, companies which benefit like HDFC AMC or IIFL Wealth Management or Reliance Nippon Life should be in the reckoning from time to time, depending upon valuations and immediate prospects. So, I am very positive on the entire segment.

On Capital Goods & L&T
There are some concerns about L&T meeting its guidance of order inflow and perhaps the management should not have given such guidance because order inflows are very bulky and they cannot really be perfectly timed. All I can say is that the order book which is in hand that offers visibility for two-three years or so.

Eventually there is a great deal of need for services of companies like L&T considering the kind of infrastructure which we need to build in this country and also in the other geographies they are operating in. There is a great demand for construction companies, EPC companies like L&T which is that the external environment sometimes has these periods of good order inflow and then there is a lull in between.

In the last few months, we have seen a lull in order inflow and that can easily get corrected over the next two-three quarters or so. But L&T’s point of view, they have got a decent order book position. What we also like is that these orders are coming at very good margins. As and when execution picks up, we should see margins also moving up. Balance sheet quality is in far better shape considering the kind of deals and value unlocking they have done over the past two-three years. It has been an underperformer to an extent, an under-owned stock. So, any positive news flow from L&T — be it on the numbers which come out today or further orders which may come in — could certainly act as a trigger for the stock to start outperforming the Sensex and Nifty.

So, very positive on L&T. It may test the patience of investors for a couple of quarters but if you believe in the India story, then L&T has to be a major beneficiary.

On Pharma & Hospital Stocks

We would like to play the healthcare companies which are focussed on India and that would include hospitals. It would also include pharma companies which have a large proportion of their revenues coming from the domestic businesses like Alchem Laboratories or JB Chemicals or some of the other companies which do not have so much exposure to the US market. That is the better way to play the pharma companies. Also good are companies with a different business model like Divi’s Laboratories or Biocon, which are not directly impacted by the trends in the US generics market.

The best way to play the Indian healthcare story would be through the hospitals. Across-the-board, the top three, four players, after a period of expansion, are entering into a period of consolidation where productivity of assets is moving up and overall healthcare spend has certainly being non discretionary in nature. So we are very positive on hospital companies. The usual picks include Narayana Hrudayalaya, Aster DM and Shalby. The trend is the same across all hospital companies. They went in for expansion, the new hospitals were acting as a drag on the bottom line of the company but now they have reached a level of breakeven and those losses are now being curtailed and some of them will even start contributing positively.

There is great alpha as far as their earnings are concerned and valuations have been on the higher side for these companies. There is great earnings visibility for hospital companies and that’s why investors are prepared to pay higher PE multiples.

On Auto Sector & the Budget

The issue with the auto companies is the increasing cost of ownership and cost of acquisition. The actual cost of most vehicles — four- wheelers, two-wheelers and commercial vehicles have shot up by 25-40%. Such a huge increase in on road prices will take some time to absorb. The sector for a year or so may show flat to slightly mid single digit growth rates.

I am not that hopeful of the government giving any relief at all to the auto industry. GST is not in the scope of the Budget and it has to be taken up by the GST Council but with constraints in tax collections, I sincerely doubt whether there will be any relief for the auto industry. It is just going to move along at its pace for two-three quarters or so, as the buyers absorb the price hikes. Once that levels off and new models come through, that will be the time for some better prospects for the auto industry. On a longer term basis, investors are a bit sceptical about the emerging disruption in the auto industry.

I would say that in short, medium, long term, auto companies need to be viewed with a lot of caution. There could be one or two exceptions. One which comes to mind with the usual disclosure that we and our clients are invested, is Eicher Motors which is perhaps at a slightly different level compared to its peer group.

On Picks in HFCs

Can Fin Homes came with real shocking numbers. It was totally unexpected. The other companies had been performing well for the last several quarters and I would say more or less in line with what the Street was expecting but Can Fin Homes was completely out of the box. It shows that for standalone HFCs, the worst may be over. What we like best is that these housing finance companies have corrected so much that they are now available at or below book value.

We will sooner or later see similar performance from some of the other housing finance companies (HFCs). So, LIC Housing or PNB or Repco and maybe even a Piramal Enterprises are companies which lend to real estate sector or to HFCs should benefit. Again over here, we have a situation where the earnings can move up and there is a lot of scope for PE multiples also to move up. Tthese are all trading at single digit PE multiples. The correction had been between 30% and 70% in a lot of HFCs and now they are getting back into rhythm. I think normalcy is coming back into HFCs and they are benefitting from the affordable housing opportunity.

I would say that from a medium-term perspective, it makes sense to invest in a few of these housing finance companies but look for companies other than HDFC. It has not corrected enough and has continued on its regular growth path and to an extent outperformed its peer group. Now we may see the return of these midcap HFCs which may not be the best company but certainly offer the best investment opportunity in that space.

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