Reliance’s ROE is in single digits and a story is getting built here because valuation is getting ascribed by private investors, says the analyst, asksandipsabharwal.com.
The profit of Reliance is not double that of TCS and HDFC Bank put together, but the market cap is. What do you think?
It has been driven by people not knowing how to value a particular stock and that is happening in many technology stocks in the US also. People do not know how to figure out the actual valuation of the Jio platform and that is leading to this sort of valuation change.
In fact, over the last 10 years, Reliance has not generated free cash flows in even a single year. When you compare it to companies like TCS or HDFC Bank or any other company which has a high ROE, Reliance’s ROE is in single digits. There is a story that is getting built because valuation is getting ascribed by private investors.
The future returns depend on execution. They need to execute and they need to generate cash flows because without cash flows, I do not think the valuations will be sustainable. Does Reliance deserve to have a market cap of more than HDFC and TCS combined? In my view, no because I like free cash flow generating companies.
On the other side of the fence, there is Asian Paints. It generates a lot of cash, demand has surprised and PE multiple is expensive. Reliance generates no cash flow, Asian Paints only cash flow. These are two contrasting names here.
Typically I do not like very high valuation stocks but I like Asian Paints and it is something which we have owned and added after the results because the result surprised me and even shocked me. How could a company do so well at a time when everything was under such distress and when I heard the management and the way they have gone about executing, getting volumes back, supporting their distributors, customers, etc, it bought in a story which I think could again surprise going forward. If you see a lakh Corona cases in India per day, this work from home is not going away so easily. So, people are finally upgrading.
In fact, there are towns and cities in India where because of some government restrictions or whatever, even laptops are not available today because now people are finally realising that they need to buy those laptops and work from home.
Asian Paints will again surprise more on the upside. It has got both margin triggers as well as volume triggers going for it and it is taking away market share also. My guess is it will continue to do well. Results of the next two-three quarters will surprise on the upside. Analysts are still building in an earnings decline for Asian Paints this year. From whatever I have heard from them and the volume growth that is in June, July, etc, they could actually have earnings growth. Stocks typically move on earnings surprises and the earnings surprise for Asian Paints will be quite positive.
What is your view on BPCL? Moving past the strategic stake news, the stock has been looking pretty attractive?
Yes, but we need to realise that value generation in these oil marketing companies is going to come only out of disinvestment and it is my view that what the government has done via its price regulation over the last six to nine months, has made BPCL or any other oil marketing company much less attractive for any strategic buyer especially one who is coming from outside India to build a business in India.
They will be unable to predict what kind of profits they will be able to generate because they do not know when the price regulation will come and then the margins will get capped. In that scenario, I am not so excited about BPCL. On every crude price decline, there is a sentimental excitement in oil marketing companies and that might play out and we could see some more upside coming in, but it is not a story where compounding returns can be made at this stage.
Many have made a case that buy value, do not buy HDFC Bank or Kotak Mahindra Bank as they are too expensive. But those who have stuck to these two franchisees are the ones who have made money or outperformed. What is your view?
That is true and that will always happen in this distressed situation in the economy where conservative managements will outperform and that is what we have seen in the case of HDFC Bank. Kotak Bank and ICICI Bank performance is similar and so to that extent there is little to distinguish but normally, ICICI would perform like an Axis historically. If ICICI was not a more de-risked bank with significant valuations in its subsidiaries, it would also have fallen the 30% kind which Axis Bank and Bandhan and others have fallen. ICICI Bank used to be in that category previously but it has outperformed.
Now financials are the weakest link in this market, the reason being the NPA situation. It is still very unclear if there will be waiver of interest on moratorium and it will be very negative if the government does not fund it if such a waiver is granted by the Supreme Court. In that case, the funding should be done by the government because the lockdown was done by the government and banks should not be expected to take that hit.
But if there is no clarity on that, then we could see another round of selloff in financials irrespective of the valuations at which they are trading today. That is the imponderable which investors need to deal with. Most portfolios, at the beginning of the year, used to have 40-45% in financials. Now, it is down to 30-35% but it is still pretty high in most portfolios. So there could be an adjustment phase for financials going forward and once the judgement comes on 22nd September, we will see greater clarity.
What is happening with some of the tyre companies? The Q1 results were very strong and there was a very strong recovery in the replacement market for both two-wheelers and PVs. Given the way the market is treating some of these names of late, was it just that pent up demand and the trade lasted only up until then?
In auto ancillaries, the movement is more to do with how the OEMs. So, if tractor or bike sales are moving up, the parts company which supplies them will gain. But in tyres, it is more about usage. The overall usage has come down. The August fuel consumption is 16% down vis-à-vis last August and it is down 10% odd versus July of this year itself. If vehicles are used less, then replacement demand remains subdued and that is what is going to happen in the tyre segment where the recovery in tyres as an auto ancillary component is going to be slower than that of all other auto component companies. That is the reason they are underperforming and they could continue to underperform because most of the tyre companies have balance sheets which have high debt.
It is not exactly pent up demand or revenge demand that we are seeing here in India but we are starting to see numbers coming. Is this a spike before it flattens out again or is this genuinely a recovery that we are going to see sustained over the second half?
It will be difficult to see a sustained recovery quarter on quarter. Obviously, you will recover because when you fall 25% and reach 75% of original, obviously you will grow. So, even if we grow 10% on that 75%, you still need 83% which is 17% down from last year.
So the recovery will be visible as things open up but given the stress in the banking sector and the stress in finances of the state and central governments, which are looking at more and more austerity measures combined with the health crisis continuing unabated, economic growth prospects get hampered. Obviously, there will be a recovery from the bottom but it will stall and from thereon, whether it can become more self-sustaining and goes higher is something we will need to see and it will depend on the global environment.
