The IL&FS default and the consequent liquidity squeeze has been a perfect storm for the shadow banking sector in India. Though the liquidity squeeze has abated to an extent, this event marks a structural change for the sector going forward, says Pankaj Murarka, Fund Manager and Founder of Renaissance Investment Managers, in an interaction with Swati Verma.
What's your takeaway from the IL&FS crisis that triggered a massive sell-off in NBFCs?
There was significant froth in the shadow banks (NBFCs) in India. Before the crisis came to light, it was very easygoing business for them in India. Liquidity was in abundant supply to borrow for short-term and then lend to riskier borrowers including real estate developers for a longer tenure and run a significant mismatch on the asset-liability portfolio in their balance sheet. Moreover, at that time equity market as well as the NBFC sector was doing well.
Hence, it was easy for them to build such a loan book and then go to equity market and raise equity capital at a significant premium to their net worth/book value.
But, now that whole cycle has come to an end. From here on, there will be a differentiation between men and boys in the NBFC sector. Financial institutions such as banks and mutual funds will be very circumspect in lending to NBFCs. They will certainly look for good pedigree and track record of risk management. As a result, I feel the sector will go through a massive consolidation where smaller NBFCs will be absorbed in the larger ones.
What's your view on public sector banks? Do you see a phenomenal change in them after capital infusion?
Government has given the state-run banks regulatory capital to take care of their bad loan provisioning. It has not given them growth capital. So, after all the NPA provisioning, they will have sufficient capital just to meet regulatory requirement. After capital infusion, most banks are out of RBI's PCA framework. However, if they want to grow and prosper from here on, they need to raise capital from markets. And, capital market would want to see there is fundamental change in the way these banks run, in terms of their risk management and things alike before they lend money. So, we need fundamental reforms in these banks.
What's your take on NHB's proposal of raising capital adequacy ratio of HFCs (housing finance companies)?
It's a welcome step. The regulator should have been done it much earlier. Many NBFCs and HFCs were indulging in a lot of riskier lending. Hence, it's a positive development. Moreover, I also feel that regulatory oversight on NBFCs should be much stronger than what exists, at present.
What's your sense on market scenario?
I am positive on domestic equity markets. It's true that we have underperformed global peers in the last six to eight months, due to several headwinds including geopolitical tensions, NBFC crisis and promoter leverage in some large companies. However, I feel some of those headwinds are behind us and market is taking support from the assumption that the present NDA government will come back post general elections. If that comes true, market will surely catch up and even outperform some of its regional peers.
Also, we are coming out of a prolonged earning recession that we have witnessed in India. Over the last 10 years (FY2009-FY2019), Nifty earnings have grown at a compound annual growth rate (CAGR) of 8 per cent which is much below the nominal GDP growth and one of the weakest earnings growth that we have seen over a decade. The 10 years prior to that -- 1998-2008 -- Nifty had an earnings growth of 15 per cent. Next Financial Year (FY2020), we will see strong earnings growth and after a gap of eight years, we will get 20 per cent plus growth in the index.
What makes you say so?
One of the biggest drags on earnings over the last four-five years was bad loan problem in banking sector and stalled projects across core sectors of the economy. But, now, we are at the end of that cycle. In the last two-three quarters, large banks have reported good set of numbers. They are making incremental provisions much more than what they require on regulatory basis. These banks will revert to normal profitability by FY20 and once that happens, it will drive the overall delta in corporate earnings. In addition, good economic health and NCLT resolutions will help boost the earnings growth.
Your view on real estate industry.
The recent GST tweaks are a bit positive for the sector, as a whole, but the fact remains that real estate sales have remained sluggish and inventories in key metro cities are at an all-time high. We need moderation in prices to clear the inventory. In addition, with the recent squeeze in NBFCs, real estate developers are facing challenges to receive funding. But, it’s a very important sector from economy perspective because it accounts for about 8 per cent of India's GDP.RERA (Real Estate Regulatory Authority) Act has been transformative. It's in early days but once, itcomes in full swing, it will bring about a notable change for the industry.
Sectors/stocks you are bullish on and why?
We like corporate banks because we think they are at the end of the NPA recognition cycle and huge provisioning that they were doing. From here on to next three-five years, they will do very well. We also like industrials as we believe investment cycle will come back, capex will accelerate and as a result of which, capital goods, engineering and industrial sectors should do well from medium-term perspective. Apart from this, we also like the CRAMS (Contract research and manufacturing services) story in pharma space.
What has been your investing strategy in last 12-18 months? How your portfolio has performed?
As investors, we are growth investors and our investment philosophy is to invest into companies that can deliver “Sustainable Quality Growth at Reasonable Price (SAGARP). We endeavor to deliver superior risk adjusted returns by focusing on good quality business which have low volatility. Our portfolios have done exceedingly well. We have not been impacted significantly despite the sharp sell-off in midcap and small-cap because we are focused on very high quality companies. As a result, our performance has been pretty healthy and we haven't witnessed any redemption as such.