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Hunting for returns in 2016? Look beyond Nifty, says Dipen Sheth

The reforms carried out by the government are going to result in an earnings gain for a lot of companies and one will have to dig deeper into themes that will likely benefit from the change, says Dipen Sheth, Head of Institutional Research at HDFC Securities.

In an interview with CNBC-TV18, Sheth said that the place to look for returns will not be the benchmark Nifty index, but beyond it.

However, by an large, 2016 is likely to be a good year for equities, according to him.

“Last year, the consensus call was 2015 will be good but it did not turn out that way,” he said. “This year, the outlook is slightly clouded. [So from a contrarian standpoint, stocks should do well].”

Sheth was joined by Aashish Tater of FortuneWizard.com, who discussed various stock and sector strategies.

Below is the verbatim transcript of the interview..
Sonia: Are you as optimistic about 2016 as the consensus is?

Sheth: Let us zoom back in the past and go back to one year ago and there was probably nobody who wasn’t expecting 2015 should be a blow out year and that didn’t happen. So, mostly the consensus tends to get it wrong, let us look at it that way. Right now almost every country or every advanced economy in the world, every large economy in the world seems to be in the doldrums and in some trouble or other and we are having second thoughts on whether this brilliant magnificent transformation of this country under the new government is actually going to work or not and we are getting daily hiccups as it were whether in parliament or outside of parliament.

So, just because the consensus is a little murky right now and things aren’t clear I would actually go into the limb and say you have no idea what is possible because you don’t have to look at what is being reported on the surface, you have to dive deeper and figure out what is really happening on the ground and when we go out and meet companies, when we look at what policy evolution is happening, when we look at how the economy is shaping up vis-à-vis the rest of the world India is a superb place to be in.

Anuj: 2015 was all about individual stock picking and if you got the theme right you would have made a lot of money, case in point being aviation specially in the second half of the year and that has continued in at least  first day of 2016. What would be the biggest theme that you will be working on for 2016?

Sheth: The broad thing that I would want to share with you is that, I would completely agree on the thing that the Nifty may not be the place to look for returns. Individual stock picking will work. Even within the Nifty if you look at the Nifty over the last year or so, the 4 percent odd negative returns but you have Maruti which has given you fabulous returns, you have Lupin , BPCL and so on and then you have the dogs like ONGC , Vedanta . Ironically Reliance outperformed the index after 6 or 7 years. So, even within the Nifty very selective stock picking will help you outperform the Nifty by a mile. The second part is that because of the changes which are being unleashed by this government and I would actually put out a whole lot of public sector companies there as well, I think the opportunity to look outside the index, do ground up research and not just go with the tide is probably going to give you significant alpha this year. The smart fund managers are going to make incredible returns for their investors I think.

Sonia: So, let us talk about some of the themes that you have observed in your report itself. There is a bit of dichotomy I see here. On one hand you are saying that the consumption is weak and on the other hand some of the top stocks that you have pick up are names like Jubilant Foodworks that are a classic play on consumption. How would you justify that?

Sheth: That is in keeping with my take here that the headline news can be discouraging. But you have to look at what structural changes are playing out in the economy and then anticipate what is going to happen. So, it is not that urban consumption is just going to fall off the cliff, it is not that people are going to stop spending on eating out or ordering food home, it is not that the large demographic shift and the way people tend to not cook at home and order home is that shift going to go away. As more and more urbanisations happens as more and more working couples end up finding lesser and lesser time to eat home as more and more people find the need and their children pressurise them to order pizzas at home, this is – a lot of consumption headline weakness is going to get countered by demographic buffers here and the macro trends, the demographics will now come back into focus. It is just that there is a little bit of cloudiness right now and we are getting worried about it. I don’t think these trends are going to go away in a hurry.

Anuj: Talking about the stocks that you identified Majesco was the big stunner all through last year and you came out with a note as well on Majesco just about two weeks back. Are you still backing that after the kind of surge that you have already seen?

Sheth: Here is the disclaimer. We found Majesco when it was already up. I don’t know how many percent since the beginning of the year and even from the price we have recommended. So, at the price where we recommended it, it was already a multi bagger. So, that kind of made us a little defensive about whether we should be really wanting to recommend the stock. So, let me go out on a limb and say Majesco might be also a very interesting stock even for this year and the reason for that is not difficult to fathom. I have said it before on your channel and I am saying it now, it has got a tremendous addressable opportunity and non-linearity in that opportunity which means it requires lesser capital as it moves forward to grow and the revenues and the profits can be disproportionate as you move forward. There isn’t a linear relationship between revenues and profits in this business. So, it is in the software products space and it is highly rated in that space and it is finding customers and it is investing in these products, into areas which will make these products more attractive. So, I would suspect that we shouldn’t take the foot off the pedal here.

Sonia: Another very strong performer in the last couple of years has been Ramkrishna Forgings , great company, very good business. It is a proxy to something like Bharat Forge , they are both in the same business but in the last couple of months we have seen a slowdown in these North America truck orders etc. How much of that do you think is already in the price and wouldn’t you worry about that?

Sheth: Bharat Forge is the kind of company which will attract 15-20 kind of multiple very easily and Ramkrishna Forgings won’t. So, I think that is the opportunity here. I  completely take the point that the last 6 months have been anything but encouraging from a broader macro or demand environment perspective for both these companies. However if you look at the kind of evolution which has played out at Ramkrishna Forgings and I am not loath to describe it at this point of time as a mini Bharat Forge, as a small Bharat Forge in the making. If they get their act right because they are investing heavily into new capacities, the volumes can change dramatically, the opportunity to address – while you might crib about the demand environment but its  own market share and that opportunity is so small that a little bit of softening of demand really doesn’t matter.
If you go back to Indian IT companies may be about 10 or 12 years ago or 15 years ago you will understand that even when North America went through a crunch in the IT business around the turn of the century a lot of Indian IT companies did fine business because they were offering clear value opportunities in terms of  saving money for people who were willing to outsource to them.

Anuj: What is your position on aviation? Are you in the camp who believes that we are only half way through the rerating or are you in the camp that believes that there is already over exuberance in this space?

Sheth: That is a slightly dicey one to call right now. Structurally aviation isn’t a great business. Factually in India it is so underpenetrated that there is miles and miles more of growth left to come purely in terms of increased penetration. Is that a space I would really want to be in? There are 2-3 exciting things happening in aviation right now, you have a couple of very capable players out there and now 3 of them are listed. To my mind all three are great managements.

The bigger thing that is driving this industry into investors favour is that oil prices have cracked. So, right now the pricing power is in their favour. You are not even going to realise this but after some time this pricing power might vanish as more capacity gets built-up. Right now it is just the demand running ahead of capacity that is giving them the fat profitability that you can see.

I think aviation is a terribly taxed sector, some of that will give you further buffers for the  future, it is terribly underpenetrated so that will give you operating leverage for the future. There is years and years of growth to come in. So, the joker in the pack is of course oil prices. If that reverses then I don’t think they have pricing power. So, I don’t want to sound like a pessimist on these guys but it is just that the quality of the business does not appeal to me. You want to play a proxy for falling oil prices I would go out and back a Pidilite or a Gulf Oil which seem to have pricing power to my mind especially Pidilite.

Anuj: We haven’t discussed pharma. How would you approach this space specially after the latest warning letter to Cadila and the kind of big decline that we saw in that stock?

Sheth: Company after company, story after story in pharma has run into what I would say are regulatory hurdles and warning letters and so on. I am not an expert on pharma and I don’t understand much of the mumbo jumbo, let me confess. But to my mind there is absolutely no doubt that there is a whole list of large and even medium and slightly smaller than medium Indian pharma companies which hold and house tremendous manufacturing talent and excellent regulatory compliance track records. I would think that some of that has got challenged but it is not going to go away in a hurry. In fact it is one of those place where the competitive advantage we have over, let us say, China is very much intact. If you come out of Active Pharmaceutical Ingredients (API) and then get into formulation, if you come out of the base building blocks of APIs and get into some of the specialised APIs I don’t think there is any second thought that India houses some great capabilities.

Some of these blocks have stumbled I would think one who can get over these regulatory stumbling blocks and two, who are in niches where pricing power is not going to be as big a deal for them in the large volume generics. So, if the are in speciality and niche areas then I would suspect that some of these guys can make brilliant come backs. So, we have done some work on Cipla recently for example. And again headline valuations will probably put you off the stock but on the large cap pharma guys Cipla is one stock to certainly watch out for. And after the recent crack I would say Sun Pharma and Dr Reddy’s should be looked at carefully. We haven’t done that but I will come back to you on that.

Sonia: You have given us a couple of stocks. Let me start off first with TGB Banquets . This stock has been a really good performer. In August of last year it was at about Rs 50 and now it is trading at close to Rs 120. What could be the triggers that could take it further upwards?

Tater: If you see TGB Hotels we think this is going to be a game changer for 2016 in specific because the company now is going to hive off its Surat property and will get a cash that will realise and monetise entire debt and still will be left with Rs 120 crore odd. If you look into the Bombay Stock Exchange (BSE) circular that the company gave the business plan for that they will look into entering into readymade food businesses I was just looking at the proxy bets. You are getting a company that will have a potential to do Rs 100 crore odd of sales this year backed by almost – because they will be spending this entire cash that now they will be sitting on for further expansion we think this is one big business proxy that is available.

Now, what they are doing is they will still be managing the properties under them but they will only be managing it. So, the entire asset light model will definitely help them in terms of growing fast and the second aspect of their business is about their quick service restaurants and readymade food businesses that they have talked about in the presentation we think that this can be a game changer because people will look at it from a different perspective rather than just a hotel stock with asset heavy company not been able to deliver.

So, a lot of changes that is going to happen in this particular stock and we feel that this can be a stock to watch for in 2016. I would just like to put a target of Rs 160-180 but we would just see a revision over there also. We just want that the company delivers as they have been talking about. Once that happens we think this will be just the beginning of the story.

Anuj: Amulya Leasing & Finance over the last two years it has been an 8 bagger already, what is your story here?

Tater: Amulya we identified somewhere around Rs 55 when they started picking stake into a subsidiary. It is available at a mouth watering level. If you see the next years projected sales, they will do roughly around Rs 250-280 crore. The leader in the pack does roughly around market cap to sales of  4 times and this is available at 0.35 times sales. This is a company where APL Apollo Tube has got tremendous distribution network setup because APL Apollo is Rs 5000 crore odd sales company that has the potential to do that in next two years. So, their distribution network is set, all they have to do is incline this particular business with them and that is exactly their plan. So, going forward what will happen is they will spend a lot less in terms of distribution network but their sales will be in terms of multiples. So, we feel that the sales will be easily going  to touch Rs 400-500 crore over next 2-2.5 years which is roughly 2.5 times. However the entire thing will get translated into bottomline in a very high margin business. That means you are getting a company from a promoter which has got tremendous investors. If you see APL Apollo investors they are very good but this is because it is a very small company of the same group mutual funds do not take interest right now. Once this becomes big I think this will be one big opportunity even from hereon.

We had a target of Rs 180 and Rs 225 for this fiscal. We think this will be multi-bagger even from those levels. So, this is another stock which we feel can be a stock even to watch for 2016 just like we recommended it for 2014 and 2015.

Sonia: The final stock that you have recommended is JB Chemicals . This stock has doubled in the last two years, what is the expectation in the next two years?

Tater: We have been very fortunate to identify Aurobindo Pharma at Rs 155, Wockhardt at Rs 135. We have been just trying to find the story and what I learnt from my research was that when a company starts focussing on the business and product development and enters new geographies the margin delta that expands is very high and this is one proven management. They hived off their business in 2011, now they have again scaled back their opportunities to Rs 1,000 crore sales which they used to do in 2011. Now if you see the market cap, roughly 40 percent is in their cash. So, you are getting a Rs 1,000 odd crore sales company at somewhere around Rs 2,300 crore adjusted at around 1.3 – 1.4 times sales. So, there is a tremendous opportunity in terms of rerating.

The second trigger that I feel is going to be very big for JB Chemical is that ANDA approval that we see for this year at 6-7 approval coming and the new geographies that the company is targeting at. So, there is lot of exciting things happening in this particular company and we again have a four figure target on this stock from a longer term perspective but for this fiscal we have a target of Rs 450 backed by Rs 600 from the next 8-12 months perspective. So, that is being conservative but we think this is another stock that we feel will be a stock to watch for 2016.

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