CLS has come out with a note making a case that FPIs or FII flows as a percentage of GDP have been closer to 0.5% in say between FY 2014 and 2022. Yes, in absolute terms, they have come. Now they are making a case that this number can rise to over 1% in the next few years. You have a very meaningful friend circle among FPIs. Are you getting a sense that they are warming up to India? Can additional flows from FIIs gather pace?
N Jayakumar: Well, the reality is that when so many people fall in love with the market, bubbles need to get created as it were. Today, the bubble would have been created had it been everybody buying at the same time sort of thing. The FPIs have been the contra to the local investors. And local investors have moved their savings allocation from about 2.5%, six years ago, to about 4.5 to 4.75% today into the markets.

This is the kind of tsunami we are seeing with SIPs coming in at about Rs 18,000 crore or 18,500 crore per month. Given that kind of an orientation, the contra which is the FPI selling, has continued right through. It is possible that overseas allocations change and sort of the cool down in interest rates happen and greater allocation happens, it is possible then that you could have a sort of a confluence of factors coming in, maybe post elections, with FPIs coming in and locals continuing to buy. There could be this kind of bubble formation where the markets could go up 10, 15% in a very short period of time before valuations really become excessive in every sense of the word.

Today, there are still headwinds that the Indian market is seeing. One of the headwinds which recently has been earnings. For the first time, this quarter has seen some kind of tailwinds where every sector has performed and delivered way better than the expectations of the analysts. So earnings have been significantly better now that the earnings season is over. They have been significantly better. They will act as tailwinds. So discounting 25-26 is possible.

The investment cycle has been set into place again. Therefore, there are capex additions; there are earnings that will come through, higher capacities kicking in. The private sector is now stepping to the table in terms of investments along with the public sector. And to the extent, the Indian public has got more enthused and become more exuberant, almost bubble-like territory in certain very illiquid stocks or illiquid pockets, but with the FPIs also potentially able to come in as interest rates sort of either get capped or start declining in the West, you could have maybe a quarter or two quarter later a kind of a bubble-like movement in the market as “everybody sort of falls in love at the same time with the Indian markets”. So it is possible.

Obviously the FPI flows have been at historic lows over the last, in fact, they have been negative as we have been seeing them. And to that extent, any shift in FPI stance towards turning positive, I do not even need to overemphasize the fact how bullish that can be.

Let me pick up on the point that you were making about earnings. There is a stark disconnect. We all knew that it was a K-shaped recovery and now it is getting magnified because what the urban focus earnings are as opposed to what rural India suppressed earnings are, there is a clear disconnect there. What do you make of that in terms of an investment thesis?
N Jayakumar: That is why a lot of the FMCG stocks are not participating. They are direct beneficiaries or they are directly hurt if rural consumption declines. Urban consumption has been there. We have seen the credit card culture grow. People have been borrowing from the future to using credit to consume. That is an urban phenomenon. Unemployment is an issue. Unemployment in various pockets, rural employment is an issue. Rural consumption is an issue. So there are pockets of disconnects or discordant notes in this orchestra that we are playing out about India.

So from that perspective, I do believe that the markets have been rational. For those who invested largely in FMCG sort of evergreen stocks, the Levers, the HDFCs from a banking perspective, the overall pockets have been and will continue to be under pressure and the over-owned pockets have been at the receiving end of sell-offs and they have not participated. And to that extent, the markets have been very sensible and very pragmatic in their approach. So given everything, I feel that the market reaction is almost like the child in the nursery rhyme that when she was good, she was very, very good. And when she was bad, she was horrid. So if people like a certain sector, they go completely overboard. And if they do not like it, they dump and move on. And that is being seen in terms of some of the evergreen favourites.

Now, not having performed for the last few years as some of the lesser known, lesser loved, undervalued perhaps, but not these sort of fancied spaces have been at the receiving end of money. And that is also true that if the mass participation is in certain stocks, like everybody loved in HDFC, HDFC will not perform. And clearly everybody cannot make money at the same time. That has been frustrating to say the least for market participants. But again, flying in the face of traditional logic, you are going to sectors that have a future.

People thought that coal-based or thermal power was going out of fashion. Those are the stocks that have done the best. Coal India is a case in point. BHEL has produced loss after loss after loss, but because of the future being what it is, it is trading at multi-year highs. NTPC has done brilliantly. So if you just take, without recommending a stock or two, if you just take some of the PSUs, which have been laggards in the past, but efficiency will come when inefficiencies get dropped off. I think that is the way people are seeing the sales of the world, BHELs, OMCs etc. where going forward, inefficiencies are being eliminated. Capex is coming in and the CEOs of the management and the board are being held more accountable for profit. So clearly the market is taking note of this and surely they discount these things upfront and no surprise in that.

Lets’s talk about the pharma space, especially the global construct which you shared with us. Large parts of Europe are aging very fast. Even the US is witnessing shortages of drugs. In this kind of a scenario, how do Indian large pharma companies and the regulatory glare on them pan out? Many of them have moved higher. Rs 400 to almost Rs 1,000 on Aurobindo Pharma, Rs 1500-1600 in Sun Pharma. Do you still find value in some of these large players?
N Jayakumar: I absolutely do because the reality is that the allocation to pharma in funds from an index perspective is still under 5%. One company accounts for 60% of that, which is Sun Pharma. Sun Pharma’s market cap at Rs 3,65,000-3,70,000 crore is three times. There are a clutch of companies, three-four of them in the Rs 1,20,000 to 1,00,000 crore range. There is one company in the Rs 85,000 range and a couple in the Rs 60,000-70,000 crore range.

For a sector which is so critical right now in so many parts of the world, not the least of them being India with in the backdrop of things like COVID and recurring flus and multiple variants of the virus propagating, this space to my mind is under-invested.

So, there is valuation comfort and there is under-ownership. Most funds are coming only from a tactical trading perspective. Stocks have moved up. Most of the companies here are low on debt, if not debt-free. Most of them are huge cash flow generating companies and they continue to marginally invest. So, these are perfect recipes for a serious portfolio allocation that has not happened and some of these actually are now benefiting from PLI, which is a move in and making India self-reliant as one of the key inputs for the pharma industry without being dependent on China and they are also profitable and the government also gives back in terms of concessions for investments made.

A combination of domestic PLI, US generics, multiple parts of the world I think the (1:06) has just begun. Never mind the FDA glare, I think the positive side of the FDA is the FDA realises how important India and Indian companies are. Their over-dependence on China has actually been evidenced by interviews that they have done, they want to reduce. So, will they take a more lenient view? I do not believe so.

Will they take a quicker view in terms of audits and turnarounds? Absolutely. So, most companies are now going through more audits because there are far many more approvals being sought for new drugs or new molecules, etc. Now, in terms of approvals, faster turnarounds are happening. In terms of corrective action, companies have become more responsive. So, I do not believe audits are negative in any manner. Audits, in fact, indicate the heightened activity and the heightened approval seeking that these companies are doing.

The response to that both from a company perspective and the FDA perspective is a lot more proactive and my personal feeling is that people tend to get spooked on audits. It is like a speed breaker on a highway, you do not expect it, but they will happen and there is absolutely nothing wrong in getting comments which you need to correct and move on. But unlike in the past, when certain large pharma companies had audit issues, report alerts or warnings, which have not been rectified for three-three years, today it is very different. Today, the feedback and the turnaround is much faster and I think that is a positive for the industry.

Where are those unloved or hated pockets in the market right now where you do see value, which everyone is not looking at right now?
N Jayakumar: I think private sector banks that people had fallen in love with, the large ones quoting at two-and-a-half, three times, three-and-a-half times book, have fallen by the wayside. But a number of private sector banks are quoting at 1-1.25 times book, they become cheaper than their public sector peers. These are well run, digitised banks, capital adequacy is adequate. They are quick to change strategies. They are in both the wholesale as well as the retail, largely retail, they are granular and there are a few banks that are available. We do not always need to look at the industry leaders, the well-known top two or three private sector banks or five private sector banks, so below that the love for PSUs has kind of ignored these.

As interest rates either ease or stay at these levels, but with interest rates start coming in, I believe that these private sector banks will get re-rated. It is a matter of time. So, private sector banks is one. The second is the entire move to thermal which is very aggressive and with the minister himself putting out targets like 80 gigawatts, etc, of thermal power, we are talking about companies that are in the PSU space and in the private space where thermal and power generation and most importantly the entire range of power and power equipment, because there are bottlenecks galore in that supply chain.

So there is a problem on transformers, where there is a problem on certain key conductors and an entire range of power equipment will come in. There is a whole host of midcap companies in that space that will be beneficiaries. People should not look at historic numbers to take a call on this space.This space over the next decade I think is going to meet with dramatic investments and dramatic opportunities. So, the power and power equipment is the other one.

Private sector banks I talked about, pharma I talked about. OMCs would go in for multiple re-rating much like the way Coal India, etc, have. So, there are enough spaces in the market where you can draw comfort from. Will it be a straight line? It never is.

Most of the spaces I am talking about have not been approached by a large segment of the market either because earnings have been flying in the face of logic or they have been weighed down by the historical baggage of earnings and earnings multiple and I think people need to shed that. The biggest bane to my mind in the market is 30-40 years of experience that some of us carry, 30-35 years experience, that you need to shed to look at the future differently and that is what the market is.

Whether I call it historical baggage or I call it intellectual arrogance or I call it the legacy of the past, call it what you might, you can soften the blow but you cannot take away the fact that some of us are weighed down by the past and we need to view this market slightly differently, especially because younger, retail, more aggressive, more daredevil investors are coming in. You need to learn from the past but you cannot ignore the present and I think therein lies the truth.

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