Brexit or not, stick to largecaps like Maruti, Hero: Dipen Sheth, HDFC Securities

In a chat with ET Now, Dipen Sheth, Head of Institutional Research, HDFC Securities, says if you want to be a forward looking investor, you should be buying things like agri inputs. You should be buying discretionary or even staple consumption in the rural interiors. Edited excerpts

ET Now: One of your reports said that monsoon is a greater event than Brexit. My question right now is there is a very exhaustive fund manager survey on Brexit, its possible implications etc. Where are you on this? Friday morning it can go either way. What should people do before that?

Dipen Sheth: We have been talking endlessly about Brexit in the days leading up to the event. Purely from a philosophical perspective, much of the risk would probably have got baked in. If you keep talking incessantly about a risk which is going to hit the markets, it means that most players have factored that into their positions already. It is not that I am going to wait for the outcome and then decide heck I am in the wrong place, wrong time, so let's get out. If I am really worried that markets are going to crack or that Brexit is a cataclysmic event, then I would have sold and I would be light today. If I think nothing is going to happen and I would not have done anything in any case. And if I was actually bullish that Brexit is not going to happen and I should remain invested, I would have remained invested. Nobody is going to wait for the event. You buy the rumours, sell the news. So the rumour has been bought. So that is the philosophy.

Now what is actually going to happen? Your guess is as good as mine and we can flip a coin. So that is the disclaimer here. But let us step back a little bit and look at what Brexit really involves. It implies that in case it happens, this is the first structural step towards dismantling or a potential dismantling of the European Union. The club is breaking down. Britain is a very large member of the club. Arguably after Germany, it will be the largest member and if Britain decides look this is a club I really do not want to be in, in any case they have not been in the Euro club in terms of the currency participation and if they step out now, then I think from a macroeconomic perspective we let markets remain a bit. But from a macroeconomic perspective, the rules are changing yet again in the global economy and nobody has a clue what is going to happen afterwards.

ET Now: So just getting back to the point about Brexit, who knows what is going to be the eventual outcome? From India’s standpoint, Brexit is history. The street has sort of absorbed that event and moved on. Monsoon really seems like it is playing the part finally after a bit of delay coming in. What do the domestics now turn towards?

Dipen Sheth: So the deal here is that we should stop looking at the world and fretting and fuming about it because there is very little we can do about it. We got a good story going. There is a right leaning government in charge. We have shrugged off our socialist hang-ups for a while. We have not eliminated welfare for those who really need it completely and to that extent, the structural healing story of India is really what should interest investors in India right now and sometimes when you look inwards, you see a lot of good stuff and I think the India story has not changed much from the time we last met or even from the time we met before that. So what do you have? You have a government which is progressively unshackling the command and control regime. You have just unshackled some more rounds of FDI controls. The world is stuck in a rut and India is going somewhere. I keep on saying this. World goes nowhere but India goes somewhere. Now you can dispute the GDP headline numbers. You can talk about IIP being negative, unpredictable, etc. You can complain about exports de-growing. But it is all baked in. It is all baked in and structurally we are improving with every passing month. As the monsoon now comes in, I think a lot of themes will open up. If you want to be a forward looking investor, you should be buying things like agri inputs. You should be buying discretionary or even staple consumption in the rural interiors. So look at FMCG, look at autos, look at CVs. In fact, ancillaries to CVs. So these is a whole lot of things to play in the market quite frankly.

ET Now: Particularly I just wanted to check with you. A lot of talk about how cement which has hitherto not surprised tremendously, there have been a few odd pockets of out-performance but otherwise there have been a couple of disappointments as well. The belief is that if monsoon is good then we may actually have a really big next 12 months for cement. Are you in the same camp?

Dipen Sheth: Sure. So the demand for cement we would like to think sitting in the cities is infrastructure creation and we want to build the story around that but two-thirds of cement gets into housing, two-thirds of which probably gets again into individual housing and much of that is dispersed across the country. There is obviously a very large urban build out. If you are looking at cement as a five, six, seven year play, then much of the market is going to shift from trade to non-trade and hence there is a cap that you can get on realisations. But in the next one or two years, especially on the back of a good monsoon, individual house construction of country is going to change, it is going to increase significantly. Obviously smaller towns are getting built out, low cost housing and housing for all and all this stuff is going to contribute its own bit. I think the sentimental boost for cement consumption after a good monsoon is going to be enough to drive up prices, I think this Diwali we should see some good price pops and if you are a believer in the longer term story for India there is no way that you can be a loser.

ET Now: What do you buy in cement, would you buy Ultra Tech?

Dipen Sheth: You do not buy the $200 types... the Shrees and the UltraTechs. We have a tremendous regard for these companies. They have been multi-year compounders especially Shree but when you have smaller stocks south of a $100 on EV per tonne basis, go for thwm. We have been pushing Orient for a while, we have been pushing Birla Corp for longer than that, Sanghi as well. Sanghi interestingly has flipped its debt recently if you have been tracking that story, it tells you that cash generation is high. It is sitting on a billion tonnes of limestone. Headline capacity is still just 4 million tonnes. It can compound like Shree for the next 15 years. You do not buy these stocks just because cement prices go up or down in a quarter.

ET Now: Why Jubilant Foodworks? You are still willing to give the management a chance to rectify the same store sales growth and for demand really to pick up?

Dipen Sheth: It is not me. I think their customers are going to give them more than a fair chance. There is lots of competition and it is actually helping them because a lot of the competition is doing price cutting and that actually get in people into the pizza consumption or a home delivery food ordering consumption gain. They have still got just over a 1,000 outlets in this country. There is space for 3,000-4,000 at last count. Very easily despite two very bad years, they have not lost money, they have not consumed cash. They have thrown out cash and they have still grown 100-150 outlets every year. This is definitely another compounder. So remember what happened to discretionary, retail consumption over the last two or three years. We were coming off a period of sustained inflation. Inflation is down to 5 per cent now from 12-13 per cent headline numbers.

Incomes are going to increase, urbanisation is going to increase and time spent for cooking is going to come down. Home ordering is going to take off, it has taken off in the metros, it has taken off in the next two metros and I think it will take off much, much more. This is a business with 75 per cent gross margins and very high operating leverage. Margins have cracked from 18 per cent to 12 per cent or thereabouts. About 11-12 per cent range in the last four years. It is not going to stay there forever with those 75 per cent gross margins. You do not buy something when it has already moved up right. We are betting on doubling of profits in the next two years from Rs 16-17 earnings last year to about Rs 33-34 by FY18. I am willing to give them a very good multiple on that because there is compounding potential her. The company does not consume cash at all. It does not need capital, it is today at a 1,000 outlets and it will go all the way to 3000 without needing capital just got to wait five years, six years, 10 years just buy it and forget it.

ET Now: Because the management when we chatted with them post earnings, themselves highlighted that it is more a behavioural pattern about pizzas versus any other items because there are too many options now, cheaper ones, more expensive ones, ordering out is just so accessible and can be done at the click of a cell phone button. Okay, let us see which way the story goes. Rallis, I get this would be a monsoon play then?

Dipen Sheth: Rallis is a monsoon play. So is Insecticides. Even today we get excited sitting in Mumbai and looking at the rains over a weekend. I think monsoon is a little more serious than that. While we do see rainbows in the sky, I think the big deal is that the monsoon is still at a 25 per cent cumulative deficit this year as well despite all the rains wherever else even outside of Bombay that we have seen. I think this will pickup. You have not seen two El Nino years followed by a La Nina year and no good monsoon afterwards so I think it is a fair bet to play that the monsoon will revive, will pick up and once that happens, sowing takes off and then most of these companies do good.

Insecticides, for example, is working at 50 per cent capacity utilisation. It deleveraged a year ago by raising some Rs 80-90 crore in QIP and you are still buying them for cheaper than that QIP price despite the 20-30 per cent run up in the stock. I think a little more than that in the recent past on the back of the good monsoons being announced or apparently good monsoon on the way and so on. Valuations are still on your side. These businesses have embedded operating leverage, they are not going to consume cash to become 50-60% bigger than where they are today. I do not know if you think that the monsoon is going to be decent and if you do not buy these stocks now-- Rallis by the way has a very interesting seeds business, it has a very interesting custom synthesis business about which it has been very secretive and that is one of our cribs about this company that they are not very transparent about what they do in the custom synthesis business. Apparently they are sitting on two large orders for new molecules which should also help them derive additional operating leverage. So if we put all of these things together I do not think there is anything by way of margin of un-safety, shall I say, in these stocks.

ET Now: Somebody wants to invest, wants to look at largecaps because he wants margin of safety as well. Assuming that he wants to take this call on Friday post the Brexit event is over, what is that one large index name that you would be comfortable making an investment in and why?

Dipen Sheth: Plenty actually, but if you want me to pick one randomly there are so many ideas, because Brexit is an external event. Brexit is going to lead to herd outflows if it does happen. Some of that herd outflow has already happened if you ask me. Also, there is a crack in the markets and what is completely unconnected with Brexit and what is completely an Indian story that I should buy is Hero Moto, Maruti, all backed by discretionary consumption.

Maruti is a little bit of a play on both urban and rural India, Hero is much more rural than urban. So if you are confident on the monsoon, go play Hero. If you think that discretionary consumption in India is going to take off based on higher urbanisation over the next three, four, five years, Maruti at 18X on 2018 numbers is not a bad deal at all. Hero is even cheaper it is at 16X. So the problem with the naysayers in Hero have been saying that they cannot grow significantly beyond 500,000 volumes per month or 60-65 lakh or that kind of range. I think they are poised for a breakout now. They lost initially in the scooters game to Honda. They have got a very exciting product line now. They have shrugged off the Honda parentage in style, I must say. You should see what they have got by way of a product pipe on mobikes as well. There are some interesting export opportunities but we are not even looking at those in a significant way at least for the next two years. I think volume growth if it comes back demonstrably at Hero can take valuations from 16-20 in a jiffy, core ROCs are upwards of 40-50% in the business. It is more like an FMCG company now.