See opportunity in future M&As; like PSU banks, but be choosy: Sundaram MF

Equity benchmarks are on track to end the financial year with double-digit gains, driven by a phenomenal performance by mid-cap indices.

Sundaram Mutual Fund believed that the party will continue. The Indian economy seems to be well on track, GST is going through smoothly and liquidity and interest rate environment is good, S Krishna Kumar, CIO-Equity at Sundaram Mutual Fund, told CNBC-TV18 in an interview. He expected the current positive environment continue and the markets will also build on that.

Going forward, Kumar foresaw huge mergers and acquisitions (M&A) activity and that should be used as an opportunity. The deals could be spread across sectors, particularly on the financial side.

“The government will be keen on creating a conducive environment for acquisitions,” he told the channel. Furthermore, old banks will be targets for companies to acquire. One sector where consolidation is waiting to happen is the insurance segment, he added. In manufacturing too, he sees the government focusing on getting foreign capital and creating such jobs in the country.

Speaking on auto ancillaries, Kumar felt that auto ancillaries were set to be a much larger sector as they will look to build on auto majors’ value seeking strategies. Many new models are being introduced, market segments are being created…there is a huge amount of value auto firms are looking to seek. This will have to be well supported by ancillaries, he said.

In the financials space, he sees valuations of PSU banks being very compelling as the government has also shown seriousness in resolving issues plaguing the sector. “One will have to play them where banks have good capital adequacy and provisioning,” Kumar told the channel.

However, one has to be choosy in picking scrips in PSUs as well as NBFCs. In the long term, one would like to be in insurance and wealth. Among private banks, old generation banks will be a bet against the new generation, he added.

Below is the verbatim transcript of the interview.

Anuj: It has been a great year for domestic investors, great year for fund managers because the index has done so well, the midcap index has done so well and good funds have outperformed, some of your funds are included in that. Do you get a sense that this party that we are seeing is going to continue?

A: The Indian economy seems to be well on track. The biggest reform that we have been expecting on goods and service tax (GST) is also going through smoothly and the liquidity environment and the interest environment are quite comfortable. There is lot more business confidence that we see around us when we speak to various corporate. Therefore, we do believe that the current positive environment will continue and the market will continue to reflect the growth and optimism.

The supporting factors continues to be the surge in domestic liquidity that is coming into the equity market, a lot of healthy corporate are resorting to corporate action be it return of capital through buybacks, through shareholders - that's a lot of money that is getting back plus many of them are also on acquisition mode. I think over the next couple of years we will see huge amount of merger and acquisition happening which will be another value unlocking opportunity.

Latha: You spoke about merger and acquisition (M&A) activity where would you be on the front foot in this space - that is always the most difficult game to play?

A: I think this time it is going to be pretty much spread across lot of sectors; particularly on the financial side the government will be keen to help or get an environment of conduciveness for acquisitions, consolidations. We do see that finally happening as some of these foreign investors to pump in money and help local banks to acquire a size. So a lot of the old generation banks which have been there and which have created value will be good targets for companies. Not to forget the fact that on the wealth management side, on the insurance side there is a lot of consolidation that is waiting to happen, so that is a big space. If you are very positive on the kind of domestic wealth’s that will come to the market clearly that is a space where existing players, incumbents will acquire and grow and consolidate.

If you look at the manufacturing side again, you are seeing that the government is very much focused on getting lot of foreign capital in and getting a lot of manufacturing jobs in the country and across aerospace, defence, light engineering there have been lot of investments happening. The foreign direct investment (FDI) levels are quite strong at USD 40 billion per year and all this will in time find its way to kind of acquire the smaller capacities be it in any of these spaces we mentioned. If you look at the other areas where India has a lot of advantages like specialty chemicals, the metal working spaces I think clearly there is a huge opportunity for the smaller players to kind of merge, consolidate and become larger as they need to get into the global supply chains basically.

Anuj: You have lot of auto ancillaries as well in your portfolios and they have done remarkably well. What is your call from here? Do you think the auto industry growth is here to stay and in that case would you continue to play it via the ancillary route?

A: The domestic industry is definitely getting a lot stronger with the improvement in credit culture, the institutions focusing on retail credit; we are also seeing the automobile industry being well supported by the financials. If you look at the last couple of years the number of new models introduced, the kind of market segmentation that has happened even within the utility vehicle (UV) space you have different kind of UVs, there are four-five segments within that as analyst would point out, so there has been a huge amount of value that automobile companies are finding to seek and that will have to be well supported by the auto component industry and many of these products are global launches and hence the local automotive component play will be part of the global value chain and that is a big opportunity. So, it is a multi-year story, if not just about last year or the year before, but I think the Indian auto component industry will become a much larger industry going forward too.

Latha: How would you play the financial sector? You spoke about consolidation in insurance and greater wealth coming in. If you have to distribute money between banks, microfinance companies, NBFCs which is the most attractive space I mean public and private banks, public banks as well you don’t have any in your portfolio?

A: Interestingly, the PSU banking space is looking up basically as you are also been covering on your channels, in the last fortnight there has been lot more seriousness with the government to move forward and we do see that there could be aggressive stress resolution in the next three months which will help the PSU banks. The valuations definitely are very compelling, so one will have to probably play them where the banks have good capital adequacy and have fair amount of provisioning cover already. You need to be a little choosy at this point but the PSU banks are coming back into the portfolio with probably 20-25 percent off the financials exposure.

Then longer term one would like to be in the insurance space and the wealth space through some of these players with another 25 percent exposure. The NBFCs again we need to be very selective at this point in time, we had a tremendous 6-8 year run. Valuations are definitely caught up so we need to be very selective on NBFC space, but we need to be there more on a consumer finance side where the long-term opportunities will continue to be there.

The private banks continue to be also an important part of the portfolio, so again that is where probably the old generation private banks would be a good bet vis-à-vis the new generation one because of the valuation differentials and the kind of growth that they will have given the recovery in the economy. So, it is spread across these four segments but it is more bottom up.

Anuj: Couple of textile and chemical themes have also worked for you in your portfolios. Is this also just a stock specific story that you are backing right now?

Latha: Rupee is a problem here isn’t it?

A: Definitely, a lot of us are surprised by the kind of strength in the rupee though people have been talking about it at some point given the India story that should be a good turn, but more than the currency what is important in these industries you mentioned particularly the export oriented companies is the fact that their competitive advantage in terms of their own cost of production, in terms of their own sourcing of raw materials etc, will become very important. For example in the specialty chemicals or in the textiles, India being one of the large producers it definitely helps basically and government policies are also been continuously favouring the domestic players here - that is positive support and also on the chemical front while China continues to be major exporter of the bulk chemicals which are input for specialty chemicals I think India also has a good low cost source and has the capacity to value at on the value chain. So, that is where I think the competence and the dominance come so the ability to value add from a bulk commodity to a value added end product like home textiles and towels in textiles and fine chemicals etc, in specialty chemical that is where I think the advantage plays out clearly.