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Why is the market rushing from one end of the range to the other end? Crude is now behaving like a midcap!
I think volatility is here to stay. When there is uncertainty and people are trying to form a view, excesses happen. People move from fear to greed and in markets like this, where we are seeing news emerging every day on every front – be it domestic markets, elections or geopolitics – things like this happen. Do you think we are in for this kind of a market where the index will remain volatile but beneath the index, a very stock specific bull market will continue to persist?
I am a strong believer in the market, but one has to look at specific companies, industries where things are changing, where trends are emerging. Stay with those stocks. There are people who ride up and down and are able to time the market, but for those who cannot, the best thing to do is to stay put, find a good company, find a good sector, great management, buy the stock and sit with them.
One of the core areas where you specialise and you have really mastered the art of understanding trends, is the retail sector. How should one understand the retail appetite in the background of inflation? How does that translate into a demand and supply scenario and opportunity for companies?
At this point of time, inflation is here to stay and the cost of doing business has gone up; but at the same time, income levels have also gone up, specially in India where we are moving from being able to sustain ourselves to for the first time getting into discretionary spends. Hence inflation of course will probably cause a dent in the demand. But reality is that there is a pent up demand and with greater affluence, greater aspirations, people are going to spend. I do not see a reason why retail cannot grow faster than 12-13-14% year on year. Overall in retail and within that in the categories like shoes and clothes, people going into organised retail malls will take away some share from the unorganised market and hence that should grow faster in the next five to ten years.
Organised retail taking away share from unorganised retail and we have online e-commerce play as well.
That is right. New channels of consumption are emerging and it is visible across all facets of our lives. What it would really mean is that the customer is seeking convenience, wanting to either walk into a store, buy on the road, buy online and all of these channels will grow. But the reality is that the market is growing faster. If I were to look at the overall retail pie and if it is growing at 13% to 15% year on year, within that, unorganised retail may lose some share but not in absolute terms.
Also, e-commerce will grow faster and hence take away share but it is taking a part of the growth and not really beating down what is going to happen offline. One very clear example is the electronic segment. Some of the large players are present in electronic retailing. Three to four years ago, people thought they would all shut down – be it Vijay Sales or Croma. But the reality is that customers have adapted, people want to walk into stores to experience the product. They want instant gratification and buy it there. Brands have also realised that they need both channels to survive. So while e-commerce has become a large player for all of us buying our TVs and mobiles, offline retail will also continue to grow.
The bond markets are indicating a recession is coming in. We may see more supply disruptions as well as China goes into a lockdown.
Yes this will be a long-term trend. There will be ups and downs and disruptions and companies will have to evolve their business models. People who are unable to adapt will face problems. Look at the banking sector. Five years ago, we all thought that banks would suffer as fintechs came in. But the reality is that several banks have embraced digital and come back strongly. Some who were not able to, struggled and are now trying to get their act in place. The same will happen with consumer and retail.
The problem with fashion retailers is that there is wide scale a and very limited players. All of them have run up so much that it is difficult for someone to jump into the trade now. These stocks have already given 34%-20% odd returns. Won’t valuations be a concern?
One will have to be stock specific. Some of them are growing at 20-25%, some are growing at 10-15%. There are companies which have 30-40% EBITDA margins and ROCs which are great. Those companies are already getting richly valued but the growth may sustain those valuations.
On the other side, there are certain companies which got beaten down because in Covid, people thought that with Covid, plus online retailing coming back and most of the retailers having fixed costs, whether they survive or whether they get their act together – those are places where there may be deep value where an investor can make a call. Hence, there would be value available in some of these companies even though they have gone up by 25% to 50% over the last year.
What about real estate? At the start of 2021, solid purchase data came in from the mega cities including Bangalore, Delhi and Mumbai. The interest rates were at an all time low. Some of the steps like stamp duty cut acted as a big kicker. But now inflation is hitting them hard and they are looking at upping prices. Is that going to dampen housing sales?
If I were to look at the long-term trend for housing sales, Covid and work from home created the need for having an extra room and a comfortable house. That brought back housing sales. Interest rates are still low, EMIs are low and on the other side, incomes have improved and over the last seven-eight years, housing prices have not moved and affordability has also improved. Some level of price increase can dampen sales but one must also bear in mind that the moment prices start moving, if it is over 10%, sales will be hit; but if there is a marginal increase in price, people who are sitting on the fence actually jump in to buy.
We have seen that across cycles that when prices start moving, volumes start going up and so yes, short term there could be an impact on sales but in the long run, the fundamentals are pretty strong and there are very strong tailwinds for the housing sector as a whole. On top of that, RERA has helped consolidate the industry and capital availability for small and marginal developers has gone down. For larger players, a gain in market share is going to happen.
ROCE and capital returns for retailers and real estate is not even in double digit and I am talking about big builders here?
The return on capital employed has lagged for most developers in recent times but historically, real estate is a sector which allowed developers to raise capital at levels of 18-20 to 25% because the IRRs existed. The issue with most developers was that people went and bought large parcels of land which are not generating returns. Now they are sitting on land which probably is appreciating at single digits or thereabouts and the ask on capital is double digit. That is a classic situation where it is a negative carry and that has really been the impact.
But if one were to talk to developers and look at some of the projects that they are doing today and look at the project level IRRs, those are in reasonably good double digits. As a whole, as people consume some of the excess land they have and as the business gets into a proper cycle, we will see ROE and ROCEs come back.
What is your style of investing? Do you use time as the benchmark of deciding the portfolio like this is the portfolio for three years, five years and beyond five years? Or is it purely based on cyclicality and compounding belief?
Not cyclicality, though it can offer great opportunities to get into businesses at attractive prices. I would typically take a five-year view, see where the industry and the company can go and if the management is great. For example, if I look at real estate, the market cap of the entire sector is less than Rs 3 lakh crore, which is 1% of India’s market cap. On the other hand, if one looks at the sector as a whole, it is 6-7% of GDP and can easily be double digit of GDP. Now will value get created there? Will some developers become very large? Yes, they will and hence you can take a call on some of those.
Buy for three to five years and even beyond, what else qualifies that cut because the minute you start increasing the time horizon, the whole notion of not what is expensive and what is cheap changes because time changes the entire terminal value. Real estate is one where one wants to buy for a long haul. What else makes that cut?
Personally, I buy for the long haul only and even in retail, there are opportunities where one can take a five-year view saying that if these companies can become omni, if they will be relevant to the consumer, if the management understands what it takes to make this transition, then the gap between the online and offline has to merge.
Today online players get valued at stratospheric levels and on the other hand, offline retailers who have created their brand, entire real estate, the presence of stores which cannot be easily replicated over the last two decades, get a fraction of that value. The customer is not going to say I am buying an online retailer or offline retailer. LensKart, First Cry all of them have large number of offline stores. Nykaa has offline stores. When we go to a bank, we do not want a branch or an ATM or an app or a website. We use it wherever we want to. Similarly, a customer will want to shop anywhere. So there will be a convergence and one has to take a call in terms of which of the offline guys will be able to make that convergence.
What is your view on value retailing? There is a VMart on one hand and DMart on the other?
These are all fantastic businesses run by great managements. Both the companies understand what it takes to serve the bottom of the pyramid and the strata of society which is price conscious. I am not sure whether this is a trade off between price and time because the person who is going into a VMart was earlier buying in the village haat. He did not have the opportunity to walk into a store and get a selection. This is somebody who buys a few shirts, possibly washes it 50 times, and needs the apparel to be looking good even after those many washes. So, it is a different kind of customer.
It is the same case with DMart. That segment is going to continue to grow. We just scratched the surface. In terms of consistent compounders and valuation, I do not want to make a comment but the entry price is extremely important. Of course, time and compounding helps if you were to get in expensive. But if you can get into something at a better value, that is much better for you.
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