What money managers expect in 2007

Ramesh Damani: To start the discussion we turn to the king of the panel first – so I’ll start with you, Rakesh, as always. Well, what do you think of the market? Rakesh Jhunjhunwala: The bullish market is not the index, it is the bullishness of the Indian economy. And as long as I don’t come to a conclusion that India’s growth is not going to accelerate or we are not going to maintain 8-9 per cent economic growth constantly – this bull market is always going to remain alive whether the index is 12,000 or 20,000. The bull market is in the Indian economy and not in the stock market.

Although you could have the economy growing but you could have very high interest rates which is a big factor in the valuation of the market. That could temporarily disturb the market.

As long as India’s economy is doing well and I see no reason why it shouldn’t – the bull market is very much alive and kicking for me.

Ramesh Damani: Sometime they say stock prices are slave to corporate profits over the long term. What is your outlook for corporate profits or the Sensex in 2007?

Rakesh Jhunjhunwala: The bullish market is not the index, it is the bullishness of the Indian economy. And as long as I don’t come to a conclusion that India’s growth is not going to accelerate or we are not going to maintain 8-9 per cent economic growth constantly – this bull market is always going to remain alive whether the index is 12,000 or 20,000. The bull market is in the Indian economy and not in the stock market.

Although you could have the economy growing but you could have very high interest rates which is a big factor in the valuation of the market. That could temporarily disturb the market.

As long as India’s economy is doing well and I see no reason why it shouldn’t – the bull market is very much alive and kicking for me.

Ramesh Damani: Sometime they say stock prices are slave to corporate profits over the long term. What is your outlook for corporate profits or the Sensex in 2007?

Rakesh Jhunjhunwala: Well, to be very frank, I don’t do too much mathematical research. I don’t say that India is going to have consistent profit growth of 25-30 per cent y-o-y. But I do believe that you have the biggest market and the biggest opportunity for all companies is the economy. Look at any sector, everything is at such an early stage of growth.

Ramesh Damani: I now have a question for you. We have had four years of solid gains in the Sensex. Do you make it five years in a row for 2007?

Rakesh Jhunjhunwala: Well, seeing the apprehensions that people have, I don’t see any reason why it shouldn’t be. Because if you have 15 to 18 per cent earnings growth, unless P/Es dip or those earnings dip, I don’t see any reason why there should not be a positive year.

Ramesh Damani: Sanjoy, in the 2006 roundtable, you had said that India will grow but it might be unprofitable growth. Were you here too early? Will margins shrink this year or inflation lead to unprofitable growth?

Sanjoy Bhattacharyya: I got it wrong the previous year. Clearly, I missed the way the economy would respond to a number of different stimuli – whether it was policy driven or liquidity driven – and many of those remain in place. To not have learned from that would be a tremendous sin. Much of what has transpired in the past 12 months is indicative as Rakesh said of a turning point for this nation’s economy.

This market bears a burden of very high expectations. And the way people are pricing future earnings suggests that, the penalty for getting that wrong will actually be quite serious.

I don’t doubt that if you have an economy growing at 14-15 per cent in nominal terms and you have certain advantages which are there to stay and which are long term in nature, things are improving. That is a clear indication that things are getting better. That can only help productivity.

Ramesh Damani: And margins then?

Sanjoy Bhattacharyya: Margins are a function of where you are. I mean clearly in manufacturing margins are driven by factors which are not solely in the control of our economy.

Today we are much more open as an economy. There is much less tariff protection; much more global impact of commodity prices. So you are not able to insulate yourself from them and as we speak today, a lot of these things suggest that margins will be under pressure.

Ramesh Damani: If you were to say outlook for 2007 in terms of the Sensex, would you say it would be a negative year?

Sanjoy Bhattacharyya: I do think though that 2007 will not have the kind of returns we have seen in the last four years. We will not see 30-40 per cent plus type returns spread. The last four years actually have seen the index multiplying 4 1/2 times.

Ramesh Damani: Raamdeo, you started this great Bull Run with low interest rates as you said because previously capital was always crowded. In 2003 capital became easily available.

Now you’re seeing the tightening–prime rates are going up, housing rates are going up. Can that then stop all or even finish this bull market because interest rates are now swinging from low to extremely high?

Raamdeo Agarwal: This is the first globalised bull run in every asset class all over the world. The world economy is struggling to figure out all this noise about inflation, and only time will tell because there is no dearth of money. The government is worried about the response to inflation and is saying the rate will fall in April. But the issue is that it is responding by closing down exports. So what happens is when sugar export was possible, you banned it. You got the inflation under control but what happened? It has shattered the entire sugar community.

Ramesh Damani: Raamdeo, what are your (Motilal Oswal’s) forecasts for 2007 Sensex earnings?

Raamdeo Agrawal: By the last count when this quarterly results got completed, our team had an EPS of Rs 710 for FY07 and more like Rs 840-845 for FY08 for the Sensex stocks.

Ramesh Damani: Madhu, Jim Rogers says that there is a 20-year bull market for commodities. But yet commodities sold off quite sharply recently. If you see, oils, zinc, copper have all sold off. What is your view on the commodities price going ahead?

Madhu Kela: See, I am not a commodity expert. But however you see there are pockets of commodities which will do well. Soft commodities in the world would do well. Things like food grains which have not seen any price – real rise in the world – will do well. But, I am truly scared when I look at let’s say something like zinc. You know on a five-year perspective is there a possibility that zinc prices can be stable at $3000-3500 a tonne while your cost of production is $500-600 for an efficient player? So these commodity prices which have really hit a significant high from their lows may not sustain. But that does not mean you will have bearishness across the board in commodities.

Ramesh Damani: Madhu, you have been one of the most successful stock pickers. Any particular themes that you think will work in 2007? In 2006, Madhu had come here and had said the thing to attract is real estate. What do you think of real estate now?

Madhu Kela: I am certainly not as gung-ho as I was last year. And in my wildest of imaginations, I also didn’t expect that stocks will go 100 times in a matter of a year. So, having said that, I don’t think you can completely ignore this sector because this is where 30-40 crore Indians are interested. Land and property would always be an interest to India. So you have to be far more stock specific and try and find value which will emerge in this sector.

Ramesh Damani: Tell us how the Sensex will end this year, plus or minus?

Madhu Kela: I am positive in a longer run. Making money is going to be tough if I take a 12-18 or even 24 months period. There are not companies which are available at 5 or 10 P/E multiples. However, we have had 50 years of under-valuation in India. What is the big deal about over-valuation for 12 or 18 months?

Ramesh Damani: Prashant, how seriously should investors view the threat of inflation and what do you tell your investors and how do you protect your portfolio in this case?

Prashant Jain: Real inflation is actually much more than probably what the numbers are suggesting. The largest component in any household expenditure is a house and houses are clearly unaffordable by whichever measure you see. If you look at the inflationary impact on the total consumption expenditure of the household, inflation is way in excess of what these numbers suggest. Banks are offering 10-11 per cent on deposits, and as we go into March they may start offering 12 per cent. So over long periods of time, there is certainly a strong case to be made that exposure to equities in Indian households which is very low should increase significantly but I don’t know at what pace it will happen – given the fact that fixed maturity plans from mutual funds offer virtually safe 10 per cent return, which used to be 5-6 per cent two-three years back.

Economic growth will still accelerate, but profit growth will slow down. Profit growth will be lower in 2008 than the profit growth in 2007, and 2009 will be even lower.

Ramesh Damani: Does Raamdeo’s Sensex earnings target of Rs 840-845 seem too optimistic to you?

Prashant Jain: Yes. I don’t look at the Sensex as one composite.

In fact, Sensex has two parts to it–the secular growth companies which would be companies like telecom, IT, consumer goods and the cyclicals. If you split the Sensex into these two parts, you will get a more realistic picture of the valuations. And it is not very good. If you look at the secular growth companies they are all trading at close to 20 times FY09 earnings – two years forward, which is not cheap.

And there are risks – telecom will certainly slow down by then. You cannot have 100 crore mobiles in India in the next four-five years. So it has to slow down. You can only argue whether it will take three months or six months or one year.

Cyclical growth companies are trading significantly above replacement cost and we are somewhere close to a peak cycle. So how the sectors will pan out, how zinc, lead, aluminium and steel prices behave, how the margins behave is very hard to forecast. One thing is clear that these are economically unsustainable prices and these profits are not likely to sustain for long time.

Ramesh Damani: Anoop, what is your outlook for the market? Are you more cautious or optimistic?

Anoop Bhaskar: Last year has been quite camouflaged. If you look at the large-caps, there are only six or seven stocks which have contributed to the entire movement of the markets. In terms of small-caps, we have been in a bear market for the last 15-18 months. So, it is only six stocks which have made this whole audience come out here and say that we are still in a bull market. The bull market has stopped around 12-15 months back, frankly.

People with only small-caps and mid-caps in their portfolios would have only gained about 8-12 per cent in the last eight months, which is not a bull market. I think we’re taking a breather.

With interest rates being where they are, a rational investor would take a three-month deposit paying about 9.5-10 per cent. So, people should invest in debt rather than equity with such returns from the markets.

In equity it is more like a marathon–you cannot run a sprint all the time. This is the point where you conserve your energy for the next 12-18 months and make sure that you conserve your capital for the next round. You cannot keep on running a 100-metre sprint for the next 20 years for sure. There are times when…

Ramesh Damani: …you got to move to debt or the like. Having said that, for the record, I think everyone knows the answer, but what would 2007 end for the Sensex, plus or minus?

Anoop Bhaskar: It will depend a lot on liquidity because what really matters today is not value, it’s only liquidity. I think the Sensex will be down between 7-10 per cent.

Ramesh Damani: In the first part, we surveyed the forest. Now we take a look at the trees. How do you turn the big picture view about the economy, interest rates, equity markets into winning stocks? There is, of course lies the essence of successful investing. I will start with my favourite stock-picker, Bhattacharyya… I would like to see three good stock ideas from you, for one year or three years…

Sanjoy Bhattacharyya: Tata Elxsi, Grindwell Norton and Rane (Madras). Tata Elxsi is in a focused business, it has gone away from doing things which it didn’t do well earlier. So, it has learnt from the past mistakes and is actually a rare company in information technology where the margins are becoming higher and higher progressively.

Second, the valuations still remain very attractive. This year it will earn Rs 16 per share. If you leave out the fact that it has had a difficult and troubled past, its earnings power relative to capital that it is employing is very impressive, a reasonably impressive management team and the growth is definitely sustainable.

Ramesh Damani: And a merger with TCS on cards?

Sanjoy Bhattacharyya: That would be a cherry on the top. I need not worry about that at all, even if it does not merge with TCS. Next one, Rane (Madras) is a play on the Indian automotive industry. It is in linkage products and manual steering gears.

Fortunately, in the Indian passenger vehicles, tractors, LCV business, a very large proportion of vehicles manufactured in these categories have manual steerings. So, growth is assured. Second, it has a very strong dominant competitive position with only two serious competitors – Sona Koyo and ZF Steering, and the record of all three suggests that the industry as a whole is doing very well. Third, it has been through a major financial restructuring. So, you will see a dramatic change in terms of the efficiency with which capital is utilised to prepare and grow for the future. And in exports, it has a link with TRW, a major global player.

Hopefully we will see Rs 100 crore exports in this to TRW by the year 2009 which will actually change the operating margin profile of Rane (Madras). Because right now the EBITDA margin is very low at 9.5-10 per cent which over time should improve and there should be benefits of scale.

It is cheap, it is going to earn about Rs 11.50 a share and it will continue to grow at 20-25 per cent for the next three years. Reasonably competent, trading at 8 times this year’s earnings, you should be all right.

Grindwell Norton is a quasi player at the middle of the abrasives market, with only two other big players: at the bottom is Orient Abrasives and Carborundum is the other one at the high end with coated abrasives.

With the industry growing at 9-10 per cent, an abrasive is like a consumable. To that extent, demand is assured, no hiccups.

The interesting thing is that Grindwell has managed to become far more efficient on the working capital front, sales growth has been 12-15 per cent and the company is now moving into higher and higher value added products as it has consolidated market share at the bottom end. So, there is a scope for increasing profitability with virtually no incremental capital employed.

Other names that I like are as follows: EIH Associated Hotels, which has gone through a major transformation. Another company called Steelcast and the third one is a company called Amara Raja Batteries.

All are on the same theme: cheap, sustainable earning power, volume growth, well managed. Oh, and one more company, ABC Bearings which has margins higher than the industry leaders. It is growing and it is very cheap at 8 times this year’s earnings.

Ramesh Damani: Raamdeo, what ideas do you bring for us?

Raamdeo Agrawal: I prefer business leaders – globally competitive and somewhat unpopular. One is Tata Steel. In 1994, it was struggling with half a million tonne and see the transformation of its balance sheet in the last 12 years. Although it is a cyclical business, this is one company that can execute, has competence, passion and trained people who understand steel like nobody else does.

The opportunity to make money in steel is going to be huge in the next five-ten years. I am not happy with the price it has paid for Corus, but one thing can happen. Corus’ average price is about $950 whereas that of Tata Steel is about $550.

The opportunity is that Tata Steel will borrow the technology and competence from Corus to bring up its entire 10-12 million tonne steel to fetch $900 average. And Corus doesn’t know how to operate blast furnaces.

They pour hot metal at $450. These guys will supply them the technology to bring it down to $150. That is what should pan out. Whether it will or not, at this price you cannot lose much. If it happens, then this should give a very good return.

Second leader in its own category is Glaxo. It has underperformed the market in the past year. The reason is twofold: its earnings didn’t grow much and valuations were pretty stretched at the beginning of the year.

But in 2008 there are 3-4 patented products which are going to be launched globally from Glaxo’s portfolio and they will be launched simultaneously in India. I think at current valuation of 22-23 times CY07 earnings, you are not paying a very high price.

The patent law is in place, the products are being launched and it has a very good, transparent management. Of course, it is not a momentum driven stock, one cannot predict whether in six months one can make money or not.

Ramesh Damani: Any mid-cap, small-cap ideas?

Raamdeo Agrawal: One idea, a mid-cap called Dena Bank. A Rs 1,000-crore bank, it dominates half of Gujarat, about Rs 6-7 EPS this year, Rs 10-12 earning next year. The bank’s book value is going to be Rs 50 next year, and there is no bank stock today which you can get below price-to-book-value of 1.

Ramesh Damani: Madhu, last year you whispered ‘real estate’ in our ears. What are the themes or sectors and what are the magic words you would whisper today?

Madhu Kela: I would like to mention the contract research and manufacturing theme out of India. If you analyse this space, and as Raamdeo said, that now we’re discussing post-patent, so people are not scared to venture into whether it is outsourcing or contract manufacturing in this space.

Multinational companies annually spend something like $45 billion on research and another $45 billion is spent on manufacturing of pharmaceutical products. So, this is one very interesting opportunity which over the next three to five years will pan out very well for India.

Ramesh Damani: Madhu you’ve also been invested in media companies. Can you shed some light on the prospects for the media group?

Madhu Kela: In the media business the biggest thing that will work in its favour is the entry barrier, which is humongous across the board. Like in newspapers, you only have 80 per cent of the advertisements in the top newspaper, 15 per cent in the second one and the remaining 5 per cent in the next twenty. The second thing is, when convergence really happens, content will be the true king.

Ramesh Damani: … and the low advertisement rates in India have to go up over a period of time, so that represents the opportunity on the balance sheet side. Anoop, give us some ideas. Mid-cap space is something which the retail investor is always enthusiastic about.

Anoop Bhaskar: There are two broad ideas I would like to share. We produce roughly around 220-odd million tonne of food grain, which we have to take it to around 340-350 million tonne in the next five-seven years, because of our population.

Plus, if you have more income, you’re going to consume better than in the past. And in the last seven years there has been no greenfield project which has been set up for fertilisers because of government policies, constraints of finance etc.

India buys around 30 per cent of the world market of urea. And we are paying around $260 per tonne to buy it from the market. If we were to produce it in India at whatever cost of gas we get, it would cost us around $180-190.

Another idea is lubricants, a market in which the pricing is not controlled by the government and where the government companies are as ready as the private sector to raise prices. For the last 12 months, the prices of lubricants have moved up by almost 37 per cent. And this is one segment when over the next two-three years, lube oil refineries around Asia are going to double their capacities.

Therefore, the price of lube oil could actually move totally opposite to that of crude oil. Because there would be so much of supply and the pricing of the final product is not controlled by the government.

These are companies which have some brands. If they are able to keep a part of the fall in lube oil prices, then the jump in profits of these companies would be very high.

Ramesh Damani: Prashant, you won’t bet on stocks but tell us some themes at least.

Prashant Jain: I think auto components. If India is to become an automobile hub, look for companies in the auto-ancillary space which bring scale, the opportunity can be very large.

And there are signs that India is likely to emerge as auto ancillary hub. And these oil companies – I’ve been wrong last year, but they are available at a fraction of the replacement cost, and now government intention is that at least the oil bonds will…

Ramesh Damani: … make up for the losses.

Prashant Jain: Yes. So the downside becomes limited. They are available at book values, and the book values are fraction of the replacement costs. So, I think there’s some value. If oil prices fall, the upside could be very fast and very significant. But clearly there is no momentum and it is an out of favour sector, so one has to be patient. They also have good earnings yields.

Ramesh Damani: Let’s hear the stock picks from the best stock-picker in India. Rakesh, you’re going to share your picks, so please, we’re breathless.

Rakesh Jhunjhunwala: I agree with Raamdeo, that Tata Steel could be an extremely good long term investment over a three-five year horizon. The steel industry has changed.

The approach to the steel industry has changed from one of government approach to one of profit. Second, when people say that Tata Steel’s acquisition of Corus is a bull market excess, what bull market is Tata Steel in when it is valued at 6 times earnings, and pre-tax 5 times?

Tata Steel will make iron ore intensive products and sell it to Corus. Plus, Corus can add 4 million tonne finishing capacity without much investment, which can be utilised with the same labour force. Tata Steel itself is going from 10 million to 12 million tonne.

Mr Muthuraman has said that the combined EBITDA margin will be 25-30 per cent. If you look at Rs 100,000 crore of sales, at 25 per cent EBITDA margin, it’s Rs 25,000 crore. Tata Steel’s equity is not going to exceed Rs 750 crore, even after an issue. And then you look at it, they are financing it perfectly.

Tata Steel has $1 billion cash, $2 billion equity will come – they put that into an SPV. That SPV will borrow $1 billion which may have recourse to Tata Steel and that money will be invested in Corus. Corus will take debt, which will not have any recourse to Tata Steel. So, Tata Steel is not really risking anything except that $1 billion, which is 6-7 month cash flow for the company. And if they succeed at what they’re saying, a 750 crore equity can produce Rs 25,000 crore EBITDA.

My second investment is Titan. It’s a very expensive stock, but there are certain companies which will produce dominance, and when they will be in their youth, they will produce huge cash flows. So I believe Titan can be one such company. It’s for a patient investor and investing in it is fraught with risk.

The third stock is Bilcare, and again this is for a patient investor for three-five years. If Bilcare is successful in doing what it has set out to do, it will be among the top companies of the world in the pharmaceutical package. It will have a fully diluted equity of about Rs 21 crore and this year it will earn about 50 crore.

It’s not cheap at about 20 times its earnings. It has invested in facilities in Singapore, it has gone into the clinical trials business. Both will take time to mature. But if they do well, this stock will give mind-boggling returns. And with this, I will conclude by saying that I’m feeling very bullish after this discussion.

Ramesh Damani: There’s a very nice philosopher, who’s an existentialist – Albert Camus and he wrote a very nice thing, which is a great way to conclude this discussion.

He said you’re forgiven for your happiness and success only if you generously consent to share them. I want to thank my panelists by sharing the joy and wisdom of investing generously with all of us today.