‘If recession comes in the US, we will not be spared'

“The commentary coming forward from the big four IT companies is going to be very critical in deciding the fate of where these stocks will head towards over the next 3 to 6 months because there is a real problem in the US,” says Gautam Trivedi, managing partner, Nepean Capital. Edited excerpts.

Let us start with your market outlook. You are of the view that the recent lows of sub-16,000 will be tested again. I mean, a bull becoming a bear you have a reputation of being a permabull.

Yes, I do, unfortunately or fortunately. But the fact is you have to take into account the ground reality of what is happening in the world – Europe, the UK are already in a recession, and the US is headed in that direction. So, every major stock market guru in the US, who has infinitely more experience and maturity than I do, is calling for one starting early next year. The question really is will India be decoupled or not? And I do not think we can decouple to be honest.

But this year we decoupled and we have done rather well, Dow is down 25%, Indian markets are flat. So, some would argue that what has happened in the last three-four months, in terms of the outperformance, just could get amplified.
Here is my point – let us think in the local currency terms, look in the dollar terms. We are down actually 14%. The S&P 500 is down 23%, the Dow is 24% and NASDAQ is 31%. So, to that extent, it does appear that we have to some extent decoupled. Having said that, I think there are a lot of factors coming to the fore now. First, till the last two and a half- to three years there was no real alternative to equities. I mean, the real interest rates were nearly at a 20-year low, real estate had been dead for the last seven to eight years and, as an alternative investment class, there was nothing but equities.

The second factor that helped equity penetration in the country was eKYC. With 750 smartphones, 4G speed, you can buy or sell stocks sitting on a bus, or on an island and the zero-discount brokerages that emerged. So, I think a lot of these factors help in doubling the number of demat accounts over the past 2 to 3 years. All very good, but there is a real incredible investment alternative to equities, which is starting to emerge finally given the rapid rise in interest rates globally, and real estate is coming back as a significant alternative. But not necessarily as an investment opportunity, but you know when to actually buy and ironically the profits made in the equity markets are fuelling that demand in the real estate space as well. Going forward, I do not think India can decouple and even the S&P 500 has corrected 10% or more 26 times since 1990 and has taken the whole world down with it. So, let us get real about the fact that things are going great for India right now – the domestic demand front, on the FDI front ticks all the boxes, but if the recession comes in the US, we will not be spared.

Just wondering how you are reading into the big news this morning – IDBI disinvestment is one step closer and I am guessing that while there are a lot of questions, we all know that this is a long-drawn process. The government has been wanting to apply for it for a while now and there have been very few successful candidates in that sense, but right messaging I would think.
Yes, I think if they can pull this through and it does not hit any more hurdles for some bureaucratic delays, it would be fantastic. I think it is the next major privatisation after Air India. Quite honestly, to do one every couple of years is really not what the government needs to do, they need to do several of these. Whether it is the Shipping Corporation, BPCL, or all the names that they had on the list, which have not seen the light of day yet. So, if IDBI goes through, it will be great but we have many more to do and hopefully after the IDBI sale, the privatisation and divestment activities gather momentum.

The other big trigger that the markets will be watching out for is the earnings season. Today, it will kick off with TCS, and as always we will track the commentary a lot closer than the actual numbers. It walks us through what exactly you are working with in terms of earnings expectations. How important the Q2 numbers, in particular, are going to be for IT?
I think IT has really been a tough spot for a lot of people, including us. We own Infosys in our fund and it actually has been a not very good performer as you can imagine. We bought it right at the beginning, when the FII selling began. In the hope that the selling was over and for most liquid names i.e. HDFC Bank, ICICI Bank, the IT companies, the selling would have stopped. But, beyond the selling the question that emerged was with the US and Europe in recession will the earnings sustain? I do not want to get into what necessarily may be the numbers for this quarter, but the commentary coming forward from the big four IT companies is going to be very critical in deciding the fate of where these stocks will head towards over the next 3 to 6 months because there is a real problem in the US. I hope the US companies, otherwise cash-rich with great balance sheets, do not cut down on IT spends. So I think we have not seen any major warning signs yet.

I am wondering where in this earning season will the positive surprise really come from? Because few things like commodities, inflation are starkly different this time than the previous quarter.
On a year-on-year basis, you are absolutely right. I would like to watch out for the steel companies and their numbers. Of course steel companies have done a great job with their supernormal profits wiping out a lot of debt. But to examine the trajectory of some of the commodity stocks with respect to where they are going forward, how they are expecting the earnings to evolve for the next 2 to 3 quarters, is going to be crucial. I also want to focus on the auto sector because we have seen a massive rebound coming back and again. According to an Economic Times report about a week ago, passenger cars are up 44% for September 2022 over September 2019. So, we are absolutely comparing apples to apples pre-Covid and that is a very positive signal. Some commentary would be very useful. I think the one sector that I would like to hear more from is telecom and see how ARPUs are shaping up for this last quarter.

Well, if I look at your top holdings they include names like ICICI Bank, Infosys, Zee, Sequent Scientific, Bajaj Auto. I have read out the top five names but cannot see or spot a single cyclical or industrial name here. Is it not that the toast of the town buys cyclicals, industrials? Are you not betting on it?
Our investment philosophy is quite different from the regular mid-cap or multi-cap fund and we look for stocks that we believe have triggers. The triggers, again, could be any one of the following – a change in ownership, change in CEO, generational change, which can be very important because good companies can be murdered by children who do not know how to run companies, are not interested in running companies. Similarly, mediocre companies can be taken to the next level like what Sanjiv Bajaj has done with Bajaj Finance and what Siddhartha Lal has done with Eicher Motors. So we look for these kinds of triggers.

We also look for factors like M&A, financial restructuring, deleveraging, de-pledging. You mentioned Zee, so the last category that we look for in terms of triggers is yesterday’s large-caps and today’s mid-caps. We believe that Zee potentially could regain some of its lost glory when it used to be a large-cap.

That is a good way – yesterday’s large-cap, today’s mid-cap and today’s mid-cap may become a large-cap. So, let us talk about yesterday’s small- cap, today’s midcap and tomorrow's large-cap. What falls in that category? That is an easier category right? Why to bet on somebody which has become small and could become big? Let us look at tiny becoming large.
I am going to give a disclaimer, one of the companies that we really like is Hindustan Foods. I think you should invite promoter Sameer Kothari over on your channel because he is today one of the largest contract manufacturers for FMCG companies and the name Hindustan Foods actually is better because he has gone beyond foods – he makes shoes, Harpic for Reckitt Benckiser, he makes Surf Excel and Vim for Hindustan Lever, among other products.

So I think that is the kind of stock. When we first invested, the market cap was sub-Rs1,000 crore. It has now climbed to more than Rs 5,000 crore and this company is going to keep growing by leaps and bounds as they have more capacity to bring in more clients – all MNC clients. More importantly, the fire in the belly that the owner of this company has is fantastic. It is an example of a stock we do like and own.

This company, if my memory serves me right and I am just discussing it here for the benefit of our viewers, has higher volume and no margin business.
Higher volume, lower margin business – yes, but they have a take or pay relationship with most of their OEMs and they have an 18% assured ROE. It is the case with Dixon Technologies.

If you like Dixon so much why not buy it only, Dixon is Dixon?
It is too expensive. There are a lot of companies in India. The companies that we do not like are expensive, the companies that we like are very-very expensive, that is the problem today in India. And frankly if a correction were to come through, it would be the best thing that can happen to the Indian stock market because this will bring in significant capital – both FII and domestic. The reality is a correction would actually be a welcome and it will be very healthy for the next 3 to 5 years for the Indian equity markets because you cannot possibly be trading at double the multiple or more than double the multiple of China. We are 20.3 times CY2023, MSCI China is at 9.3 times, MSCI emerging markets is 11 times. So we are clearly very-very expensive. We have always been historically expensive but now we are getting to the very-very expensive zone.

I do not know if I am correct with this one, but is Varroc Engineering in your portfolio?
Yes it is.

So I am wondering how you have read into the news of them selling their four-wheeler lighting business at a reduced price from the earlier 600 million euro to now 520 million euro? And how is the Street reacting to it?
Yes fair point, I mean first of all, we cannot possibly have all blockbuster stocks, we are not exactly Sachin Tendulkar in his prime. So this stock has been a bit of a disappointment given what you just said, but we are trying to connect with the management and figure out why that has changed so we do not have an answer yet.

Where is Cement sector? Especially after Adani’s buying Holcim’s stake, now there’s a buzz that they may be interested in JP Associates as well. That is where all the M&A seems to be heating up and no one can ignore that price action of India Cements.
Yes, I think cement has been a bit of a laggard like pharma for the last few years and given the infrastructure spend that has come from the government and that they have really done a great job of building roads, highways and the pick-up in real estate, I think at some point that has to start reflecting in cement volumes, pricing. So, I am a little disappointed that the sector has not done anything. We do not own a cement stock, talking of cyclicals that is probably an area we would put money into because it is a very local India business and it is not really impacted by global cement prices because there is no benchmark global cement price. So, that is something we are actively looking at, just have not gotten comfortable yet in terms of buying it. What you said about Adani and JPA and depending on who else is out there looking at bidding for JPA’s assets, I think, going forward, there will be a lot of M&A activities. So it might end up falling into our trigger-based methodology where we look at stocks that have a trigger – M&A being one of them.