Havells may some correction in valuations, says Dhananjay Sinha

“ PSU banks have actually done very well over the past two years, and last year also, there was a big rally. It was expected that the big hangover of NPAs that PSU banks were facing was actually receding because post the pandemic. I think there was a significant improvement as far as NPA is concerned because large companies gained a lot by way of operating performance, cash flow, etc. Interest rates were actually reducing, so interest costs have been falling,” says Dhananjay Sinha, Director & Head of Strategy Research and Chief Economist, Systematix Shares and Stocks.

Would you want to bet on the names like PolyCab, Havells at the moment or not because Havells has been very volatile with respect to its earnings. It is one quarter a surprise and the next quarter of a shock. How should one deal with this space now?
Dhananjay Sinha: We are aligned towards more consumer goods companies, including FMCG discretionary and some of the durables, but we need to be selective as far as durables are concerned. We have seen there has been a lot of uncertainty and volatility with respect to durables companies, and our initial thought was that because of the fall in commodity prices, metal prices had come down, we had expected these companies to actually do better through margins etc. And the fact that a lot of these companies are more entrenched also in the rural areas, especially companies such as Bajaj Electrical and Orient Electrical etc.

We were very positive about that till about two quarters back, but I think the performance in terms of results has been very volatile. Despite the fact that we had a sort of a decrease in commodity prices last quarter, we saw a fairly tepid performance with respect to top lines, etc. I think there is a certain issue with respect to the top-line growth and the momentum of demand. We have heard from multiple companies that rural demand has not been that great. I think that has been the case.

Going forward, I would say that we are looking at a scenario where some of the rural plays, especially those that depend on agriculture etc, can actually do better. I would say I would be somewhat more constructive in that space. But I would say that by and large, I am more inclined towards looking at large-cap consumer companies, staple companies, etc. at this juncture.

But are not you surprised that Havells still continues to trade at a very high price to earnings multiple similar is the case with Polycab despite volatile earnings or people are just giving it the benefit of the doubt because what has happened in the last three years has been unprecedented?
Dhananjay Sinha: I think some of the large dominant players have actually gained significant market valuations and stuff, and they are dominant players in their own industry. And hence they also get a premium because they have actually gained market share from the unorganized sector, and that has been a secular trend since 2016 and post Covid I think that has only gotten accentuated.

But what we need to really look at from now on is that at such high valuations one has to really look at what is the trend in terms of volume growth because you know after a point of time when you have gained a lot of market share you become a proxy to the industry and hence your growth starts to taper off.

We have seen that, for instance, in a company such as Asian Paints which has gained substantial market share etc valuations went up but last year we have seen that they have actually underperformed. So I think beyond the point you need to really look at whether the gains in market share will continue to get you that kind of volume growth or not. So in the current context I would say that there is a certain amount of correction that can happen or normalisation that can happen with respect to valuations.

Coal India, ONGC, BPCL -- all of these names are doing well, and of course, the public sector banking space has seen quite a bit of re-rating. Do you see a bit of change as far as investor’s interest is concerned as far as public sector space is concerned?
Dhananjay Sinha: PSU banks have actually done very well over the past two years, and last year also, there was a big rally. With the underlying assumptions 2-3, one is that the expectation was that the big hangover of NPAs that PSU banks were facing was actually receding because post the pandemic, I think there was a significant improvement as far as NPA is concerned because large companies gained a lot by way of operating performance, cash flow, etc.
Interest rates were actually reducing, so interest costs have been falling, so there was deleveraging, etc.

Then, we had a host of forbearances that RBI and the government provided post-pandemic. So all that played in favour of the banking sector in general and PSU banks in particular, so there has been a re-rating. Secondly, I would say that since mid-2022, there has been another rally after a small phase of correction largely because there was a sort of a bounce back as far as the lending growth is concerned.

The systemic lending growth rose to almost 18% and 17% and PSU banks also rode that gain. They also benefited from low-cost deposits, so there was a margin expansion and leverage of the balance sheet. They had capital and all that translated into high pre-tax, pre-provisioning profits. So I think that has been history now. Going forward, some of these triggers are receding, and I think more so for the PSU banks because our understanding has been that the gains in profits of banks essentially is an inverse reflection of weakening operating profit of non-finance companies, so whether interest rates have risen, operating profits have fallen.

We just spoke about what is happening with Delhivery, what is happening with Nykaa, and Zomato. As much more and more float is coming into the market, do you believe a real price discovery of these stocks is happening? Earlier full shares were not available to sell, and that is why you saw price differentiation, and now when there is a sell at every price, you can see the difference in valuations.

Dhananjay Sinha: So these digital consumer platforms are something that will create a long-term structural sort of business, and so essentially, what you are seeing now is sort of some normalisation as far as price discovery is concerned. I think these stocks have undergone a lot of correction, but some of these companies are making operating profits already. So companies that can make operating profits now in the context that this whole digitisation platform will be a structural theme for a long time, should be able to plough some of these operating profits into the business, into technology, expanding regions and reach, etc. I think they can do well.

They are also sort of adopting omni-channels wherein they have a mix of online and offline stores as well. So they have very good prospects from a long-term standpoint. Valuations are something that we will have to really need to take a view on. There is a good amount of correction that has happened. After a few months, I would say that these companies will come to a certain valuation from where they can start creating value for investors. So I think I am very constructive in this space.