Long-term investors should largely avoid paint stocks: Sandip Sabharwal

"HUL has reported good numbers and they have given a decent guidance but it has got marred with this royalty increase. Now if these companies have to work in the favour of minority shareholders any incremental royalty increase should be on incremental sales, it cannot be on old sales," says Sandip Sabharwal, asksandipsabharwal.com

Historically when MNCs have increased royalty to their parent, it is always considered to be bad news for minority shareholders and it is always considered to be good news for the MNC owners in this case, how should one read into the HUL news?
HUL has reported good numbers and they have given a decent guidance but it has got marred with this royalty increase. Now if these companies have to work in the favour of minority shareholders any incremental royalty increase should be on incremental sales, it cannot be on old sales. For example what is the parent going to add in terms of value to its brand like Lifebuoy or Lux or any of their Kissan brand detergents etc. It is no value addition and just 1% almost 0.85% additional royalty effectively means 6% to 7% of less profits for forever perennially. I think it is a negative move so markets would not like it. So fundamentally strong performance will get more than negative by this royalty increase.

Lot of brokerages and I had a similar kind of thought that royalty goes higher which means there is going to be permanent cap in terms of where the money is going to move. A lot of brokerages are in fact coming out with a view that yes the impact could be about 1% to 2%, it is a complex issue but the margins right now are so high and since this is a peak margin period for HUL the impact is not going to be as severe as last time when the royalty hike was announced?
Actually if that is the logic it should be the reverse. If they are at peak margins and margins are going to actually decline going forward, then the impact of this could be even higher so I do not know whether that logic works or not. We cannot behave like ostriches and not look at tax as they come in front of us. You have a view you do not want to change it and just to justify that you give any view. So it is a negative corporate governance issue. It should impact in the short-term and longer run. Whether there will be any impact or not that we have to see but it is actually on a valuation paradigm. If you are doing a theoretical valuation on a net present value basis, then the net present value of the company goes down by around 8% to 10% at least.

Wanted to get in your thoughts on Asian Paints as well, the view from the brokerage community is that while margin outlook has remained better, revenues have been a miss. Competition remains one of the key concerns and even a pickup and volume growth. Are those valid?
Asian Paints numbers are quite disappointing in terms of the kind of volume growth they reported as well as the overall growth so it was a significant miss. Now margins are better because obviously the raw material prices are inching off and I think from here on next one or two quarters we could actually see margin improve a bit more. But top line could be still under pressure.

Now the paints industry is an interesting one where what people need to actually now analyse is the long term. Over the next two-three years the competitive intensity is going to increase significantly and the kind of margins which these three-four players who were controlling the entire market are enjoying will become very difficult and valuations of these companies are still very high.

So someone who wants to think and play short term maybe there could be some revival in profitability and growth but longer term over the next two-three years as Grasim enters next year in my view profitability pressures will increase significantly and to that extent given the current valuation of 65-70 times earnings, I think there is still a derating potential and it is a space which should largely be avoided by long-term investors.

If we were to now see a Paytm, it is at 533. The last one year, I am not talking from the IPO, the last one year this stock is still down 46%. You got a Zomato now which is also available for Rs 51 a share. What is your call when it comes to these stocks?
The issue I think is that they might under market pressure do some things which will lead to some profits in the short term but longer term directionally it might not be possible. So it might not be a secular change towards profitability. It might be just one or two quarters but then if that happens, then markets could react positively. So, it could present trading opportunities. You talked about Zomato and Nykaa, those are the ones where we should actually be seriously looking at buying at some stage. So those are the more I would say durable businesses which can actually get into good profit cycles at some stage.

Now there were two stocks where we saw a spike in late trade yesterday and then we saw the announcement also that came out. It is to do with HZL and Vedanta. What did you make of this one, it is almost at $2.9 billion deal with the international assets of HZL is what is going to be transferred.
Yes, I think it is quite ridiculous, in fact they are transferring assets, they are asking for some royalty from HZL. So two negative flags on corporate governance on the same day one by HUL which we already discussed and second this one by Vedanta.

The other big headline, Tata Motors is seeking $600 million for that EV business, they are in talks with sovereign pension and impact funds, and are looking at a 15% to 20% premium from the last round. Yes, while this is really going all guns blazing in the direction of EV, is it enough to nullify the kind of problem, mess or what have you to describe the JLR problem?
I think what is happening is that the JLR issue has played out and there seem to be some green shoots emerging out there as per the latest releases by the company. And if China reopens and stabilises, then we could see some uptick coming through there. On top of that if they can raise this amount of money, I think getting a premium over the last round might be tough given what has happened to the valuations all around, but even at the same valuation it is significant.

So, after avoiding Tata Motors for several years now I believe that it represents some sort of contrarian opportunity given the fact that domestically they have been doing very well. JLR has been pulling it down, but if that looks like stabilising, then we could actually see the stock coming back. So, I am not negative on the stock from these levels.


Here is one stock which represents gaming, which represents lifestyle, which represents hospitality. My friends, when they travel to Goa, they tell me that there are long lines outside some of the casinos, but when I look at Delta Corp numbers, the numbers do not capture that?
That is something because of the fact that the capacity is constrained. There is a ship only, and only so many people can go and there is only so much pricing power you have within set of available competition. They have some triggers going for them, they have this litigation going on related to Daman.

If it goes in their favour that could be a big positive. They are adding a bigger ship which increases their capacity. So, that will actually drive growth.

Actually, it is a very unique company. It should actually, ideally trade at valuation, which are higher than current valuation, but I think this entire issue related to GST on online gaming, government intervention, etc. keeps the valuation down. It is a significantly cash generating business so, I would think that at some stage, it should perform.

Interestingly the IT stocks have gone up post numbers. Nothing very great which came out, but is this the market way of saying that the worst of the bad news is out in the open and worst of the stock prices are out in the open. I mean, history tells us that when stocks they stop falling on bad news, that is the time market bottoms are made?
It is very much possible. So, all the large cap stocks have moved up by 5-6% since their results or 4 to 5% and that is what the market is playing for that the worst seems to be over because the commentaries were not as negative. The only thing which could put a spanner in the work is the rupee strength which we are seeing now and in my view, rupee could strengthen more going into the next couple of months.

The sharp rupee fall last year, where the rupee fell I think, if I remember rightly nearly 14% was a big driver for them to hold on their margins. Now in a slowing growth environment if the rupee also appreciates that would hurt profitability growth. I think that is the negative you need to watch out for. These are 10-15% per cent return stocks now so if they have already moved up 4-5% the return potential comes down. So, we will wait for to see if they correct again.

Just wanted to get in your thoughts as well then on what the outlook is on some of those PSU stocks because it seems like overseas investors once again are really betting on these the likes of BHEL, Coal India, IRCTC. They have seen an increase in their foreign holdings, your view?
I think the specific stories in PSUs will continue to get interest. Now, GAIL is something which is tough to predict but it is much below historical levels so some people might be taking a contrarian bet. The other companies which are unique are BEL or HAL or even IRCTC. So, I think there will be this phenomena where some investors will take bets in these companies. But they have had a very sharp up move. And FPOs of these companies, I think will stream in post budget running up to 31st March as the government tries to get more revenues. So, I think when those come in that will be a better time to look at them.



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