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"The importance of market capitalisation is the find of 1999" - Views on News from Equitymaster
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  • Jan 15, 2000

    "The importance of market capitalisation is the find of 1999"

    An MBA from IIM (A), Mr. Ajay Srinivasan embarked on his career with a stint in ICICI's project appraisal cell. He then migrated to ITC's financial services division and handled a gamut of businesses ranging from stockbroking to private equity investments. When ITC Threadneedle launched its schemes, he headed the company's fund management. He took over as the Managing Director of Prudential-ICICI Asset Management in 1998.

    In an interview to www.equitymaster.com Ajay Srinivasan, MD, Priudential-ICICI spoke about his AMC's latest offering - a technology fund, the future scenario of the stock market and the potential of knowledge-based industries.

    EQM: If we see the year-on-year growth we are witnessing mixed trends in economic indicators. In non-food credit its around 5.5%, which is good. But if we look at non-oil imports and customs duty collections, they are still languishing.

    Mr. Srinivasan: It is the beginning of a turnaround. A lot of these numbers will start looking better as the turnaround picks up. Currently if you look at cement, steel, consumer durables, housing, these are the sectors where you can clearly see the turnaround taking place and it is still being sustained. When it spreads into other places, you will see a pick-up in the other indicators you are talking about.

    EQM: In terms of the Sensex are you looking at a very good year?

    Mr. Srinivasan: Are you talking of earnings or are you talking of the price?

    EQM: Both

    Mr. Srinivasan: Ok. Lets take it one at a time. As far as earnings are concerned, a lot of companies over the past two years have really felt the pain of the slowdown and this time around it is really going to be better whichever way look at it, as the base effect will definitely come into play.

    The other is the price and there are at least two-three things that will come into play. So far, the Sensex has been pretty meaningless as all the action has been outside the Sensex (stocks). Infotech (IT) is under-represented in the Sensex compared to the broader industry. A lot of the action has been in non-Sensex stocks. But going forward I think you will see 2-3 things that will get some attention back to the Sensex. For one, some of these Sensex stocks are really looking cheap and over the past 3-4 days (5-7 January 1999) you have seen of the impact.

    EQM: Bajaj Auto, TELCO

    Mr. Srinivasan: Yes Bajaj Auto, TELCO, Hindustan Lever, ITC. The FMCG stocks in the Sensex and Nifty, like Hindustan Lever, ITC, Nestle Colgate have been totally ignored. I think they have very attractive valuations. So first is the valuation imperative. Second is the fund flow imperative, where you will see institutional investors coming in the market. All of them would like some exposure to liquid stocks. And with everything looking better you are bound to see some amount of money going back to the Sensex. The third is if you look at the entry of insurance companies and pension reforms, which we believe will happen in a year. These are big institutional investors who are going to be driven by what is available in the index, and their interest is also going to get focused on the big, liquid stocks. There will be action outside the Sensex, I don't deny that, but a lot of attention will come back to the Sensex. So from all these points, I think you are looking at a very good forecast for the Sensex.

    EQM: In a previous interview you had said that you don't like the structure of the steel industry. Could you elaborate on that?

    Mr. Srinivasan: When you look at the competitiveness of an industry, I think you are looking at the level of free trade existing in that industry. And in the steel industry, I think there is too much in terms of duty that protects the industry. I think in any industry, your basic raw materials must be competitive, and in the steel industry that would include iron ore and power, and of course there is finance. But domestic iron ore is of poor quality and power is very expensive. If you are not going to be competitive here, I think on a global level it will be more and more difficult as trade barriers fall. If you look at the Internet, technology and other advances, they are going to bring down barriers so quickly that you have to look competition outside your markets.

    EQM: Would you put tyres and paper in that category?

    Mr. Srinivasan: Yes. I feel the same about paper and tyres.

    EQM: Last year we saw Thailand and Malaysia give far better returns than the Sensex. This year we saw the Sensex give a 60% return, where would you put India vis--vis South-East Asia at this point in time? How would emerging markets manager look at India?

    Mr. Srinivasan: That's a good question. I think India is today very different from what it has been in the past. The attraction stems from there. Today you don't find people debating that we have moved into a new era. Everyone is talking about ideas, innovations, marketing. I think if you look at that, India has a much clearer benefit than others. India always had it in the past. India always had a much broader base of companies, a broader industry and economy than other South-East Asian economies. But people preferred those countries because the systems were much better, you could enter and exit markets quite easily.

    But today India is different. One reforms like demat have changed that because with demat a lot of investments can go in and out of India easily. Two, the government is more liberal as far as FDI (foreign direct investment) is concerned. A lot of money being poured in through FDI and a lot of portfolio investments follow FDI. The FDI also has an impact on rupee outflow. If you have a steady stream of FDI, your view on the rupee becomes positive, than if you only look at non-oil imports for instance.

    Thirdly we are in an intellectual and knowledge era. This has shown a lot of people what Indians can do. In Silicon Valley there are lot of examples of knowledge-based companies being driven by Indians. More and more foreign investors are believing that we have a competitive edge there. And its not a simple competitive edge in terms of labour advantage but it is a mind advantage. That is why where people are looking for this, you will definitely attract more money than other economies, traditional South-East Asian economies with trading, banking.

    EQM: Coming to the IT valuations, do you still think there is some upside left? You launching an IT fund?

    Mr. Srinivasan: Its not an IT fund. It's a technology fund. There are many parts to technology and IT is one part of that technology. IT itself has five components - IT services, IT products, e-commerce, education and ISP. So when we look at IT we are looking at all these components.

    Let's discuss the IT potential. The NASSCOM report which sees the IT industry growing from US$ 4 bn today to US$ 87 bn in 2008, of which US$ 50 bn will be exports.

    The second important factor is increase in spend towards e-commerce. We have not seen that so far, with too much preoccupation with Y2K. But now you will see a lot of e-commerce spend from businesses.

    Another area for growth of the Indian IT industry is going to be moving towards non-English speaking population, which is large. And thirdly moving up the value chain, moving up to projects and turnkey products.

    So IT potential is big. Now within IT you may find some companies that look stretched as far valuations are concerned, but that does not take away the attractiveness of the sector. Our job as fund managers is to identify stocks that are listed and are attractively valued. We are also looking at unlisted stocks. By unlisted I don't mean companies that are targeted by venture capitalists I mean companies that are pending listing. Sometimes we get attractive valuations there.

    EQM: But your definition of technology is rather extensive.

    Mr. Srinivasan: Regarding our definition of technology, I agree with you that it is broad. So when I say technology, I am looking at media, convergence, networking, life sciences. The kind of wealth creation you have seen in IT, you could see in other knowledge-based industries. You have already seen it in pharma.

    EQM: Can you give some examples of companies involved in the life sciences business?

    Mr. Srinivasan: Currently, we have only a few like Ranbaxy, Cipla and Dr Reddy's which do original research. But if you look 12-18 months forward you will see a lot of biotech companies. In fact the next round of growth will come from biotechnology. For instance we ended the century with the first case of breaking a human in genetics. There are already companies like Nestle, Novartis that are doing path-breaking things in genetics. A lot of it has not happened at a commercial scale, but it will in future. We have a totally different paradigm here. To cite another instance, it could soon be possible to grow a plant with the inherent capacity to resist pests, thereby making pesticides redundant. This is the kind of innovation we are talking about, and that is 2-3 years away.

    EQM: Coming to the other sectors like refineries. There was a time when fund managers could not get enough of them, and now you see that they are out of favour. Do you still find value in it?

    Mr. Srinivasan: The P/E of the refinery sector over the past five years has been going up and down. The sector has been re-rated, de-rated several times. Initially the growth was driven by deregulation. There are two things. The first is the holding pattern. A lot of large investors had significant holdings in these stocks. As they come across new opportunities, they sold these stocks to buy new ones. So there is a constant supply of refinery stocks. Another thing that has happened over the past few months is that investors are looking for a bit of excitement and are willing to pay for that kind of excitement. This is the kind of excitement that software gives you along with media, pharma research. But it is different with refineries as it lacks the excitement. The margins, the throughput are known, so it is not in keeping with the times. But if you look at valuations these stocks are really cheap.

    EQM: We have seen a dichotomy between the P/Es of Indian pharma companies and the MNCs. Do you think this trend will persist?

    Mr. Srinivasan: Yes, in fact most stocks we like are Indian pharma. There are others like Pfizer, but that stock has run into problems because of issues like the 100% subsidiary. So although there are other pharma stocks we like, but they have other issues affecting them.

    EQM: We have seen that apprehension with Hero Honda also, despite the fact that Honda will be coming 5 years. Don't you think Hero Honda will have built up a decent market share by then?

    Mr. Srinivasan: Yes. We like Hero Honda. Its in a different business (than Pfizer) and 5 years down the road is a long time. But a 100% subsidiary in pharma is a different game. You don't know what products will come through the Indian arm and what will be sold through the 100% unit.

    EQM: What is your view on Bajaj Auto?

    Mr. Srinivasan: Bajaj Auto's strengths are in its brands and historical prowess. The auto companies have had to innovate and we have seen Bajaj Auto doing that. The last quarter has been good for the company. But the question everyone's asking is whether it can sustain that. If it can, it is a good stock.

    EQM: In your view what is the single most important factor that will drive the market from hereon.

    Mr. Srinivasan: I would say there are three factors - liquidity, sentiment and the fundamentals. I think domestic liquidity should remain good, even foreign liquidity should remain decent in terms of demand barring unforeseen circumstances.

    Fundamentals will have a lot to do with second-generation reforms, which I have mentioned earlier. The budget holds the key here.

    Then what happens to the NASDAQ will be important as that is driving a lot of sentiment today. Then of course there is the sentiment on the border.

    EQM: Your view on FMCG stocks?

    Mr. Srinivasan: I am glad that FMCG has rebounded. This shows that there some degree of rationality in the Sensex. The trend affecting the FMCG is very similar to the one affecting refineries, which I mentioned earlier. People can say with a fair amount of certainty that for instance, Hindustan Lever will show 30% growth for the next 20 years. But they can't say that for software stocks beyond a year.

    However there are some benefits in FMCG companies. First is the earnings growth, which is secular. Over the past, at the time of economic upturn, FMCG companies have done better than in terms of sales and profitability. So they are also an economy play and not just a defensive play. For instance stocks like Colgate, which is really cheap. It has very limited downside at this point of time and a huge upside.

    EQM: How do you plan your new offerings? For instance you just said that FMCG stocks are cheap and IT stocks are also doing well. So how do you decide whether to launch an FMCG fund or an IT fund?

    Mr. Srinivasan: The system is driven by investor demand. So we have to offer a fund to suit investor interest and then we have to deliver a performance regardless of whether valuations in that sector are high or not. For instance, last year we launched the FMCG fund and since then the sector has underperformed, but we have still delivered a 30% return. So we have to find ways to register growth, maybe with a better range of stocks, etc. So ideally I should be launching a cyclical fund as cyclicals are performing well, but the market is inclined towards technology so we launched a technology fund and then our team decides how best we can perform to expectations. But that is the way it is even across the world.

    You would normally launch a fund when the stock prices are higher than what you would them to be.

    EQM: Where do you see Prudential-ICICI in a year's time in terms of size?

    Mr. Srinivasan: We are roughly among the top few. I can't say what the figures will be in a year's time, and I am not even looking at that. We look at the mutual fund market and we try to grow faster than it.

    EQM: So where do you see the mutual fund market?

    Mr. Srinivasan: I think the private sector mutual fund should grow by 50%. Therefore we believe that we could grow more than 50%. And if you take into consideration pending reforms in pension funds and insurance, the growth could be more than that.

    EQM: What is your view on interest rates and forex?

    Mr. Srinivasan: I am reasonably sure about forex because FII inflows are good and I am basing my view on the rupee on that. Since FDI and FII inflows are good, rupee will be stable, despite the oil prices. You may see a 4-5% depreciation, but that is OK.

    EQM: What about inflation?

    Mr. Srinivasan: Inflation I don't think will be a significant concern. Interest rates will be fine. There will be some pressure to bring it down. RBI has already spoken of a policy to maintain CRR (cash reserve ratio) at 3%

    EQM: Do you think that it is possible to reduce interest rates without a cut in PF rates?

    Mr. Srinivasan: No I don't think so. That is why I think the budget is going to be important.

    EQM: We have seen some re-rating in terms of certain business groups. What do you make of it?

    Mr. Srinivasan: I think it is a question of who places an importance on market capitalization and who realises that market capitalization is important. I think the importance of market capitalization is the biggest find of 1999. Also as ESOPS (employee stock options) increase and a lot of companies will be issuing ESOPs. Then even employees are concerned about market capitalization. And more and more groups are concerned about market capitalization. That is why we no longer find the largest business groups of the earlier era among the leading lights today. These groups are now realising the importance of market capitalization.

    EQM: What is your view on the debt market?

    Mr. Srinivasan: The biggest problem with the debt market is liquidity, that's how the growth will come. For that stamp duty rationalisation is a big driver. Another driver will be infrastructure projects, which are funded by debt in a big way.

    EQM: What do you have to say about net-based trading?

    Mr. Srinivasan: Its happened in the US. People will get excited about it initially. For it to happen in India, internet usage has to increase dramatically. We are still talking about 2-3 million internet subscribers in the country. Also information is not widely available in the country.

    The way our markets have moved, I think more and more people are realising the importance of giving it to professional managers who can understand the markets better.



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