EQM: Where do you see the market heading, especially in the context of Y2K fears?
Mr. Bhat: Whatever sell-off had to come has already come. This time, the FIIs have acted in advance of the operators. After December 15, there could be a build up of positions in anticipation of allocations in January 2000.
However, fresh allocations may not take place in January. And it is quite possible that you may actually see an FII sell-off in January if the (long) positions are excessive.
EQM: Last year, around this point in time, there were similar expectations of a harsh Budget. But what actually happened was that the tax break given to the mutual fund industry turned out to be a market booster?
Mr. Bhat: The one positive that could outweigh all the possible negatives could be a section 401 (k) type of amendment, whereby pension funds were allowed to invest in the stock markets. This in fact provided a big boost to the US economy. If this sort of an amendment were to come about, then possibly you could see a repeat of what happened last year.
(Section 401 (k) regulates the pension fund industry in the US including their investments in the stock markets).
EQM: Coming to your portfolio, the infotech (IT) sector enjoys the highest weightage. Most of the other funds too, have followed the same allocation strategy. Do you anticipate this to change in the near future?
Mr. Bhat: No other sector is expected to grow as much as the IT sector. I anticipate P/E multiples to match up with growth but for the foreseeable future this sector will give good returns.
If you see FMCG sector valuations in the recent past the market was willing to pay 50-60 P/Es for a 25% growth. That has fallen now. Similarly, at some point in time in software too, the 90-100 P/E multiples will be justified only if the infotech companies grow commensurately.
Other wise we could witness a 20-30% downward rating in infotech too.
At present, all we would witness is a correction in infotech stocks and they could be quite sharp at times, but I believe that these stocks will come back after each correction. Please keep in mind that UTI is one of the biggest factors responsible for the current valuations of IT stocks. Typically, funds entering the sector at this point may not be losers but they may not be very big gainers too.
EQM: Coming to individual stocks in your portfolio, a lot of analysts have had reservations on both Silverline and Pentafour. What made you invest in these stocks?
Mr. Bhat: Basically, both management's have realised that they stand to gain through increase in market capitalisations.
In Silverline the concerns were that the margins were being eaten away by the foreign parent. The reverse merger addresses these concerns. As far as Pentafour was concerned no one really had any doubts about the operations of the animation and multimedia operations. The doubts were about the software operations. Now, the spin-off of software addresses this doubt too.
EQM: Similar reservations have been expressed in Aptech?
Mr. Bhat: Aptech has been the second strongest brand in the training market. The money that they raised has been used in acquiring companies abroad. Besides, it is common knowledge that margins in training are under pressure. NIIT despite greater revenues from software development failed to boost margins whereas Aptech even with a smaller diversification has been able to do so.
EQM: In refineries your exposure has been only to HPCL. There is a consensus that BPCL is a better company with a relatively stronger marketing focus?
Mr. Bhat: As far as refinery stocks go everyone seemed to have enough of it. BPCL has a 65% government holding with an issue expected some time or the other. Although both the companies are comparable and I agree with you that BPCL has stronger marketing focus and better financials too, we reckoned that if the reason for the refinery stocks not performing was supply, then HPCL, where the government holding had already come down to 51% was a better bet.
EQM: In pharmaceuticals your portfolio seems to be heavily weighted towards Indian pharma stocks?
Mr. Bhat: Cipla has a clear strategy as far as exports are concerned. They have identified products, which are going off patent in each of the year's and are selling drugs other than those in the export market.
Sun has an amazing recall among specialists. The management too has been receptive to suggestions from the investing community. They earlier routed exports through the partnership firm. That is now being done through the listed company itself. That I believe has led to a change of perception.
EQM: How about Wockhardt?
Mr. Bhat: Wockhardt, I feel is the next Cipla. The amount it spent on R & D last year was Rs. 400 m. Even in terms of the time it writes off the R & D expenditure: 3 years flat, is commendable. The problem of real estate too has been sorted out with the property transferred to the Wockhardt Life Sciences. This company has all the capital-intensive businesses such as intravenous fluids, agrochemicals and hospitals. It has also taken quite a bit of the debt. Thus the return ratio for the pure formulations company will improve dramatically.
EQM: Do you believe that the valuations that the MNC pharma companies have hitherto enjoyed are no longer valid considering the companies such as Pfizer and Smithkline Beecham are routing their new products through their 100% subsidiaries. And in the future there would be a dichotomy between the valuations that an innovating company, a manufacturing company and a marketing company would enjoy?
Mr. Bhat: I think so. Companies such as Glaxo, E Merck, German Remedies and Hoechst, which do not have 100% subsidiaries definitely deserve higher valuations. Overall, I foresee a brief rally in the MNC pharma stocks as and when the DPCO is relaxed. This could happen slightly before the budget. But I don't see profit growth over the next couple of year's.
EQM: Is there a possibility of a consensus that FMCG stocks have tanked enough, emerging in the near future?
Mr. Bhat: It is quite possible.
EQM: The only FMCG stock you have in your portfolio is HLL. How do you see Britannia, ITC or for that matter Cadbury?
Mr. Bhat: In case of Britannia, the valuations are still high. As far as ITC goes the profitability growth will be there but FMCG companies are evaluated more on the topline growth which I don't foresee. Another important factor is that Capitol was the biggest FII on the ITC counter. I believe they decided to get out of all tobacco stocks worldwide. So now you have the situation that the FIIs trade in the stock only for participating in the Index.
In Cadbury we are witnessing big fluctuations quarter to quarter. So overall if one wants an exposure in the FMCG sector, HLL remains the best bet.
EQM: What are the future plans of your fund?
Mr. Bhat: The last fund we launched was the gilt fund. We have plans for a retirement pension plan scheme and a monthly income plan scheme. Our tax saving fund has been made open ended. We believe there is no point in offering a vanilla equity fund.
EQM: Do you feel that if the tax incentive given to mutual funds were to be withdrawn now, it would impact subscriptions to the industry?
Mr. Bhat: No I don't think so. The tax incentive provided the required trigger. This was followed by an extremely good performance across the board by all the funds. Now even if the tax incentives were to be removed the performance would justify subscriptions flowing into the industry. I don't foresee any large-scale withdrawal.