Indian Stock Market Needs Correction, Says Nepean Capital’s Gautam Trivedi

Gautam Trivedi: Not really surprising. A lot of the people who’ve been in this market—like myself for over two-and-a-half decades—think we have the baggage of history, if I can put it that way.

We have seen this movie many times before and sometimes, you know, we’ve seen this not ending very well. So I think what’s different this time is the fact that you’ve got a whole bunch of new investors who are entering the market. I’m referring to the domestic retail investors, who were not present in the previous bull markets as much because a lot of the previous bull markets were led and driven primarily by the FPIs. And again, you know, FPIs have been net sellers of over $4 billion. So I think, this is more of a rally led by domestic investors as the penetration of the equity culture continues in India.

Most certainly. It’s interesting to use the term baggage of history and yes, you’re right. These reels have played out multiple times in the past, sometimes not ending too favourably.

Do you expect a bit of a “hard landing” in some sense? Or, do you believe this flow of money kind of helps cushion any kind of sharp blows that Indian markets may take?

Gautam Trivedi: You know, that’s a very good question. I hope there’s no hard landing because the newer investors were investors for the first time in the Indian equity markets. I hope they don’t have a bad experience.

A correction is always good. And the fact is that if they get a correction of five, maybe even a 10% correction—I’m talking of an average correction—it will, I think make them wiser, make them more mature. And I hope that they continue to invest in the Indian equity markets because that’s something which this country really needs. We need capital to grow this economy at 8-9-10% GDP growth and to see our Prime Minister’s vision of becoming Viksit Bharat. So I think that equity culture has to come from within. It cannot only come from overseas. So I think it needs to be a correction, no question.

Now, if you look at exactly the two pockets of pain, or potential hazards, one would be the F&O market. So in the F&O market, as we know, 180-odd stocks and of course the index. So that’s one aspect where I think the froth clearly is, because 99% of the daily traded volumes in the Indian stock exchanges are F&O. So that’s one bubble.

The second bubble of course, is small caps, followed by some mid caps. So you’ve seen that also happening. In fact, we brought it up because we ran a screen last week of the top 1,200 stocks in India. Of them, 880 stocks—I repeat, 880 stocks—or 73% of the 1,200 stocks are up 36% or more from their respective 52-week lows. And the reason I take the benchmark of 36% is because the BSE 500 over the last 12 months is up 36%. So if I take that as a cutoff, 73% of the top 1,200 stocks in India are up 36% or more. Of course, so many of them are up 100%, 200%, 300%. But the point I’m trying to make is that that’s where the froth is and I think that’s where the correction needs to come.

There’s been this development of this whole new set of sectors that have come to the fore. Most of them are not necessarily in the Nifty 50 or Nifty 100 but beyond that. Mid-cap, largish mid caps or small large caps as the case may be.

What has impressed you from there the most? If 2023 was a year of defence that came to the fore and railways, suddenly this whole semiconductor space came to the fore as well. What is standing out for you?

Gautam Trivedi: I think you made a very valid point. There are certain businesses that didn’t even exist 5-6-7 years ago that are now getting listed. So you know, we had only two companies in the EMS space—Dixon and Amber, and of course, PG Electroplast—may be three companies. But now, we have about 15 companies that are listed in the EMS (electronics manufacturing services) space.

And I firmly believe that the EMS space is where the Indian IT sector was 25 years ago, valuations notwithstanding. So I’m not saying the word buy, right now. The point I am making is, because the growth that we’re seeing in this sector is similar to what we saw with the Indian IT space, I think the Prime Minister has done a phenomenal job along with his core team of ministers to market India to the outside world and bring semiconductors, televisions, mobile phone sets, etc., to get manufactured in India and as an alternative to China.

So I think that the ecosystem that we’re seeing is developing, it’s in its nascent stage in this country. And I think, you’ll see the fruits of that over the next five or 10 years, definitely play out. So I think these are some of the emerging sectors.

Again, like I said, they’re not necessarily all the buys today, because valuations are expensive. But I think from a longer term perspective, if an investor has a 3-5 year view, I would certainly start accumulating some of these names.

Gautam Trivedi: You know, the question really is more to do with the fact that the correction that we spoke about earlier today, is that correction coming. If that correction is indeed coming, then I think it’s better to hold off and if you get some of these stocks 5-10% lower, that’s the best time to build up a position. Again, what I’m saying is true to the whole market. It’s not necessarily only for the EMS space, given the fact that as I said, 73% of the top 1,200 stocks in India have rallied 36% or more and the list is even more staggering when you look at the stocks that are up 100% or more.

So the point I’m trying to make is, these are stocks to keep on your radar, on your list of stocks to buy, as and when the correction starts, which I hope happens soon, for the majority of the market.

Viewers, keep in mind, Gautam Trivedi is not predicting when the correction will happen. He is merely saying that at some point, a healthy correction should happen.

Gautam, if at one end we have pockets like EMS and some others, at the other end we have HDFC Bank, Kotak Bank, etc. It’s befuddling some of the best minds of the Indian stock market as to why these stocks are not quite moving. One of the factors could be that the global supply has kept them at bay… What’s your prognosis on this?

Gautam Trivedi: I think it’s a very valid question, with respect to the fact that for the longest time we thought private sector banks were the gold standard, and PSUs, as you know, were really not well run, no skin in the game for the CMDs who were running it and lacklustre industrial appeal. That’s of course gone 180 degrees, as balance sheets got cleaned up and the fact that, you know, these PSU banks became more prudent in their lending practices. So I think, as a result of that, you’ve seen a gigantic investor sentiment surge towards PSUs and away from privates, HDFC included. So I think that the correction, in terms of time correction, is still happening with the private sector players including HDFC Bank.

I think, specific to HDFC Bank, as you asked, there is, I think, a bit of a wait and watch as the merger of the two entities play out and the impact of that on the balance sheet—as we’ve seen over the last few quarters—starts to play out. I think people want to see evidence that the issues of the past are behind them and from here on HDFC Bank is back on the growth trajectory. Otherwise, you will not get this bank at half the valuation that it has historically traded over the last 20 years.

Gautam Trivedi: You know, it’s a broad statement. And I think you’ve got in one breath a State Bank of India, which is you know, has always traded at a different valuation than the rest of the PSU banks and at a different level of respect, should I say, from the PSU banks. But at the same time, if you look at the number of stocks that are now in the top 100, you have seen a lot of other names come in there—Canara Bank, Punjab National Bank.

So, if I look at the top 100 stocks in India, that’s a large cap definition by SEBI. You have a total of 21 PSUs and not PSU banks, but 21 PSUs, you know, which is remarkable… You had ONGC in there, but now you’re looking at so many more PSUs coming in. So I think the overall sentiment clearly, from an investor’s perspective, has improved for PSUs. And yes, you may still have some PSU banks that may be trading at sub-point eight times or definitely sub-one time book (value). But again, it’s very stock-specific, versus having a broad generalisation.

Energy stocks are under pressure. Inox Wind is down 5%, Sanghvi Movers is down 7%, and KP Energy is down 5%. Now, according to some media reports, the ministry has decided to bring back reverse bidding as wind tariffs rise in auctions. This is on the back of undersubscription and high tariff discovery in recent wind bids.

Under reverse auction, bidders continue to bid against each other after the initial bids are open until a bid tariff goes unchallenged.

How do you look at the wind energy space growth, per se, over the course of the decade and are these near-term impediments large enough or will they be taken into stride?

Gautam Trivedi: The way I see, what’s happened in the wind energy space is that the government’s focus—at least until a few years ago—was largely on solar and making sure that the solar manufacturers did well and succeed in India.

What I guess, at some point dawned upon them, was the fact that solar generation happens only from eight o’clock in the morning till about 4.30 or five o’clock in the afternoon. So after that, solar power generation

doesn’t happen. And that was impacting the stability of the grid. So, as a result, they went for hybrid bidding. And basically, I think, most of the PSUs are now doing hybrid projects when it comes to renewables. So it’s not only solar, but solar and wind, starting from the first of April, last year. Very clearly, the government announced that they will auction as much as 10 gigawatts per annum of wind projects, or 2.5 gigawatts every quarter. So I think that itself was a blessing for the wind energy industry. And as you said, this one industry was actually in big trouble… You’ve seen the stock prices of the two and there will be two listed companies in this space. Both Inox Wind as well as Suzlon. So you’ve seen a reversal of fortunes for both these companies, and of course, for the wind energy sector. Now, this new announcement just came over the weekend.

The way I see it is, if the government thinks that tariffs are too high and need to be lowered and the reverse auction process will end up resulting in lower tariffs you know, frankly I’m not so sure if that’s necessarily a good thing because if you get some of the crazy competitive bidding that we saw pre-COVID and even up even 10 years ago, we don’t need that to come back because these projects need to be profitable. And I’m not going to put a number as to what that profit level should be in or should not be. But yes, this does bring about a more transparent competitive bidding process. And if it does, and if the tariffs get driven down, I think that itself will correct on its own, if the tariff structure gets so low, that some of these companies may find that they may just not participate in the bidding. So I think, the market itself should be self-correcting, if the tariffs become too low. That’s my personal view.

What’s happening to some of the other power-related themes? I mean, one is renewable, of course, and the kind of capacity that is being set up. We were talking to the coal secretary earlier today. He spoke about how the availability of coal is at 19 days, which is the highest that we’ve seen in a long time and thermal capacities are being ramped up.

What’s your view on the conventional power space?. They are continuing the cash flows to conventional power projects, but at the same time also ramping up renewables. So are these stocks moving ahead themselves or is there potential for investments there?

Earlier in the interview, when we started off, you mentioned how a correction would be healthy. Maybe you’re waiting for one as well, who knows?

If that’s the mindset with which you are currently sitting on Dalal Street, how are you going about choosing companies in which you deploy money? Is growth the panacea, or are valuations and low valuations, the must have starting point or something else?

Gautam Trivedi: Good question. So we’re actually at a special situation point. So the way we approach investing in the market is, we look for stocks that we believe have triggers that will play out over the next three to five years. I’ll give you an example. We own a company called Eureka Forbes. Very interesting company. Full disclosure, that we own it. But the fact is that it is a very interesting company, wasn’t that well run when it was under the umbrella of the Shapoonji Pallonji group.

And when internationals came in and acquired a 74% of that company, this is going to take a longer time to play out as they restructure the inner workings of the company. They launched more products and brought in Pratik Pota, the erstwhile former CEO of Jubilant Foodworks to come and run this company and turn it around. So I think there are a lot of positives going for it. So this is an example of the kind of turnarounds that we believe exist in companies. Valuation is one aspect of it, but the fact is, what’s not priced in from our perspective and what will play out over the next 3-5 years. So, like I said, … if you focus on those opportunities, there are quite a few of them in India right now.

Gautam, what explains this arbitrage available between Inox Wind and Inox Wind Energy, since you mentioned that you look at that space because there is clearly a very large arbitrage there?

Part two of my question—you mentioned Eureka Forbes, a large block deal had happened. A lot of chatter around how foreign promoters are selling businesses and therefore why should people invest in them? Clearly, Eureka Forbes was in the past known for that as well. Can you talk about that?

Gautam Trivedi: I think there is still an arbitrage left between the two Inox companies. And frankly, I think it’s before the NCLT (National Company Law Tribunal). So you know, until that happens, there are ways to play this and may be get into an Inox at a cheaper valuation. So be it.

I think the runway of growth for the wind energy space in India is still very large, notwithstanding the reverse auction process that’s been announced. So I think, I wouldn’t worry about that. Your second question was with respect to Eureka Forbes, right?

Gautam Trivedi: I’ll tell you what it is. If you look at the last 6-7 years, the one phenomenon that we’ve noticed—and I’ve gone on media and said it as well—is the fact that global private equity funds are coming and buying out promoter stakes in listed mid and small-cap companies. But keeping the companies listed, and the objective of keeping that company listed is because when they want the need to sell a chunk they can do so.

Now, there could be various reasons to sell a small block or a big block, depending on you know, when they come in and when they’ve invested in the company. One, could be the fact that they made a significant amount of money in the stock from the time they got into the company. So that’s one.

Two, there could be limitations with respect to the life cycle of the fund from which the initial investment came in. It doesn’t mean they can’t roll it into the next fund that they have raised but there are multiple reasons. I don’t know specific to why Advent did sell a block. But I suspect these are some of the reasons that private equity funds end up using the fact that these companies are listed and use that as windows of selling down blocks.

Well, the third element of course, which I would say is increasing the free float, because if it’s specific to Eureka Forbes, Advent International owned as much as 74%.