Can defence and real estate continue to be flavour of the market? Rajat Sharma answers

Two themes have been the flavour of the market in the month gone by – defence and real estate packs. Just after the recent tensions across the border, we have seen all these defence companies doing well and along with that, the real estate pack has been doing well, though on the number front, the numbers were not that great. But from the April lows, these stocks have given a double-digit return. Can these continue to be the flavour of the market in a couple of months ahead as well and also are the valuations comfortable and trading in a decent zone?
Rajat Sharma: Let us take them one by one. When you talk of defence and the moment you say flavour of the month, that should at some point die. Flavour of the month is for a month, two months, a quarter; but a flavour of the month cannot be sustainable. Now, I do not for one doubt that defence companies are strategically important for India.

We are seeing increasing hostilities in the world and stocks like Bharat Electronics which produced the radars that really saved us with this war. These are great companies but let us talk about valuations and let us not get carried away with wars or skirmishes. These companies are trading at very expensive valuations. Will they continue to trade at expensive valuations for a while? Sure, they could because the sentiment is so much in their favour. But are they value buys? Would you like to buy them at these prices and hold them for the next two, three years? My sense is you will get these stocks for cheaper than the prices at which they are available now.

Coming to real estate, valuations are again extremely stretched. You look at DLF, Prestige Realty, the Lodha Group and most of these companies something very interesting is happening. When I talk to investors in real estate in the market, they feel prices have run up a lot, like real estate prices are zooming and the house prices and excluding Bombay where there is a slowdown, but in Delhi, NCR region, Bangalore, Hyderabad, a lot of these house prices are going through the roof, but a lot of that is not being reflected in the balance sheets of these companies. So, valuations have stretched.

I do not know why because house prices are really robust. They are selling. Prices are going up, but the money is not being reflected on the balance sheet. So, take a guess where it is going. Real estate is a cyclical business, and in their peak cycles always run on very high valuations. But all of that has already played out for a lot of these largecap real estate companies. From here, do these companies have the legs to keep running higher and higher? Maybe another two quarters I would believe, but that is not on account of fundamentals as reflected in their balance sheets, but more on sentiment. So, it does not fit in my scheme of things. This is not a sector where I am initiating or looking to buy anything more.

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What is your view on the consumption space? How do you see this space shaping up given the kind of government push that we are seeing to increase consumption and also the early monsoon that has set in. Do you expect any kind of growth momentum going forward for this space and within this space, are there any particular pockets where you find more value?
Rajat Sharma: Yes, we were looking at consumption. But consumption is a very large area. There are consumer discretionaries, like Voltas, but I was specifically looking at FMCG where valuations have still not come down but that is largely on account of extreme margin pressure. So, the revenues are not growing whether you talk about HUL or Asian Paints or Nestle. I was trying to understand why that is. So, we started looking at a host of factors and we realised that quick commerce is the reason why a lot of these FMCG, the companies that sell 20, 30, 40, 100 rupee items, like soaps and ice creams and biscuits and bread, butter, coffee these kind of companies, the reason why rural demand is not slowing down, but urban demand is slowing down is because quick commerce has allowed a lot of these new players to come in the market. Earlier, whether you would go to a Nature’s Basket or a Modern Bazaar or any kirana store, you would see there would be a rack for coffees and there would be Nescafe and Bru or there would be one more brand. Today people are buying on Blinkit and online, so maybe Eternal, this good news. For people who are buying on these, online platforms are like shops. So, for stocks like HUL and Britannia and Nestle or Marico which sells hair oil, there are so many kinds of coconut oils which you can buy online and this is likely to stay. So, this margin pressure is likely to continue unless some of these larger players buy out some of these brands on the Blinkits of the world and take them under their umbrella and sell it as theirs. But that could take a while. So, I am positive that stocks like HUL would eventually do well when they figure out how to deal with this quick commerce game, but that is a while away.

So, while we were doing this research, let us look at all these stocks. I figured there are two stocks which are not impacted in FMCG with quick commerce – cigarettes and alcohol. Now, I do not drink now, but I do invest in alcohol companies and these two things will never be sold on Blinkit because the government regulation will not allow it. So, both stocks are available at decent valuations. I suggested adding these two stocks to our client portfolios and ITC in particular, after yesterday’s correction because of that BAT news of selling some 2.3% stake has become even more attractive.

If this whole BAT issue is behind us, these stocks should trade far higher. You have America with a population of 34 crores with three large cigarette companies. You have India with 154 crores increasing number of smokers and one monopoly. Four out of five cigarettes sold by ITC. These are the stocks in FMCG that I really like.

You have talked about how valuations are stretched in the defence and real estate baskets. But apart from that, do you see risks in any particular sectors and you think investors must avoid and steer clear of?
Rajat Sharma: From time to time, there are these sectors which get really overheated and everybody wants to buy something in that sector. Personally, PSUs are still since they corrected a little from the top, everybody is like jumping on to buy PSU stocks not realising that they are still far more expensive than where you have power generation stocks like SJVN and NHPC which used to four-five years ago trade at Rs 24-25, they ran up to 150-160 for SJVN, today it is trading at Rs 100, 120, it is not like it has become very cheap, just that it has fallen from its peak.

But people find it attractive but I still think the whole world is not getting into solar and hydro so soon. So it’s still very, very expensive. I find government power stocks and PSU themed stocks like defence stocks, real estate stocks to be expensive.