The way to take part in UP’s development is through private sector financials, says Dipen Sheth, Head – Institutional Research, HDFC Securities, talking to ET Now. It is certainly a buy on dips market. You should be willing to let go 5% or even 10% from the top which means that the midcap could correct 15-20%.



Edited excerpts:



Before we talk about this, long show of yours, how many kilometres you did?



1600 kilometres through India bad lands as you would say.



Diesel car or petrol car, SUV?



Both diesel, both Toyota Innovas.



Do you still like the Maruti stock?



Yes, we do. Toyota is not listed here. So we spent two weeks in what you would call the bad lands that is Uttar Pradesh and a bit of Uttrakhand and people were very sceptical when we started doing this and the first question that came to people’s minds was why UP and why now? What is the big deal and why as a stock market investor should you be in or as an advisor or a brokerage should you be interested in researching what is happening there?



The GDP of UP I am sure will be bigger than the GDP of some European countries put together.



Yes but even so it is a terrible-terrible laggard and all the bad news and all the bad stuff about UP is very easy to spot. Social indicators, macroeconomic indicators, human development and so on and here is 16% of India’s population, one out of six Indians lives there, contributes about 8% to GDP.



So, you can understand even by India’s standards, how big a laggard that state is. So why should we be doing this and the justification that came through when we did some of our homework before the trip was “UP is to India what India is to the rest of the world” and you will be astonished to see the parallels.



Here is India which also houses one out of six global citizens on the planet and in PPP terms at least, India contributes some 7-7.5% to global GDP and that is exactly UP’s position in India and global investors are now looking at India being in some kind of multiyear healing process which should take up growth rates from the 5-6-7% to may be a couple of 100 bps higher at an aggregate level and it is a huge economy and the same applies to UP.8% of India’s economy if it is growing at not 5% or 6% but 11% or 12% and believe you me that is possible.



I believe that is possible after driving 1600 kilometres through that state. If you get 700-800 bps incremental growth on an 8% contribute, you are looking at 60-70 bps incremental growth to India’s GDP.



So why should UP suddenly make a comeback, why now?



UP has been lagging for I do not know how many decades and the same thing could be said about India. Three years ago India made a change of choice and it is not just that we elected a BJP-led government or who have chosen Narendra Modi and so on but look at the qualitative factors behind this change that a mai-baap left of centre leaning sarkar and political and… clearly shifted to a right of centre leaning discourse and mix at it were.



It was led by somebody who was controversial to say the least. But somebody who was charismatic and I think in three years time I do not know about foreign investors but Indian investors have given him a heads up. Now is everything right? Certainly not. But are we completely different as an economic creature from three years ago and most certainly we are.



Coincidentally, three months ago, UP made a similar choice. The UP Chief Minister is a controversial leader yet again and he is kicking stuff all over the place in UP and some of those kicks are landing in the right places and that is what we figured out when we drove through this state.



Where does it equate or rather how does it equate to the equity market health right now? Our equity markets already are pricing in this great recovery. Are we at that inflexion point or are we still behind the curve when it comes to that?



The current dilemma as it were in Indian stock markets is we agree that the near term is challenged on valuations but here is this big multiyear structural change and healing which is playing out in the economy and in the long term, it has never looked better.



If you were not an investor in the stock markets and you if you were a real economy person outside of Dalal Street, you would say India is changing like it has never changed before. The dilemma is whether you want to buy on dips or you want to exit on every rise that happens and God know we have been rising almost continuously since last Christmas. We are up close to about 25-26% from those levels and it has been a straight run. A lot of chartists will tell you that it is time there was a little bit of selloff but to my mind the Indian investor, the retail investor and the inflows into mutual funds are telling you that they believe now that the long haul is possible on this economy and to bring in UP into this, I believe the long haul is possible on UP’s economy as well.



For us, it is certainly a buy on dips market. You have got a free ride and you should be willing to let go 5% or even 10% from the top which means that the midcap could correct 15-20%, some of the front lines could correct 5% or 10% in that range but a lot of this has been anticipated for the last two or three months and has not happened and the confidence of people that we saw in UP, some of the anecdotal and in fact specific instances that we saw from the bureaucracy tell us that things are actually on quite a roll.



There is difficulty, there are hurdles but a lot of them look like they are surmountable challenges and hurdles and maybe three years ago or three months ago in UP you would not have been able to say this with the same confidence.



How should an investor approach this current market to be able to cash in on this mega long term story which is playing out right now?



Now we are getting to the crux. This is where the rubber should meet the road and for 16000 kms, the rubber met the road in a very simple way.



In financials for example, we met NBFCs, banks, microfinance companies and across all horizontal slices of financials whether it is auto lending, agri lending, SME lending, LAP loans, housing finance or micro finance. On financials, let me get to specifics.



The sheer low level of financial penetration at a time when two-thirds of the formal banking system is actually starved of capital and capability to lend which I am obviously referring to the PSU guys. Barring an SBI or a BoB, there is stress across the PSU pack, they have their share of stress but they look like they are managing that stress in a constructive way.



At a time when two-thirds of the formal lending environment is stressed and is avoiding additional lending, the private sector pack despite its allegedly high valuations -- NBFCs at 6x-7x, some of them at 9x-10x trailing book -- the small finance banks, the microfinance companies, the private sector banks, the midsized banks all the private sector looks across all slices and verticals are costly but we certainly figure out there is a reason they are costly.



Here is sustainable multi-year growth possible for people who have a fix on asset quality, there are notable exceptions in the private sector pack which we have not been able to get a fix on also.



Let us work with the assumption that UP makes a comeback, the GDP growth rate which was subpar from the India average at 5-6%, moves up by 30-40%.



It can go to double digits very easily. You have seen what has happened in the early part of Nitish’s rule in Bihar and the low hanging fruits.



Let us look at the best assumption that UP’s per capita income explodes. That is the headline. So what is the repercussion?



How do I make money? How can one who is watching the show and has bought into your argument that what India is to the world, UP is to India -- heart of the market -- heart of Indian economy is going to be running? How do I participate in that?



Right and remember this was a heart that was not pumping well at all. Now you are going to have the blood flowing through your system. Like I said, private sector financials look very well placed. There is a little bit of misbehaviour and recklessness at the margin selectively in microfinance. We saw a lot of overleveraged borrowers, a lot of reckless lending but we also saw some very responsible lending by microfinance players.



In this instance, I must mention an unlisted and a not for profit microfinance company called Cashpor.



Is it an NGO?



Well you can call it an NGO and they have a not for profit mandate obviously and they are run by a trust. You can read upon Professor David Gibbons and the wonders that he has achieved in Eastern UP after replicating the Gramin Bank Model there. But even outside of Cashpor, we met the folks at SKS or Bharat Financial if you will and while there are pockets of stress and a little bit of instances where borrowers have gotten overleveraged, with some very strong operating practices, a lot of technology getting into the field, you can have borrowers of Bharat Financial just scanning their finger prints and getting a confirmation of whether they are eligible for a top up loan or whether they are eligible for a refresh of their current loan in a matter of minutes by some backend processes which look at credit bureau checks and so on.



We also saw reckless microfinance companies and I am not going to name them right now but we saw NBFCs for example like Chola, Mahindra Finance, Shriram Transport.



What about the sugar economy because unique aspect about UP sugar?



It is unique because in a slightly twisted sense, sugar is where farmers have got fixed prices. If you look at the pocket between Lucknow to Agra, which has a magnificent six lane highway made by the last UP government and it is probably the best road in India on current form. We saw potato farmers who would in a good season sell their potatoes for Rs 8 a kg and right now they were selling for Rs 2.5 a kg. When infrastructure changes and prices are determined more rationally and prices have been prescribed in sugar cane for a long time some of that has obviously worked against these sugar companies. But right now they are on a cyclical high. So sugar farmers are the most prosperous in UP.



But what about JPA, GMR, Unitech? Typically when a cycle revives, some companies survive and blossom. It is like the 2000 analogy I give everyone that Amazon also corrected 99% but when the bubble became a realistic cycle, Amazon became whatever it has become today. If one works with the assumption that I do not mind putting 5% of my capital to work but I want absolute return ideas, would you like to skim in this pond?



I will tell you what is wrong in doing this. If you are an ultra HNI and you want to put 5% of your net worth, it is a gamble you are taking. A lot of these companies have got overleveraged balance sheets for whatever sins of commission, omission and accidents and cycles. On an overleveraged balance sheet, if the cycle comes in your favour, equity value multiplies, the cycle does not work out so well or you do not manage to ride the cycle well equity value can evaporate.



I completely take the point that many of these guys are at option value. Is that an option? Do you really want to play sensibly and remember as a financial news channel your job is to popularise and promote and propagate the concept of sensible equity investing to retail investors. They are not really the stuff that a serious long-term retail investor should look at. Can some of these stocks go 5x, 10x from here? They might but is that the kind of game you want to play? If you really swing the bat hard and not look at the ball, you might hit a six. Do you want to play cricket like that at 191 for 3? No.



You just want to win. So what is the winning formula in this market?



So we lost seven wickets for what about 26-28 runs yesterday. A lot of that happened because of bad swinging. I would not say overconfidence but getting jittery at a time when the big shorts were needed. If you just keep on telling yourself that I need to hit big shorts and I want to play glamorous cricket, I want to invest like a pro, if you want to look smart and handsome, then maybe you should take these chances and you might look very smart for some time…



Classic example which I give everyone is that if you bought into a Nestle five years ago, it was one of the finest companies, you would not have made money. A good stock or a good company may not be a great investment.



That is the argument you might give me for some of the private sector banks that I am gung ho on or some of the NBFCs but for a good stock at a high price, the question to ask yourself is are you looking at growth and are you going to look at time correction and ultimately is the market going to or are the returns going to be on your side. Look at Kotak which is horribly costly according to so many people, but we have a buy on it. If you look at some of the tech guys, they are cheap and we still have buys on them and we have been questioned why. They are still 30% ROC businesses. A lot of them are going to give double digit dividend or buyback yields this year. There are different ways in which you play the value game. Sometimes you get growth at a reasonable price and so 4x may not be a reasonable price to you but if I am getting 20-25% compounding for the next five years, 4x for a financial is fine. Maybe 10x trailing book is not.