Deepak Shenoy on why you can’t benchmark Reliance and how to calculate its value

Primarily, you should look at growth. If you are seeing 25 to 30% growth, then paying 30 times earnings is not very difficult for those businesses and both Jio platforms and the retail business have that kind of potential going forward, says the Founder, Capital Mind.

There has to be a way in which people understand that what is the right value of Reliance and this is what Reliance can do. Yes, a significant amount of rerating has happened but what is the right way to value Reliance now? Do you think it is still undervalued or has the last 100-200 point rise been a function of news or perhaps momentum?
All of the above and as a disclosure, we are invested and so a little biased there. If you look at Jio platforms which owns Jio and a bunch of other start ups and technologies -- we are talking of a valuation of $100 billion if it was listed, which is about Rs 700,000 crore.

If we look at Reliance Retail which is roughly Rs 250,000-300,000 crore possibly given about 8 times EBITDA. Just these two add up to about Rs 10 lakh crore. We have heard about a $70-75 billion valuation of the oil to consumer business. I am talking one year from now. We are probably looking at about Rs 15 lakh crore in valuation, if you took a sum of the parts.

Of course, you will give it a bit of a discount because it is ownership of a lot of businesses. So, Reliance is kind of reasonably valued at this point. The last 100-200 points have possibly been run up on momentum. A lot of stocks have run up on momentum, even companies that are bankrupt are going on upper circuits. So I do not deny that there might be a little bit of a froth building up here. It is at a PE of 31-33 which is again not extreme compared to say some of the FMCG stocks where we are seeing 80 times earnings for something that is growing at 10%.

Here, at least, the growth is in your favour. That way, I do not think it is ridiculously overvalued. I do think there may be a little bit of froth but that is part of the game, you will be 10%, 20% above fair value at any point or below fair value at any point, that is how the market is. Again, I am invested and so I am not going to pretend that I am not biased.

What is the benchmarking? When we say that this PE is expensive and this PE is cheap, for a company like Reliance, because there is no other parallel I can think of in the world, how would you benchmark it with anybody else?
I think you cannot because it has got these diverse businesses. So you have got no benchmark. Only the oil to consumer business to whatever is in the oil and gas space. So at one end, you might look at it like a super BPCL, at one end, it is a combination of petrochem and refining for the most part. That business is growing at 8-10%. You pay commodity valuation for that but it earns a lot of money.

At the same time, they have got the fledgling ownerships in Jio and retail where the potential has not been reached yet. So you will probably give it, you will compare those businesses to corresponding retail businesses, part of which could be the online retail businesses, part of which could be the offline retail businesses. You have got giants like Wal-Mart and Amazon.

So, perhaps there is a combination of that valuation for retail. You have got Jio as a telecom business and again valuations can be quite high, depending on whether you look at it not only as a telecom business per se but also an application service provisioning, provider business where they add this layer on top and where you have potential technologies like instant meetings, online or online translation or the whole TV and media piece that is integrated into the telecom so you get those valuations.

Primarily, you should look at growth. If you are seeing 25 to 30% growth, then paying 30 times earnings is not very difficult for those businesses and both Jio platforms and the retail business has that kind of potential going forward. However, they have to demonstrate this, they have to demonstrate that the growth can come in EBITDA as well. They have done it in the last three or four years but I would not hesitate to pay a larger PE for that part of the business, I would not pay this much for the oil to consumer business.

Would you be too perturbed about Aditya Puri selling 95% of his stockholding in HDFC Bank?
To be fair, I would be more perturbed if he sold it the minute he left. He is going to leave in a few months, he is 70 years old. If it was for a sinister reason, then we would have seen signs of issues in some numbers. I do not think this is particularly bad for HDFC Bank and again we have an investment and so are a little biased there.

The whole banking system is going to come under stress after November. The moratoriums end on August 31st if they are not extended and I do not think they will be and then the NPAs will start to emerge. Given that there is a lot of retail impact of the coronavirus lockdowns, we are going to see the impact of the situation around NPAs only in November. We will see the impact only in the December quarter when Mr Aditya Puri will no longer be at the helm. So, we should wait and watch those situations. The stake sale does not perturb me too much, there may still be some pending ESOPs which may come about. About 95% of his stake is gone, there maybe more in the pipeline that he could exercise and use. We do not know about that.

So, at this point I am not super concerned, I do not think he is the kind of a person who runs several other parallel businesses of his own which need funding. I think he has done an awesome job for the last so many years, he has brought this bank to this phenomenal valuation, he deserves to do whatever he wants.

What is the big disappointment with ICICI Bank? It is down over 6%?
Yes it is quite rough there. There is a bit of a position there as well but as much as we are looking at bank results, the main problem is not going to be this quarter. It is not going to be the next quarter. It is going to be the December quarter and it is only then that we will know the real damage to the system.

So to a certain extent, both Axis and ICICI which are a little bit more SME and corporate focussed, are going to face the brunt of this hit on SMEes because they have pan-India exposure at a very broad level.

I do believe that they are both strong banks and they will survive through this damage and perhaps reactions to a lot of financial situations are going to worsen over the next two quarters and only then start getting better. Right now, I do not know why the stock is down 6%. To be honest, it is a market which can both make and break companies based on whatever indications they get but I would not read too much into results at this point. It is too early to say anything about real impact. Let us wait and see. If situations get bad we will know from the debt markets, we will know from the actual NPA numbers on the street. I do not think right now even ICICI Bank management will be able to predict what happens after August 31st.

When it comes to names like Asian Paints, I guess there is nothing to complain about. It perhaps gives you colour on what we are likely to hear from the other paint companies as well?
It is interesting. They have got something which is better than a really lousy quarter but we have to remember that this quarter, which is July to September, may not be quite as good because a lot of painting gets halted in the monsoons.

In any case, demand may show up only in the October to December quarter which might actually be quite significant because there will be a bunched up piece of demand. They are very expensive. They are the most expensive paint company in the world with a lot of operations reduced because of the corona lockdowns and so on. We will have to see how they come back. In general, paint should do well. There is not so much dependence on crude prices as we tend to imagine because they can easily pass on the price changes to customers. But at the same time, demand will come in the October to December quarter so the next quarter’s commentary will be more important than what we are hearing right now.

It is getting clearer by the day that the government is definitely going in for privatisation. They are accelerating the process right now. More and more names are coming to the fore, not just BPCL. Is there still an investment opportunity in any of the PSU names or would you just look at it as a short-term trading opportunity?
Back when they announced BPCL’s disinvestment plans sometime last year and it has taken a year for them to come to a point where they can get bids on the table. Any announcement now will take about that much time. If they do too much, they face the ire of the unions and that will be a challenge.

BPCL is likely to see very good participation. It is a relatively undervalued asset because it is owned by the government. Change the ownership and you should get a substantial premium on what you are seeing today. Similarly, a lot of other PSU companies do exist where such a situation comes.

It is the best time for the government to think of disinvestment because the markets are high, the economy is not doing so great but there is enough liquidity for people to both borrow in India and abroad. So I hope more of these come. Whether they will actually be profitable for an investor is largely dependent on what the government does in terms of disinvestment.

BPCL actually stripped away a part because they could not afford to disinvest that. So the specifics will matter but there is a lot of money to be made. A lot of these companies are terribly undervalued simply because they are owned by the government. So on a case by case basis, I think there is opportunity.

How have you looked at the capital goods numbers? L&T quarterly earnings were a bit of a weak show. The management also said that they would refrain from giving out any sort of guidance due to the uncertain environment. Do you think that this is a prudent strategy at a time like this when we are looking at an uncertain surroundings? What do you make of L&T stock price and the stock for the long haul?
I personally own L&T as well as we have suggested to customers. The problem with L&T has been that it has been five years of nothing for it and on the stock price itself it has been 13 years of nothing, This is not making money for a few years but it is like more than a decade of not making money, if you had invested in the late 2007-2008 timeframe.

This company is now much bigger than what it was at that time. It now owns L&T Finance but also owns L&T Technology Services, MindTree and L&T Infotech. Those form roughly 40% to 50% of its market cap. But overall, the company has now diversified into multiple ranges. A lot of its core profitability has come from the infrastructure business which is likely to pick up. We are seeing some activity of the government in railways. A lot more activity on roads will come up. L&T won a Rs 2,500 crore contract last month so it is not really completely paused in everything but they will need the government to start pushing more money into infrastructure for a new capex cycle to begin both even in the private sector.

It is a useful bet because the downside from here seems relatively small. The upside could be relatively large if there is a change in attitude on infrastructure and capex. We have not had a capex cycle for five years now and typically around that time five to seven years is when a new capex cycle will start. You should have patience if you are going to hold the stock. 13 years is patience enough but then the stock will take three or four years more and some time in the middle, we should have some triggers from the government. Again I am biased because we have a position.