Nilesh Shah: The stars are lining up for the real estate industry, says Nilesh Shah. Should we invest?
We have seen a slight reversal in global commodity prices, be it gold or crude, or the pause in industrial commodities. Are we to be aware that commodities could now reverse and if commodity prices reverse or hit the pause button then a) commodity stocks will go down, b) this is bad news for many industries?
Our take on commodity prices is that the exponential rise we’ve seen over the past six or nine months is unlikely to be sustained. This is the nature of the commodity cycle; at higher prices, supply comes out of dormant capacity and demand begins to decline, ultimately bringing about the equilibrium which leads to lower commodity prices. It is the nature of the commodity cycle over hundreds of years and this time is no exception. However, we continue to believe that the prices of some commodities will remain high as imbalances between supply and demand are expected to persist. In terms of ranking, copper, aluminum and steel should be the ranking to regain stock in the commodities sector, as the cycle of copper and aluminum is likely to outlast the cycle of steel.
You think aluminum and copper will experience a bigger rise than maybe steel. Thus, some commodities will continue to rise or remain high. Many Indian companies are consumers of raw materials. Which will be the most vulnerable to high commodity prices?
The impact of commodity prices will be felt in many sectors, but basically from top to bottom we have to divide it into two parts: companies and sectors that will be able to pass cost increases on to consumers without impact volumes, without impacting demand; and businesses that will not be able to pass cost increases on to consumers without impacting demand or overall business volumes.
We believe that the ability of the automotive industry to pass cost increases on to consumers will be limited. On the other hand, the household appliance, wire, cable, real estate and construction sectors should be able to pass cost increases on to consumers.
Much of the growth in consumption will come from the employee segment. Hiring in the IT sector continues at a strong pace and this has resulted in improved home sales and this is reflected in how real estate has risen in very unexpected ways. Do you think these stocks have already been discounted for this improvement in home sales or is there more room for a rally?
Housing is a longer term trend. A decade ago it contributed almost double digits to India’s overall GDP and it is a wide range of housing construction and real estate. Now it contributes to a higher figure of India’s GDP.
Now the stars are aligned for the housing industry. Home loan interest rates are among the lowest. RERA is aligned with the interests of consumers and developers; affordability has increased; house prices have stagnated. Put all of these things together and we think housing is a long term trend and the way to play is directly through real estate stocks because the home improvement industry is tied to real estate. When investing in real estate, make sure you are leaning on the right developers as this industry has a lot of governance issues. In real estate, I believe the big gets bigger; the best governed companies are getting bigger and bigger. It will be the trend.
How do you see Indian internet companies? After Zomato, all eyes are now on Paytm, Nykaa, Policybazaar. The question is, what is left on the table once these companies are listed because the maximum juice has already been released?
Let me accept that we are like blind people trying to figure out the elephant in this case digital businesses. Over the decades, we have developed the ability to value physical assets. Someone is setting up a steel plant and if industries amortize it in the first year of spending, we agree because we know that this steel plant will produce value over a period of time and we are at it. feel comfortable using depreciation charges rather than canceling all expenses.
Like physical assets, a business also creates digital assets. Today, they don’t capitalize digital assets, they write them off. The value of the platform, the value of the contracts that are on the platform, the employee base they’ve created, the consumers they’ve attracted to their platform – these are all expenses that are not capitalized but are likely to benefit a period of time. It is now a question of developing expertise in the valuation of digital assets. It is a work in progress for us.
We take baby steps. We built our model in terms of what a digital platform should deliver on the way to profitability. It’s a longer and more uncertain path, and yet we’ve tried to build a model to determine where they will be over a period of time. If the quarterly results point to a move in that direction, I’m sure investors will continue to stick with digital businesses. If there is a gap in this path, prices will eventually reflect it. This is one more fundamentally, but the market is also made up of sentiment outside of fundamentals. As for the digital cess, there are believers as well as non-believers.
Now, whenever the prices correct, the believers will continue to buy, but the unbelievers will panic and rush to sell. So the downward movement is much larger as believers will wait for unbelievers to sell and then accumulate. This is the kind of area where we will see higher volatility, especially on the downside, and your belief in your model will be tested.