It is an all-time high on the Nifty, it is an all-time high on the Bank Nifty but nobody is feeling happy, excited, everybody is saying ah! We missed the rally! Is that the real way of looking at the market that you can see an all-time high but you cannot feel the all-time high?
We all are feeling it also. It is at an all-time high but nonetheless the bigger issue is that people are generally cautious about the kind of valuations we are scaling versus global markets and we are particularly not so worried about the relative valuation. But also from the perspective that there are some global worries which could have impact across the world, the fear of recession sometimes next year, the interest rate hikes continuing longer – now it is very difficult to fathom how much of that has got factored in terms of the valuations today.
Broadly these are some of the concerns which are pretty much valid as far as the markets are concerned. We are in a sort of bull economy over the next four-five years and every dip is going to see more buying into our markets. When we interact with global investors, they show a lot of keenness and interest. They are more sceptical about valuations, oil price and all of that. All of these things should be taken care of when we think about the growth over the next few years and when the markets are suggesting that they are buys on declines. It means that we are in a bull market and hence one should be okay.
Now the other thing to beat the high valuations is the investors need to be ready and prepared to see spending more time to see decent returns. In the interim, volatility should be ready to bear in mind. The other important factor is even when we look at the market’s valuations, there are contrasts which we see within the segments. These are segments which are reasonably valued. There are segments where there are excesses. It is a balance which as a fund manager one needs to build into the portfolio.
Where are the excesses in the market and where do you see opportunity in the market? What is your high conviction idea and where are you looking which others are not looking at?
Today the pharmaceutical sector is a very structural sector. There is a good amount of opportunity and Indian companies have shown their strength supplying the products globally at low cost. Now they are facing some challenges in the last one or two years post pandemic. I believe these are all business cycles.
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Today the cycles are not very favourable but once the cycle turns, the valuations look pretty attractive. These companies have derailed in terms of their cash flow generation and the ROEs such that the profit is stabilising at current levels and creating a good base for the next one or two years. So, pharmaceutical is one segment, banking is the other segment where even the mid-sized and large banks have collectively cleaned up the balance sheets. Now they are poised for decent credit growth over the next few years as we see an expansion of the economy taking place plus the stabilisation of margins.
The credit cost is under control and the valuations are lower than the five-year averages they were trading at. That is one category which really deserves to be looked at from that perspective. The IT sector has corrected from the highs and is still trading higher than the five-year averages. I would say the next one or two quarters may provide an opportunity as the global worries may treat some of these stocks more unfairly over the next one or two quarters.
That is the point where one can think of enhancing the exposure. That is how we are focussing on a few segments which look okay and reasonable. It is just that the cycles are not so positive and there will be waiting time in these segments. There are segments which have seen front ending of the returns taking place and maybe engineering which has a good long-term outlook but the returns have come about quite too early.
Segments like consumer durables where the valuations have not corrected and are not reflecting the current picture of some slowdown seen in the overall consumption, the competitive pressure is very high and the inability of the companies to pass on the pricing. That is leading to margin contraction and those probably are not getting fully reflected in the valuations. These are some of the excesses which we are seeing broadly as far as the segments are concerned.
Tell me a little bit more about what it is that you have been doing in your mid and smallcap funds? Any new buys and sells?
In the sectors which I mentioned broadly, we are trying to keep on accumulating the businesses which we like over the long term and where the valuations are reasonable. We also feel that the valuations may be high but the visibility and longevity of growth is there for us to see and those are the areas where we are okay assigning slightly higher multiples.
Some of the urban consumption stories are still doing okay and we believe they should continue doing well like retail, malls, etc. We are pretty much happy owning and accumulating those types of businesses. There is also merit in looking at one more category which is right now getting penalised. FMCG is linked to rural consumption growth and as of now, rural consumption or the entry level consumption businesses are getting impacted because the pockets of these people have got impacted quite a bit due to inflation.
Our sense is that closer to the budget and as we near the election in 2024, it will be imperative for the government to build a much more balanced growth environment and push some of the rural growth as well. That is the point where some of these categories should also start showing up. Wherever we see opportunities of that kind which are more rural driven and the valuations are becoming okay, we do not mind accumulating those businesses as well.
Did I miss autos because the fund has fairly decent exposure to it. Are you not worried about semiconductor shortages, labour shortage, perhaps supply challenges as well that could plague the sector?
Absolutely. That is the kind of worry which we have in terms of the supply chains still not being fully repaired and companies talking about their business being impacted. That is one worry which we have at the back of the mind. But while we have exposure to auto and auto ancillary, both in India and globally, auto is in a down cycle for the last two, three years.
The trough the cycle has seen is at decadal low and from here, whenever the recovery takes place, it can be very sharp and good and it will be durable as well for three, four years. So from that perspective, we are trying to look at companies and businesses where they will not be affected because of the EV transition. So, technology neutral type of companies and wanting to play the sharp cycle recovery as and when it takes place.
o that is autos that you did not miss out on. We wanted to talk to you about the new buys that we have seen which are as well as which is part of the DSP Small Cap Fund. What is the larger plan when it comes to agri commodities?
Our overall experience and analysis suggest that agri is a huge opportunity as far as India is concerned. We are the second largest agricultural market across the world and looking at some of the matrix, we fared very poorly in terms of yields and production may see usage of mechanisation and all of these are good opportunities.
We are talking of companies which have created a wider distribution for their products, good brands and just like the pharmaceutical companies, these are the segments which are trading pretty reasonably in terms of valuations. When we talk of sugar as a sector, there is a big transition taking place because of the ethanol play where the more structural part is not currently being recognised by the market.
Markets generally tend to give low multiples to these companies because of sugar business but I think ethanol is going to overtake the sugar profitability over the next two or three years. That is the kind of opportunity and it is more structural. That deserves to trade at premium multiples. These are again some of the bigger opportunities which we like to tap through a few of our funds.
Is there a case for rerating of PSUs and are you folks doing that in the case of railways stocks, defence stocks and also PSU banking stocks and their outperformance?
First of all, one should ideally not differentie between different types of companies – PSU and private. The differentiation arises because of the operating matrix. We have broadly observed that in case of PSU businesses, the operating matrix tends to generally be poor as compared to their private counterparts which is fair.
PSU businesses have tended to trade at lower multiples than the private sector and there are cases where some of the PSUs have shown their capabilities to improve their operating matrix and become more comparable just like their private counterparts, which is where the rerating potential takes place. For us, that has been one of the primary criteria of stock selection across the board, let us say defence, railway containerisation companies and PSU banks.
We have looked at businesses which have inflected where the matrix have improved and there we are not hesitant to take exposure. We have decent exposure in some cases. We start with smaller exposure but the principal criteria is that the operating matrix needs to give us that kind of confidence around these businesses and that is where we are open to looking at the cases.