How is Street taking the measures announced by the government to tame inflation? Do you think it will calm inflation down?What are your thoughts on the way inflation in select agri and a lot of industrial commodities have come down?
The steps will help cool inflation in the near term. The longer term trajectory depends on food and energy prices and the industrial commodity prices. But taking a step back, we think a large part of the inflation spike is driven by global commodity prices and more specifically food and energy prices.
India is food surplus and we have seen the wheat export ban come in. So that is not a pressing worry. The energy prices are a bit worrisome, but our base case would be if the global central bankers are raising rates to slow down growth, can the crude price remain disconnected from a global economy which is supposed to slow down?
Our view is that as the crude prices stabilise and commodity prices are seen correcting, the impact will fit through slowly and we estimate the cyclical component should come down in a matter of six-nine months.
On the other hand, in India, in terms of manufacturing, there is a significant capacity available in the aggregate labour market. There is no labour shortage which many of the developed market economies are experiencing. So, the structural factors for inflation are less strong, the cyclical factors have become stronger due to the global economic situation. In order to tame that, some steps have been taken but for the trajectory of inflation, one would be monitoring the energy prices and how long they remain high.
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By and large, we think that oil at around $110 is manageable but if the crude price goes above $120 and remains there for a long period of time, then it is time to worry, but not before that.
That is one part, the other part is that industrial prices are coming down for the user industries like auto, capital goods. There is a reasonable topline growth, but margin pressure exists and there is a lot of unmet demand both from the export side and the domestic market. Do you see a strong case to take a look at these beaten down capital goods stocks?
Yes, that is a good point. For auto and other consumer and capital goods companies that have recently announced results for the March quarter, in most cases, the top line growth was strong and better than expectations. The problem was mostly with the margins.
As and when the commodity prices rollover, the top line growth remains reasonably strong and the margin comes back, earnings will bounce back and maybe that can happen a bit sooner than expected. We would say volume upside is there in automobile and consumer stocks.
Most of the product companies are adding significantly to the gross block and they are doing so as a part of their global strategy. We have in the past discussed the China plus one strategy, where multinational companies are looking at setting up a base of production outside China.
There is substantial urban demand in India that is also working in favour so we are seeing not just top line growth and commodity prices coming down, some of these industrial and manufacturing companies will also see growth because they are added to gross block and given the picture on import substitution and the potential for export, the asset turn from these assets is going to be reasonably high. That will drive the earnings growth in the foreseeable future.
The other point is about the IT space which has seen 20-25% valuation correction in many of the top names. You are underweight on it but can one take a tactical bet there valuation wise or not yet?
We have been more constructive on largecap IT given the kind of valuation correction that has happened. Some of the largecap IT are also protected by very strong cash flows and very strong payout ratios. It makes sense to look there but we would be a bit more cautious on the midcap IT space because some of the midcap IT companies are going through some corporate restructuring and we need to see how that pans out.
Some of the other midcap companies with either a geography or a domain exposure can turn out to be a risk. It is the largecap IT companies which are very well diversified and that to some extent, mitigates those risks. So it is time to look at some of the largecap IT companies but for midcap IT, we will still wait and watch.
What about the opening up theme of travel, tourism, leisure or apparels? Are you looking at raising exposure there and are you bullish there?
That is a very interesting space and let me just give a background because we spoke about auto and consumer names where volume growth has been strong but the margin profile a bit weak because of the commodity prices. Now how can you offset the price pressure a) when the prices roll over but b) if the company has significant fixed cost or significant volume leverage? That is when you look at stocks in the travel and tourism space or even in the movie exhibition space where a lot of fixed cost is there, When the volume grows, there is a bit of variable cost going up which can be easily offset by operating leverage.
That is one space which in the consumer area got a lot of fixed cost. That area is looking pretty interesting to us because the white collar job market in India has been pretty strong and thanks to strong hiring in IT and other sectors, which of course in a way is not so good for the IT companies’ margins, but nonetheless is good for urban consumption. We are quite bullish on the stocks where most of the costs are fixed like in travel tourism, hospitality, or in exhibition business.
In the last couple of months, almost a dozen overseas diplomats and prime ministers and premiers have visited India. India actually emerged in a big manner because the Quad Summit is going on right now in Japan and the US President Joe Biden, Japanese prime minister Fumio Kishida, our own Prime Minister Narendra Modi have been present. India is emerging as a favourite ally for global supplies, China plus one strategy etc. Our business is also getting a boost. What are your thoughts there?
That is a great point because, of course, the first implication is security and defence. I will not comment on that because I am not an expert but I can obviously share some thoughts on the implications we are going to have on the business side.
Over the last three-four years, there has not been oneoff impacts. We have been through the trade war, we are still going through Covid and now this Russia-Ukraine war and so on. When we talk with global experts and the policymakers, one thing comes out very strongly that people are looking to reorganise and diversify supply chain.They want to have manufacturing supply chains in countries that are friendly, where there are less possibility of this kind of disruption. That is on the top most agenda of many of the boards and many of the global companies.
I think India can play a very significant role because the Indian economy is now much more formal, thanks to the formalisation efforts, much more manufacturing friendly than it has been through tax cuts and various other incentives. So putting all this together, both the local factors and the global factors are coming together for India to get much more foreign investments for manufacturing and that could be due to substitute imports or even promote exports. That is the broader message that we are getting from all of these developments.
I was curious to know how has the correction shaped your own portfolio from the peak and not in terms of prices? I do not want to talk about specific stocks but how much has the valuation of your portfolio in India corrected and how are the numbers stacked versus the valuation?
I won’t be portfolio specific but what I can share with you is that during this correction that has happened and that is going on in the markets is that we have taken this opportunity to study some of these opportunities in greater detail. We see that some of the smallcap and midcap names have corrected much more than the frontline names. So some of them, particularly sectors that we discussed like industrials, chemicals, movie exhibition, hospitality and travel related spaces, are beginning to look quite interesting.
Even the small lenders are beginning to look very interesting and that is one part we want to play. Overall, when we look at the correction and the results that have come out, it seems the benefits of a more formal economy is now going to trickle down from the top tier companies to the tier-2 companies or so-called midcap companies.
Now this segment has been through a lot of trouble whether it is through adjusting to GST and Covid and trade war and the actual war. This sector now looks quite ready to bounce back and the companies which operate in this sector may be midcap in a stock market term, but they dominate their own industries. We see quite a few interesting opportunities opening up there, thanks to this correction at the same time improving fundamentals of these companies.