Weak Walmart earnings and guidance hit Amazon also and generally there was a sense that growth is an issue. With each passing day, inflation is no longer that big an issue, growth is. But if Unilever comes out and raises the guidance and says that things are manageable, we should take note of that; isn’t it?
Absolutely. If we retrace the last six-seven months the lead indicator for the trouble in global markets was actually inflation which drove interest rates high and ultimately led to softness in demand.
So if inflation is ebbing and my hypothesis also is that in the next couple of months, the inflation should ebb and gradually come down – not to say that we will go down to as low as levels as we have seen last year – but certainly lower than from where we are today. If that is the case, then on an incremental basis, the worry on interest rate hikes and hence subsequently the softness of demand should incrementally taper down.
Hence it is an incrementally bullish or positive sign. Going forward with inflation ebbing and interest rate worries receding to a certain extent, over the next couple of months we are in a good spot.
There was also this data floating around in investing circles on the probability of a recession. Some 15-16 countries are part of that and in India, it has indicated there is zero percent probability of a recession. If the Indian scenario looks so insulated, do you think sometimes as investors, we underrate ourselves and the strength of our own economy?
Absolutely. I have been making this point wherever I have been. If you look at CY22 and also CY23, our bottom up story looks fairly robust on the back of a strong chance of a capex cycle coming about. The real estate sector, which is an important component of our economy, is also bottoming out and finally we are seeing salary increases coming through and that will be good for consumption spending 9 to 12 months down the line.
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So the three important constituents of the economy are kicking into gear and then on top of it, the fact that in 2024, we will have national elections and ahead of that the government narrative is also likely to be pro-growth rather than pro-reforms like we have seen in the last four-five years, we have a very good concoction of a bottom up story. It is gradually looking up. In that context, we have been faced with higher inflation and being a commodity importer, it has impacted us but given that those fears are also incrementally receding by the day, from a one to two year perspective, we have a very strong bottom up domestic cyclical driven recovery story which stands out relative to the growth and probably in absolute terms as well.
Tell us about how do you expect one of the high growth and very comfortable margin themes which are there on your radar, to ride out this kind of a market for the next 12 to 24 months?
One is the economic theme – to be played through industrials, capital goods, real estate and some parts of consumption spending. It has the making of an one-three year theme which in the grand scheme of things on the shorter time horizon.
But if you look at where India is in its evolution path, I would say that the three themes which will make money for investors over the next 10 years would be brands, market share gainers and basically innovation or innovators. These three themes in my opinion are very relevant to where India is in its global evolution.
Brands because India’s time for brands has come, given where the per capita GDP is today and where it will be in 10 years time, the incremental brand adoption will be fairly high. Market share gainers because over the last five years, we have seen a good bit of reforms come through and we have seen the pain. Now over the next 5 to 10 years, we will probably see the gain of market share gain of organised sector at the expense of unorganised sector. Then we can carefully play the enablers and adaptors in the context of innovators and innovation as a theme. These are the three themes which in my opinion makes a lot of sense for investors to be part of from a fairly long term 5 to 10 years perspective.
Inflation appears to be peaking. How have you scaled back the growth estimates of the companies in your portfolio — in general, by at large or not very meaningfully yet?
We were slightly early on this. I realised that inflation will probably eat into it and so if we separate India Inc into two parts – commodity users and commodity earners – then over the last six-nine months or six-seven months, we have seen a good bit of earnings corrections in the case of the commodity users. The shape of the earnings has shifted more towards commodity earners.
Net-net, we have not seen so much of an earnings cut across the market but between the segments, there has been a bit of rotation of earnings sort to speak. With inflation ebbing. the source of earnings might actually shift back to commodities earners to a certain extent or commodity users to a certain extent.
I would say that the current quarter is a worst quarter from that perspective where we are seeing the worst impact of commodities and yet no impact of price increases that the companies have taken. Come to second half of this year, we would start seeing some sort of benefit of pricing power starting to get reflected in company’s financials.
So to answer your question, given the verbose commentary that I made on net balance, we have seen good bit of earnings cut remaining, but net-net in the second half of this year, we will probably see some sort of earnings growth coming back driving pricing power and areas of the economy which are doing well.
What valuations have your portfolios come down to in case of a reasonable correction in the valuations of the stocks which you are holding, versus the valuations what kind of growth do they offer 24 months far out?
Just to put it into context for everyone, Indian markets were seeing levels where they have actually derated by 20-25% since the beginning of this year and it is not subject to the fact that the growth outlook has dimmed all of a sudden. It is more driven by the fact that the interest rate regime globally and in India has changed and we have seen meaningful increase in interest rate expectations for the next couple of years.
As that happens, obviously it acts as a bit of gravity to the valuations of Indian stocks and globally. In India, it has been to the tune of about 22% to 25%. So, factoring that in, we are looking at somewhere around 17 to 18 times one year forward earnings.
If you look within pockets in terms of the portfolios that we have, we are probably looking at somewhere between 20% and 25% growth. Relative to the growth, we are probably in a fair zone and not in a deep value zone. We are probably in the fair zone where we think that as long as we own the right companies, we generate earnings growth that we have talked about. The earnings growth will lead to the overall returns for investors.
What about the midcap and small cap end of the basket? Have they come down to attractive valuations yet?
I would say selectively within midcaps, we see some value emerging overall. Smallcaps have probably some more room to go but if you look at mid and smallcaps as a basket rather than cutting the spectrum in terms of mid, small or large, I would actually cut in the sense of valuation buckets.
The high valuation bucket over the last six to nine months is where markets have taken a hammer to and they have seen valuation correction to the tune of 50% or more. The lower parts of the valuation target have remained where it is and that includes some largecap names, some midcap names as well as some smallcap names.
So in the expensive bucket, where we have seen valuation corrections of about 50% odd, we are getting there or thereabout with regards to overall fair valuation.
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