What is your take on the pharma space? There is a sense emerging that the worst for pharma may be coming to an end on pricing pressure, inventory issues, raw material, all of which lasted for five years. Do you subscribe to that view and have you started adding some pharma stocks?
I would say that yes, over the last three months or probably slightly longer, we have increased our weightage in pharma though unlike IT which is a sectoral view, in pharma we have taken a more nuanced bottom-up, stock-specific view which is we have increased our exposure to stocks which are more exposed to the US generics because that is where pricing pressure is abating. We have to see how long it will last but for now, that seems to be the case for the next few quarters.
Secondly, on the domestic-oriented companies, the commodity tailwind or shall we say lack of headwind is kind of having its positive impact on the numbers. Though I would say that the sector has had a good run and we might see some profit looking in the very short term but that aside overall we used to be underweight, we are now mostly neutral is what I would say, but in this sector we rely more on stock picking to make the difference rather than sectoral weights.
You have a lot of names across your funds as far as the capital goods space is concerned and they have had a very good run in the last 12 to 24 months. But the view now is that valuation is becoming a bit of an issue. Is the best of the times already priced in and is that a bit of a challenge now?
From a near-term perspective, some bit of profit booking on account of stellar performance cannot be ruled out. Also, as the base grows, when these companies were growing 12 months ago, they were at a depressed pace. 12 months later today the base is probably slightly higher than or not as depressed as it was.
But still some of the leading EPC companies in the last result season, beat the consensus estimates by close to 20% odd. Now I do not recollect in my 20-25 years of market experience in India, when was the last time I saw such a big beat coming through. Likewise, the earning surprise is there or thereabouts.
The quantum of surprise is probably a little lower than what it used to be on the back of higher base but the momentum still continues. So maybe, it is time to take a more selective view. But in terms of the theme, in terms of the capex cycle, that is probably still intact and probably one of the strongest themes at the moment in the market.
What is your standing as far as midcap IT is concerned? It appears that on incremental bad news, the IT stocks are not falling anymore. Do you think in the next six to eight months when the order book visibility and demand visibility comes back, this pocket can deliver good returns or would you stay away?
Returns are an outcome. I would say the next six to or three to six months is a good time to look at IT services selectively from a 12-18 month perspective. From where we are with regards to demand, with rates at peak and US banks etc. being where they are, probably a lot of bad news is being priced in at the moment. But from a return perspective, are things going to improve in the next one or two quarters? My guess would be no. It will probably take the next year for that improvement to come through. But the valuations over the next one or two quarters would be such that they may be good to add. On net balance, we were underweight on IT by about 300 bps at the end of last year.
We moved that to neutral at the moment and in weakness we would look to go overweight. This is a more sectoral call than stock specific as opposed to what I talked about on pharma. But we would look to move overweight in weakness in this area.
You also have Equitas Small Finance Bank in your small cap fund. You have Shriram Finance in your mid cap fund. What is your take on the NBFC and the small finance side? The Q4 numbers showed very good numbers on. Do you think that the risk reward and the earnings growth potential in some of the small finance and NBFC names are higher than the banking?
I would say lending financials from the next one to two years’ perspective are in a good spot. Within lending financials, given that interest rates have peaked or closer to peak, bank margins or NIMS, are broadly at its highest level and gradually coming down. Given that the liquidity conditions are likely to ease, NBFCs are in a slightly better position than that of banks within the context of the financials.
So incremental allocation from our side has gone more towards NBFCs as opposed to banks. With regards to small finance banks, my view on a structural basis has always been that this is an area where we would like to take back but only on very high quality companies because the segment is quite risk prone. Anything goes awry in the macro and this segment could see a meaningful kind of negative downdraft cyclically though, and one has to guard against that. So, cautiously optimistic on S&P, probably more positive on NBFCs, and generally, structurally, from a one to two year perspective, positive on lending financials is how I would summarise.
One issue which in the last few days come to the table is a pivot or a pause, especially with the kind of numbers we are seeing on the inflation front. All over the world, not only in India, the agri-commodity side and a bit of energy has seen a spike, which is making many believe that the pause which central bankers, got into will be temporary in nature and rate hikes will be back. Could it become a near-term headwind for the market globally?
In my opinion, on net balance from the last six-nine months, I have been saying that inflation across the globe and India is likely to be stickier than what most people think. And apart from the commodity price movements which will do their own stuff in near term. My sense is the reason behind a slightly structural higher inflation, every country is going for a Make-in-India version within themselves.
Now, if every country were to manufacture their own goods rather than kind of getting them manufactured at the lowest cost location and selling at the highest price location generally from a two to three-year perspective or from a medium-term perspective, structurally, inflation is going to be higher than what we have been used to over the last 5-10 years where things used to get manufactured in the lowest cost destination overall. So that is one of my resident long-term views with regards to how I see things evolve.
Now, in generally inflationary circumstances, two asset classes do particularly well. Equities is one which has the best-known inflation hedge. When overall things go pear-shaped, gold could be a good risk option. Again, from an asset allocation perspective, a slightly longer-term answer to your question is yes, inflation is likely to be stickier and hence, while rates might have peaked, coming down might take some time. The asset allocation needs to be thought about in that context.
How are you playing the power value chain – be it the generation companies, both on the legacy side or in the renewables, the power, the wind, etc. And then there are transmission towers, then there are generators and motor companies down. How are you really playing this entire value chain?
I would leave the framework with you in terms of the way we go about this. So, in all of the segments of the supply chain that you talked about, some parts are very prone to regulatory risk, some parts are very prone to kind of overexposure to the government and hence kind of could lead to receivables issues is that our focus has always been in such circumstances to focus on nuts and the companies that supply nuts and bolts to these industries. Because that is where we have the best semblance of pricing power, a best semblance of working capital needs. In other words, what is best in terms of return ratios, and are usually the most profitable places to be. We have a couple of names in broader portfolios and that is the framework we use to look for names in this area.
