Currently the market is trading in a range. Do you expect a correction or a breakout on upside?
There is no reason for the market to break out. We believe the market can continue to inch up on the back of every quarter’s earnings growth and more covid vaccinations. As a fund house, we remain constructive on the market and are looking for opportunities where the valuations are reasonable and earnings growth is good.
Many money managers are sitting on cash. Are you one of them?
Not so much of cash but we are cognisant of the pockets of the market where the valuations are quite steep and we are avoiding very extensive stocks. There are industries where there is a good tailwind of earnings, and at the same time valuations are fairly reasonable. So rather than taking a cash call, we are more overweight on those businesses in manufacturing, banking and financial services where the valuations are reasonable and earnings support is significant.
Mid and smallcaps are in a dream run but most of your funds are large cap focussed. Is it right to be focussed on large caps right now?
I do not think we have a preference for large cap over midcap or small cap. In our contra portfolio also, there are a couple of stocks which became large cap from midcaps and that is why we look large cap focussed. Otherwise, we have been maintaining approximately 65% large cap and 35% midcap and small cap as our normal coverage. This is more of a bottom up market and I see significant opportunities in textiles, chemicals, banking and financial services.
Telecom has lagged in this market rally. You own in all your funds. Do you see that the market is missing something that you can see?
I do not think the market is missing anything. The benefits of consolidations in the sector have not come through. Ideally, in any sector, if such a consolidation happens, the outcome would be higher pricing power but we have not seen that yet. We are down to three players and I do not see any reason why our mobile bills should remain as low as they are. But we believe that such a large consolidation will eventually lead to higher pricing power. Equity investment is a long-term game and in this country we have all the ingredients for telecom companies to do well in future.
Is the metal story over and is it time to sell?
You have to see where the higher profitability is coming from, and the answer is China’s focus to decarbonise. That country is the largest producer of steel. Now that it has gone on record saying it wants to reduce overall production, China will be exporting much less. Moreover, unlike Chinese firms, Indian steel companies have access to a far cheaper iron ore. Multiple factors are coming together and that makes one believe that steel companies not only have good profitability today but can also more or less maintain it.
The export numbers for steel from India for the last three years has been consistently going up and we continue to watch this space. This sector is coming out of a significant long bear market. Structurally, if companies continue to grow in the next decade, then this sector has more legs.
Inflation is one issue that is going to be key in a few months. Do you see a rate hike and if yes, what would be your strategy to deal with it?
Do we see a rate hike both in the US and in India, over 12 months to 18 months? I think yes. We are better off believing that two things are going to happen — the rate hike and that would coincide with the negative impact of Covid going away. Inflation will come only when the negative impact of the pandemic is behind us, and growth comes back. From an equity perspective, the first leg of inflation, which is on the back of a growth and recovery, will boost earnings significantly. At the same time, if you are extremely leveraged, the rising interest rate is not good for you.
We are looking at which of the companies we hold will get negatively impacted by higher interest rates and which will be positively impacted by higher growth and then saying I want to be in those businesses that are going to benefit from the economic recovery and vice versa.
Zomato is a loss-making company. How would a fund manager value such a company? For long-term investors like you, are such companies worth investing in?
These companies have created a completely new service– delivery of food at home. Not that it did not exist, but it was unique for a particular restaurant but now this has been democratised. Today I am not restricted to one or two restaurants. The second big positive is there are a fairly limited number of players participating in this industry.
The challenge remains how to value a company. Traditional techniques like a discounted cash flow methodology where you project their cash flows or PE multiple or a price to book are not an option. So that is a challenge for investors. The second challenge is that given that it is an emerging sector, there is no reason to believe that you will not have new players coming in. To that extent, those unknowns have to be dealt with.
Internally, we are evaluating all the businesses in the form of how they can deal with competition; if they have an enduring mode that is sustainable competitive advantage, so that even if new players with deep pockets come into your industry, you can survive. Those are the questions we will have to answer before we can come to any conclusion.
Cement and real estate has gained a lot of traction in the market. Are you underweight or overweight?
In the last five years, prices of residential properties have gone nowhere. But in those five to six years, wages and the purchasing power of the individual households have gone up and so affordability has increased. Secondly, with rapid fall in the interest rates and home loan rates, EMIs have come down. Now this combination with the need for a larger house given that the work-from-home environment is there to some extent for multiple quarters to come, are the emerging needs of households. We are seeing signs of real estate sales picking up.
Very clearly, cement benefits not only from residential uptick but also from infrastructure spending that has been happening and there is more stress than ever before. That is another sector we are constructive on. We are overweight on both residential real estate and cement.
Anything you like to add…
I want to highlight one very important aspect which is not really well covered and that is the resurgence of manufacturing. Manufacturing sector, in general, has suffered from extra capacity that existed in China and their ability to sell it cheap. Because of that, the profitability was subdued in these segments of market for a very long period of time.
What has changed in the last few years is China’s need for employment in the manufacturing sector is reducing due to rising per capita income. The cost of manpower in manufacturing is increasing for them. So, over the last three years, there has been a shift of manufacturing from China towards Vietnam, Cambodia, Southeast Asia, Bangladesh and others. We did not benefit much from that but–Make in India, PLI, lower tax rates for the new capex, lower corporate tax rate and now low interest rates along with dedicated freight corridors ensures that there is a significant government focus on making sure that manufacturing happens and that creates a lot of jobs.
We are very clearly seeing the resurgence of the manufacturing sector after remaining on the sidelines for more than a decade. We will see a lot of private sector capex in textiles, metals, mining, chemicals and engineering goods. We will see a further expansion in cement capacities as well. Their valuations are reasonable, they are not very expensive and the growth is significantly picking up there