Informist, Wednesday, Mar 6, 2024
By Apoorva Choubey and Anshul Choudhary
MUMBAI - The topline growth of Indian corporates is likely to accelerate as domestic consumption improves, private sector capital expenditure picks up and deflationary trends in some parts of the economy dissipate, according to Sumit Jain, deputy chief investment officer at ASK Investment Managers Ltd. Jain expects 8-10% growth in India Inc's topline in the next few years, which he believes will drive earnings growth of 13-14%, even as raw material cost-led tailwinds seem to be abating.
In the nine months ended December, Indian corporates witnessed about 5% revenue growth, but they saw significantly sharper margin expansion, Jain notes. His confidence that topline growth will be higher over the next few years stems from his base case assumption that India's GDP will grow at 10-11% on a nominal basis. The Interim Budget has projected a nominal GDP growth of 10.5% in 2024-25 (Apr-Mar).
"This (financial) year, the topline growth also got hit because of deflationary trends, and once that impact fades away, we will see some normalisation," Jain tells Informist in an interview. "In addition, the consumption side of the market, which is impacted at present, is seeing early signs of revival," he says.
ASK Investment Managers, which had an AUM or assets under management of 259 bln rupees as of January-end as per data from the Securities and Exchange Board of India, focusses purely on discretionary investing in listed equities. Their clients include high networth individuals, institutions, pension funds, family offices and sovereign wealth funds.
Jain alludes to the fact that many consumer staple businesses have stabilised at the lows, while two-wheeler sales volumes are improving and consumer durables sales, which were impacted for a while, are seeing normalisation. The buoyancy in the tourism-related ecosystem, being driven by the government's measures to boost infrastructure in areas like aviation, is also a heartening sign, he says.
Another factor that underpins Jain's view is the continuation of strong capital expenditure by the government, which he says will be followed by a revival in capital spending from the private sector over the medium term. This spending will boost the Indian manufacturing sector that also stands to benefit from the supply chain dislocation being seen worldwide, he adds.
Given this underlying view, the portfolio manager is positive on domestic-oriented businesses, such as premium consumer discretionary plays, tourism-related sectors, automobile and banking. While Jain agrees with the consensus narrative that some stock valuations are not cheap from a short-term perspective, he believes businesses that continue to grow better than others over the longer term will continue to command premium valuations and create value for investors. "If corporates continue to deliver earnings growth, as we are seeing currently, then I would not be too worried about valuations," he says.
Here are the edited excerpts of Informist's interview with Jain:
Q. It has been an unusual sort of ride last year for markets. Where do you see this going?
A. Directionally, the way markets have behaved has not been surprising, but the quantum may have. However, that's the very nature of markets. Currently, businesses are faring well and earnings growth has been decent. Moreover, this earnings growth has been backed by capital efficiency. So, I believe the confidence in the longevity of this earnings growth is high and that is driving markets. At all points, we could argue whether this kind of an upmove is justified or not, but if the focus is more on the longer term, then value creation will happen.
Q. So what kind of returns would you expect in the next one year?
A. Frankly, it is difficult to predict how much the returns would be over a one-year period. But, there is a high probability of corporate earnings growing at 13-14% over a long period of time. And, markets are defined by how long-term earnings growth plays out. After seeing an earnings growth drought for a long time, Indian corporates have witnessed earnings improvement in the last three-four years and markets have actually rewarded that. For the next financial year too, there is a high probability of 13-14?rnings growth. We would look to get into businesses where the earnings growth is much higher than that.
Q. Do you think this is a reasonable expectation, because earnings growth has not really been supported by topline growth in the recent past and the difference between topline and bottomline growth is quite substantial? Where do you see the earnings growth coming from?
A. In the last nine months, we saw about 5% revenue growth and significantly sharper margin expansion for Indian corporates. The raw material price-led tailwind may not be available beyond a quarter or so, if raw material prices remain the way they are.
The raw material-led tailwind may not be available as much, we may probably see it for a quarter or so. But beyond that, if raw material prices remain the way they are, that tailwind may not be available. So, growth of corporate earnings will have to be driven by improving topline growth. At the current juncture, we have seen some deflationary impact as well, wherein commodity prices went down, and that impacted revenue growth. If India is able to grow 10-11% in terms of nominal GDP, we should see acceleration in corporate revenue growth. That is our base case scenario.
Q. For a 13-14?rnings growth that you are expecting, what do you think would be a reasonable topline growth? And do you see signs of that topline growth now?
A. An 8-10% topline growth is something that's a likelihood. This year, the topline growth also got hit because of deflationary trends, and once that impact fades away, we will see some normalisation. In addition, the consumption side of the market, which is impacted at present, is seeing early signs of revival.
Meanwhile, capital expenditure is continuing from the government's side and should be followed by a revival in capital spending from the private sector too. Current numbers don't display that when I look at some businesses such as abrasive industry, bearing industry, etc. When one thinks about the manufacturing ecosystem, as a whole, it is a long-period cycle. Unlike services, where you can build an ecosystem in a relatively shorter period of time, a manufacturing ecosystem takes some time. So the revival (in private sector capital expenditure) may happen in the next six months or nine months; we don't really want to get into those details. But, directionally, India can see a significantly larger manufacturing opportunity, especially with the supply chain dislocation being seen worldwide.
Hence, many parts of India's economic ecosystem should actually start to accelerate. Consumption and manufacturing should then start to fare well, and as other areas start normalising, they should also see topline growth accelerating.
Q. You said there are visible signs of revival in domestic consumption. Can you throw some light on these signs?
A. Let's start with consumer staples. Many of these staple businesses have stabilised at the lows. When one looks at two-wheeler volumes, there has been a pretty decent improvement there. In other areas of the rural economy, some stabilisation or improvement in a few pockets is being witnessed. Hence, I think we won't see more negative news there. On the contrary, we may see positive news flow there. Consumer durables sales, which were impacted for a while, are seeing normalisation as well.
On the discretionary side, tourism is one area where we are seeing a lot of buoyancy, whether it is aviation, or hospitality. That's driven by a lot of steps taken by the government, for example, the number of airports have virtually doubled over the last 9-10 years, and are slated to go up even further. The kind of infrastructure creation that we are seeing in the railway and road sectors is phenomenal. I believe tourism is one area where supply is also creating demand and there is a change in consumption patterns.
Q. Many fund managers expect downgrades to corporate earnings estimates for FY25 because there are global risks that have cropped up, which may keep inflation higher. And secondly, it also poses the risk of interest rate cuts being delayed. So what is your view on that?
A. If geopolitically things don’t play out well, then export-oriented businesses may see some impact at an aggregate level. But on the domestic side, where our confidence level is reasonably high, we should start to see things actually turning better. There is going to be a push and pull of the two, whether the growth ends up at 8% or 10%... I don't want to get into those minute numbers. But, given that a large part of the market is still domestic-oriented, we should see that acceleration (in earnings).
Coming to global macroeconomic issues, worries related to them have been lingering for a while. We've been talking about world GDP slowing down for more than two years now. Theoretically, what you're saying (about downgrades) may happen, but realistically, we'll have to see whether it actually materialises. Let's take the Red Sea crises as an example. While logistics costs have gone up, if things don't escalate significantly, the impact should be contained. So far, we've seen some slowdown in some of the chemical businesses, and a few export-oriented businesses. However, many of these corporates have also said that they are seeing some signs of the slowdown bottoming out. So, if the tensions don't escalate, these corporates should see acceleration in growth a few quarters down the line.
Q. Do you not think that if the Red Sea issue is prolonged, then we have a risk of inflation remaining higher at a global level for a longer time?
A. That's a possibility if the issue remains, or if it escalates. But, the world will figure out its own logistics path as well. If one considers a scenario where nothing else changes, but the Red Sea crisis escalates, and logistics costs go up, we may see some transitory inflation. But at the same time, what would also happen is relatively higher restocking. For example, during the time of the COVID-19 pandemic, we saw that as logistics timelines increased, restocking was higher, so we may actually see better demand in many areas.
Q. Keeping this backdrop in mind, when are you expecting interest rate cuts to actually begin?
A. I think the peak interest rate is in sight and if there aren't any geopolitical misadventures, we should start to see interest rates being lower than they are. In fact, there is a 50% probability, as being assigned by many, that the Fed funds rate would actually go down by 100 basis points by the end of this year.
Q. But those expectations are being tempered right now.
A. I think the markets would respond to this in terms of direction. If directionally we believe that interest rates are headed lower, whether it is two cuts this year or three cuts, markets will suitably respond. It's the direction which matters more than the quantum of the rate cuts.
Q. Looking at the ground level reality and incoming data, it seems there might not be a single rate cut in the US. The economy is booming and unemployment is at historical lows. What would be the trigger for a rate cut, even in India? And if there is no rate cut, what happens to the market and valuations?
A. Let's talk about the US first. The US economy has done alright so far and inflation has started to come down already. Unless we see some flare up of prices because of geopolitics, I see inflation continuing to trend down. There are multiple aspects to it, one of which is that supply chains would be a lot more normalised. So, we may not see higher inflation because of supply side behaviour, as we saw in the past. Housing price and commodity-led inflationary pressures should not be a worry either.
Coming to India, if we look at the government borrowing programme, we are seeing that overall borrowing will be lower this year as compared to what it was. And we have already seen some impact in terms of how the 10-year government bond has behaved. Given the relatively lower borrowing, and inflation not being a worry, we may see a rate cut.
If it doesn't come by and earnings remain at an elevated level (say, 13-14%), I don't see that impacting valuations because markets would actually be focusing more on the long-period earnings growth. In the past, interest rate cuts have been followed by earnings growth surprising negatively, so that will be monitored.
Q. There has been a narrative doing the rounds that valuations are so high that it's not the right time to enter stocks. What is your view?
A. Valuations are a function of long-period growth. If we believe that valued-added growth will actually be delivered in the long-term, then markets will continue to compound wealth. At present, on an optical basis, markets could be fairly valued or slightly more than fairly valued, from a short-term perspective. But, if corporates continue to deliver earnings growth, as we are seeing currently, then I would not be too worried about valuations. If you look at India's valuation versus that of the world, historically, it has always traded at a premium. Businesses and economies which continue to grow better than others will continue to command premium valuations.
Q. So, keeping that in mind, which sectors look attractive to you?
A. Multiple areas look attractive. We are more positive on domestic-oriented businesses as compared to exports because exports will have their own vagaries in terms of growth. The manufacturing ecosystem is one sector where we believe the cycle has already turned and will continue to do well over a long period of time.
The discretionary consumption side, in particular premium consumption, will do well as income levels keep rising, and aspirations keep going up. We are more focused on premium consumption compared to pure staples, because premium consumption has the potential to grow relatively faster. Many tourism-related areas will also fare well, which is in essence linked to discretionary spending. Automobile and pharmaceutical sectors are other areas where we are bullish.
We are also positive on some financial services-oriented businesses. In the case of lending businesses, we look for a combination of growth, asset quality and return on equity, and assess if the company has the right technological framework or not. It could be a non-banking finance institution or a bank that meets our expectations on these parameters.
Q. Public sector (PSU) stocks have been in the news recently and they have been among the best performers over the last two months. What is your take on state-owned businesses?
A. Things are changing for PSUs. Order books of many of the state-owned businesses are a lot better and operational efficiency is improving. Businesses which can continue on this path can keep creating value. Markets have rewarded many of these businesses which have delivered.
Q. You manage a big fund in terms of the total corpus. How do you find a correct mix between large caps, and mid- and small-caps?
A. We are always bottom-up investors. Over a long period, rather than the size, it's the quality of management and the quality of business that creates value. Those businesses that have pricing power and companies which can show strong execution prowess will differentiate themselves from others. Over the last one year, we've seen huge divergence in the performance of large caps, and mid- and small caps. When you look at small-caps, many have delivered decent earnings growth, but by their very nature, they are volatile and they are a lot more cyclical. They benefit when commodity prices fall because their margins tend to expand.
Q. How do you manage the liquidity in your portfolio when it comes to small- and mid cap stocks? Do you go for smaller ticket sizes or stakes when you're looking at the smaller caps?
A. We look at liquidity at the aggregate holding level. We don't allow the illiquid portion to go beyond certain thresholds. If the liquidity doesn't accord us buying into some stocks, we may look at relatively smaller positions.
Q. You handle many HNI, family offices and corporate clients. How is the mood among your clients right now?
A. The kind of equity interest that we are seeing among our clients is way higher than that seen previously. Not only is the equity interest higher, their understanding of markets is also a lot higher compared to what it was in the past. We are just starting to see relatively higher household allocation towards equities and I think we'll continue to see an increase in that.
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