Increasing FDI, lowest capex to net profit ratio, increased headroom for fiscal expenditure to power growth: Manish Bhandari, Vallum Investment Advisors

Manish Bhandari of Vallum Capital Advisors (Image| Twitter - @VallumConnect)

Despite the underperformance in India markets over the past year, India will continue to see strong growth backed by multiple drivers. Manish Bhandari of Vallum Investment Advisor who runs an Alternate Investment Fund said in his annual letter to shareholders, “The future of India is powered by multi-fold growth engines.” He identified three significant drivers for growth. One, the FDI in manufacturing is increasing as the post-COVID world looks to build supply chain security with friendly countries. It increased approximately 80% from $ 9 billion in FY21 to $16 billion in FY22. From April 23-December 23, FDI increased further to $36 billion. “We have witnessed India entering FTA with Australia and UAE and are currently in discussion with other countries like UK, EU, and GCC. Countries across the world are looking at China+1, and Europe+1 from a supply chain perspective and these agreements will allow India to easily integrate into the Western manufacturing supply chains.” Bhandari noted.

The second important driver Bhandari pointed out was the low capex to profit ratio which in all likelihood marks the end of the long capex downcycle in India. Bhandari noted that Indian corporates have improved their cash flow position (PAT + depreciation), substantially. BSE 500 PAT has increased to Rs 14,600 billion in FY22 from Rs 7,600 billion in FY18, while the capital expenditure has remained constant at around Rs 4,000 billion for the last three years. This has meant that the Capex/PAT ratio, which has ranged from 80-100% for BSE500 companies, has collapsed to an all-time low of approximately 48% in FY22E. “This creates room for the private capex cycle to take off,” Bhandari noted.

The third driver according to Bhandari is the fiscal headroom that has got created because of subsidy rationalisation, post-pandemic. “The normalization of Covid subsidies is creating space for increased central government capital expenditure, powered by election cycle spending in the coming years.” From now until 2024, India will witness 13 state elections and a general election, which will create its own spending momentum, according to Bhandari.

With these drivers in place, Bhandari said that it may be time for mid-cap and small-cap companies to make a comeback. Mid-market space remains accused of underperformance for a second consecutive year. “…we term this a ‘deployment’ year. Cycle analysis suggests that midcap/small-cap strategies with stock-picking abilities are likely to reap benefits in the coming years.” Bhandari noted.

Currently, approximately 45% of Vallum’s only fund is invested in quality, difficult-to-copy consumer brand names, 37% in deep value where earnings cycles are recovering from prolonged business downturns where prices are temporarily depressed because of short-term factors, and the remaining 18% has been invested in discounted asset-based businesses where fixed assets account for a large portion of appraised value. “It is the first and third category that contains our current winners and the losers lie in the middle. We believe, over time, all will be winners.” Bhandari said in the note.  In FY23, Vallum’s portfolio beat the benchmark by 296 bps net of fees. 97% of client assets and 95% of clients beat the benchmark, and 87% of client assets beat the benchmark by more than 300 bps net of fees, according to the shareholder letter.