Daily Voice | Dhiraj Agarwal of Ambit Cap feels markets not over-heated, though some pullback may happen

Dhiraj Agarwal of Ambit Capital feels there is a possibility of some earnings downgrades

Markets aren't over-heated, of course, there could be some short-term pullback, but there's more room to rise, believes Ambit Capital MD Dhiraj Agarwal.

In an interview to Moneycontrol, he says that the earnings season has so far been mixed, but that has been a feature of the Indian market. He feels one encouraging element is the improvement in gross margins of many consumer-facing businesses. This is driven by a sharp fall in the wholesale price index (WPI) over the last few months.

"At an aggregate level, I do not see any major earnings upgrade. There is a possibility of some downgrades," says the industry veteran with over 25 years of experience. Excerpts from the interaction:

The market rallied more than 17 percent from March lows. Do you see a big opportunity for investors?

The markets have rallied 17 percent from the March lows, but it is still up just 8.5 percent year-to-date, on the back of a weak 4.5 percent return in 2022, just to put this move in a slightly longer-term perspective. These numbers are moderate, especially in the backdrop of a strong macro environment.

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Dhiraj Agarwal

Managing Director|Ambit Capital

Having said that, many large global markets have actually done better in 2023. Japan is up 21 percent, the US (S&P500) is up 18 percent, and most European markets are up 15-20 percent.

Hence, I do not think markets are over-heated, though some short-term pullback may happen. Small-caps are a little more ebullient (NSE small-cap index is up 18 percent YTD), and while there are still excellent opportunities, diligence level should be enhanced at this point in time.

Are you taking exposure to new-age technology space, after June quarter earnings?

While we do like a few names in the new-age space, these names do not fit into our greatness investment framework. We need to see earnings, cashflows and ROCE (return on capital employed). That sometimes deprives us of some exciting opportunities, but in the longer run, sticking to our investment philosophy has always worked well for us.

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Do you still see big opportunities in small-cap space, considering the healthy capex cycle?

Small-caps are very diverse, and often it is very difficult to paint them with a broad brush and, in India, it has been possible to find great opportunities in the small-cap space. Two factors are very important for making long-term investments in smallcaps – scalability and sustainability.

Our Good and Clean framework is designed to identify companies that are undertaking capex for profitable and sustainable growth. Many small and mid-sized companies have broken the scalability glass ceiling and have become large in the last 10 years, and many more have the capability to do so in the next 10 years.

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We are able to find companies that can grow earnings Ten X, as India marches towards becoming a $10 trillion GDP economy. So yes, this space still offers a lot of opportunities.

Your take on the asset management companies....

Mutual funds and equities form less than 9 percent of the household savings in India compared to more than 40 percent in the US (and more than 40 percent in Brazil, an emerging economy). This allocation was just 3.7 percent in FY20. While this growth is bound to taper down, mutual funds and other investment funds’ share in household savings should keep rising for many years to come. Therefore, asset management companies have a long runway of growth.

Have you seen any surprise element in the ongoing corporate earnings season?

Earnings season so far has been mixed, but that has been a feature of our markets. One encouraging element is the improvement in gross margins of many consumer-facing businesses. This is driven by the sharp fall in the wholesale price index (WPI) over the last few months.

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At worst, WPI was 17 percent, and 10 percent higher than CPI, which was painful for margins. Now WPI at 7 percent lower than CPI, gross margins for many businesses are looking strongly up.

Revenue traction is however superior for investment-demand-oriented businesses. In FY24, we estimate investment demand to grow at 14 percent versus consumption growth of 12 percent. It is worth noting that during 2015-20 this was reversed, which means consumption was growing at 11 percent per annum and investments only at 8.5 percent.

What about any major earnings upgrade after the quarterly earnings season?

At an aggregate level, I do not see any major earnings upgrade. There is a possibility of some downgrades. This also has been a predictable characteristic of our markets. Analysts in India always start the year with optimistic expectations and as the months pass by, the estimates get downgraded.

For example, at the start of FY23, Nifty EPS estimate was Rs 880, and the year ended at Rs 835; for FY24, the estimate at the beginning was Rs 1,020, and we will likely close the year at ~Rs 950 (current estimate is Rs 980). It will be nice to see more realistic estimates at the beginning of the year and positive revisions throughout the year.

One sector that clearly disappointed you in ongoing earnings season...

The IT sector results have been weak almost across the board. The big debate is if the growth will pick up in FY25. Especially with the narrative, that USA will manage to cool inflation down while avoiding a recession. The jury is still out on this.

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