Managements across core businesses of the economy are extremely optimistic and backed by strong earnings across infrastructure, auto and capital goods, according to Naveen Chandramohan, Founder and Fund Manager of ITUS Capital.
Naveen with more than 16 years of experience in the financial markets has maintained that auto ancillaries (especially around B2B Manufacturing) is a theme that has a significant (3-year) runway ahead of growth. "This certainly looks attractive to me with growth being sticky (B2B driven)," he says in an interview to Moneycontrol.
He feels the market is discounting a rate cut in 2HCY 2023 from the Fed. "It’s an environment which is very different than what we saw in the middle of 2022." Excerpts from the discussion:
Do you think time has come to focus on new age tech companies for a portfolio?
It's interesting to get some context to why the focus from multiple funds and mutual funds have come on new age tech companies which have found their way into the portfolios of many – Zomato, Paytm and Nykaa being the ones investors would find today in many portfolios. 2022 was a year when the terminal value of businesses got reset – this happens because of the interest rate regime change alongside an environment of tightening of liquidity globally.
In September 2022, the market had a change in structure. It began with the UK Gilt market completely losing liquidity following which there was a change in stance of central banks globally. The UK central bank had to step in and provide liquidity and since then the Fed focussed on ensuring bank reserves did not drop. The Asian Central Banks, especially BOJ and China eased by bringing in a total of $1 trillion into the system (you can look at the performance of Japanese equities since then) and things have looked very different since.
Today, the market is discounting a rate cut in 2HCY 2023 from the Fed – it’s an environment which is very different than what we saw in the middle of 2022. Currently, the market is pricing in a re-evaluation of terminal value (with lower rates) and this has benefited the macro of high-growth companies globally.
In India, this has benefitted all the new-age tech companies too in their valuation discounting. They have come out with their earnings too focussing on buzz words like ‘adjusted EBITDA’ which makes me want to learn new aspects of investing. My view on them does not change – their business model has to be clear around how they generate cash flows and I do not see that.
An investor can certainly make healthy returns in the short term but I do not see merit. In full disclosure, we had an investment in Nykaa but exited last year as the capital allocation was very different from our expectation and in areas which we believe were sub-optimal for future incremental returns.
Considering the gradual uptrend in IT space, do you expect the momentum to pick up in IT stocks in coming weeks?
We do not invest in uptrends or exit in downtrends. We invest in businesses where valuations have low downside despite us being wrong. Neither are we investing with a duration of weeks in mind – that’s trading.
In terms of IT, as I mentioned above, as terminal value changes it benefits IT too. However its important to remember that IT got hit pricing in a recession and hard-landing in the US. So far, the demand cycle of projects has not been affected in the earnings of companies.
In fact, the larger companies have reported better earnings and order books due to consolidation of projects. The valuations had de-rated going into the end of 2022, and we are reverting to mean. From here, I believe IT companies returns to investors will be a function of earnings growth.
Have you seen any large downgrades after December FY23 quarter earnings?
Consumer companies – the narrative was strong going into the earnings season and the valuations were rich. Many of the consumer companies came out with strong earnings but on a much higher base. I see a healthy correction in them as a good thing in the market as valuations correct a bit. Now, it’s not a large downgrade because consumption should continue to grow in our country.
What is the message you get from the management commentary after quarterly earnings?
Managements across core businesses of the economy are extremely optimistic and this is backed by strong earnings and this is across infrastructure, auto, capital goods – any economy facing business.
In certain areas, exports have slowed down, but its important to understand that we are coming of a high base, so it is not right to interpret significantly from one quarter. The one area which has been lacklustre vs expectations has been QSR (quick service restaurant).
Do you think the market has discounted Adani Group issue? Are these stocks still overvalued?
As you are aware , Adani has 6-7 large entities and they have created significant market cap over the last 6 years. Many of these entities have scaled their market cap around debt levels which are difficult to manage and sustain. If you look at the systemic risk across entities and who owned the equity of Adani groups
a) More than 90 percent of the debt of Adani was issued in the form of $ bonds (financed by USD investors offshore).
b) The Indian banking system has a very low exposure to the Group – limited to working capital ringfenced by secured assets
c) The risk of contagion on the system has been low
d) The domestic Mutual funds in India too have not owned the equity of any of the Adani companies.
We would not own companies with this level of debt, but the bonds of Adani Ports look attractive as they are backed by real cash flows. Have all the headlines been discounted, I am not very sure. Sentiment takes at least 1-2 quarters to completely change unless the action from the group is otherwise (for it to be faster).
Do you expect the rate cut by the RBI to begin in the beginning of 2024 as most of experts don't see rate cut in rest of current calendar year?
I do not expect RBI to cut – no. This would change if there is any global liquidity issue, but I expect inflation to be structural.
Which are the sectors that look undervalued now and should be start buying into?
I have maintained that auto ancillaries (especially around B2B Manufacturing) is a theme that has a significant (3-year) runway ahead of growth and this certainly looks attractive to me with growth being sticky (B2B driven).
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