Daily Voice | Niraj Kumar of Future Generali bets on these 4 themes, recommends ignoring short-term gyrations

We believe that the Indian economy will continue to grow at a steady pace and has strong macroeconomic fundamentals. With a focus on indigenization, de-risking supply chains, China+1 strategy etc. we believe that we are likely to see a significant pick up in the CAPEX cycle in India. This along with our cautious view on global growth makes us constructive on domestic-oriented themes like Banking and financials, Cement, Infrastructure, Capital Goods and industrials while remaining cautious on the outwards facing sectors like IT & commodities.

In this context, we like the Banking & Financial space which remains the best proxy to play the domestic consumption & investment theme. The tailwinds are quite strong for the sector with most large private banks delivering steady teen earnings growth with the best-in-a-decade balance sheet. The stressed assets are at a multi-year low while the capitalisation levels at a multi-year high. The return ratio profile of the sector has normalized after years of asset quality-induced sub-par return ratios. The sector is also trading at an undemanding valuation at below historical median levels.

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We also like infrastructure & capital goods space. The impetus on the infrastructure sector is palpable with significant ordering taking place in sectors like railways, power, defence etc. resulting in order book to sales multiple for many companies rising significantly.

We also like Cement which would be a beneficiary of strong volume growth owing to Infrastructure spending and pick up in the real estate sector along with falling input costs which should result in significant improvement in profitability over the next few quarters.

Are the valuations attractive for the pharma exporters?

Pharma is a very heterogeneous sector and hence warrants bottom-up research rather than just a top-down approach to generate outsized returns in the sector. Having said this, the overall operating environment for the pharma sector has indeed turned positive after years of downcycle. The recent strong stock price & financial performance of the sector were based on two factors.

a) Declining price erosion on the back of record drug shortages in the US
b) Presence of multiple limited-period high-value opportunities like Generic Revlimid, Spiriva, Albuterol etc.

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While the first factor has been aided by the withdrawal of a large number of companies from certain drugs/therapeutic segments owing to unfavourable economics and hence is more sustainable in nature, one must be careful in extrapolating the second factor. The recent financial performance of a large number of Indian pharma companies has been aided by contributions from drugs like Revlimid.

We must be cognizant of the sustainability of such earnings and cash flows. Ideally, opportunities like these should be valued based on NPV (net present value) rather than PE which would look optically low. Adjusted for these one-off opportunities, we believe that the return profile of the export piece of the business is inferior to the domestic piece of the business and hence our preference is for the domestic-facing pharma companies vis-à-vis export-oriented ones.

Your take on the IT space, especially after September quarter earnings, and outlook for H2FY24?

We are not too optimistic about the global growth outlook. We believe that as the lagged impact of the synchronous global tightening plays out, we will see a moderation in GDP growth rates in the developed world. There are already signs of growth moderation with several high-frequency indicators like PMIs, new mortgage applications, and housing sales slowing down considerably.

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Since the fortunes of the Indian IT sector are closely linked to GDP growth rates & consequent IT spending in the developed world, we believe that the IT sector can face growth headwinds in the near term. This coupled with margin pressure owing to lack of growth and wage increments would lead to sub-par earnings growth.

September quarter results reflected the same with most large-cap companies delivering modest growth (some even de-growth) on a YoY basis. While the deal wins continue to remain strong, the tough macro environment is leading to delays in the conversion of deal wins to revenues and hence outlook remains uncertain.

In the context of slowing growth, the valuations of IT companies have not been corrected enough to make them a compelling investment. However, despite our near-term concern due to cyclical headwinds, we remain extremely constructive on the sector over the medium to long term owing to superior cash generation abilities of the businesses, good capital allocation policies and structural growth potential owing to elongated IT upgradation/modernization cycle.

Q: Any thoughts on the consumer discretionary space?

We believe India is at a stage where incremental per capita income will find its way into discretionary consumption and hence we are structurally positive on consumer discretionary space. However, from near near-term perspective, one should have a selective approach while picking stocks.

We remain positive on spaces like jewellery & apparel where there is a large shift from unorganised towards organised players and the runway for growth in these segments is enormous. While valuations in these segments might look expensive, the visibility of sustained earnings growth and high return ratios justify the valuations.

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We also like automobiles and are seeing a revival in demand and the story of premiumization playing out. However, we are cautious on spaces like consumer durables where we believe that despite reasonable demand, competitive intensity has surged, and newer players are disrupting the markets because of which profitability is likely to remain under duress in the near term.

What are the imminent risk factors for the equity markets? Is it oil?

Equity markets are dynamic and are almost always surrounded by risk factors. At the moment, several factors like elevated bond yields, geopolitical tension, elevated crude oil prices, and a politically heavy calendar (Indian state elections, Indian national elections, US Presidential elections etc.) over the next 12 months are major risk factors.

With respect to the elevated bond yields, we are not in the camp that believes in ‘higher for longer’. We believe that the current elevated bond yields are due to a demand-supply imbalance in US bond markets owing to a very high supply on the back of a very high fiscal deficit and lack of demand as the US FED is unwinding its balance sheet through quantitative tightening.

However, as we move forward, we expect growth rates to slow down considerably which should result in the US Federal Reserve turning less hawkish hence bond yields should cool off and monetary conditions should ease.

The other risk factor, higher crude oil prices, we believe is mainly on the back of geopolitical tensions and is not demand-driven hence we expect it to be short-lived unless tensions escalate.

Finally, while political events do impact the markets in the near term, from a medium to longer-term perspective, any fall in markets owing to surprise political verdicts are usually a good opportunity to add equity exposure.

We recommend investors ignore short-term gyrations and stay focused on businesses that deliver superior earnings & return ratios and use corrections as an opportunity to build an equity portfolio.

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