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Daily Voice | Rajesh Bhatia of ITI Long Short Equity Fund explains why the power sector is a strong medium term investment theme

Given the recent actions of the RBI, inflation control is now a clear priority for the central bank, and that could impact liquidity and optimism in the domestic market, says the MD & CIO of ITI Long Short Equity Fund.

May 06, 2022 / 09:48 AM IST

"With the strong Government focus on addition of renewable power and aggressive plans for capacity addition through 2030, the Renewable Energy (RE) segment will see very strong action through this decade," Rajesh Bhatia, MD & CIO of ITI Long Short Equity Fund, told Moneycontrol in an interview.

Moreover, companies are also looking to carve out their RE business and list it separately or sell stakes to investors in the same, leading to value unlocking, he added. This makes the power sector a strong investment theme to be kept on the radar in the medium term, he said.

On the RBI move to hike rates, Bhatia said given the recent actions of the central bank, inflation control is now a clear priority.

Edited excerpts:

The power sector is the real star in the current year. Is there still time to enter these stocks or is the rally over?

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Power demand has seen a sharp increase this summer, as temperatures soared across the country. Due to very high international thermal coal and LNG prices, the supply response from merchant players has not been quick, which led to a power shortage in the country. Due to higher volumes, utilisation has improved for power producers.

We had seen a similar shortage in October 2021 as well, which cooled off subsequently. The current surge is also expected to normalise as we head into the monsoon season. The power regulator has also stepped in to cap power tariffs in the Day-Ahead Market at energy exchanges.

Given the sharp rise in the stock prices of power companies, fresh allocation at these valuations does not offer an attractive risk-reward. However, the coal-based power sector has been under-invested for several years now and such episodes are bound to happen regularly in the future, which would keep interest in this sector alive over the medium term.

With a strong Government focus on addition of renewable power and aggressive plans for capacity addition through 2030, the Renewable Energy (RE) segment will see very strong action through this decade. Power companies have their presence in this segment, either as a producer or as an EPC or as a material supplier.

Moreover, companies are also looking to carve out their RE business and list it separately or place a stake with investors, leading to value unlocking. This makes the power sector a strong investment theme to be kept on the radar in the medium term.

Do you think the time has come to start taking gradual exposure in auto stocks, which have been range-bound for several months now? Also, your thoughts on monthly auto sales data…

Domestic auto sales were down sharply across subsegments (Scooters: 40 percent, Motorcycles: 34 percent, Cars: 37 percent, and commercial vehicles :29 percent) versus the peak seen in FY2019, despite a modest bounce from an even weaker base impacted by the pandemic in FY21. A few subsegments, such as exports, tractors and SUVs, provided some respite to the sector.

We have seen a series of issues, such as BS VI transition, pandemic-induced demand destruction, supply chain disruption, a chip shortage, extreme commodity prices etc over the last three years, with no ‘normalcy’ at any time. It has been as if Murphy’s law was in play (anything that can go wrong will go wrong) in the sector over this time!

Currently, we are observing some early signs of stability in some of the factors that led to the fall in volumes. Improved mobility and opening up of the economy, stability in prices of a few commodities, expectations of a recovery in rural earnings, supply chain improvement, good traction in retail sales etc. Other factors such as the chip shortage could take more time to normalise.

Given the inherent cyclical nature of the industry, the replacement demand cycle, and growing economy, the sector should see a rebound from low volumes over the medium term. Most companies have passed on the cost increases to the extent possible and tried to maintain the gross profit per vehicle, despite an optical slide in gross margins. With the hopes of recovery, one can look at selective stock exposure in the sector, as some of the stocks are trading at very reasonable valuations.

The recent monthly volumes were below expectations, as most companies reported a month-on-month slide in wholesale numbers due to production issues. Given that the base volume in the month of April 2021 was impacted by the second wave of the pandemic, we saw strong year-on-year growth numbers. Some of the current production issues are expected to ease out over the next few months, with a marked improvement expected in the second half of FY23.

The US Federal Reserve, as expected, raised rates by 50 bps, in its biggest hike in two decades. What are your thoughts and expectations considering the current global environment?

Along with the 50-bps hike in the repo rate, the US Fed has also given clarity about the possible path of its actions (with possibly 2 more 50 bps hikes lined up). While the US market rejoiced over the clarity, the global macroeconomic challenges are far from over. There is a risk that tightening (QT and rate hikes) of this magnitude may derail economic growth across geographies, while fighting inflation.

China, on the other hand, is currently struggling with low growth due to their zero-tolerance policy towards COVID. The cause of inflation, apart from demand, has been serious supply disruptions led by the Russia-Ukraine war situation and Chinese lockdown. While the US Fed, Bank of England and European Central Bank are on their tightening path to fight inflation, the Bank of Japan is trying its own medicine, with strict yield curve management, sending the Yen into a tailspin.

China is looking to stimulate the economy, at the same time, it is constrained due to the recent episode of excesses in its real estate sector. If one has to borrow the words of the RBI Governor, currently, tectonic shifts are happening in the global macroeconomic space, with very limited clarity on how and when it will settle.

The RBI does not seem to be in a position to stay behind the curve. Hence, do you think it will keep raising rates till inflation comes down to the target range of 4 percent (+/- 2 percent) on a sustainable basis?

With the global inflation challenge mounting up, the RBI pre-empted with the rate hike on Wednesday and is apparently in an inflation-fighting mode. The central bank objective is to control inflation expectations, and yet provide for economic growth, a task easier said than done. Given the recent actions of the RBI, inflation control is now a clear priority for them.

We have entered the fourth week of the March quarter earnings season. What are your thoughts on the earnings announced so far and do you still see a major earnings downgrade for FY23?

A clear highlight of the earnings season has been the tremendous inflationary pressure felt by the corporate sector, impacting their profitability. Even for the services sector, such as IT and BFSI, the cost pressure was visible. Although coming off a weaker base and supported by price hikes, companies reported good topline growth, largely it was profitability that was below estimates.

Consumer level inflation is also hurting demand growth across sectors. Given the persistent cost pressure, which could spill over into 1H FY23, the earnings estimate for FY23 would be at risk of a downgrade.

The market has been very resilient for several weeks now, even though there are several issues, including inflation, geopolitical tensions, elevated oil prices, Fed rate hikes and FII selling lingering. Your thoughts....

As mentioned earlier, global central banks are on a tightening path in their efforts to fight inflation. With the RBI also changing its stance and prioritising inflation control, domestic liquidity will also be in course correction mode!

The odds are mounting against the domestic markets, with support perhaps coming only from strong domestic inflows into equity markets. Domestic optimism could change given the moves by the RBI and the US Fed over the coming time.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Sunil Shankar Matkar
first published: May 6, 2022 09:48 am
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