Anil Rego, founder and fund manager at Right Horizons, is optimistic about the building materials demand outlook due to increased investment towards infrastructure, urbanisation, and a recovery in housing and commercial real estate markets. In the building material space, plastic pipe companies are likely to see stable quarters ahead, while metal pipe players’ margins are looking up given their improving product mix, he says in an interview to Moneycontrol.
On the second sector which is banking, the seasoned investor for over 3 decades, following a contrarian style, says the industry is witnessing robust credit growth momentum driven by the continued traction in retail and SME segments. He expects the banks to deliver healthy earnings growth.
Q: Do you see any risk factor that can dampen the growth prospects for the rest of the financial year?
The global slowdown, political uncertainties, persistent inflation, and global market correction are concerns for the near term. Inflation has been persistent, which has now led to delays in expectation of rate cuts in advanced economies and domestically the rate cuts are expected by FY25. The markets have touched record highs and have been volatile amid these concerns.
We expect consolidation in the near term but don’t see an impact on growth prospects over the long term. Indian economy is positioned favourably relative to advanced and emerging markets and is poised for growth.
Domestically, companies are fundamentally better with healthy corporate balance sheets and robust credit growth across the industries. Earnings have been healthy and are projected to grow so we don’t expect these risk factors to have a significant impact over the long term.
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Q: Do you expect tremendous growth potential in the PSU banking space, even after a recent rally?
PSU Banks over the past few years have operated with low levels of capital and due to poor operating performance were unable to approach the markets. This has resulted in slower balance sheet growth. Return ratios of PSU banks have been under pressure for many years with quality names in PSBs taking a significant stock of provisions towards stressed accounts and reported losses over FY16–20, resulting in negative return ratios.
However, we are witnessing the profitability of most PSBs has improved significantly and a few have also been able to raise capital from the markets. This, along with continued moderation in risk-weighted asset density, has led to steady improvement in capitalisation ratios such as Debt/Equity. PSU banks, especially the quality names, have been witnessing a recovery since FY21.
In Q1FY24, most PSU banks reported a +1 percent ROA (return on assets) and are expected to continue to generate RoAs of +1 percent in the near term led by cyclical gains and benign credit cost. However, core profitability adjusted for volatile income streams makes it questionable to maintain a RoA of +1 percent consistently over the long term.
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Considering the landscape of current valuations in terms of the near-term asset quality cycle, earnings, and leveraging we believe selective opportunities are available that are likely to maintain RoEs (return on equity) in the mid-teen ranges.
Q: Federal Reserve chair sees tighter policy through 2024. Does it mean the rate cut will be pushed in 2025?
As inflation in the US remains elevated, the FOMC is expected to hike interest rates one last time by the end of 2023, taking the rates to a peak of 5.5-5.75 percent before cutting them from 2024.
However, the pace of rate cuts is expected to be stretched more than previously anticipated. The federal funds rate is expected to fall to 5.1 percent in 2024 and 3.9 percent in 2025, so inflation is back to its 2-percent target in 2026.
Q: Do you think the RBI should be worried given the Brent crude is rising above $90 a barrel?
India is a net importer of crude oil so an increasing price trend will impact the current account deficit. Consequently, it depreciates the domestic currency and increases consumer prices thereby increasing inflation. So a persistent higher crude oil price will be a concern especially since inflation has been running rampant for a long time and we are at near peak levels of interest rate.
However, we believe a price range of $90-100 per barrel of crude oil is already priced in the estimates of inflation projection and GDP growth.
Q: Are you worried about midcap and smallcap segments given the expensive valuations?
We now see opportunities granular in nature within distinct subsets of subsets as the broader narrative of the mid- and small-cap has warranted attention beyond the scope of fundamentals that was bolstering the narration. And rightfully so, considering the structural shifts were steering towards the multi-decadal growth outlook of the economy that benefits businesses across the board. This will result in benefits trickling down to the SMIDs (small-mid) and likely result in relatively superior performance.
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Now, we see limited opportunities that are available at reasonable valuations and are of the rationale that quality names are a better risk-reward investment and recommend avoiding businesses with historically weak execution and governance track records. We do believe there is steam left in the engine but it is constrained to those names that have a strong track record and their earnings are expected to grow consistently above the industry peers.
Q: Two sectors that can still give tremendous opportunities...
Building Material Segment
We are optimistic about the building materials demand outlook due to increased investment towards infrastructure, urbanisation, and a recovery in housing and commercial real estate markets. In the recent Financial Budget 2023-24, the government proposed to increase the funds for PM Awas Yojna by 66 percent, to Rs 79,000 crore, boosting the pace in the affordable housing segment in India. Additionally, the government has proposed investing heavily in transport infrastructure projects benefitting the real-estate markets across India, especially in Tier-2 and Tier-3 cities.
Plastic and metal pipes are witnessing robust demand. Upbeat commentary from management on the demand outlook, the government’s focus on housing & infrastructure, and industry consolidation are factors working in the industry's favour. Companies are incurring capex aggressively or actively pursuing inorganic growth opportunities to cater to the demand. Plastic pipes companies are likely to see stable quarters ahead. Metal pipes players’ margins are looking up given their improving product mix.
Paints and adhesives companies are registering robust demand uptrends. Selective companies have managed to secure double-digit volume growth in Q1FY24 and are expected to deliver double-digit sales growth in FY24.
Banking
The Banking space is witnessing robust credit growth momentum driven by the continued traction in retail and SME segments. On a segmental basis, home loans, Auto loans, and Credit card outstanding continue to grow, while corporate loans are recovering gradually. The corporate segment is gradually recovering, and a pick-up in capex would be crucial to maintaining growth momentum. The management of companies has also been upbeat about the growth momentum. Asset quality is likely to remain healthy. In FY23, incremental earnings were primarily contributed by the BFSI sector and we expect the banks to deliver healthy earnings growth.
Q: Your take on JPMorgan adding Indian bonds to its Emerging Markets Index from June 2024
JP Morgan said India's G-Secs will be incorporated in three of its bond indices consisting of similar instruments issued by the governments of emerging markets. Starting from 1 percent, the allocation would rise to a maximum of 10 percent by March 2025. As the index is followed by global bond fund managers widely, it is estimated that funds of $40-45 billion could flow into India.
Watch: Decoding The Impact Of India’s Inclusion Into JPMorgan’s Emerging Market Bond Index
Incremental allocation would also lead to a decrease in yields, which will bring down the cost of borrowing for the government and also indirectly lower the cost of borrowing for the companies. Further higher inflows will likely have a positive impact on the domestic currency relative to others.
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.
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