For Sachin Shah, Fund Manager at Emkay Investment Managers, the source of confidence in Indian manufacturing stems from the structural point of view more than just the make-in-India initiative or the performance-linked incentive (PLI) scheme.
Two of the most important factors for him to be excited about any investment in manufacturing are RoCE (return on capital employed) and cash.
Seasoned for more than two decades in Indian equity markets, Shah believes that the manufacturing sector has the potential to create multi-baggers over the next 5-10 years.
In the pharma space, he is quite optimistic on the CDMO (CRAMS) space. "We believe there is a significant tailwind to the sector (China+1, Europe+1) and structurally the business is inherently profitable and scalable with a such a large highly qualified scientist pool available in India," he shares in an interview to Moneycontrol. Excerpts from the discussion:
Do you expect manufacturing to grow faster than the key benchmarks?
We have been quite sanguine about manufacturing since the last two years. Our confidence in Indian manufacturing stems from not only from 'Make In India' or 'PLI Schemes' but more from the structural point of view. When we talk about each of our strategies, two most important factors for us to be excited about any investment are RoCE (return on capital employed) and cash. Remarkably, despite facing numerous crises, the manufacturing industry displayed improvements in both these aspects.
The cash ROCE (CFO divided by capital employed) which was on a decline for many years looked up for the first time in FY21 and rose beyond the long-term average and has continued to do so in FY22-23. CFO represents cash flow from operations.
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Another crucial structural change that took place was the enhancement of cash flows and the focus on its allocation. During the Covid-19 crisis, a remarkable and evident trend was the significant improvement in working capital investment. The incremental investment in working capital as a percentage of EBIDTA (earnings before interest, tax, depreciation and amortisation) decreased from 25 percent to as low as 7.5 percent between FY19 and FY23. Every rupee saved on working capital can be used to repay debt and consequently the debt to equity ratio of BSE500 companies came down from 0.8x to 0.55x.
The positive impact of enhanced ROCE, streamlined balance sheets, and improved utilisation quickly became evident as the rejuvenated capital expenditure (capex) cycle gained momentum in no time.
We do believe that the manufacturing sector has potential to create multi-baggers over the next 5-10 years. Over the past two decades, the manufacturing sector lost a significant market share in GDP as well as stock market indices to services (BFSI and IT). As manufacturing sees unforeseen expansion over next few years driven by both domestic consumption as well as exports, we expect the tables to turn in favour of the sector.
Over next 5-10 years, we believe that the manufacturing sector will regain that market share, both in GDP as well as in equity indices.
What's your take on the possibility of a major correction in the market if the Fed gives confirmation over rate hike cycle and reduction in volatility?
As of going ahead, we think its high time to separate the man from the boys in each sector. In case of auto, clearly premium and luxury is bound to do better than the economy segment and not only for four-wheelers but also for two-wheelers.
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Within banking, we would now bet only on those banks who have invested in distribution and hence able to mobilise deposits easily and cheaper than competitors.
Is it time to add exposure to pharma space?
We are quite optimistic on the CDMO (CRAMS) pharma space, we believe there is a significant tailwind to the sector (China+1, Europe+1) and structurally the business is inherently profitable and scalable with a such a large highly qualified scientist pool available in India.
The domestic branded generics space continues to grow steadily at high single-to-double digit annual secular growth, with very high gross margins and profitable operating margins.
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The pharma sector underperformed in CY22, valuations therefore had become quite reasonable. Long-term investors can invest in some of the high-quality businesses run by superior management at reasonable valuations.
How do you see the ongoing corporate earnings season?
As of today, 36 Nifty stocks (ex BFSI) have reported a sales/EBITDA/ PAT growth of 4 percent/21 percent/29 percent YoY. The slower revenue growth seems more an outcome of lower commodity prices, even as EBIDTA margins have expanded 260bp YoY leading to strong profit growth.
Which sector has delivered strong performance in the June quarter? Do you think this will remain in the coming quarters too?
Overall, the banking sector has delivered very decent first quarter (Q1 FY24) results, we are quite impressed with growth in advances and deposits along with maintaining the margins (NIMs and spreads) at large private sector banks.
Most of the capital goods companies also delivered very strong results, more importantly the order in-flows, order book and outlook commentary were even more encouraging. We believe both the above sectors should do well for the rest of the year too.
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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