Is it now time to orient the anchoring of the portfolio? In the last two-three years, if you bought into PSUs, you have had a home run. If you bought into engineering, defence, shipyard, it has been a good run. But now increasingly, those businesses are trading at just around fair value. Looking at the construct of the world where risk-off movements are coming back now, is it time to have a defensive stance in the portfolio?
Deepika Mundra: Again, the gap to intrinsic value is what we think. Take defence as an example. Defence is going to be a multi-year theme. We are not seeing defence spending coming down anytime soon. We are not seeing India’s focus on indigenisation going down anytime soon. Did the stocks reach fairly exuberant valuations? Yes. We in fact trimmed some of our defence exposure, which we were quite heavy on last year, but also execution misses took place and this is what we had highlighted last time also, that order books are growing, they are multiplying, but these companies need to execute as well. But at the same time, this is going to go on for a long time, and just in terms of order wins and execution, defence companies are continuing to do well. There is a price for everything. If you are a long-term shareholder, then some of these dislocations give you opportunities.
Do you sense that there is any sort of bubble in any segment of the market, be it SMEs or the IPO market? Look at the kind of valuations that they come out with and still get more and more appetite and continue to double and triple from their listing price too.
Deepika Mundra: Yes, the IPO activity has been hectic. It has kept us really busy as well. But the one thing about being fully deployed is you do not need to evaluate every single IPO. So, the one thing that we are clearly staying away from is loss-making companies, especially companies which do not have a handle on profitability which they themselves can control.
So, these can be new-age companies which were not there five years, seven years ago, in new sectors. They are great just in terms of the scale that they have built, but there is no sight of profitability. Those things try to give you a sense that yes, there is some bubble or there is a lot of euphoria just because these companies have scaled rapidly in the last four to five years, but just setting up capacity we think is not the right thing. There has to be a sight to profitability. So, I would say if we had to think about something that we are avoiding, it would be some of those areas. And we will be focused in the IPO space on companies that are more niche, that are more focused on what they are doing rather than just one trend in their space. So, two names that we have added, I would say auto ancillaries is one, which we have had added to via the various QIPs and IPOs that have been happening.
Vikas Pershad: If there is a bubble, it is not in any particular sector I think. Although you might have a question about renewables or some niche products, it is in an asset class which has volatility. The F&O market is something that we pay more attention to. The inflows are very large and much larger than they were a year ago, but they are not astronomically large compared to recent levels, as is in the case of the F&O market. There will be more restrictions on that that might pull some liquidity out, that probably has more impact on the small and midcap (SMID) names. But given our long-term horizon, we will step in before we have our lists ready to go. I think what will happen is that at some point we will get a correction and then people will say, is this still cheap? It will be cheaper.
But you do not have any cash?
Vikas Pershad: Nikunj was asking about whether we are positioned in defensive names. Defensiveness is derived from dislocation from intrinsic value, from the price that you are paying rather than a particular sector. If you have a staples name that is barely growing the top line, earnings may be mid-single digits, trading at 70 times earnings, that to us is not a defensive, and we are zero weight in a lot of the staples names.
But we are overweight, or we have off-benchmark names in the same space. If you take biscuits and cookies, for example, we are not in the largecap names there; but we are in some of the smaller companies because we see genuine earnings growth which is not in the price yet. So, that is our interpretation of defensiveness, that is how we express it.So, let us look at a construct. I will use 15% as a benchmark. Where do you think there could be scope for 15% earnings growth for next three to four years CAGR? Which end of the market, which company, which sector can grow above the 12-13% nominal GDP of India?
Vikas Pershad: So, this is the question we ask ourselves all the time is if you assume this same 15%, that implies a doubling in five years. We are looking for earnings growth rates and valuations that imply an equity can double in less than five years because we are trying to beat the market. It is not just absolute returns. Deepika mentioned auto ancillaries. EMS in certain names. Now, we spent some time with some of the Delhi-based EMS companies last week. The revenue numbers are massive. The question is on margins.
What we have seen in Taiwan with some of the EMS companies there is that they can get the revenue, but the margins either get diluted because if you are getting much larger ticket size items, if you are going from a general purpose data centre to an AI data centre, you cannot put the same margin on that because that implies many multiples of increased value. So, in the EMS space, it will come, but not in all of them. We have seen margin hiccups in that space. Auto ancillaries, pharmaceuticals and some of the smaller ones.
Deepika Mundra: Yes, some of the industrial names in particular, those which are export-focused in particular, we see a lot of labour disruptions in Europe because of that business shifting to India to some extent. So, industrials, I would say. In autos, you can still get double-digit earnings growth, particularly in the two-wheeler space, those companies which are gaining market share, so that would be another one.
Vikas Pershad: We should also talk about where we would not see it, because in this market, you can add value through what you own, but then also through what you do not own. So, consumer staples, in a a lot of the PSUs, we do not see it. PSU banks in particular. IT services, broadly. It will be hard to get that kind of an earnings momentum and then in healthcare, I mentioned pharma, but not all pharma. Hospitals, healthcare services, we probably will see it.
Isn’t hospitals a very competitive space? They always have capex which is on, competition is intensifying. There used to be this huge arbitrage where everybody from small towns used to move to tier I cities for the healthcare needs, but now given the way how money is moving into the healthcare sector, private hospitals are mushrooming everywhere. Why do you like the healthcare space or the hospital space?
Vikas Pershad: Well, it depends on where the footprint is. So, some of the companies are in areas that are more competitive. So, North India is quite competitive. One of the leading Delhi-based hospital companies acquired the Jaypee asset last week and so competition is improving. They were not the only ones who wanted that and so that part of the country will be more competitive. Now, there are some assets here that will come online in Bombay, in Worli, for example, a crown of an asset, and those are rare to come by. So, it depends. You have to do your homework, especially now that you have so many choices at your disposal.
Power is such a big story within the entire renewable theme and you have been doing a lot of work there. What interests you because, I mean, everything from transmission to storage, the supply chain is huge.
Deepika Mundra: So, power, I mean, across the board, when you talk to companies, you are seeing energy intensity go up whether it is more electric vehicles on the road, data centres being built in India, semiconductors someday in India, so all of these things are more energy intensive. So, the demand for power is going to remain elevated and utilisation levels at the generation level are high, which is driving the need for capex across all levels. Generation capex, particularly in renewables, has already kicked off. The government has tried to simplify a lot of things in terms of bringing supply chains within the country itself so that execution gets a boost. But the space that we most like is the transmission space. We think it is fuel agnostic, execution is better, it is shorter-term execution. If interest rates fall, again, that is something that benefits as a space. So, transmission is the one we like most.
Since 2022, the transmission capex of the country has repeatedly increased. So, every time the government comes up with a plan, they bump it up and that is because the flow of generation of power is different. It is more renewables, which is more transmission-intensive, so that is the one we like most.
