What is the outlook for the overall capital goods space and in particular L&T? How do you see this engineering giant?
I wouldn’t want to talk about one value in particular, but clearly on the side of capital goods, in industrial companies we see a revival beginning. Private capex, especially in certain sectors, is coming back. It will take time for the economy as a whole. I think there are about three to four quarters left before we see private investment return for the economy as a whole, because right now the output gap is quite high, but some segments are seeing announcements of capital investments.
The second big thing is that the Middle East economy is recovering very strongly thanks to oil prices and our capital goods majors are also beneficiaries of the projects announced in the Middle East. So that will be a second part of that. Overall, positive on industrials.
In pecking order, financials first as the economy begins to recover, financials will begin to gain fastest; the second would be the metals and the third the industrials, it would be the hierarchical order.
What is the view on the cement basket and playing this sector long term?
In the longer term it is good. Overall, the MNC pack fares better. We have seen a huge increase in input costs; Petroleum coke and other inputs going into cement, we have seen prices increase almost twice over the past year, hurting the sector. Volume growth is tepid, at best it’s not skyrocketing growth as we saw in 2003-04 when the last cycle took off. I think we are still behind the cycle curve. But it’s positive growth, 3-4%, a lot of cost reductions were made in 2020-2021. Manufacturers are very efficient, cash levels are good, debt levels are low, but margins are permanently squeezed due to input cost pressures.
We are looking for the main actors of the multinationals. They seem to be the best positioned and we’ve seen some buying coming in there, but overall the cement may still be a few quarters away before it really starts to gain momentum. There is a lot of infrastructure spending by the government, they are the beneficiaries. What is holding cement back a lot is that the rural economy is not coming back yet. Much of the cement drain is also for rural housing, which hasn’t really given a boost outside of government spending. Private rural spending has not returned.
We have seen other surrogate sectors of rural demand also suffer such as two-wheelers. Likewise for cement, the double barrel gun will really work when the rural economy also fires. I would say it’s probably two quarters out but that’s a good point to get into the cement right now because a lot of the negatives have been factored in and growth will come back, not yet but eventually we’ll see double-digit growth entering this sector.
As for the prices, they held the prices down, but it was the cost that caught up. With WPI in the double digits, the cost is hurting them and they haven’t been able to fully pass that cost on to the end user because the demand in the field is not a raging demand, largely at because of the rural sector still lagging behind.
What is your vision of the opening of professions?
Retail and hospitality should do well. They did well in hopes of reopening trade. Add to that the entertainment sector which should also benefit, but we can certainly look at hotels. There is still plenty of steam left and the return of international tourism will begin now, with international flights permitted by the end of this month. There should be some normalization there and with the start of the summer season, we could see foreign tourists returning after a long hiatus of two and a half years. This will be positive for the sectors.
The retail sector should do well. Whatever business survived Covid emerged with very strong balance sheets and those businesses will be able to grow now. Also, listed retailers are doing well, both sectors would be positive for me. It will be a very strong trade recovery.
Among the hotels, the high-end hotels have already arrived, so we can wait, but from here too, the domestic and foreign demand will increase a little and they can increase their income. So, after surviving the past two years, we finally see a turning point coming for hospitality and retail.
What could happen to a merger between PVR and Cinepolis?
Positive, the multiplex will gain market share. They are widely present in the big cities, they have taken over all the exhibition space. So I’m very positive on that. It’s a play on the themes of Indian consumerism, on the theme of growing wealth and with integration in both vernaculars where we see films being released simultaneously in multiple languages and also international films coming in and being dubbed in Indian languages.
So there will be a lot of drivers for these actions. What to look at, of course, is the amount of leverage. The past two years have not been good for these stocks. Also globally, AMCs, because Robinhood traders had entered them, were able to raise a lot of money, but otherwise many multiplex chains around the world had to shut down or suffer deep cuts.
For us, these players survived. I wouldn’t be able to comment on a particular title but the segment is good. This is a very small segment when it comes to listed players in India and it gives them a chance to raise funds on much more favorable terms than their unlisted colleagues. They are expected to gain market share. So overall this segment is a plus, it’s a buy.
We are now getting new purchases regarding the Nykaa counter. What is your vision for the new age tech space?
With interest rates normally rising, the high growth momentum playing out, revenue-based games are being hit hard and that’s what we’ve seen globally. We have seen this in India too. So some players that have models where they’ll go into profitability over the next five to seven years will go on sale, but there’s a lot of players that are in full swing, that were revenue multiples with no visibility on positive cash flow or profitability. These companies will struggle.
In an environment of increasing rates with a rising refresh rate, dynamic games and futuristic games will have a harder time. So I would say you have other options. Normally in an inflationary environment, in a rising interest rate environment, the first port of call is financials, industrials, metals, materials, energy stocks. These tend to do better in these kinds of environments, high growth stocks don’t.
It might be a rebound considering they were sold so furiously but I wouldn’t be in love with them. Valuations are still too high and business models have yet to be proven. Many of them don’t have a moat either. The barrier to entry is only the depth of the sponsor’s pockets in the PE space. There’s actually not much in terms of technology or any differentiation in the business model. So I would be careful. A few of them will emerge as very strong players. It will take several years. We will have time to dive back in again. It is not the moment. Now is the time to stick with cyclical stocks and more on the value side rather than the growth side of the equation.
Do you think that after the recent correction, it’s time to start buying IT again?
Yes absolutely. It is a long term purchase. IT remains our favorite after financials. Again, a big reason is that we don’t have product companies in India. We have service companies that tend to perform even better during recessions because people outsource more, people tend to hire outsourced IT vendors to do their jobs, and the theme of digitization and automation that really caught on after the Covid outbreak.
We’ve seen 10 years of IT advancement shrink into two years. Thus, much of the growth of the next few years has been tested by companies. Every business wants to automate their entire manufacturing chain, their supply chains, their customer chains. Thus, our IT companies will benefit where the slowdown comes into play, with a geopolitical risk that will cause certain sectors to be affected or not to have as much visibility.
Suppose European banks have looked at the contracts, but the exposure of European banks to Russian companies or within Russia itself will mean that a few of them will withhold new IT spending, but that’s not still a major hurdle. We’ve seen Accenture perform on every metric, from revenue growth to controlling margins to controlling costs. They delivered quite a substantial number and that was an advantage for Indian IT services companies as the business models are quite similar.
Accenture is higher up the value chain when it comes to consulting revenue. Our companies are still at the bottom of the value chain. So it’s even better that there isn’t so much competitive intensity. They will continue to win large orders. IT remains a purchase and must be kept for the long term. They are very well run, cash rich businesses with good margins. Even when they post low margins, we’re talking in terms of mid-twenties levels.