Focus on top 500 cos, stagger investment: Kothari

Rajesh Kothari, CIO, AlfAccurate Advisors, says: “There can be time and price corrections, but as a theme, when we look at the top 500-600 companies, that is basically the universe one should focus on and there are enough opportunities over a period of time. We are asking investors to stagger their investment in our Budding Beast, which is our mid and smallcap offering, rather than doing the lump sum. But otherwise, as a theme with a five-year view, this will continue to deliver reasonably good returns to the investors.”

Let us build upon this point which you have shared with us that India could turn out to be the breakout market for this decade and probably that is the reason you mostly have high capex stocks in your portfolio. If you could expand upon that argument.

Rajesh Kothari: It is actually very simple. If one wants to take a view on the market, there are four questions one should ask yourself. First, what is our growth? That is most important. So, if we look at the India growth, at least 6.5%. Of course, the recent number is pointing towards 7.5%. Even if you assume 6.5%, in an environment where the world is entering into a slow lane, Japan is struggling, China is struggling, entire Europe is struggling, the US is trying to do a little bit better, so the world is growing at three, we are growing at six-and-a-half, double the pace of growth of the world. If the world does a little better, we can further improve upon, so that is the first point.

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Second point is what is this growth coming from? Is it coming from higher credit or is it coming from an unleveraged balance sheet? The answer is corporate India has repaid more than Rs 2,50,000 crore despite Covid for two years. It means the growth is very healthy. It is driven primarily by the internal accruals. In fact, somebody said, FDI in India is not so strong, but if you look at the corporate India balance sheet, probably we do not need FDI. They do not need FDI because they are flushed with funds. So, the growth is driven by internal accruals.

Third is, what is the consistency of the growth? For the first time after 2002-2006, which was a golden period of the Indian economy and for the market, Sensex became five times in five years, for the first time the Nifty has delivered 15% plus double digit growth, not for one year, not for two years, not for three years but for the fourth consecutive year. This has never happened before.

And last but not least, what is the outlook on growth? If you keep growing at 6.5% it means nominal GDP growth is 12%, it means the organised sector can grow their revenue by 13-14%, it means some benefit of operating leverage, so profit growth can be 14% to 15% over a long term basis on a compounding basis, which is again one of the highest in the world. So, if the answer to these four questions are yes, then it is all about we are in a structurally bull market.

No doubt, corrections will be part of the market and therefore you keep looking at valuation, you keep looking at the pockets of opportunities and that is how you keep building the portfolio. But overall, we are in a structurally bull market and with 8% GDP growth number, if it sustains, then I will not be surprised that the returns can be much better than probably what India has seen in the last 10 years from the equity market perspective.

This point is well established now. What are your thoughts on the valuations of the capital goods space right now because they went to a bit of a sideways correction because after doing a very good run, depending on which stock we are talking about, the minimum was doubling, some of them quadrupled as well. Are the valuations back in the comfort zone? How does the investor tackle this issue that this is a very strong, broad-based theme, but sometimes stocks actually become expensive here?

Rajesh Kothari: The valuation is a function of growth. Look at the top 10 companies in capital goods space and look at their market cap from 2010 to 2019. I am not looking at March 20, which was a suppressed number due to COVID. For 10 years, the market cap growth has been zero percent for 10 years because the earnings growth was zero percent or negative.

From that zero percent earnings growth, now we are going towards 25% to 30% growth because it is in cycles and cycles produce very high growth or probably de-growth or flat growth. And look at the number of new drivers which are resulting in this growth. It is just not from building of roads or building of ports or building of railways, it is coming by the new growth drivers, be it a data centre, be it a smart grid, be it an automation, be it process efficiency, be it a new EMS opportunity, electronic manufacturing opportunity and further, it is supported by the PLI efforts of the government, Make in India efforts of the government.

On top of it, for the world supply chain, India is becoming important, be it Europe plus one or be it China plus one. So, in the entire thing, the confluence of factors are working in your favour. When the confluence of factors work in your favour, the growth becomes extraordinarily high compared to what it should be but that is how the cyclical stocks behave in terms of their cycles. Therefore, in the capital goods space, please do not look at the valuations at first go.

First, you need to look at the order intake growth because if the order intake growth is strong, the profit growth is after the next two years. So, valuation will always look artificially high or artificially low, that is not the right way to look at it. Valuation is all about the order intake growth. If you are bullish on India, if you believe the data centre capacity will become five times in next five years, if you believe that the huge PLI benefit will result in significant manufacturing growth, then the order book growth will be 18-20-25-30% for the next three-four-five years. If that is your thesis, then valuation will also reflect the same. It will remain at a higher level because growth is at a higher level.

I also see you are bullish on real estate now for some time. For the very premium luxury real estate, one is getting a sense that prices are hitting a ceiling, at least in the Mumbai region as there is oversupply here. What phase of the real estate cycle are we in and could it become a bit of a roadblock if supply actually comes in?

Rajesh Kothari: There are two important things. Typically, the real estate cycle is for 8-9 to 10 years. These cycles are for 8-10 years. These are not two-year, three-year cycles so that is number one. Number two, our approach within real estate space is to play through the real estate beneficials rather than play direct in a big way.

So, for example, be it a building material companies, be it a wire and cable companies or the related entities, it can be tiles, it can be plywood, it can be pipes, it can be paints, it can be wire and cable and so on and so forth and that is where we see the lag. Am I right? A typical real estate demand, when you look at the registrations, the same registration will come for the interior after fourth year and fifth year.

Probably now we are entering into a very good cycle for the building material over the next two to three years and we are watching that space and probably would have some exposure. We are already having good exposure in the last four years in this entire proxy real estate space and probably we would again add a few important names in this space over the next 6 to 12 months.

Also, areas of the market which you are still not comfortable in, like chemicals. I mean, I remember you have played this theme early on, then it went to a variety of issues, it went to a very big correction and everytime people are saying that perhaps the time is right to get in. Would you be cagey about it or would you start building somewhere at least thinking that two-three quarters far out pricing and dumping by Chinese, all of that may reverse?

Rajesh Kothari: As I always say, the exit strategy is as important as the entry strategy and thankfully, we exited at the right time in March 2023, almost we made it zero over a speciality chemical exposure. We are monitoring that space. There are a few interesting names within that where we are becoming a little bit more positive. We have not yet taken any exposure to that.

But the China story is still against us and whenever China does something, they do it on scale and when they do it on scale, it becomes a problem from the pricing perspective. So, I think it is still a wait and watch kind of a mode for us. We are watching it very closely. The valuations have not corrected while the growth has already corrected, that is another problem in speciality chemicals.

So, you are not getting companies at 15-20 PE. The good companies are still trading at 30 PE to 50 PE. However, the growth, unlike capital goods, where I say the growth is very high, here the growth has been significant and there is no visibility that it will continue to be so or not. So it is a very tricky situation right now in speciality chemicals. It is a very complex situation and again one needs to be in the speciality side of it rather than the commodity side of it and that is where basically in one or two stocks we are in the final stage from the evaluation perspective and once the valuation turns a little bit favourable, we will take some exposure to it.

Last week, be it the regulator commentary, be it generally, the big HNIs loading up way more than what they can handle the volatility of whatever reason, the midcap and smallcap part of the market went through a bit of a shake-up. What are your thoughts now?

Rajesh Kothari: You will be surprised to know that when you look at BSE mid and smallcap index, which is about 1,100 stocks, which is up roughly about 65% April to February, 25% to 30% of it is actually the largecaps within mid and smallcap index.

If you run attribution analysis, you will come to know what is actually moving and what is not moving. There are so many good mid and smallcap companies, actually they have not moved. This entire mid and smallcap index are driven by a few specific pockets. There are a few specific, be it large or be it mid, but they are part of mid and smallcap index whether we like it or not and that is what is basically driving it.

Clearly, I have been saying that SME is one segment where valuations are absurd and it definitely has to correct. The microcap as segment valuations are on the higher side compared to what it used to be. So, definitely corrections will come. When you say smallcap, there are 5,000 companies listed in India, so you do not know what we are talking about. But if you talk about top 500 companies, I do not think valuations are that unreasonably high considering the growth, the improvement in return on capital employed (ROCE) and considering the overall balance sheet health. the valuations are okay.

Of course, there are pockets where it is a little bit higher than the 10 year average and there are pockets where it is a fair valuation. What we are suggesting is that there is a possibility of time correction as well as price correction and both are very important for the healthy market behaviour. These are parts of life.

After 75% up, you should not expect next year to be again 75%. So, definitely it will moderate. There can be time and price corrections, but as a theme, when we look at the top 500-600 companies, that is basically the universe one should focus on and there are enough opportunities over a period of time. We are asking investors to stagger their investment in our Budding Beast, which is our mid and smallcap offering, rather than doing the lump sum. But otherwise, as a theme with a five-year view, this will continue to deliver reasonably good returns to the investors.

Roy Walsh

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