Which investment theme to last for 5-7 years?

Ravi Dharamshi, Founder & CIO, ValueQuest Investment, says “financials, manufacturing, energy transition, digitalisation are still very much intact. The problem is the markets have already recognised them. All these stocks have rallied. So, getting a combination of a theme that is relatively unnoticed in the market or is very attractively priced is the challenge that we are facing right now. There are still a couple of themes where valuations are attractive and the theme also seems to be playing out over the next five-eight years. I do not expect the stocks to get cheaper over here.”

How would you assess the market right now? FY24 has been a year of grand returns. Are gains likely to extend themselves? Gains may be lower but are we in for another positive year?

Ravi Dharamshi: It will be a tale of two halves. First half is likely to be positive and we are clearly awaiting two big events – one is election and the other is interest rate and in two different geographies. In India rate cut as well as election results are most likely to be positive for the market. But in the US, that is where the joker in the pack lies. Interest rate cut might still go ahead as planned, but the election might throw up a surprise and that can lead to some kind of volatility in the market. So, that is what we are looking at. Currently, the positive momentum continues, but in the second half, we can see some volatility.

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Why do you think the second half will see volatility? Is it because of US elections?

Ravi Dharamshi: Yes, US election is the key over here and once all these events markets have been factored in, then we will probably be back to looking at the earnings and that can throw up some negative surprises because not everything is firing in full cylinder as one would expect.

Everything is not firing on full cylinders. What exactly are you referring to?

Ravi Dharamshi: Clearly, the rural consumer is not yet doing very well. Discretionary consumption at the bottom of the pyramid is not doing very well. Exports are not that strong. So, those are the areas of concern from the larger macro point of view. However, that is where the opportunity also lies. Markets have recognised the problem areas and that is why these stocks have not been performing since the last two years or so.

That is where the opportunity lies if there was to be a revival. But there is this entire rotation in the market. The recovery is totally investment led and that too government capex led. Handing over the baton from the government led capex to private led capex will happen this year. Also, maybe at the market level, a change of guard will happen from investment led theme to consumption led theme towards the end of the year.

While we spoke of US elections and global interest rates, we have got a local election which everybody is saying is almost like a no event right now. But after that we have a budget. Do you think that rather than elections, we should focus on the budget and there could be an element of volatility coming because of that?

Ravi Dharamshi: No, I think just as much as election is a non-event, the Budget is pretty much a non-event as well. It has been pretty well laid out what are the priority areas for this government, how is this government going to approach? They are trying to push the envelope on the investment side but incrementally from this point on, their ability to push more investments is limited. So, they need the private sector to fill in the gap over there. I do not think even a budget can throw up any kind of a surprise which none of us has ever thought about.

There was a deep and a very shaky selloff in mid and smallcap stocks in March. Do you think the froth in the mid and the smallcap space is over and markets have now adjusted?

Ravi Dharamshi: First of all, froth is a strong word, but if we were to say that word, it is more in the SME space than in the mid and smallcap space. The degree of euphoria or bullishness varies from space to space. So, SME has the maximum kind of froth over there, which has kind of corrected itself due to the regulatory nudge and I think it was more definitely required. But mid and smallcap, you can say are probably a standard deviation above its long-term average, which makes it on the expensive side, but I would not call it a euphoria or bubble; that is a too harsh a term in my opinion.

On the other hand, the largecap space is definitely looking attractive. So, we have the entire gamut, entire spectrum available in the market. I would not be worried about a small spot in the market being a little frothy because that would be like tail wagging the dog.

A lot of market experts are maintaining that PSUs were the leaders and PSUs will be the leaders and one should buy all PSUs on dips. How have you approached the PSU stocks?

Ravi Dharamshi: Our approach has been very clear. First of all, PSU is a basket that is defined by the market. We do not look at government owned companies as a separate basket. What we look for is themes that cut across all sectors. What has been exciting for us is energy transition as a theme, financials and revival in the economy themes.

Now, if there are players within the PSU sector that have the right to win that space, that is what excites us. So, for example, defence is one thing that we were bullish on for the last three years. There is only PSU defence that exists as a sector. Private sector is virtually non-existent. So, in that kind of a case, we would buy PSU defence companies.

But if you tell me about banking, larger banking companies, then I do not believe that any of the PSU banks have a right to win over there. They are more a beneficiary of a cycle and the valuation arbitrage that existed between the PSU and private banks. I think that valuation arbitrage has played out. Now, incrementally only a company or a bank that has managed to set itself apart from the rest of the pack, will thrive, Men and the boys will be separated.

So, are the themes centered around financials, manufacturing, energy transition, digitalisation still intact?

Ravi Dharamshi: Very much intact. The problem is that those themes are still very strong, but the markets have also recognised them. I cannot say there is anything that is totally unrecognised in the market. All these stocks have rallied. So, getting a combination of a theme that is relatively unnoticed in the market or is very attractively priced is the challenge that we are facing right now.

But having said that, there are still a couple of themes where valuations are attractive and the theme also seems to be playing out over the next five-eight years. The probability is getting stronger. So, I do not expect the stocks to get cheaper over here.

Let us look at electronic manufacturing and I am looking at public information. It is not a recommendation. Let us say you have invested in companies like Kaynes. This is a pure play on EMS. But the run-up in some of the EMS stocks, which are especially in manufacturing, has been extraordinary. Do you think this theme will continue? Gold is now trading at the price of diamond when it comes to EMS manufacturing?

Ravi Dharamshi: I do not disagree with that. I think the valuations are stretched, but the valuations are stretched in the context of current earnings. Now, if it is a larger decadal trend that we are thinking it is, then you have to take your call. Are you going to let yourself be bothered by the fact that there could be one year of underperformance or some even negative performance or are you going to look at the five-year, seven-year picture and say these stocks can grow even further from here and we should be in the riding wave rather than trying to be cheeky about the correction.

I will give you an analogy. In the late 90s, the IT sector was growing at a 150% growth rate. Obviously, those kinds of growth rate cannot sustain for a long period of time and that culminated into the dot-com bubble. I do not think we have reached that kind of a phase where we can say it is a bubble. They are expensive because they are growing very fast; the scale of these companies will change dramatically over the next five-seven years.

If that is the case and if that scale change is combined with growth and profitability, then the companies can get even more expensive value from here. So, to cut the long story short, the larger trend can be a year of underperformance, we are still very bullish on the larger trend.

But during a time of local elections, global elections, macro events, the themes which we have identified – financial, energy transition, manufacturing –. Are you happy to own and bet on these themes for at least three to five years?

Ravi Dharamshi: No, I think the probability of these themes panning out has gotten even stronger and stronger. So, let us take one theme that we are talking about, which is the capex cycle that was kickstarted by the central government capex. This will be the year when the proportion of private companies contributing to the capex cycle will increase and that can be seen in the sales order book of the listed companies. Actually, the order book is already there. It is only about execution going forward. So, the private capex cycle is going to pan out this year.

Second, energy transition as a theme. Again, within that also, there are many buckets. Power transmission remains one theme where the probability of that keeps getting stronger and stronger because unless we put our power transmission capex in place, the energy transition entire theme will fail. So, we need to put money as of yesterday in power transmission and I am talking for the entire world. India, the US, Europe, China, every continent needs to put up power transmission lines so that the renewables can be smartly connected to the grid.

When you say power transmission, you are looking at companies which are second derivative beneficiaries. Transmission, power, meters, companies which essentially aid the distribution of power?

Ravi Dharamshi: So, see, the way we go about selecting our subsectors is where the delta is going to be maximum and where the profit pool is going to be distributed amongst fewer companies, where the competition is not very high. There could be financers also, like we have seen some of the power financers are doing fantastically well.

However, we want maximum delta combined with the ability of a few companies to capture that opportunity. Some of the power transmission companies, equipment companies are very well positioned. There is very less competition over here and overnight there cannot be new players entering this sector, so that is what is exciting us at this point.

William Murphy

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