Are the markets in good shape and will we continue to increase with the global markets? Or is there a case for a consolidation or a break here?
I prefer a consolidation or a break. The market has its own mind. You have to be a little careful about how valuations stack up. The economy will emerge from the last year and a half of downturn. We will have a year of commercial decline and this will make a significant contribution to profitability. I don’t think 2022 or 2023 will be indicative years of how things will go. You have to be a little vigilant. The long run is okay when it comes to how businesses stack up. The narrative for virtually every Indian business is reasonably strong and so on the business side of it, all is well. I was worried about valuations and their ranking. Bubbles are created in the market and you will have to navigate them. It could be 2022.
When it comes to ratings, the street is quite divided. Metals are still far from their long-term averages. Is this a space where you worry about valuations and whether the super cycle is going to continue or not?
It is contrary to that. There is a lot of talk in the world about the digitalization of the economy. Part of the market is completely stretched on the commodity side. If you’re worried about what’s going on in the specialty chemicals industry and obviously the IPO market which to a very large extent has gone beyond logic. There are spaces that pass. When it comes to hard commodities and capital goods, cash flow is very real. These actually strengthen the balance sheets.
At the other extreme, when it comes to IPOs or some of the specialty chemical companies, I will be very careful because you cannot buy shares for such high prices and I hope someone does. The other end will buy the same stocks given the sky-high valuations. This is not how it ends.
Where to watch when bubbles are being created? Where to find value and where to invest for the next two years?
Just look at the spaces that did nothing. Look at the most unpopular parts of the market, the companies and businesses that generate cash flow and invest money in it. You made a point on the metals space and some of the companies are generating cash flow equivalent to the entire FMCG industry.
I really think the profit cycle has started, but this is a very different subset of businesses. So to take one of the big steel companies you know and look at the 2022 numbers that some of those companies will report, that’s bigger than the profitability of the entire FMCG industry. This is the strength of this business and everything else is trivial. You don’t need that cash flow to be there. A year or two, clean up the track record of all the mistakes you’ve made in the past ten or two years. So, this is where I would look at it.
The second thing that comes to mind is that the real estate market in India has stood still for the past two decades and the industry has consolidated quite significantly. Going back to 2007, some companies have returned to IPO prices, not to mention historic highs. But over the past decade, they’ve improved on every measure they’ve worked with over the past 12-13 years. If we tackle specifics that are not very popular, the probability of coming out in 2022, 2023, 2024, even if the market corrects itself and the probability is very high, we can expect quite interesting returns on wallet.
What about finances? While there has been a natural shift to more established names in the private sector, the PSUs are also fighting back. What trend do you see playing in finances in the future?
Our feeling is that the corporate cycle is going to revive the market and when I say market it is actually capital markets and corporate profitability with a decline. The profitability of companies will withdraw from the very traditional activities of manufacturing, capital goods, export-oriented activities. Unlike the past decade, when it was households that got into debt, it will be the return of business lenders. But there are too few on the market.
When we talk about finance or lenders, those with B2B books are likely to withstand the cycle much better than a consumer-oriented business and that would be our preference on the financial side and the lending side of the curve. There are also opportunities in the financial sector, with non-lending activities at all levels, but their price is high.
Brokerage firms, insurance firms, and asset management firms don’t come cheap. If there is to be a preference on the lending side, then it’s the corporate lenders and you choose how you want to deal with the expansionary side of the other financial companies that are missing.
Speaking of businesses that aren’t cheap, consumer-oriented businesses also fall into the same category. Do you lean towards export-oriented companies within that space and maintain a cautious stance towards consumer-oriented companies on the national side?
After our arrival in 2021 and maybe 2022, there would be pockets of opportunity in minor markets and that could be largely city centric. Per capita incomes are still rising and in some markets they are increasing more than average inflation. After a long period of time, we see the urban markets rebounding like this. Urban consumption pockets could be a pretty robust way to play the consumption cycle, but I wouldn’t say it’s going to be a broad structure that will unfold. This will be where wage inflation is higher than nominal inflation. In the end, it will be a business of two. It cannot be a very generalized trend that we have seen happening over the past decade.
What would you like in the auto and auto accessories area?
When it comes to the markets, the narrative we use going into 2023 or the start of the next decade is that the market has consolidated quite significantly on the national side. Maybe for one or two participants there will be a significant market share and that’s basically because they have the track records and the reach of the distribution.
The market doesn’t have pricing power yet and I don’t think it will come back very soon. The ability to pass the price increase on to the end consumer is not there, which means we have to start by focusing on who would be the volume supplier and this is where we think about auto accessories.
There are many who have consolidated the markets, not only nationally but also internationally and this could be a good trend to manifest over the next couple of years. They have scale, they have reasonable capacity, and they can fuel the draining supply chain. The Chinese have largely withdrawn from the international space and this part of the market looks interesting. But again, this is not going to be generalized and you have to be very selective.