“I need to see cash and cash flows — ability to fund growth. Competitiveness comes from balance sheet strength. So even if the P&L is weak, but balance sheet is strong, I will be positive because balance sheet repair is not where the company’s attention will go to and it will get back market share, margins, earnings, sooner than later“, says Ganeshram Jayaraman, MD and Head, Avendus Spark Institutional Equities.
Here are excerpts from a freewheeling chat at his office in Chennai last week :
With more and more funds chasing Indian markets, is the investible universe in India getting smaller and are the valuations moving up sharply?
The investment universe in India is actually very large when you look at countries like Brazil, South Africa, Russia, Indonesia. Brazil is mostly commodity-focused, Russia is big on gas players and Indonesia, coal.
India is like the US. The investable sectors are about 12 to 15. And that makes our earnings profile very stable. If you look at the last 25 years and take the five worst years for emerging markets, there is not a single year where India’s earnings have declined significantly. And this comes from political stability and economic stability as well. No emerging market has had all the three — political, economic and earnings stability — together. And so, there is a premium you pay for stability.
While we don’t have to be worried that there could be a big crash, we will always be costly unless these three factors break. In 25 years, it hasn’t been broken. The closest we came to was not in ‘99 or 2008, but in 2013 where, in a period of 1-2 years, rupee depreciated sharply, the infra theme/capex died, growth slowed and then repairing that took five years at least.
After the sharp run-up since the Covid lows, what is your outlook for the Indian equity market from hereon?
Today, when I look at markets, I’m very positive if I take a ‘rest of decade’ view on India, though I am cautious with the near-term outlook.
Firstly, India has political, economic and earnings stability as discussed. Secondly, the baton of the world’s fastest-growing large economy will get passed on from China to India. Next is the asset quality clean-up and the benefits of consolidation that has happened across sectors over the last few years. The consolidation happened because we took the tough decisions, like GST, RERA, IBC, corporate tax cuts, etc.
What consolidation did was, when India and the world saw inflation in 2021/2022, companies could take price hikes. Companies could see margin growth led by volume growth. And last calendar year, when the raw material prices eased up, it showed up in margins expanding and earnings growing even though top-line growth was weak. This is helping the next phase of capex cycle. Over the next five years, I am most positive on manufacturing and capex. The last time I saw corporate balance sheets as healthy was in 2003, when I was a credit analyst, two years into my career. It is also coming because of factors like PLI, import substitution, China plus one, as well as consolidation.
One more thing which you can’t ignore is the fact that India is possibly one of the very few countries in the world where there will soon be 100 million people with $10,000 per capita income. Now for the 1.4 billion, per capita is low, but if you slice it up, each bucket is bigger than some of the countries themselves. $10,000 dollar is where the premiumisation opportunity starts picking up. At $5,000, the focus is on food, clothing, shelter, essentials and then come healthcare, travel, entertainment, education, or durables. So, discretionary consumption starts after $5,000.
Why are you cautious in the near term?
The caution is coming after four years of good run following Covid. For a stock to do well, there are multiple variables. Will volume growth pick up? In volume itself – will it be because of market share gains or because industry is growing? Then you’ll ask whether the company can take price hikes, whether the product mix will improve. Can raw material prices be a tailwind? Is there operating leverage, financial leverage benefit? Is there anything left undiscovered, like a hidden patent or excess provisioning? Then, the stocks can re-rate.
Actually in the last 4 years, you had all these variables doing well. From here on, you need strong macros to carry it forward. I am not confident that we can extrapolate last 3-4 years into the next one or two years. One, personal loans which banks were growing at over 20 per cent in last 3-4 years could grow lower as banks themselves find this a little worrisome. So, the second/third order impact of this will be on consumption. Two, government’s capex growth could slow down. Even though there is a double-digit tax growth, government capex growth will be 5-6 per cent from here, in our assessment, to meet fiscal deficit targets. This all assumes that we don’t face spike in oil prices or see gas price doubling, resulting in high fertilizer subsidies like it did because of the Ukraine war. Then there is export slowdown due to weak global demand.
Besides, liquidity in the system is already negative. I think deposit growth in the current year will be a lot less, which means credit growth will be less. And macro-led volume growth needs credit growth. This may, however, be mitigated if India gets flows from the bond index inclusion. Otherwise, if macro tailwinds are not as much as you had in the last few years, then your earnings growth can see downgrades which is where I’m telling investors, step back a bit. If you are on a turning track, you can’t play like T-20 cricket. You need to wait for the loose ball.
What we are telling institutional investors is, in a portfolio construct, go back to quality stocks, build some cash. And in cyclicals, go for companies in two buckets — One bucket is where there is earnings growth, which I told you is in the private capex. Otherwise, there are some companies that will gain market share because in certain sectors, somebody else is losing. So, if you have enough market share gains to offset industry growth being weaker, you will still have healthy earnings.
Since you have a lot of foreign investors among your clientele, what is their view on India?
2008 was a dream opportunity to invest in India and after that, 2013 was one of the best opportunities. But I remember meetings in 2013 where if I told foreign investors I was there to discuss India, the meeting would end in ten minutes. Today, we know that investors in quite a few countries in Asia, who were earlier investing in China because their local economies were not in great shape, are now turning to India. The investor interest in India today is unbelievable.
When Indian markets were attractive, the interest was bad but now when it is not as attractive or cheap relatively, (although the long-term story is good), investors are flocking together. If you have been in the market for many years, you will have IQ, no doubt. But what will make investors survive here is EQ rather than IQ — whether you are willing to say ‘yes’ when not everything is in favour.
What would you call as your key market learning over the years?
One thing I’ve learnt is that every year, markets give opportunities once a year. There will be at least a 5-7 per cent correction. Once in 7-10 years, markets will give crazy opportunities, which came during Covid, in 2013, in 2008 and in 2002. Since we can’t wait for this alone, we have to capitalise on the small corrections. More importantly, every year, there are one or two sectors where there is misunderstanding-led or confusion-led opportunity. For example, in 2023, insurance stocks were attractive; In 2022, auto stocks were attractive due to semiconductor shortage, fear of EV takeover in 2-wheelers; In 2021, capex stocks were at 10-year lows; In 2019, pharma was a great opportunity and so on.
Micro-caps and small-caps are alluring, because you can pick it early, watch it grow, make 50x or so. However, probability of success could be 5 out of 100. You will have to have a VC-type mindset. But if you look to make use of opportunities every time they present themselves, large and mid-cap investing is also very rewarding.
What is your approach to high-valuation stocks, or when do you sell a stock?
Selling is a decision you make on management quality, balance sheet quality, earnings potential. Is it top-of-the-cycle margins? Is it top-of-the-cycle leverage? Has the end-consumer leveraged to buy your product? Is your earnings character unsustainably high? These are some of the questions I will ask. I will not get out because it is just high PE. It is the sustainability of the ‘E’ that matters.
Sometimes, reported accounting earnings can be misleading. You will have heavy R&D spend. Accounting rules may say expense it off and so your earnings can be hit. But, I will say that this benefit of this R&D spend will play out as revenues over the next four years, so don’t look at accounting earnings.
Some FMCG companies, for example, can have huge A&P spends as they build the brand. When they are investing for tomorrow’s earnings, we need to defer that cost and then see what the true earnings picture is. Overly provisioned P&L of banks is another example.
Sometimes, working capital cycles can keep going up, but the P&L can look good and hence, the valuation. So the most important aspect of stock picking is in finding the true colour of the earnings profile, okay, and then say the stock is not as cheap or not as expensive as it appears.