is one of the top holdings in your portfolio. What are your thoughts on the global auto space right now as markets are reopening gradually?
The advanced economies are significantly ahead of India in terms of vaccination time, schedule and scale. Economies are opening up across the US and Europe and we are seeing a strong resurgence in demand across all consumer segments including passenger cars because customers want to travel more safely and there is a huge pent up demand in the ecosystem.
So global automobile demand is seeing a huge resurgence though it is being impacted in the short term because of global shortages. I think the demand is very strong and Tata Motors, with JLR as a subsidiary, is also benefiting from that. On top of that, JLR itself has undergone significant restructuring over the last couple of years and has become much bigger and more cost efficient. We think JLR will do exceedingly well over the next two to three years and on top of that, their domestic business will also see a strong resurgence in demand as Indian economy opens up over the latter half of this year. So net-net, Tata Motors on a consolidated level, will have to have very strong numbers over the next two to three years.
You have a reasonable exposure in both corporate and retail focussed banks. Do you think leveraging will come back because big corporate banks have shown an inclination to deleverage in the last couple of quarters?
We like the top four or five banks in India because corporate India has gone through a cycle of deleveraging but as economies open up, we will start revival in India’s investment cycle. We have already started seeing some announcements across some corporates in the commodity sector, especially in steel, where some of the companies have started making announcements for investment plans.
Likewise, public investment or the government expenditure on capital expenditure continues to remain strong on the infrastructure side. We expect investments in corporate borrowings to revive towards the second half of this year as the economy opens up. So should be the case with retail. The top four or five banks in India have raised capital in the early part of this crisis and they have a very strong franchise and distribution across India. On top of that, the asset quality has been good despite going through a crisis. We expect 20% plus earnings growth over next two to three years and from a valuation perspective also they look very attractive.
How are you approaching the broader markets? Almost 22-23% of your portfolio is composed of mid and smallcaps. What kind of themes and pockets of interest do you have in your broader market portfolios?
As economies open up and bull market matures, midcaps and smallcaps continue to do well. But as investors we are trying to have a slightly more quality bias and we are selective and investing into these companies. We are really excited about consumer discretionary spending in the retail sector because we think it has been a year where consumers have not stepped out of their homes and have not gone out for shopping or for entertainment. So companies which will benefit as the economy normalises will be those with pent-up demand. As things open up, these sectors will be significant beneficiaries and these are some of the sectors that we are really betting on on the midcap side.
What are your thoughts on the earning cycle? This was a third straight quarter of good earnings though the commentary was a little circumspect depending on what sector they are representing.
We are very constructive on the outlook for earnings from this year’s perspective and more importantly from a slightly more medium term perspective. In the last 10 years, there was a sort of loss declared from earnings growth perspective for corporate India because in the last 10 years between 2010 and 2020, Nifty earnings grew at about 7.5% CAGR which effectively means it took 10 years to double Nifty earnings. On a broader macro level, the doubling of Nifty earnings can now be achieved in the next five years from 2020 to 2025 which effectively means we will probably have a 15% to 16% in earnings CAGR over the next five years. A lot of these earnings could be front loaded because 2021 will be a very high growth year because of the low base of last year.
So from an immediate current year perspective as well as from a slightly more medium term perspective, over the next five years we remain very constructive on outlook for earnings and we think after a very long time we are seeing strong earnings coming back for corporate India and that bodes very well for outlook for equity markets as well.
Which is the area which you are completely steering clear of where you do not like the valuations or the earning potential in the next two, three years?
India is a very diversified economy. When we have a broad-based economic revival, most of the sectors tend to participate and benefit out of the growth in the economy. Having said that, there are pockets of markets where valuations are extremely rich and one of those sectors is consumer staples where valuations are extremely rich and in the near term, these companies have headwinds in terms of their ability to absorb significant rise in raw material and commodity costs and how much they will be able to pass on to the consumers.
Earnings could remain moderate for consumer staple companies because it will take some time for them to pass on the rise in commodity costs to the consumers and until those costs pass through, their P&L and their earnings growth will remain moderate. That is one sector where we see earnings headwind and valuations are extremely rich.
What are your thoughts on bigger city developers like , Oberois of the world and also tier-2, tier-3 ones?
We have seen a strong resurgence in demand in the real estate market for the last five months. Until March, every month, Mumbai recorded highest-ever sales in the last 10 years and that has been partly aided by some pricing discount which the developers offered to the consumers. On top of that, there has been a stamp duty reduction by the government and interest rates have been the lowest they have ever been on housing loans.
A combination of all these factors has triggered a very strong demand from consumers to buy their own houses. So far we do not own any property developers at this point of time but we are playing the sector more through ancillary routes by investing into consumer durables and building materials which are a proxy play on real estate development. As construction happens, these companies tend to benefit by a rising demand for their products from the construction companies.
We find it slightly difficult to deal with property developers because the way the accounting standards are designed for these companies and the way they prepare their statement of accounts, P&L has lost relevance for these companies for an investor to make a judgement. One has to rely on cash flows as a metric for evaluations and valuation of these companies. We find them slightly more opaque from a financial disclosure perspective and that is why we are playing it more through ancillary sectors rather than property developers directly.
Is there any area which represents tier II, tier III rural which temporarily or transition-wise may get impacted but is a good theme to bet on and load up on if the market punishes them temporarily?
This time around, the distribution of the virus has been really in the tier II and tier III towns and we are seeing a far more intensity of the virus in terms of its spread in the rural areas and that is impacting lives and livelihoods there. In the short term, this will have an impact on the economic activity there. There are significant amounts of rural plays in the Indian ecosystem. India will have the third back-to-back good monsoon this year. I do not think we have had in the last 10 years. A good monsoon will do a lot of good for the rural economy in India.
A lot of companies across the agri value chain — be it across fertilisers or the agri input space will be a beneficiary of that. Likewise, companies including the tractor space should be beneficiary of that and eventually at the end of the day, 50% of India lives in rural areas. So if the agri season is good, that will effectively translate into strong consumer demand for a lot of other consumer industries. So, consumer sector, especially consumer discretionaries should do well.
You not only look at individual stocks, but watch macros very well. Are you looking at any ignored space?
Globally, there are lots of concerns about the spike in inflation. Whether this rise in inflation is transitory as the global central banks are saying or is it more structural in nature and how soon and how fast will the global central banks respond to that are important because that will have implications across all asset classes in the world.
More importantly, we have seen a very sharp spike or resurgence in commodity prices. Whether this is purely because of demand or because there have been some supply side bottlenecks as well over the last 12 months because supply chains have not been fully operationalised and stabilised. So what part of it is due to supply chain dislocation and what part of it is due to demand resurgence is something which we need to figure out. We also have to see whether we will see a pullback in commodity prices in the second half of the year as is the consensus expectation.
We believe that commodity prices will moderate. The last 10 years have been very bad for commodities as a basket where commodity prices were extremely depressed. In the next 10 years, commodity prices will remain much higher than what they have been in the last 10 years and while commodity as a sector has done well in the last six months from a stock market perspective, we still think that globally the sector is grossly underinvested. As this cycle plays out, we expect strong outperformance from commodities. A significant amount of money will move into commodity-oriented sectors and companies within those sectors.
