How is Union AMC analysing the commentary and the performance in some of the consumer facing companies? Is the higher raw material cost impact on margins going to last for a quarter or two?
One set of consumer companies are giving a lot of attention to margins. We think that margins generally are not a big issue for consumer companies purely because of their strong brands, this historical ability to pass on raw material inflation to consumers and adjust accordingly. According to us, a bigger matter of concern is the surprise on demand. It seems that the demand is a little bit weaker than what was expected earlier. On the rural side, we are seeing some weakness in demand in the consumer discretionary side. That, according to us, is a matter of bigger concern. We are less worried about the margin pressure which we think is transient.
Do you think the market is pricing in the fact that demand growth is softer than expected?
Overall markets are pricing in substantially higher levels of growth and substantially lower levels of cost of equity. That is why, the overall market levels are significantly at a premium to current values. The markets are clearly pricing in much lower levels of interest rates for a fairly long period of time. So either the interest rates have to remain low and growth rates have to adjust downwards or vice-versa. In either case the markets then have to reduce valuations.
Looking at the economic expansion, do you see similarities with the 2003-2008 period?
We think macroeconomic growth can be far superior than what we have seen in the last five years. If we go back even before the pandemic period, our growth was slowing down and a lot of fire fighting measures were being undertaken to increase the level of growth in the economy except Covid led to a fall in the economic momentum and we have seen a slowdown. But having said that, clearly there is a lot of pent-up demand and capital expenditures have been postponed for a fairly long period of time.
All of that is going to come back with a bang which will result in a far stronger macroeconomic outlook in the next five years. So yes we expect a reasonably good macro outlook over the next five-year period.
Which area or pocket of the market are you most convinced about right now in terms of risk reward, earnings trajectory and valuations?
We are far more convinced about the IT sector because the demand trajectory has clearly moved upwards and it is not for one or two years. It has improved on a sustainable basis for the next three- to five-year period and hence the overall level of growth is going to remain strong and the valuations are also going to remain reasonably elevated for this pack because of these reasons and we are very positive on this sector.
How are you playing Indian IT via the top four large ones where the underdog has come back very smartly or the big two which have always been competing for the top slot in performance? Or are you playing some of the midcap and the rising emerging companies there?
There is opportunity across the board. If there is an industry which is experiencing robust demand growth, there are a lot of players who can benefit from that and hence we are picking and choosing players which have those capabilities to capture the upcoming demand surge in the space. We are very well positioned in some of the spaces.
What is your take on credit growth and also within that, not via the banks but via the return of consumption among retail and so housing finance and NBFCs?
It is difficult to comment on whether the growth will purely be driven by consumption, but at least we are far more sanguine and positive on the return for corporate credit growth because we think that the capex cycle is about to turn. We expect a stronger economic outlook which has to be driven by an upswing in private sector capital expenditures which will spur demand for corporate credit. We are far more positive on the corporate credit cycle than the retail credit because retail credit is also driven by interest rates which may or may not remain favourable at the levels we are seeing today.
Suppose rate hikes start happening in the middle of next year, do you think there is a case for valuation compression overall for the market?
Yes. It is fairly apparent that earnings get discounted by cost of equity and it also is dependent on long-term growth. So either the cost of equity has to keep going down, growth remaining constant or the growth and valuations keep going up. According to us, interest rates have bottomed out and we cannot expect further fall in interest rates. Growth is already very strong in terms of the built in valuations. Interest rates are a big headwind and according to us, one of the biggest risks to the markets over the near to medium term.
What about the midcap end of the market? Are you playing any export themes like auto ancillary, textile, chemicals?
There are lots of opportunities in the midcap space but valuations have gone through the roof in a lot of these cases and we are seeing speculative activity being rampant in the small and midcap space. According to us, the number of landmines which are present in this space is far more than we have seen historically and hence we would advise all the investors to be very cautious in this space and approach it with extreme care.
