How should one approach commodities because that is where there is action, excitement and demand in the short term. Also, there is no large pushback from commodity consumers. Is there money to be made in , Vedanta, or SAIL?
So far as commodities are concerned, our view is that the current spot prices or the current spreads which a lot of these commodity companies are making, may be a bit difficult to sustain. These are exceptionally good times for a lot of these companies. Eventually you will see a bit of a pushback from the consumer industries and you may even see some government intervention at some point.
But broadly, we like the commodity space but it is again a little bit more stock specific. For example, our team does like Hindalco and Tata Steel. Hindalco has become more of a conversion business wherein 70% of their EBITDA comes from the conversion business and that reduces their dependency on commodity prices.
Tata Steel is a deleveraging story. It is generating a lot of free cash flow, bringing down debt and they have a captive iron ore mine in India. Those things help but broadly speaking, I would be careful of extrapolating the bull run we have seen in commodities in the last few months to say that this is going to be the trend for the next couple of years.
It is unclear whether this is the beginning of a structural bull run in commodity prices and therefore inflation going up etc. We still have to see whether the Western world will be able to grow as strongly as it likely will this year going into next year.
Just a thought on autos and auto despatch numbers would be due in the next two, three days. How would you approach two-wheelers considering these are plateauing and CVs are picking up?
The big picture to keep in mind is that the penetration level for two-wheelers in India is relatively high whereas the CV cycle lasts for four, five years. We have had a pretty bad situation as far as the CV cycle is concerned and it is only now that the CV cycle is beginning to come out. We do think that in the next couple of years, we will see very strong demand for CVs both from a replacement perspective as well as from a new vehicle perspective.
As far as two-wheelers are concerned, at the current valuations we prefer more of the export-oriented two-wheelers, something like a Bajaj Auto rather than a Hero, purely from a valuation perspective and from a longer term growth perspective. CVs is our preferred bet, the way we would play autos is mainly through CVs and not so much the two -wheelers.
Are you venturing into the broader markets in a more meaningful way? Would you see room for growth in some of the pockets there?
Absolutely. The economy is coming off a depressed in last six to 12 months. Given that we expect a fairly strong economic rebound continuing in FY23 and FY24 as well, we will be much stronger than what people are expecting right now. There could be upside surprises from the government policy action. Right now, there is a lot of scepticism on stuff like privatisation or even interest rates. Real estate is one of the big drivers and there is obviously the sharp decline in interest rates and that is the number one worry in a lot of peoples’ minds. But a 25-50 bps increase in local interest rates can easily get absorbed.
Every real estate company we are speaking to is seeing very strong demand. There is a lot of pent up demand plus the decline in interest rates has made affordability a lot easier as well. We have not seen new additions to inventory and new supply coming in so the demand supply equation has gotten much better.
Housing finance companies are another way to play the real estate sector. We like parts of the real estate sectors.
In case of chemicals, in the short term, there may be some concerns given the increase in raw material prices. Margins have probably peaked out in the short term but the structural story remains intact. A lot of the European customers in particular and some of the US customers are looking for a China plus strategy. India stands out as one of the attractive alternate sources of supply. A lot of chemical companies are very confident about their outlook for the next couple of years. So this is another segment we like.
But overall, as far as some of the smaller sectors are concerned, when there is a more broad-based revival in the economy, they tend to do well but I would keep an eye on valuations. I would be careful of getting into companies where governance or balance sheet issues exist.
