Industrial stocks: ETMarkets Smart Talk: Industrial stocks look expensive from 1-2 years’ perspective: Darshan Engineer

“Make-In-India, tariff rate tweaks, etc. all have been put in place to boost domestic manufacturing. All these policies are long-term in nature and aimed at boosting manufacturing growth on a sustainable basis,” says Darshan EngineerPortfolio Manager, Karma Capital.

In an interview with ETMarkets, Darshan has an overall buy-side research experience of 11 years, said: “Recovery in the power sector and other old economy sectors, too, is driving the demand for a lot of industrial goods” Edited excerpts:

After the US Fed rate hike. What is the trajectory you foresee for RBI and how will it impact markets?
The US Federal Reserve has had to embark on an aggressive rate hike and liquidity tightening cycle to bring inflation under control. There are several reasons behind the high inflation which include loose monetary and fiscal policies, supply chain disruptions on account of Covid-19, and geopolitics.

In contrast, India’s RBI and central government followed a conservative and calibrated approach while responding to Covid-induced economic disruption.

As a result, India did not have to face severe inflation. The RBI, too, hiked rates multiple times in CY22 to ensure inflation remains under control.

The Indian rupee should ideally appreciate/ depreciate against the USD at a rate equal to the difference in their respective inflation rates.

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So, if the USA and India both face high inflation, and if the US is going through a rate hike cycle, India also has to take similar rate hikes to protect the Indian rupee.

We have seen this in the recent past with the Turkish Lira as well, and more recently with the GBP and the Japanese Yen which haven’t taken the necessary rate hikes and fiscal policy measures.

The Indian rupee is no exception and RBI will have to ensure that there is a certain rate difference between its benchmark rates and US Fed rate in order to secure a smooth depreciation of the INR and stability in forex reserves.

The net outcome of all this is that the cost of capital in India is set to go up even further which will impact the valuation multiples of equities. Fortunately for us, the domestic economy continues to show strength in various areas.

The good monsoon season we witnessed ensured that the rural areas can hopefully pick up in the coming quarters. To that extent, equity markets will be able to overcome the higher cost of capital, albeit with slight volatility.

September turned out to be a volatile month for equities where 60,000 on Sensex acted as resistance while for Nifty50 18000 proved to be a big hurdle. How do you see markets moving in the festival month – October?
The past few months have been very volatile. May and June 2022 saw a sharp correction across various large equity markets including India. This was followed by a strong rebound in July and August 2022.

Hope emerged among market participants that inflation had peaked due to a fall in prices of various asset classes, especially the commodity basket, and the fact that the US Fed would subsequently slow down its rate hike cycle or even stop the hike cycle as early as Jan 2023.

However, inflation figures in early September and subsequent strong data points relating to employment dashed those hopes away resulting in a renewed bout of volatility and pulling the markets down since then.

Considering how markets have moved from extreme fear to extreme greed, within a matter of a few months, it is very difficult to predict what will happen in October.

October will mark the beginning of the earnings season globally and domestically.

Hence, Indian markets should see stock and sector-specific actions in Oct 2022, unless there is an abrupt global event that can be either positive or negative.

What are your expectations from India Inc. for the September quarter?
Indian companies, in contrast, have a

growth outlook, except possibly IT services where we are witnessing some slowdown.

Interestingly, Q2FY23 will be the first quarter in the last 3 years to see a completely normal restriction-free economy. At the same time, different parts of India also see regional or national festivals that give a short-term boost or increase the demand for various goods and services.

So, in India’s case, Q2FY23 should see moderate to good revenue growth. Depending on the sector, we should also see profit margin pressures abating gradually.

Thus, even earnings can see similar growth. Going midway into FY23, many corporates will also start to talk about FY24 outlook.

How are you viewing Gold in the festival season?
I have always considered gold as an asset class that should be a small part of the overall portfolio. Gold has not delivered any capital appreciation in recent years due to a variety of reasons.

In an ideal world, gold would have appreciated a lot, considering the high inflation we have seen in various parts of the world historically. The strong USD, too, has pulled down gold prices in recent months.

This is good for an Indian consumer who normally purchases gold for jewelery during the festive season. However, INR depreciation means that this correction in gold prices globally doesn’t translate to a similar price correction for the Indian gold buyer.

Cabinet approved Production Linked Incentive (PLI) Scheme on ‘National program on High-Efficiency Solar PV Modules’. The government is stepping up efforts to boost manufacturing. Do you see Industrials picking traction in the near future?
In the last 15-20 years, the import bill of India consistently went up. Interestingly, apart from crude oil and gold, electronic items, heavy engineering capital goods, and solar components have emerged as large import items in recent years.

It is not as if Indian companies don’t have the capabilities. It was the cheap cost of production coupled with relaxed import duty structures that led to a surge in imports of such items.

However, now the cost of production in other countries, too, has gone up due to higher costs of labour, power, and other charges.

At the same time, we have also tweaked our tariffs to make Indian domestic manufacturers more competitive.

As a part of that, PLI, Make-In-India, tariff rate tweaks, etc. all have been put in place to boost domestic manufacturing. All these policies are long-term in nature and aimed at boosting manufacturing growth on a sustainable basis.

At the same time, we are also seeing the demand for basic goods and commodities picking up again. The energy crisis in Europe has firmly put the spotlight back on the necessity of having a strong thermal and nuclear power supply.

Recovery in the power sector and other old economy sectors, too, is driving the demand for a lot of industrial goods.

That’s one reason why we have seen industrials do extremely well in the past year. Several of them have already increased multi-fold in the last year or so. Hence, the valuations look expensive from a 1–2-year perspective.

How do you see the hotel and travel industry sector doing? Do you see traction building up in this space? Any top stocks which are on your list?
Covid-19 since Mar 2020 and the subsequent waves coupled with vaccine mandates in several countries have restricted the free movement of people.

Humans are by nature, social and like to go out and enjoy different experiences. Hence, it is not possible to restrict them from outdoor activities for too long.

Thus, there was a huge pent-up demand for travel and outdoor entertainment, and once lockdown restrictions eased, we saw a strong rebound in hotels, airlines, leisure travel, and related ecosystems.

We have observed that most people have now assumed Covid-19 to be a part of their life permanently. We see this in the unrestricted movement of people within cities, within a country, and between countries in most cases.

Governments also have not re-imposed restrictions, despite the onset of new waves and variants. Vaccines and new mild variants have reduced the negative health impact of Covid-19 among infected people.

Even countries like Canada and Hong Kong which had strict restrictions relating to the movement of people, especially inbound tourists, have relaxed their rules significantly.

Even before Covid-19, for various reasons, these sectors have been through tough times. For example, the hotel industry was facing a situation of low room rents and low profitability due to excess supply.

Airline players were struggling with high-cost structures and a lack of adequate pricing power to cover them.

In the past 2 years, however, we have seen some consolidation in the various travel-related sectors. There has been a better pricing discipline and focus on profitability among the remaining players.

They have also rationalized their cost structures and Capex plans to ensure better cash flows.

Post Covid-19, all these factors have come together to create a positive long-term growth outlook for the entire travel, tourism, leisure, and outdoor entertainment sectors. Stocks from these sectors, too, have done quite well from their lows.

Valuations are no longer cheap, and one needs to be selective and have a long-term view on these sectors, to make money from here on.

Global headwinds are already emerging and travel is one of the first areas to see cuts in spending. As a policy, we cannot name individual companies but there are several organizations in the ecosystem across market cap categories that look interesting.

As interest rates are likely to rise – what should be the right portfolio mix for investors who are looking to remain invested for say 5 years?
Corporations and households eventually adjust themselves to work in a higher interest rate regime. A strong, long-term economic growth outlook should more than adequately cover up for higher rates.

With that in mind, despite the near-term volatility, India is well placed in terms of economic growth for the next 5 years, barring any adverse event risk.

With that in mind, despite higher interest rates, I would prefer to have a higher allocation to equities compared to fixed income in my overall asset allocation.

What is your take on the small & midcap space which has managed to buck the trend? What should be the ideal portfolio mix for small & midcap space?
The past few months have been interesting when it comes to the performance of small and mid-caps in India. Ideally, they correct much more than large caps during downturns.

But in recent years, such drawdowns have been sharp and quick. Such periods have generally led to companies with poor business models falling by the wayside while good quality companies tend to recover well from their lows and very quickly move to new highs over time.

There are quite a few reasons for the same.

Normally, many of these companies are serving the domestic market which has been relatively insulated from global challenges. In many cases, there are company and sector-specific reasons for a strong business outlook.

Finally, strong retail flows into Indian equity markets through direct and SIP routes are also leading to capital chasing many of these good-quality names.

In recent months, we have seen several small and mid-cap companies reaching new highs and trading at rich valuations.

Any stocks which are a play on the capex cycle for long-term investors who plan to hold the stocks for about 5 years?
In the past 15 years, there have been multiple instances where expectations relating to the Capex cycle pick-up increased, leading to a short-term, sharp movement in prices of various capital goods and industrial companies.

Mostly, the expectations didn’t translate to reality, eventually leading to price correction.

Hopefully, this time, multiple government initiatives coupled with a strong bottom-up demand for various goods and increased competitiveness of Indian companies should lead to a better and more sustainable growth outlook for companies in these sectors.

Again, as a policy, we cannot give individual names. However, in terms of sectors, we can look at companies in industrial consumables, equipment providers, component manufacturers, etc. many of whom are in the small and mid-cap space.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)


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