January 9, 2024 | Posted in News
Venugopal Garre says: “The current play on PSU infrastructure is good. It is good for the next maybe 12 months but you will have to start looking at more proactively potential opportunities in the private sector and whether these PSUs can actually tap that or not. Quite a few of them cannot. So this is a transition phase for them because a mix of capex will change over time.”Venugopal Garre, MD, Bernstein, says, “the return expectations have to be a bit more modest this year from equities and unless we see any further sudden surprises coming in later in the year. That is how we’re starting the year with an 8% Nifty return expectation for this year. We are essentially saying that book profits right now wherever you can because it could be a range-bound in a volatile market especially in the sort of a near term. Not really changing a three-year or a long-term outlook where we are still extremely bullish on India from a long-term perspective.”
We have had a good 2023. How much of the 2023 good market, good momentum will spill over to 2024 as well? Are we in for another year of positive returns?
Venugopal Garre: Yes, last year was exceptional but I think at the beginning of last year, there was a lot of uncertainty. I do not think this call for last year was something which was conceived at the beginning of last year. In fact, we ourselves upgraded India only at the fag end of March and early April to a buy. Now the reality is that given the fact that we are sitting with a lot of gains last year and more importantly, as I see a lot of the base support especially for the economy to a large extent is behind.
Earnings revisions are pretty good in the last six months of the calendar year and has also led to a situation where EPS revision momentum is more or less moderate now. We are more or less looking at a peaking of EPS momentum even though EPS growth is still very decent. So putting this into picture and the fact that a lot of the surprise positives in terms of a rate cut possibility this year, which was not thought of in the first half of last year, as well as a much better political stability outcome, which again was something which was iffy in the beginning of last year, got digested in the market, especially in the November-December rally.
The return expectations have to be a bit more modest this year from equities and unless we see any further sudden surprises coming in later in the year. That is how we’re starting the year with an 8% Nifty return expectation for this year. We are essentially saying that book profits right now wherever you can because it could be a range-bound in a volatile market especially in the sort of a near term. Not really changing a three-year or a long-term outlook where we are still extremely bullish on India from a long-term perspective.
Given that the valuations are not cheap in the market right now, are there any bottom-up ideas and should one be scouting for new ideas?
Venugopal Garre: Historically, when it comes to individual stock picks, we tended to avoid taking valuation calls. Fundamentally we have always looked at the construct of earnings growth, sustenance, momentum of earnings, the secularity of business and management.
By the way, this year is going to be a bottom-up year to a large extent where you have to be very careful about stock picks. A lot of these largecaps look fairly okay from a growth sense as well and perhaps may not necessarily have rallied as hard last year for a host of factors, given that we have a lot of alternate options as well. So if you look at the India portfolio that we have assembled, everything is a largecap at this juncture. So I will just mention a few because this is a published report.
The financial sector looks fairly attractive. So HDFC and Axis are there in the portfolio. Infosys and IT are the only representation at this juncture because it has been an underperformer in laggard as well, Cipla in healthcare, which is an overweight sector for us. Reliance has been a pretty big laggard last year. So that is another one.
We upgraded telecom to overweight and so Bharti Airtel is another large cap. NTPC has rallied hard but still eking out some return possibility this year because the sector looks okay. L&T is another one where despite having run up and being rich on valuations we are still sort of keeping it from a growth and a cycle sense. So these are the broad stocks to a large extent. Even Adani Ports something we added in the Adani stock for the first time in the India portfolio. These are the stocks which from a largecap sense, looks fairly okay from a growth perspective.
Let’s touch upon one of the long-term compounding themes and with a spotlight on digitization, given that we have seen so much progress taking place and so much more to come. How are you looking to play this theme because it seems to be very divided when it comes to the view of AI on IT as that could be more of a bane than a boon for traditional IT players?
Venugopal Garre: That is right. Digitization is a pretty large underlying theme. The ways to play it are going to be spread across. I have always mentioned that digitization is something which could be an existing corporate primarily you know sort of digitizing. They also get benefits out of it. It could be using digital channels to sell products or it could be primarily about their own entire data architecture, things they are trying to make themselves more efficient by digitizing internally.
So there are a host of ways of doing it or you primarily play individual companies which are direct consumer tech plays which are representations of digitization that could be in the financial sector, which could be in the retail sector. There are a host of ways to play it. Now at this juncture, I would probably say it is very early because a lot of things are developing. A lot of new companies will list probably you will have much better direct and larger options to play digitization.
Consumer tech as a space is something that we like over the long term. Look, we downgraded it heading into this year. This is something we discussed in our previous interaction as well as in November. I am thinking about shifting to IT services within tech. So we have actually done that. We are more or less neutral consumer tech at this juncture. But that is not a bad way to play long term.
The only area within consumer tech which is a bit scary for me and where I have burned fingers, essentially is a fintech part of the things where the regulatory clarity is still very tricky at this stage. That is something that we need to see how that evolves. But that is one way of playing it. IT services will be a beneficiary medium to long term as they are the implementers in any case. But it is a secular growth sort of sector. I do not really think any of these digitization initiatives are going to lead to a major change in their long term growth trajectory.
It is all about them coming out of this low growth trajectory and moving into the normal trend line average growth over the long term that I guess they should be able to do, which is where there is some value out there.
Just going back to the list that you were earlier highlighting, I mean Reliance, Bharti, L&T. It is clearly back to the largecaps. Does that mean you are looking at phasing out from the mid and the smallcaps?
Venugopal Garre: Mid and smallcaps are excellent spaces over a long term. A lot of multibaggers come from there. I have been fortunate enough to have identified quite a few of them over the last 25 years. But the reality is at this juncture I have moved to an underweight on SMID relative to largecap. I had this 20% allocation in the India portfolio to SMIDs which I have actually made zero right now.
It does not mean I would completely avoid every SMID company or every small and midcap. There will always be bottom up opportunities that I would be evaluating and investing in. That is the call at this juncture. In any case, Nifty was expecting high single digit returns which is not the case with SMID overall. That is where I am at this juncture, in terms of how I am assembling. My entire India portfolio is assembled around largecaps at this juncture. It is going to change over time. It is not like something is cast in stone. We change it every quarter. We will see how things span by and you know review it a quarter later.
Fair point. But you had a call to go overweight on IT and with the exception of Infosys, 2023 was not a bad year for IT. In fact, the IT index gave a return of 24%-25% which was higher than the Nifty. What makes you bullish on IT? The cycle is not great, valuations are above the historical average?
Venugopal Garre: If I were to look at last year, to a large extent, the heavy-lifting of returns was done by SMID in IT services. I was in some way down the line playing it through my SMID allocation. But I was not directly playing the largecap IT, which to some extent has lagged quite materially last year.
The second thing is within largecap IT space, the idea simply was that if I am talking about an IT services earning momentum bottoming out. You are going to get some negative information even in this particular quarter numbers but then at the margin, looking at the earnings growth estimates of consensus, look more or less realistic. Now since I am not negative on the sector long term, I felt that perhaps this is the time to start pushing that sector from a largecap sense. That is the reason we decided to have the overweight on IT services. It is not a very large overweight, our largest overweight position is in financials.
It is a marginal overweight on where the index weights are. Hence in the India portfolio, we have one largecap which features out there as the way to play that because that has been the biggest laggard in any case, trending closer to average valuations historically.
One call which everybody will have to take now, whether it is election cycle or valuations or the recent runup, is how to approach government companies, especially the ones dependent on the government for orders, railways, defence and infra. How would you approach that space?
Venugopal Garre: There has been this underlying theme around public sector companies in the market. The reasons are very simple. They were relatively cheaper valuations wise and they were getting their growth. This is across the board. We look at financial sector PSUs to the capex side of things. One of the key underlying factors, especially since you mentioned the capital expenditure linked ones – be it defence or infrastructure, they had this major advantage over the last two to three years because we were going through a pretty strong government capex cycle.
If you were to look at the government’s allocation to capex within the central sector budgets and the special allocations they did to the state, they had the flexibility of doing that for two reasons. One we managed to build in, get a much larger tax collection than expected especially in indirect taxes that buoyancy basically helped.
Number two, we had the flexibility of keeping higher fiscal deficits. If you think about it, that 6% fiscal deficit, 5.8-6 accounting adjustments wise it is actually more than six. This financial year, which is getting over, I do not think we would have been allowed to have such higher fiscal deficits in the pre-Covid era. The fact that we managed to keep in plus 3.5% per state is a unique situation. Now over a period of time, we will bring that down because you have to align it with how things happen globally especially around inflation and things like that.
It is not a perpetual fiscal deficit number. So as you bring it down, government capex will also moderate and shift towards private capex. So what you are playing right now from a sense of PSU infrastructure is good. It is good for a while especially for the next maybe 12 months but you will have to start looking at more proactively potential opportunities in the private sector and whether these PSUs can actually tap that or not. Quite a few of them cannot. So this is a transition phase right now for them because a mix of capex will change over time.