“This is what is leading to capex recovery from the large sectors. On top of it, if you look at the last 12-18 months, there is a clear improvement in balance sheet cycle of mid and small size companies,” says Vijayaraghavan Swaminathan, Avendus Spark Institutional Equities.
When you talk about supply side concerns and you have highlighted as to how large companies are trying to fight it out and do whatever it takes to try and protect their market share as a midsize companies as well fighting it out, we have seen that play out quite evidently so in the entire paint sector and now two wheelers as well are vying for the top slot, all of them pretty much across the board. What could it result into for some of these consumption spaces?
Vijayaraghavan Swaminathan: Typically, if you connect the sequence between demand, supply, earnings, and valuation sequence, if you go back to slightly from 2016 to 2023, so India is clearly coming from industry consolidation phase where we have seen multiple sectors where the top three, top five are gaining disproportionate market share.
This market share accumulation largely resulted in these larger companies wanting to protect the market share.
This is what is leading to capex recovery from the large sectors. On top of it, if you look at the last 12-18 months, there is a clear improvement in balance sheet cycle of mid and small size companies.
Mid and small size companies in order to regain the market share, so they are also in the process of creating capacity. So, because of this market share protection mindset, both from larger companies and from the mid-size companies, so we are clearly in for a supply cycle.
Importantly, what supply cycle does is supply cycle creates competition and more importantly, fight for market share typically restarts supply cycle. So, if you step back and look at three examples, private banks, paints, cement, all these three sectors despite delivering good earnings in the last say 18-24 months, the multiples got de-rated because of perceived supply coming in.
So, what we are effectively concluding is, in the last five years from a demand-led earning cycle, we need to gear towards supply cycle and supply cycle will be definitely negative for valuation multiples because fight for market share can clearly result in pricing war between the companies, this could lead to lower valuation multiples is something which we need to prepare for in the ensuing supply cycle.
Get in your take on the entire auto and auto ancillary space and largely because of the fact that you do have the monthly sales numbers as well today trickling in and as per your report, you have spoken about the higher agri-income, the freebies, etc. What is all of that pointing towards because there was one time when we were talking very clearly about this premiumisation trend really playing out, but basis the kind of findings that you have had with respect to mass consumption, what is it looking like for the auto sector?
Vijayaraghavan Swaminathan: Specifically, if you look at consumption, what we need to keep in mind is consumption is also seeing a lot of wallet share shift. Consumers are no longer going for the same consumption pattern which they had, say, three-five years back.
So, because of smartphones and its associated peripherals is becoming a larger category, so there is no clear pattern of consumption shifting back to specific sectors because of broad-based wallet share shift which is happening in the consumer wallet.
What is specifically happening in auto sector in particular is, in the last six months, we are seeing a clear shift towards economy segment of two-wheelers or entry-level cars seeing signs of pickup.
Mind you, two-wheelers, fiscal year 25 volumes if you add up, even if you annualise the volumes, we are yet to go back to fiscal year 19 volumes.
Two-wheeler is definitely coming from a low base and it is creating a good cycle and more importantly, if you divide the breakup of two-wheelers or four-wheelers where the demand is clearly coming back is the entry-level products and clearly because of weaker urban consumption, we are seeing the top end of four-wheeler demand or two-wheeler demand is definitely seeing some signs of moderation.
So, while the overall demand, while overall volumes looks interesting, but if you dissect the data it is only entry-level products started seeing a comeback so which is in line with the mass consumption recovery point which I had earlier highlighted.
So, looking at the construct that you have just set out for ourselves, where is it that you think we are going to go from here, especially because now instilled by the stimulus China is also a very big factor and what would be your sectoral overweights and underweights in the market?
Vijayaraghavan Swaminathan: So, sectorally, what we have been saying is that this is going to be a very tricky market where every sector has got a lot of nuances. So, I think the way we have approached the choice of sectors and stocks is basically create a portfolio with a more of a barbell portfolio mindset, with the one-third of weight going for quality management, who can see through the adverse macro because of their experience of seeing through them in a successful manner.
The other one-third should be going towards quality cyclicals, cyclicals which can benefit from private capex recovery or cyclicals which can benefit from the real estate consolidation or real estate completion, so clearly balance the portfolio between one-third of weight between quality cyclicals and one-third with quality managements and we also incline to have some more turnaround companies, so that is the way we are positioned or that is the way we are recommending sectors.
But right now, if you look at where do we see margin of safety, barring private banks, there is no pockets of margin of safety whatsoever in any part of the market, so valuation multiples have significantly re-rated despite earnings moderation across. So as a result, at this point of time, there is only one pocket where we have good margin of safety, which is there with private banks.
