ravi dharamshi: Anti-fragile India: If the world markets go up 1x after fall, we will go up 1.5x: Ravi Dharamshi

“We are on the cusp of a manufacturing renaissance, a capex revival and credit growth and real estate cycle in India,” says Ravi DharamshiFounder & MD, ValueQuest Investment Advisors.

When markets go down, long-term investors get good entry levels. So will you smile now?
Honestly the smile is not because the market is falling but everybody is making the mistake of extrapolating the US inflation onto us and the way the US interest rates are rising onto India and thinking that we will also fall the same way US markets are falling. We have demonstrated in the last one year that India is anti-fragile. I use the word carefully because a lot of people use the word decoupling, resilience and different terms, but I don’t think we are decoupling. We cannot head in a different direction from what the mother ship US is going into. Neither are we showing resilience in terms of falling less than the world. But when the falling stops, if the world markets were to go up 1x, we will go up 1.5x. That is the kind of resilience and outperformance that we are showing in the face of macro headwinds.

I would say India is anti-fragile and there are good reasons why we are showing this kind of outperformance. The smile is more that India will do well in this world where there is all kind of uncertainty around.

Price action has been nothing short of breathtaking. When we spoke last, you said if you buy the fall in May and June, you will be laughing in the second half of this year. That has happened. But what happens now? In the case of an energy crisis in Europe, there is going to be a huge Fed attempt to bring demand down. It will have an impact on global growth.
There is no denying that inflation is proving to be far more sticky in the US and if inflation is going to be sticky, then interest rates in the US are going to go up and if that happens, then worldwide there will be an environment of risk aversion .

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Having said that, the impact will be more directly on India on the export front, but it is more on the export of services front. India is in a different cycle, whether it is in the manufacturing cycle, capex cycle or real estate cycle. We are in a far different cycle than where the world is. A couple of days back, Akash Prakash had also written an article saying that we are at the opposite end of the real estate cycle as compared to China. I think that is absolutely true but that is not only the case in real estate, it is true on the manufacturing cycle front as well. The crisis is not a new thing. We have experienced so many crises. In the last 10 years, we are skewed with so many things going wrong – whether it was a self-inflicted wound or something that emerged externally, but India has found a way to survive that and thrive in that environment and luckily the things seem to be falling in place in geopolitical context as well.

I am not sure how much credit should go to the government, but I am definitely enjoying the benefits of that. So in a scenario when people want to move out of China, their manufacturing supply chain in the environment where the energy bills in Europe are shooting through the roof, everything points to India being the only choice as a manufacturing destination, which is large enough to take the kind of shift that is happening in that world.

So every earthquake that is happening elsewhere in the world is leading to people looking at India even more favorably. I am actually very excited by that fact. We are on the cusp of a manufacturing renaissance, a capex revival and credit growth and real estate cycle in India.

So given the fact that you are talking about how India is looking for a bright spot, is it time now to avoid the export dependent sectors like IT, pharma etc. and probably look at capital goods, capex theme etc.?
Yes, so I will not broad brush the whole thing but definitely at this juncture, pharma has its own challenges. Buyers in pharma are consolidated. IT will definitely face the challenge because we saw a tremendous expansion in margins and a big pickup in growth. To some extent, that growth was bunched up because of Covid and now with the Covid situation normalising, some of that growth could go away and some of the cost that had not been there during Covid times like travel can come back and hence the margins get impacted. So IT definitely faces at least two-three quarters of pain in terms of margin and a little bit of slowing down of growth.

Pharma has been in the challenging space for most of the last three-four years except for a few quarters during Covid where some amount of temporary demand spike had come. Again I am not saying that this is the export market to avoid, but there are other export markets which are doing well. So, manufacturing, engineering and defense exports are picking up. Those are the places that one should be focused on from the export point of view.

I am essentially looking at companies that are more domestically focused; if they do have an export play, well and good but you want to look at companies that are linked to the domestic cycles because that is where the revival is happening.

So what would fit that bill? Would it be companies within the defense space or some soft capex themes, capital goods or infrastructure, real estate?
Across the board, capacity utilizations are rising. Whether it is steel, cement or engineering goods or power – everywhere the utilization levels are rising. For example, power had 69% PLF in the last month which is the best ever since a long time. That is telling us that even in thermal power, some amount of capex is going to happen soon enough.

Yesterday somebody from the industry said that we will need an additional 32 gigawatts of thermal power by the end of this decade if you want to absorb all the new renewable capacities that are coming in. So the capex cycle this time around is different from the 2003-2008 cycle, in the sense that thermal power capex is much lower in quantum as compared to that cycle.

The bigger chunk is being taken by renewable but even though thermal power capex which was on a decline for the last 10-11 years is going to see a small revival from annual addition of one gigawatt, it is going to go to 5-6 gigawatt kind of an addition over the next four-five years.

So sector by sector, there is an increase in capacity utilization, new companies being registered and the number of environmental clearances going up. All these are leading indicators that the capex cycle is about to pick up. One of the things that we track is the cash flow from operations to the capex done by the company and this number is at an almost two-three-decade high. We have not seen this kind of companies making profit since the last six-eight quarters. But they are not commensurately investing in capex.

Some of it could also be because capex intensity could have gone down in that industry because there is a larger automation happening. At the same time I feel this number is unsustainable and there has to be some amount of capex pick up happening. With yes. sector specific capex is going to pick up. Overall numbers might still not look that attractive for a year or more.

If one looks at the underlying valuation there is 110% merit in the big picture you have shared. Capex, utilization rate all are picking up but some would argue that is trading at a PE multiple of 50 plus, 60 plus. Some of these stocks are at multi-year highs?
No doubt about it, the market has a sense of this way back. It is not that they are thinking about it today. Today the actual event is panning out in terms of capex picking up or the order book for these companies going up, but the market recognized this much earlier. However, having said that, these 50, 55, 60 times multiples can be a bit misleading because it is on a low profit base.

The profits of the companies as compared to the peak that was achieved in the 2007-2008 cycle, is at the same level or just about higher than that. So, the profits are yet to be picked up. Overall, the utilization levels are low. Material prices are falling down now and so some amount of gross margin improvement and operating leverage is still ahead of us and the tailwind or the visibility in the sector is there for at least three years. That tells us that the profits are going to come better and better over the next 8, 10, 12 quarters. If that is the case, then some amount of derating might happen but still the absolute prices will still go up from here.

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