Broader markets have underperformed the benchmark equity indices in 2022 so far amid rising interest rates and sustained outflows by foreign institutional investors. The BSE Midcap and BSE Smallcap indices cracked 6.37 per cent and 10.32 per cent, respectively, on a year-to-date basis till July 26. On the other hand, the 30-share BSE Sensex declined 5.12 per cent YTD. In an interaction with Business Today, Sushant Bhansali, CEO, Ambit Asset Management shared his view on how long the underperformance in midcap and smallcap space will continue and which themes may throw big gainers going ahead. Edited excerpts:
Business Today (BT) How do you see midcap and small caps going ahead despite rising interest rates?
Sushant Bhansali: Since the start of interest rate tightening globally, the market has entered into the reset period where a clear differentiation between levered versus unlevered and quality versus non-quality can be seen across indices irrespective of large, mid, or small caps.
As the interest rate has started rising, the cost of equity is rising and leading to higher discounting and valuation decline. We will see a higher dent within the midcaps and small caps companies with poor track records. Companies with leaner balance sheets and better cash flow cycles will not only be able to survive but thrive and gain market share further, clear dispersion will be witnessed going forward.
Our proprietary Good & Clean framework helps to keep appropriate accounting and quality checks for midcaps and smallcaps within the portfolio to avoid risks.
BT: Which factors do you think will drive markets going ahead?
Sushant Bhansali: Six major factors will drive the market going ahead:
a) Agri: Healthy harvest should bode well for moderating food inflation and improving rural aspects.
b) Centre spending: Continuous government spending as seen in the past that can be witnessed towards roads ie four times growth compared to FY20 and railways 32 per cent CAGR compared to pre-COVID level.
c) Credit growth: We have seen double-digit credit growth over the past three months and have been broad-based with asset quality improving. The sustenance of the same trajectory will keep the market upbeat and gain confidence in the underlying economy.
d) Crude oil: We have seen in the last two weeks, that crude oil has declined, still 30 per cent up on a YoY basis, as and when the crude declines structurally and remains in the range of $80-100, it can improve the macro aspects in terms of current account deficit, imported inflation, interest rate, etc.
e) Private capex: We have seen a deleveraging cycle during the pandemic, the re-leveraging aspect on a broader level across the sectors shall revive the recovery in investment rate and lead to higher earnings growth and multiple expansion phases as seen during FY04-07.
f) Global inflation: While inflation seems to have peaked out in India, globally it might not have. The actions of various central banks will be keenly watched out by investors.
BT: How can investors move forward on Dalal Street considering rising inflation, interest rates and volatile crude oil prices? What should be the right portfolio creation strategy?
Sushant Bhansali: There are three aspects for creating the right portfolio strategy despite rising inflation, interest rate and volatility, which shall take into account the top-down and bottom-up approach:
a) Quality: Withhold those companies which are good in terms of capital efficiency and clean in terms of strong corporate governance. Invest in the businesses that have leadership traits, a higher margin of safety, lower leverage and a proven track record. While building the portfolio, the investor can consider scalable businesses, have quality management and deliver consistent earnings growth. In fact, uncertain times give the best opportunity to invest in some of these companies.
b) Risk management: Stock weightage is as important as the selection of quality stocks. Higher diversification is a hedge against ignorance. Risk management with allocation to winners can lead to return optimisation. There is a thin line of difference between diversifying risks and diversification of risks, a portfolio that is better concentrated with growth, resilience and margin of safety, lesser are errors and there is the maximisation of wealth generation.
c) Sector allocation: Investors shall prefer sectors which are B2C in nature, have higher pricing power and have better growth opportunity which will help to take a call on the top-down approach. The above two attributes will address the bottom-up approach while creating a portfolio.
BT: Why Ambit Asset Management has maximum exposure in the consumer discretionary segment? Which type of companies do you think will outperform?
Sushant Bhansali: India is at the inflection point in terms of per capita income as we transition to a $10 trillion economy in a phased manner in the next decade. The per capita income is to see a hockey stick curve, where we find the biggest beneficiary shall be the consumer discretionary sector due to higher purchasing power and also consumer discretionary is the aspirational story to achieve the $10 trillion mark.
Companies with strong balance sheets and market leadership defined by their pricing power, scalability and competitive moats should outperform the sector. Long cycles are made of short cycles, many come with challenges. The ability of companies to survive and convert the economic challenge into an opportunity will be the key.
BT: How do you see building material and chemical segments going ahead?
Sushant Bhansali: Building material acts as the underlying for the shining India theme without taking undue risks in terms of cyclical and maintaining higher consistency with B2C companies. Within the building material segment, we witness various sub-segments which can be seen such as paints, adhesives, pipes, sanitary ware, tiles, etc.
We have seen that across the market, leaders within the building material companies gain market share compared to pre-COVID levels highlighting higher formalization and K-shaped recovery. Going ahead the companies that can protect profitability despite inflation worry will be preferred compared to others.
Also, one big trend we are witnessing across most building material companies whether, in paints, pipes, tiles, laminates, or plywood is the capex expansion. The companies with better asset turnover & execution shall witness higher growth.
In the chemicals space, we are witnessing structural tailwinds towards specialty chemicals that have higher earning potential and better consistency compared to agro chemicals which are commoditised and lack the above attributes.
Within the chemical sector, we have seen companies evolve in the last decade, except for two companies that are within the top 100 companies, most are still within mid-cap and small cap bucket. Going ahead we expect the transition of chemical companies from small to mid to large caps.
The companies with a quality track record, capacity building, and tapping China + 1 and import substitution opportunity will grab the transition. Companies that successfully diversify the revenue stream with complex chemistries and pharma segments will witness higher earning upgrades and multiple expansions.
BT: Which other sectors do you think will throw big gainers?
Sushant Bhansali: The upgrade or downgrade shall be more narrative-driven as the market has initially factored in the upgrades and downgrades which can be commensurate to the overall valuation of the market. The domestic theme shall witness lower volatility compared to exports which have many factors such as global growth, inflation, and currency.
We strongly witness a sector which has resilience in terms of earnings growth, higher margin of safety in terms of leverage, competitive moats like pricing power and most importantly, a reasonable risk-reward ratio which addresses that valuations will take preference. Strong governance results in a better perception of the company which is very important in the current market volatility.
We find few sectors like financials, auto and consumer discretionary are addressing the above factors that give reasonable confidence to remain cautiously optimistic compared to others.
BT: How is the Indian market looking in terms of valuations after a robust correction since October last year?
Sushant Bhansali: Since the market was at its high in October 2021, the PE downgrade is faster than the EPS downgrade. At the peak, the Nifty 1-year rolled forward P/E was at 22.7 times which is now at 17.5 times, below the long-period average of 19.5 times.
During Q1FY23 earning season, except for the IT sector, we are witnessing execution by the companies better than the market estimates.
India’s valuation looks higher on a relative basis compared to the other emerging markets but the global positioning attributes such as the fastest GDP growth, better political stability, rising export share and rising weight in the emerging market make India relatively strong than the previous cycles and the reason for attaining higher multiples.
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