“The broader markets on its part is way too expensive than historical numbers. One-and-a-half times deviation from the mean when you come to valuations on the small and midcap index whether it is 2007 levels or 2017, 18, 19 when you saw massive rally in the broader market. So, there is room for cautiousness to be exercised, not that I am very bearish on the market but I think some caution is warranted,” says Manish Sonthalia, Emkay Investment Managers.
This market has made a very decent comeback. IT index at an all-time high. Bank Nifty marching towards an all-time high. Has that sharp correction or the sharp correction which hit us in October, November, do you think that is over?
Manish Sonthalia: So, I am not in the camp who believe that the worst has been over, not that the markets will fall, but the markets can fall and this is based on whatever we are seeing at the ground level. Earnings slowdown, consumer leverage actually blowing off.
The government not spending enough that is leading to a massive slowdown. You saw the GDP numbers. FY25 GDP estimates have been revised down. So, where are we currently? I think instead of the markets believing a 15-17% of an earnings growth in FY26 and 27, I would go with rather a 10% to 12% sort of an earnings growth and give it a multiple of around 18 times as opposed to Nifty 50 actually trading at 20 plus PE in the past four years, run up to the pandemic, after the pandemic the next four years. So, based on that a 10% correction even from here is possible, not that I am saying it is going to happen, but it can happen and that will all depend on how strong the dollar index is and how weak the rupee is. If the rupee was to get weaker, then you will see FIIs selling abate off.And once you see pickup of government spending and the government doing something to put money in the hands of the consumer, you could see some uptick in earnings on the Nifty 50.
The broader markets on its part is way too expensive than historical numbers. One-and-a-half times deviation from the mean when you come to valuations on the small and midcap index whether it is 2007 levels or 2017, 18, 19 when you saw massive rally in the broader market. So, there is room for cautiousness to be exercised, not that I am very bearish on the market but I think some caution is warranted.
Till the point in time, we have the new budget getting announced and that is only just about two months away, you have the new regime coming in the US because that is also going to move global markets in a big way, depending on how policies are now.
So, these are some of the moving parts and it is a sideways market in the next two months. But we will take up cues on many of the things like policy matters, how the government is spending, fiscal deficit numbers, so on and so forth. These are some of the parameters to be watched out for.
When you say 10% correction, where do you see the scope of that coming? I mean, which part of the market do you think could trigger that correction?
Manish Sonthalia: So, just going back, after the pandemic actually government gave a whole lot of dole outs, fiscal deficit was expanding, and now that is shrinking. So, obviously, consumer is one segment which is really vulnerable and we have seen that the commentaries from largecap consumer names are not only talking about consumer staples, but consumer discretionary as well, there is a lot of hope and obviously, the medium-term and long-term outlook on consumer discretion is very positive, but something got to move at the margin because there is really very little money to spend as far as the discretionary side of things.
And the LIG and the MIG, low-income group, middle class, base of the pyramid, that is really stressed out.
Secondly, the capital goods space, the government did a corporate tax cut during the pandemic, expecting that the private sector will pick up capex, there is not too much of capex that have happened. It is really disappointing. And we have seen the capital goods space, the valuations are probably discounting the next five years of earnings.
And everything that goes with the private sector capex, only the government seems to be spending and even that spending is somewhat tapered off in the run up to the elections and then the monsoons and the first two quarters have really gone. So, expectation is second half, there should be pick up in spend. So, the entire capital goods space, you have the consumer segment which is vulnerable.
I think silver lining in terms of earnings growth will be coming in from the export related sectors. The ITs, the pharmas, banks, in any case were very cheap. They will lend a helping hand to the index. But really, the consumer and the capital goods space is vulnerable.
And picking up on that point especially staples, given that it is a flat volume growth, mid-single digit sales growth expected from Godrej consumer and the kind of rub off that it is happening on the entire peer group, clearly does not seem like we are quite out of the woods when it comes to rural spending and especially on a category like staples.
Manish Sonthalia: So, rural in any case was in stress over the last two years. There is hope and commentary that kharif is going to be good. Rabi, because the water levels are pretty decent, you will also have a decent rabi harvest. But how does one justify valuation vis-a-vis the growth? I mean, it is all about premiumisation in the staples space.
So, the conundrum in staples is that, yes, at the margin, things are turning up because rural is turning up but there is nothing left on the table as far as growth and valuations are concerned. So, does it make for a very good investment into staples? Absolutely not. Complete underweight on staples per se.
Where are the other spaces other than staples where you are still underweight and believe that earnings pressure is going to continue in the Jan quarter as well?
Manish Sonthalia: So, I think the entire capital goods space is again pricing in too much of optimism. For the near term, the railways, the defence, the power, the renewables, these are very good medium-term themes to play out. They will play out.
But the near-term outlook on many of these sectors are clouded and does not give too much of comfort as far as near-term valuation. So, they could go through time correction, price correction, both of them. But these are some of the spaces, the entire investment side of things because of the massive slowdown by the government spending and mind you the benefit of doubt was given by the markets all this while. Now, the markets will really start to believe only when the numbers start to come in.
Yes, there has been some spending that has happened in October, government balances with RBI has come off, so obviously those sort of moneys have come into the system. But 7% GDP growth being whittled down to 6.5%.
Then, there is going to be again, a massive case of a derating for the entire capital spending because only the government seems to be spending. So, entire capital goods, power, railways, defence, they are vulnerable as far as I am concerned regarding the valuation and the near-term earnings momentum.
Well, speaking of earnings momentum, it has been a little bit disappointing when it comes to the entire commodities space, just wanted to understand what your outlook is on the earnings here and how you see them shaping up.
Manish Sonthalia: Yes, so commodities was a drag on the overall Nifty earnings and I think it is all going to depend on how the tariffs play out in the US and how China slowdown is going to get mitigated.
But there are certain specific commodities where China has a monopoly and if they were to restrict supplies globally, the prices would shoot through roof. We are already hearing about gallium and germanium, these are some of the spaces where prices have skyrocketed.
Two other metals like alumina, which is aluminium and copper, they are clearly in a bullish spot so to speak, but not so gung-ho on either steel or coal or iron ore because a lot of that has to do with China’s slowdown. But as far as the drag on earnings Nifty 50 numbers were concerned regarding the commodity basket, going into the second half there would be somewhat of a helping hand that will come also from the commodities per se.
You have a very large exposure to pharma, it is almost all the funds, Suven, Laurus, Divi’s, why is that?
Manish Sonthalia: So, obviously, the regime changes, meaning that it is advantage India and disadvantage China. To a very large extent, you could say that the Biosecure Act has come in as a helping hand for India. Again, out here, if it does not get the assent of the president just now, it will happen somewhere during the new regime and that is going to be advantageous for India. We are talking about very large market as far as the CDMO space is concerned, something like $200, $250 billion.
India is not even $10 billion in terms of revenues currently in this space. So, there is a long runaway and because India has superior chemistry skills, we have definitely an advantage. And the companies which are already present out here have strong moated businesses.
These are high entry barrier businesses and that is where this space is currently the most exciting. Secondly, when it comes to manufacturing of tablets and capsules, I mean, that the cost structure at which India is manufacturing, if let us say manufacturing was to get shifted to the US, the US decides to manufacture all the oral solids themselves.
They just would not be making any money or they will be losing tonnes of money because Indians themselves are finding it hard to make decent ROCs. So, we have the lowest cost advantage as far as oral solids itself are concerned and so is the case with injectables. So, given that the developed markets present a very large opportunity in terms of pharma and it wants to move away from China dependence and obviously advantages will come to India and that is why this space, both in terms of orals, injectables, or CDMO, we definitely would be having an advantage.
