Longer, secular trend in manufacturing to continue in India: Ravi Dharamshi

Share some money-making idea to start the new year with.

Market has its rhythm but it does not necessarily follow a calendar year. I think just to give a bit of a backdrop of what has happened in 22, we were expecting India to outperform in the world because finally India had a strong balance sheet, a low leverage and growth remained strong. However, below the surface level the growth stocks or the midcap, smallcaps did not do as well as expected so some amount of internal realignment happened in Indian markets as well. So going forward I think the current trend is likely to continue for a foreseeable future until Fed pivots and then some of these mean reversion trades again will go back and the secular trends will revert back.

So describe that point for us when we let us say started 2022, hindsight I can say it has been a difficult year to call but some of the trends were very easy, interest rates would go higher, it did; quantum is where we are debating. Fintech and consumer tech had become Humpty Dumpty and they have had a great fall. Value stocks were getting a step motherly treatment, they have made a comeback. So these were obvious trends in 2022 Jan. What are the obvious trend for 2023?
You have absolutely hit it on the head. Even if we get the fact that there is going to be a recession in developed markets most probably in US as well, still how the markets are going to react is anybody’s guess. How much of that recession is factored in remains a question and I think you very rightly said we are not debating whether there will be a recession or not because of the way the interest rates have gone up it is pretty evident that there is going to be a slowdown. Now whether that is a mild recession and a short recession or whether it is a long protracted and a severe recession is the only question in everybody’s head and, of course, the second order effect of that is how will the US markets react to that and subsequently how will Indian markets react to that.

So I feel to a large extent a slowdown in global economies is a positive for India and India will continue to outperform but on an absolute basis that is not a very good environment to create wealth. If the world was to actually start recovering, India’s outperformance will actually stop but at the same time on an absolute basis India will actually do well.

For India even if we gain 10-15% from here I think that would be a great outcome from the current year’s perspective.

If I can just come in here, while you are saying that this is known that there is going to be a recession in US, what could be a wild card this year? How is China reopening going to impact India, what is your take with respect to that?
China will probably in the next few months come out with adverse data as they open but eventually opening up is the biggest stimulus that you can provide to an economy and China will gain strength. We are already witnessing that to some extent, metals are beginning to outperform, the commodities are coming back, dollar is also starting to weaken. So some of those pro-China trades will be in action at least in the early part of the year. Just coming back to the earlier question that you posed what are the trends which are very-very visible, I think one trend which is of course panning out with a little bit of lag is that private equity market is seeing a funding winter and that is likely to continue and lot of mark downs are yet to happen.

Over the next 6 to 12 months lot of mark downs will happen. With this what the second order impact of that is on the Indian economy is that all these discounts that we have been enjoying from the startups are going to go away over a period of time because every business is trying to finally chart a path to profitability and that will mean a little bit of rise in the consumer inflation.

I think that is one trend that is visible, how to profit from it is a separate thing. One more trend that I feel is very strongly unlikely to continue forward is the India’s outperformance. But I am an absolute return investor, I do not have to figure out which is going to be the best performing market in the world, I have to still focus on the absolute return, from that perspective I feel India is still going to give absolutely positive return.

Somewhere in 2022 you changed the anchoring of the portfolio. You moved back into financials. You sold out or you reduced exposure to IT and pharma. Six to eight months you see that anchoring to continue?
Yes I think we do not see any reason to change our portfolio positioning. I will just give you a recap of how we had changed. We had broadly moved away from global focussed sectors from sectors that were pricing in a lot of growth. Manufacturing was one trend which we believe is going to rise over the next decade. Second was energy transition, third was a cyclical recovery and the capex recovery in domestic markets releveraging of the economy. So these were the four broad trends that we were bullish on. We continue to stay bullish and there is a lot of outperformance that is happening in this space also and when I say manufacturing it covers a broad range of companies right from outsourced manufacturer to chemicals to electronic manufacturers, defence.

How much is manufacturing as part of your portfolio?
I would say at this juncture it would be closer to 25-30%, I mean it is top of my head, I am not sure exactly what it is but it would be 25% to 30% would be manufacturing, about 35-40% would be financials.

Toh bacha hi kya fir, 25%?
Of course, one-third portfolio left.

And what is that one-third portfolio?
Some of the cyclical recovery plays whether it is real estate or whether it is capital goods those kind of themes are featuring in our portfolio.

You talked about the winter that the startup world and the new-age tech is facing. But given the fact that we have seen deep correction in all of these counters, is there a case to be made to may be look at some of these as big risk reward plays?
You are right the listed space of the startup world has faced correction but it is the private world which has not yet seen the mark down and I was talking about that particular, private equity world seeing a mark down. The listed space has seen a lot of derating. I would say they are closer to reaching a place from where one should be betting on than being worried about 50% of capital erosion in those stocks. But, however, you still need to figure out which are the ones that are going to survive this funding winter and which are the business models that can survive and stand on its own. If they need further capital raise, then that is a challenge. I would not bet on those kind of business models.

You have sold out of IT because you do not want to buy sectors with a global challenge whether it is metals or IT but Indian manufacturing sector also ultimately is dependent on global growth. I am just looking at instance like what sound bites we are getting from garment exporters, what kind of feelers we are getting from some of the machinery exporters all of them are saying that if the world slows down it will start impacting our order book so if we are in for a real recessionary/slowdown and opening up of China which is negative for Indian manufacturing do not you think that manufacturing theme somewhere will get challenged?
You are right we will do far better if there were global tailwinds rather than headwinds. But see India is a play on incremental market share being taken away from China. We are not really charting new growth territories essentially, it is a realignment of the supply chain that is benefitting India and I do not see that trend changing. So even though China will open up and that will lead to some amount of commodity inflation but I think most of it is now behind us so we are actually still suffering from gross margin erosion because of the inflation last year whether it was in freight or RM.

Going forward, I think India will do well in terms of managing those cost inflation, I am still again not expecting a new commodity super cycle, it is just a re-inflation trade to some extent that we are expecting. So I believe the longer, secular trend in manufacturing in India will continue and India will have to navigate these cyclical headwinds from time to time in terms of RM inflation and in terms of global slowdown.

Let us say your portfolio from a bit of a longer period, it is not just a positional trade it is also three to five year view, with respect to that how are you looking at autos. Is it the time to perhaps bet on two wheelers now if you have a three to five year outlook?
In our scheme of things we are very positive on autos but our preference is more commercial vehicles, then passenger vehicles and then two wheelers. We are not very-very bullish on two wheelers, from valuations point of view. These companies are trading at really attractive valuations but the trend of EV adoption is actually eating away into their share. So the growth is going to be a big challenge for some of these two wheeler manufacturers. I will keep my eyes open as market is in a state of flux where the disruption has actually hit them or is hitting them at this point of time. We have to see there will be a phase of consolidation at some point where again this funding winter will end up hurting the start-ups and if that happens then maybe some market share shift can start happening again for the guys those who have stronger balance sheet, brand and distribution which is the incumbents over here. So I will keep my eyes open, I am not at this point of time placing my bets on two wheelers.

Tesla is down some 65-70% that is the lynchpin that got everyone excited that what Tesla has achieved if you walk on the same path we will get a zero in front of our market cap. If the lynchpin the real hero is down and chips are down could that actually lead to a de-rating in EVs because lot of EV stocks whether it is stock like , or M&M after that EV deal or some of the EV ancillary they were rerated between 2020 and 2022? What are the chances they could go the fintech and the consumer tech way?
First of all, in Indian market there are hardly any EV listed plays available. There are indirect plays available so we have not had that kind of price rise or market cap gains which can lead to that kind of erosion. The number one reason for Tesla price erosion has more to do with the valuation of the stock rather than the performance of the company.

Your top holdings is something which is available on your website just for reference?
They are available in the public domain but not so easily.

There are some megatrends which are always at play and I am bringing this point out which is that let us say if you bought into the private bank theme 15 years ago, it has worked like a charm, banks like , irrespective of the volatility they have really compounded like a charm. Then came the NBFC , the consumer theme, what is the large compounding theme for the next couple of years where you would say in MOSL tagline buy right and sit tight?
Clearly defence was one theme and we continue to believe defence is one theme that will do well from here as well. See, this is literally the birth of defence manufacturing that is happening in India. What we did is essentially put in place a mechanism where we have to procure locally and there is a negative list out there. We cannot procure these items from outside India so there is no choice but for this manufacturing to happen in India. This is roughly about incremental 125000 crore kind of production that needs to happen in India over the next five, seven years and some of these companies were very small vis-à-vis compared to the opportunity size that it presented.

Now one leg of that rerating has surely happened but I believe the story is not over after some amount of consolidation and correction the theme will continue again.

Second theme that I am very-very bullish on from a 5-10 year point of view is energy transition. See, the world is rapidly moving towards renewables and there is no choice and earlier it used to be driven by regulatory no more, now it is driven by economics and energy security means.

The beauty about the renewables is whether it is wind or solar I can produce it locally, I can produce it cheap, I do not need to depend, I save on my forex currency as well and I am secure in my energy needs. So it is a huge shift that is happening, it will eventually lead to just like we have that Maslow’s hierarchy of need where we put now Wi-Fi below the basic needs, below Wi-Fi there will be power as well, power will become free, incremental cost will be almost free if not free.

So in that kind of a scenario we have to think how will the manufacturing industries where power is a huge cost can turn out to be a huge winner over the next decade.

Of course, it is something what we will keep monitoring whether it is happening or not but I feel a dramatic shift is going to happen in the manufacturing cost whether it is a people cost because of automation or whether it is the power cost because of renewable shift. So I think exciting times lie ahead of us in terms of figuring out the first order and second order winners in the energy transition theme.

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