FY22 to bring economy back to FY20 level

Discipline is coming back and a lot of companies are back to business though it is not fully on because not every part of the country has opened up all the way, says CIO, Equities, Mahindra Manulife MF. . How are you analysing the market in terms of valuations. What kind of approach are you adopting at the fund?The way the markets are right now in terms of too many data points flowing, we have seen one of the worst points in terms of Covid which has hit economies across the world. In India, to an extent the valuations are something which we need to understand in the backdrop of Covid-19 induced impact, something which started as a lockdown driven by health concerns and finally it spread as an economic implication as the lockdown kept on getting extended. In the current context whatever I or you would have thought in April or May has really gone for a reasonable change in the outcome. In July, it is now exactly four month after the lockdown. We are still not really seeing a situation where economic activities have rebounded fully and to an extent, understanding the valuation has to be in that perspective. The broad assumption going on right now is that the economy was moving at a particular pace, there were corporate earnings playing out and therefore there were FY20 problems in the last 10 days of March. FY21 suddenly went into a very different business outcome led by this lockdown. FY21 is likely to be part of our bad memories and ignored for a long time to come. It is more or less expected that FY22 will bring the Indian economy back to FY20 level after a dip in FY21. It will rebound as and when the economic normalisation starts. In that context, one year -- FY21 is a year which has gone really bad for all of us. We are looking at it from the bottom of the economic cycle. Just to give an example, in June this year, Indian economy was operating at anything from 25% to 90% of the previous June. For example, in electricity, we were broadly 90% of last June; petrol, diesel consumption was broadly at 85% of last year. Commercial vehicles were at 25%, passenger vehicles at 50% and two- wheelers at 65%-70% of what these companies were producing a year ago. However, discipline is coming back and a lot of companies are back to business though it is not fully on because of the logistics issues as not every part of the country has opened up the way we all want it to. So, we need to take valuations with a little bit of this added variable of analysing where the economy is not operating at full utilisation level. The valuations are reasonable compared to what they were two months back. In the consumption space and FMCG sector in particular, the Marico management talked about the valuation they are trading at versus the outlook and the tailwind they got from people staying at home and consuming the essentials. What is your analysis?There are two parts of this entire exercise. One, consumer staple as we know is possibly has quite a resilient demand. It does not go much up and down vis-à-vis what happens to the economy as such. There might be some premiumisation effect here and there, but conceptually, demand does not really get impacted because of any slowdown. That is what the word staple actually suggests. But while valuation for consumer staples historically has been on a relatively higher scale, what we are seeing right now is not a very material difference vis-à-vis a long period average for almost all of these companies. Also one thing we have to remember right now is that markets typically appreciate companies which create cash flows. Markets like those companies which do not come back to shareholders on a frequent basis for raising capital. If you look at the entire spectrum of consumer staple companies, almost every company fits into an amazing cash convergence cycle. They do not need to raise capital and so there is never a worry about these companies coming in to raise fresh money and to an extent, they are all high payout companies. Typically, the dividend payout is quite high again which investors like. So, in an overall context, in the consumer staple as a space, valuations are not materially higher than what we are used to in the last three-five year cycle. At the same time, the earning resilience of the space is quite interesting especially in the current year context where one heard the managements saying that they are talking about getting back to normalcy much faster. Unfortunately other businesses like consumer discretionary may not offer a similar resilience. Maybe that is where the valuations are seen as acceptable with both earning trajectory as a comfort as well as long-period averages justifying these kind of valuations based on balance sheet structures. People have found renewed attractiveness for this space. What are your thoughts on the valuations of the IT space?IT as a space is interesting in a sense that for a lot of these IT companies, the business model is driven more by developed markets, the western world which are the end users and they are paying commercial revenues to the Indian IT industry. Clearly a lot of companies are going to turn more and more digital based on the Covid experience of lockdown. Lots of customers are moving to digital. By default, the corporates will move to digital and that is where one of the big sources of revenue for IT companies will come in, where they will help migrate those corporates to a more agile digital platform. That is one part where the business tailwind comes in. Secondly, even from a year-on-year perspective, Indian rupee is far more favourable to exporters. IT companies typically earn dollar revenues or foreign currency revenues. They are possibly making more money for a similar amount of billing in the same dollar terms. Thirdly, on a relative basis, certain industries in India are not likely to perform as well as what was expected six months back. IT came out as a pretty resilient business in terms of earning right now. Traditionally, not a single IT company in India at least for the last 10 years have raised capital. In fact, many of them have used cash to buy back shares. So again, it is something far more positive for a shareholder that companies are generating cash and using it to extinguish equities and by default create more value for the shareholders. We are broadly neutral on the space. We like certain companies and that is where we are more positive and have a position. Broadly as a sector, we will be more or less neutral vis-à-vis the underlying benchmark. How are you positioned on financials which has the largest weight in the market right now? What are you making of the risk they face say in one to two year far out?Typically, in this crisis, as far as the credit quality cycle is concerned, post the Covid-19 induced lockdowns, normally companies with strong balance sheets, a stronger credit processes will emerge far stronger. The intensity of losses differ among the players while directionally a lot of companies are likely to have some asset quality pains. But companies with better credit quality controls demonstrated in the past, will do better. If you look at the other way to analyse the same businesses somebody with a better customer franchise as demonstrated by a strong current account and the kind of balance sheets which helps them reduce cost of funds, and which are not looking at too much borrowing from the bond market etc where the customer franchise helps them get money much faster, will do better. Some of those companies will have a lower cost advantage. On top of it, the third variable which is that a lot of banks and maybe some NBFCs have moved to a digital model over the last two, three years. As a customer as well as an investor, in the last six months, very broadly there has not been much of a disruption for many of us. So we will look at some of these companies as they are technology driven with capabilities, their strong CASA franchise, their historical credit quality and have experience. In our portfolio, we basically went underweight the financial space, especially the lender space we went underweight and within which we are more positive, more favourable towards large banks especially with large franchises with customers, very good CASA ratios and historical credit quality deliveries. We are underweight on NBFCs as such because that is the space where we expect some sort of a combination of credit cost as well as liability side. Also the ability to raise capital can create problems for growth. The other space in the BFSI space is insurance, which in exchanges is a space where we are broadly positive and holding some of those companies in our portfolio. In the midcap end of the market, the home appliances space has shot up. The view is that people are staying home, they are experimenting more in their kitchen lab and making different kinds of cuisines and baking a lot. The entire range of home appliances are also mirroring that demand is robust in the midcap end of the business, have you looked at any of these and what are your thoughts there?Sure, some of these trends were visible even before this work from home started. Look at air conditioners, washing machines which are some of the products one migrates to after having that basic od say a TV and a refrigerator. Those products are already on an upswing in terms of how consumer demand has been going up. Just to give an easy example, air conditioners have moved away from just being used in one bedroom to second to third and maybe to the living room etc. We have up-scaling of demand of some of these products in a very meaningful way over the last three, five years. Work from home would have accelerated some of those things. Maybe some new set of products would have come up. Maybe dishwasher as a new segment possibly can come in. Coming to our portfolios, we have been holding some of these positions in our funds but if you really analyse the market directly in terms of what sort of products are available, unfortunately there are not too many consumer companies in the listed space. This particular category of home appliances has far more players operating in the unlisted space but yes, from whatever is listed, we have chosen our preferred companies and our preferred categories there.