The power sector has a long runway ahead, in helping India achieve a 6-7% real GDP growth, according to Manish Sonthalia, chief investment officer of Emkay Investment Managers.
"Power generation, distribution, transmission, energy storage, renewables such as solar and wind, cables, transformers and the entire value chain has a long runway for growth for the next five to 10 years," Sonthalia told NDTV Profit's Niraj Shah.
Within these segments, in the current valuations, the value lies in the public sector units, according to him. "Many private sector counterparts are trading at many times multiples of the largest power transmission companies in PSU, which also have a higher margin of safety," he said.
(Source: Emkay Investment Managers Company website)
(Source: Emkay Investment Managers Company website)
The energy and oil sectors are largely dependent on policy and regulatory intervention. Currently, the valuations in this sector are "absolutely comfortable", the CIO said.
"Markets are banking on the fact that natural gas might come under GST. The expectation is that once the budget is announced, the entire pipeline distribution of natural gas will be paused and companies are going to benefit because of input credit," Sonthalia said.
The auto sector is largely dependent on discretionary demand, which has been soft across this quarter, he said. The inventory pile up has extended to over two months and companies will start giving discounts in order to clear inventory, according to Sonthalia.
"But given the earnings momentum, the market is bullish on the premium segment of the motorcycles. The 125-CC to 400-CC two-wheeler premiumisation trend in the mid term looks very sound," he said.
Sonthalia also highlighted the five broad themes that will hold in good stead— consumption, financialisation of savings, energy transition from fossils to renewable sources, the 'India manufacturing' story and the artificial intelligence takeover.
"Find stocks among these themes, where you are early in the game, where the market has discovered it and price is near perfection. This is where good opportunity lies," he said.
Watch The Full Conversation Here:
Edited Excerpts From The Interview:
Manish, markets have looked stretched for the last 12–18 months and we still continue to move higher. What do you think about the market currently?
Manish Sonthalia: You are right. The conundrum is huge liquidity and the problem is earnings and valuation.
You got to pick and choose within the entire universe, where there is a comfort in terms of earning and valuation and those stocks will have decent inflows into them. I was just doing some numbers. You know, India has some 57 sectors. If you take the mean valuation of each of these 57 sectors, hardly 10% of 5–6 sectors would be at some comfortable valuation zone compared to the last 10 years mean valuation. The rest 50 sectors will be trading at higher than 10-year average mean value. So, that is the state of things.
As we speak, SIP flows—basically smart institutional money—keep piling on. There are Rs 20,000-odd crore in SIP flows. As long as that continues, you got to pick and choose between the broader market. India has a long runway to go from here. Obviously, the medium-term outlook is definitely bullish and even the long-term outlook, but problems in individual sectors will remain for the near term. That is where stock picking will come into play. So, that's how things are.
Definitely, I think, if you don't have some very nasty macro surprises or regulatory policy surprises on the negative side, all dips will be bought into. India is turning, as somebody said, from a country of savers to a country of investors. That is unlikely to be reversed very soon.
Which are the themes where you might be comfortable currently?
Manish Sonthalia: Obviously, capital expenditure, railways, defence, infrastructure, these are all important themes in India's context for the next 5–10 years. India manufacturing story, per se, rests on this. So five themes which we have also talked about in the past are consumption, financialisation of savings, energy transition from fossil-to-renewables, the India manufacturing story and the digitisation-artificial intelligence taking over. So these five themes will stand in good stead.
Within the five themes, one needs to find stocks, where you are early in the game, where the market has discovered it and you know priced it at more than priced to perfection. That is where the opportunity lies.
Mind you, there will be newer companies that will come to the markets every now and then and because most of the sectors and stocks are well-discovered and priced to perfection, given the liquidity flows, you may have a certain advantage in getting into these stocks slightly early.
Power is a theme that has come back with a bang and across the whole ecosystem generators, distributors, equipment suppliers, financiers. If you're trying to play capex, is power still looking relevant, or are the valuations too stretched?
Manish Sonthalia: I think, the point to note here is that India was underinvested in energy during the demonetisation days and the run-up to Covid.
Given the growth that we are having, you know, India really didn't have the energy security that we needed to achieve this sort of a growth. So power is obviously one of that.
And if you are to achieve a 6–7% real GDP growth, you have a long runway for all segments of power. And within that, it will be generation, distribution, transmission, energy storage, and among renewables, solar, wind, cables, conductors, transformers, I mean you name it. So I think the entire value chain will have a long runway for growth for the next 5-10 years.
Now, within that, if you compare where the value is, I strongly believe that the value lies in the public sector units at the current valuation. So let's take a case for transmission. Many of the private sector counterparts are trading at many times multiples of the largest power transmission company in the PSU space. So you have one such opportunity or let's say a thermal or let's say, the guys who are making the equipment. So there is a very big disparity in that entire value chain in the private sector and the public sector.
Yes, I understand there will be some discount in valuation. But if the growth is out there and the bulk of the growth is going to come to a few players because they are so large that you can't ignore them, then obviously there is where the value lies.
And you are absolutely correct that for power, it's not the end of the road as yet. Many of the private sector companies are trading at lofty valuations. They can go through some time corrections and many of the companies are trading at 60–70 P/E. Probably you're discounting the next five years of earnings. I mean, you can’t have a very stretched near-term valuation. You know, markets will look forward into the future, maybe in FY26 numbers, FY27. But markets can’t be looking at FY30 numbers, just yet. So the big theme stays but you know within the valuation set, I think PSUs have a higher margin of safety...
Any thoughts on oil upstream or maybe even some of the city gas distributors or oil-marketing companies?
Manish Sonthalia: I think this sector is very dependent on policy initiatives, regulations and announcements. So valuations are absolutely comfortable.
Mind you, if you talk about the upstream oil companies, they don't get the market realisation of the Brent that we see on a day-to-day basis. There is a huge tax element that is out there and they get a discount. But even after accounting for all of that, the valuations are extremely comfortable, I would say and given the high dividend yield on all of these companies, I would think if you're looking for one of the five sectors in those 57 sectors it's basically energy.
And mind you, petrol and diesel prices have not changed over the last two years. Still, these guys are making normal margins. Let's say a GRM of $2–3 and marketing margin of $4–5 on a blended basis. A 5 P/E, 6% dividend yield. How can you go wrong? So there is a deep value as far as the energy space is concerned.
If you talk about the CGT companies, obviously the markets are banking on the fact that natural gas is going to come under GST. If that happens, then obviously, you know, the expectation is that maybe in the Budget, even after that, you have the entire pipeline distribution of natural gas cost and the companies obviously are going to benefit because there is an input credit that is going to be allowed. You have the city gas distribution companies, where once you actually market the natural gas, whatever costs are being paid by the consumer they can be taken as input credit.
You have the LNG terminal regasification guys who actually import gas, regasify it and sell it. Obviously, the costs which are included in the regasification will be allowed as an input credit for some of these companies. So I think this sector, the CGT apart from the deep valuation which some of these names were, let’s say 3–4 years back, have got normalised now to somewhat rational valuation. They are now banking on the fact that natural gas comes into GST, and if that happens, then obviously, that's going to be a boost for the margins for each of these players...
With the price cut that M&M had to take, is this pointing towards some demand stress and a start of maybe a prolonged price cut cycle?
Manish Sonthalia: The consumer discretionary demand has been soft all across in the first quarter. So autos obviously being a discretionary spend is no exception.
Having said that on a YoY basis, first quarter numbers for the entire auto pack will look fantastic. But if we were to project the demand going into the future, a normalised demand growth was expected—5% for the four-wheelers, passenger cars, and two-wheelers was around 6–7% volume growth for FY25 and a muted demand for the HCV space and tractors.
What is happening right now is that there is an inventory pile out in the passenger cars to the extent of two months of inventory. And obviously once that happens, as we've seen in previous cycles as well, you have to give discounts. So, you are starting to see players lowering the prices, because you have to clear your inventory.
So margin tailwind, going out into the future is not going to be there. We expect that the second half of the year, whatever expectation of volume growth is likely to play out. In the interim, there can be some compression in valuations, because valuations are rather full, given the earnings momentum they have been likely to see.
More bullish on two-wheelers and within the two-wheelers, the premium segment of the motorcycle, which is 125 plus, 150 plus, going up to 350–400 cc. There I think the premiumisation trend, if you were to look at from a medium-term perspective, looks very, very sound. And that opportunity is going to play out. And you have the likely players—two or three of them. You have international players like Harley and Triumph also come through. Obviously you're looking at the premium-end of the motorcycle, starting to look very good as far as the opportunity side is concerned in terms of growth.
On LCVs, you got to wait and watch. Many of the players are alluding to the fact that they see a growth for FY25 as opposed to a flat growth. So you know, all of these things are so unpredictable. It's just six months back and unfolds to you right in the place. So HCVs, two-wheelers on a positive, passenger cars is a wait and hoping that monsoons is going to be good and rural recovery will play out and in the second half, we'll likely see some growth. In the interim, maybe an underperformer vis-a-vis two-wheelers.
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