China's economy is still recovering from the Covid blow, and foreign investors are betting on India to be the next big economy, according to Pramod Gubbi, founder of Marcellus Investment Managers Pvt.
"The structural story around reallocation from China to India is the biggest driver we need to watch out for, from a three- to five-year perspective," Gubbi told NDTV Profit's Niraj Shah.
Many were invested in China, but it has not delivered in terms of returns. And, there is no other alternative in terms of size and growth dynamics other than India, according to him.
Investors are doing their research and opting to invest through India-dedicated managers, Gubbi said. The only issue is valuations in the Indian markets. Though Indian markets have always traded at a premium, FIIs will take time "to make sense of why this premium exists", he said.
In the short term, the economy and the markets don't necessarily have to go together. But in the long term, "economic growth supports corporate earnings, which in turn drives returns to the stock market", Gubbi said. The economy is in good shape, according to him.
Since the markets are forward-looking, they have resulted in high pricing. The next leg of growth will come when the promise of economic growth translates into earnings growth as well, Gubbi said.
On the auto sector, he said, new launches help drive sales and placed cars and two-wheelers in a sweet spot. With the banking system flush with capital, it has also supported credit-driven purchases, he said.
The government's recent initiatives for semiconductors is positive, according to Gubbi, who attributed the move so as to tackle rising demand and to curb import bills.
The government is also pushing for manufacturing in India to make the country self-sufficient, he said.
Watch The Full Conversation Here:
Edited Excerpts From The Interview:
Let's start off with whether the GDP print, the global cues, etc., make you sanguine about the prospects of our markets, or are you circumspect because of the valuations being high when one looks at the current year of earnings?
Pramod Gubbi: I think this is the point that we've been making—that on the economy, clearly a lot of things are ticking the boxes. But as history suggests, the economy and the markets don't necessarily have to go together, particularly in the short run. In the long run, of course, economic growth supports corporate earnings, which in turn drives returns in the stock market. But in the short term, they can be fairly disconnected.
If you take the next 3-5 years, I think the economy is in a pretty good shape. There's absolutely no doubt about it. We all have to feel sanguine about it. But from the markets' standpoint, I think the markets tend to be forward-looking. Therefore, there seems to be a lot of pricing in, of these positives, from a valuation standpoint.
Given where we are, I think the next leg of growth will come when the promise of economic growth translates into earnings growth as well. Remember, the last four years have been fairly unique in terms of the shape of the economy, given what all we've been through—the disruptions around Covid, the lock down, and the massive rally in commodity prices which put pressure on corporate earnings and the deflation that has followed. Therefore, we haven't really had a clear period in terms of earnings growth to make a proper assessment of the companies' balance sheets and earnings growth. So I think, going forward, that will be the trigger. We will have to fulfill the sort of expectations that the market has in terms of these earnings growth coming through and corporates have to deliver that to justify the valuations today. Of course, there will always be pockets of mispricing in the market. That's what make the markets interesting, but at the overall level, this is a reasonable assessment—that the economy is in good shape, the markets are factoring that in, and we will need to see delivery in terms of earnings growth.
The missing element for 2023, you could argue, was the participation from foreign institutional investors. Now, it could be an EM factor. What's your sense? When do FPIs make a comeback? Will it be dependent on China improving its performance and therefore EM as a basket getting money, or is it something else?
Pramod Gubbi: Well, I think, it's a mix of a few things. The overriding factor has been the reallocation from China to India. That's ongoing. I don't think we've seen the proper beginnings of it. That will continue to play out over the next 3-5 years.
As we speak to allocators, we get a sense that there is clear interest in India as the next big economy to bet on. Many of them have been heavily invested in China and China hasn't particularly delivered in terms of returns, and the policy changes have left them wanting. Now, if you look elsewhere, there are not too many alternatives, which match up to China in terms of size as well as the growth dynamics. That is why interest in India is growing and it is structural in nature and we haven't seen the beginnings of that. That's perhaps likely to pan out over the next 2-3 years because it's unlikely that that money will come through emerging market funds because then, exposure to emerging markets would mean that investors will get the same exposure to China. Instead, what we're seeing is people looking at India-dedicated managers like ourselves and a whole host of other managers to get exposure to India. To that extent, they're preparing, they are doing their homework on India. At some stage, they will be in a position to press the button. The biggest hindrance to them making that call has been around valuation. Remember India stands out in terms of its earnings multiples compared to most other emerging markets. It has always been the case. We have always traded at a premium compared to other emerging markets and more so today. For them to make sense of why this premium exists and therefore it makes sense to press the button now might take some time.
In the interim, of course, there will be shorter term flows that might be dependent on interest rates, although I'm not sure given the sort of economic data that we're getting from America, particularly in terms of jobs data as well as wage inflation, if the Fed will be rushing to cut rates. There are pockets of the economy which are slowing down. We're also seeing data in exports of Indian companies. Having said that, it doesn't seem like the situation is so dire that there is a desperate need for a rate cut. But should a rate cut happen, we can expect flows to pick up. But these are not the structural kinds. These could come in quickly and go out quickly as well. But the structural story around reallocation from China to India is the biggest driver we need to watch out for, from a 3-5 year perspective.
Auto sales numbers, the way they have come out and the way they've come out for the last few months and also how the auto index has fared for the last few years, I mean, it's had a positive return almost every single year since 2020, if you will. The numbers for February, thus far as well don't look that disappointing for two-wheelers in particular, may be for passenger vehicles as well.
Now juxtapose this—economy buoyed no doubt by tax buoyancy, but three quarters in a row economic print is okay. But the economy-linked CVs or tractors not quite doing well, but passenger vehicles and two wheelers are doing well. How are you looking at the auto pack, per se?
Pramod Gubbi: It is a bit, mixed data, including the GDP print that we saw yesterday. Consumption clearly is not firing, but at least the second derivative seems to be changing where it seems to have bottomed out. That doesn't time with the sort of exuberance that we've seen from consumers in terms of purchase of passenger cars and two-wheelers.
There is an element of new launches, which drives auto sales as it is. And we are seeing the auto industry, especially the cars and two-wheelers being in a sweet spot on that front, in terms of the launch cycle that clearly is driving. And also, I think, the banking system being flush with capital is also supporting credit-driven purchases, whether it's automobiles or mobile phones, and so on. So to that extent, there is support from the supply side, which seems to be offsetting any sort of weakness because discretionary consumption in general, which is where autos would come in, isn't particularly firing on all fronts. Remember, two-wheelers had been through a long period of lull in terms of growth. So there is a little bit of bounce-back plus the other supply side factor has been the emergence of electric vehicles or electric scooters, which is again, pushing through some of these positives as well. So to that extent, I think it's not that straightforward that we can see sustainability in terms of growth on these fronts. We'll keep our eyes and ears open on the sector. Our play has been around luxury because clearly, one aspect of consumption that has held up has been the high-end spending. So our exposure to two-wheelers has been through Eicher, which makes the high end bikes catering to the more well-off in the country. That's done well for us, but for the rest of the sectors, we will continue to keep our eyes and ears open.
Quickly run through a piece of news that came in earlier today, or may be late last night. CG Power signed a joint-venture agreement to build, operate and outsource semiconductor facility in India. In fact, the Indian government has cleared three semiconductor facilities in addition to all the work that has already been done.
The stock was active today. It's interesting to see the kind of push that the government is doing on some of the things that—relative to may be some of the other nations, who had an earlier head start—we were lagging in. But now, we are kind of trying to make amends for that. What do you make of this push around semiconductors, the policies, the parks that are being thought of, and so on and so forth?
Pramod Gubbi: It's a great initiative. And in some sense, I don't think, we have any other option because there is a strategic importance to the sector, given the ubiquity of semiconducktors in our lives. Whether it's in consumer electronics or defence, there is a strategic reason why we need to become self-sufficient on that. Also, from an economic standpoint, given the sort of inport bills that we get on our consumer electronics and consumer goods, there's also another reason why we need to build that capacity in-house. Plus, I think we are due for a big pickup in manufacturing. That's been the case with this government with a lot of initiatives—around pushing manufacturing, for self-reliance, import substitution, and also job creation. To that extent, getting into something as high tech as semiconductors fits into that initiative as well. Multiple reasons to do this. It's a phenomenal initiative. It's not easy. I think we need to hold our horses but given where we are starting from, in terms of 28 nanometres, not particularly cutting edge. There's plenty to be done there and we have the capabilities, but hopefully over the next few decades, we can move up the value-chain towards the cutting-edge semiconductor manufacturing and become a powerhouse in semiconductors globally. But it's a great beginning. I think this is something that the economy and the country needs from a long-term perspective.
We mentioned about consumers and how consumption is weak and presumably because of the large competition coming in paints, the last 2-3 months actually have taken a bit of a hit.
I was looking at the performance of Asian Paints. An underperformance of 18% to the Nifty is not something that we are used to seeing in Asian Paints. It has been this bedrock of performance all through the last decade, and may be even for the last 2-3 years. There's this wonderful chart that we have, about how the multiples of Asian Paints have gone through the roof since 2012. And suddenly, we find Asian Paints is available at valuations that it last traded at back in 2014. Are these concerns overdone, or is it fair to be concerned considering that the paint sector hasn't seen a deep-pocketed, large manufacturing competitor come in, in a really long time?
Pramod Gubbi: I don't think there are easy answers. I think, the two extremes are that new competition will come in and disrupt the whole thing, nor is it fair to say that Asian Paints has successfully faced competition throughout its history, and will be able to overcome this easily. Truth always lies in the middle and that's what makes our jobs easier to figure out, on balance, where does this lie.
It's not true that there hasn't been a competitor of this nature. Remember, Sherwin-Williams, the world's largest paints company came to India and couldn't compete for whatever reason, and left the country. This has always been the case. This will always be the case. If you want to invest in businesses which make lots of profits, you'll have to be prepared to face competitive entry. Remember, that profit pool itself is a magnet for competition. Nobody would like to enter an industry where the incumbent doesn't make money. So in some ways, the continuous entry of new competition in this sector is a testament to the attractiveness of this industry. And the fact that the incumbents have managed to hold fort, not just for their market share, but also increase market share over time, also indicates the presence of entry barriers.
Why have some of the world's best paints companies struggle to compete in India? This suggests there are certain modes or sustainable competitive advantages. And from our assessment, a lot of the modes lie on the supply-chain, where it is a hard product to distribute across the country with so many SKUs. So you need plenty of data to drive efficiencies in the supply-chain, which in turn are passed on to the dealers. The dealer economics become far more attractive. And that's what the incumbents have done to hold fort over the many decades that they've operated. Having said that, never say never. The next big competitor could have tricks up the sleeve which are very different from those who have tried to play this in the past. Our job is to keep our eyes open and see what those initiatives are—whether they actually threaten the dominance of the incumbents from the past, or will they continue to face challenges like the competitors of the past have done.
The market seems to be suggesting that indeed, this will be a tough ask to defend. Having said that, the markets could also simply be saying that look, until and unless we've figured where this settles we would rather stay out of it, which is why you're seeing this play out closer to the launch or the entry of the new competitor while the news was out for a couple of years now. In fact, the stock hadn't gone anywhere but the correction has been much sharper in the last few weeks, around the launch time. Our job is to act on data and evidence rather than anticipation. Like I said, it's easier to take the extreme stance and say that, look, we're not really concerned about it. Our job is to be concerned and watch it. But at the same time, we can't simply say that the competitor has come in. So let's get out of it. We'll need to make a more objective assessment of the situation.
Do you fear multiples, margins and ROCs for Asian Paints and the Bergers, etc, coming under pressure?
Pramod Gubbi: In the shorter term, yes, obviously. You've seen the actions from these players already. They've already started cutting prices. But to the extent they've already preempted some of these. They have invested in backward integration by bringing in manufacturing in some of their supply inputs in fold, which adds a few percentage of the margins, which becomes a little bit of an armour for them to cut prices without compromising on the margins.
But having said that, I don't think we should expect the status quo. A competitor of this size and capacity addition of this size should definitely have some impact on ROCs and margins in the short run. But the longer term trajectory depends on how the incumbents react. Like I said, I've shared one of the strategies in their arsenal which is backward integration. Some of them have invested in new growth lines, which could offset some of the lost market share or you know, ROCs and margins crunchy. Therefore, for the longer term, we still remain quite positive.
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