Industrials Show Potential For Value Opportunities, Says Invesco's Taher Badshah

Taher Badshah: Between those two factors—essentially the core fundamental factors and some of the other elements also which come as part and parcel of a reasonably decent bull market—I think there is a fair bit of predominance of the former. That probably makes this rally a little different compared to what it used to be in the past. It is not probably the first time that we've seen a reasonably decent broad-based market rally and, you know, fairly strong performance as we all know, of mid caps and small caps, particularly in the space of the last 12 months.

But I think this time it is different from the perspective that it's supported by, as you know, reasonably decent earnings trajectory and earnings growth as well and the outlook and the forecast as the things stand today are looking reasonably healthy.

So I think under the circumstances therefore, if I were to probably you know, contrast it with let's say, the last mid-cap, small-cap rally, which we saw around the end of 2017, or early 2018, or towards, or during the period of 2017, if I reflect right, it was a very strong rally at that point in time as well. But would you argue that it was also supported by strong earnings growth at that point in time? Probably not. I think, in that year too, we saw a very strong performance of the broader market in India, probably led by different kinds of factors at that point in time which were at play.

But I think, this time around, therefore, to the extent it gives that added layer of confidence. However, I am not saying that we can't have periodic draw downs. We will, and especially the market tends to at times get a little ahead of itself, versus even the good fundamentals that we see. I think that's likely to happen and probably, we will see those kinds of instances as we saw in the last couple of weeks where there was a reasonably sharp draw down. But I would like to think that's part of course, if you get those kinds of corrections and valuations at some level. Therefore do become a little more amenable, palatable. I think those will only be good entry opportunities. We still see the overall economic configuration as reasonably healthy. I don't really see a lot of devil in it at this stage.

Taher Badshah: You are absolutely right in saying that. Look, if the growth rate tapers off meaningfully or materially, I think obviously that will lead to a fair bit of compression and the valuations as they stand today. But, I would like to think that it's not as much only about tapering. I mean, that's likely to happen. At any base, you will have to contend with the fact that you know, you can't have 25% or 30% compounding every year and you will slow down to some extent.

But if it is reasonably healthy, and if it doesn't slip down too much, I think what the market will probably focus on is it reasonable, lower, but is it longer enough and is it sustainable enough for relatively longer duration compared to what it has been in the past? And if that were to be the case, then probably what we can argue for, is valuations peak perhaps at least a couple of notches higher than what they used to be in the past averages, at the same point of time in the cycle. I hope you know what I mean.

So basically, what I'm just saying is that you probably have a case for a rerating, probably of a somewhat better magnitude on a longer history and especially if earnings growth is of a better trajectory or better magnitude compared to what it has been in the past and the longevity is probably somewhat better than what it used to be in the past.

Taher Badshah: So you know, we are to be on the side where you see visibility. I think, you see visibility in the camp where there's a possibility of growth being relatively stronger compared to what it used to be in the past. There have been policy initiatives earlier and there have been policy initiatives now as well. But, you want to just try and understand as to what is the stability of these policy reforms and probably what kind of longevity it can bring. You can be in one camp but you don't have a choice but then keep assessing and reassessing at all points in time.

So even though we may be in the positive camp as of now we don't have a choice but to continuously reassess what the landscape is looking like, how our assumptions are being fulfilled, and if there is any detraction from that. We, as money managers, we don't have a choice but to kind of take the reality into account and start trying to see as to what kind of precautionary measures we need to take, or reallocations that we need to do in our portfolios.

But as things stand, I think, like I said, it's all about assessing the visibility and you know that there are certain factors which are driving and likely to drive the growth of a particular theme. If those come into question, and you strongly believe that those questions are merited, I think you don't have a choice but, irrespective of whatever camp you are, you need to reassess the situation.

Taher Badshah: Today it goes without saying that the industrial cycle—which has been in a decently strong momentum and which we all actually should wish continues for a longer period of time for the good of India—I think is still in good shape. And that is where much of the incremental opportunities at least from a point of view of not having to worry about the visibility of growth is going to come through. And that is where a larger part, a larger section of our portfolios is, obviously, directed.

But be that as it may, I mean, we don't have a choice but to also look at value opportunities, which might unfold as a result of the market being significantly attentive or concentrated towards one particular area. It always happens that if a larger section of the market looks at only a certain set of companies and a certain set of stocks and industries, there will be laggards, there will be value which will start developing in some other parts of the market.

So, I think, from a growth standpoint, clearly the industrial segment and everything related to the investment cycle by and large is likely to continue to do well. But we try to mix it with some of the value opportunities that we might probably spot at various points in time and different sectors. It could be consumption at some stage. It was pharma—let's say about 3-6 months ago—which is just trying to kind of make a reasonably decent comeback. They—pharma and healthcare—have played out pretty well. It could be banks at certain points in time, although we may probably find it difficult to actually see triggers around it at this stage. I will probably also be constrained to give you what would be the catalyst which will probably take some of these banks up in terms of the valuations that we are on. But value does tend to develop at certain points in time and if you believe these are franchises, which are reasonable to bet on and they provide value. I think we don't have a choice but as managers to reflect those in our portfolios.

Taher Badshah: Probably only want to add that sometimes we don't really know whether these valuations are true or not, in the sense that you might get earnings upgrades along the way, and especially if the cycle is strong.

So, what appears to be high valuations might be apt valuations and we've seen that happen a fair bit in the last 2-3 quarters, where some of these companies in these sectors which have looked apparently very expensive, have turned out to deliver relatively robust earnings and once upgrades to earnings come in, then the upgrade cycle itself is sufficient enough to ride these stocks.

Taher Badshah: We do have some exposure to life insurance companies and very selectively though. We like the proposition in a couple of cases, especially where the product basket is reasonably well-diversified.

Last year when we saw the changes brought about in the 2023 budget, with regard to the insurance companies, I think it was a reasonably decent value opportunity, which got created at that point in time in some of the reasonably decent front-line insurance companies. We did approach it from a value standpoint at that time and it reflected in some of our value strategies, or at least a value portion of some of our funds. So I think that is something which we were able to play but from a value standpoint at that point in time.

I think, in general, this is a sector which still has growth characteristics. We know that, right? We might not be underpenetrated as far as life insurance is concerned, but it is still a reasonably decent growth portion of the economy and the financial services segment.

Incrementally, I think, the approach that we've had to banking and financial services is also a little different compared to what we've been used to in the past. Five years ago, we were always largely focused on lenders. So whether it be the banks and the NBFCs, today, the landscape has changed as far as banks and financial services together is concerned. There are good number of opportunities in non-lending financial services and I think insurance is one part of that opportunity. So it does make sense to look at some of them particularly where we see the product basket as I said, being relatively more broad-based and appropriate.

Taher Badshah: We had started off with conviction around a couple of them, about a year-and-a-half back and then a couple of others have joined the party or joined that proposition as we felt all along.

So I still, personally like the defence theme. That's something which I believe is something which will probably have stronger legs and more visibility as we go along. I think that sector is reasonably concentrated, in the sense that you have a few players who are dominant in their respective sub-segments of their defence ecosystem, and each one of them has an important role to play.

Within that as well, we probably like a couple of them over a couple of others. But, by and large, I'm reasonably constructive on that space. I've been for a reasonably good period of time and that still seems to be the best place to be around in this thematic-driven or policy-driven part of the market. I think, railways is another where we have probably not been able to have a lot of exposure. But that's something which is, again quite exciting because there could be a couple of plays which are even in that segment, which are not necessarily capital-intensive based, in the sense that they're probably not as balance sheet driven as what probably other such segments are. So I think that's something which is another area that we've liked.

I think power along the way has provided some opportunities either in the form of certain utilities or probably even in the case of certain financiers. Those are the players which have made a pretty strong cyclical comeback after a very long period of time. Obviously, the cycle as of now is still in their favour, and we're still in the early stages of that cycle. Probably that is what you would like to think, but then we have to be watchful. I mean, these are some of the segments, which have shown certain challenges as the sizes have grown and as the cycle has tended to become more peakish. So I think we have to be careful about those. We have to be watchful and careful about some of those challenges and risks, which are associated.

But at this stage, we would like to think that these are still either in the early or in the mid-cycle stages of their new cycle.

Taher Badshah: Hunt for value, to some extent. But it's clearly very difficult. And it's just started nibbling at it, if at all. It's not something that we are able to get our hands around, and probably develop a lot of confidence.

But like I said at some point of time in the earlier part of the conversation, we need to be watchful of some of those value pockets which might develop and we probably may not have the necessary triggers. I mean, we might have some expectations but the triggers may not have fully manifested. So we are approaching it from that standpoint. We're taking some baby steps. So we would like to think that there can be a couple of things, which can change the fortunes of the sector.

I hear you when you say that raw material prices have probably once again started to go up. And that takes away some part of the sheen from the sector once again. (That) at least supported the companies during the last 12-18 months, when volumes were actually a little difficult to come by. Probably the next leg of the story, if at all it unfolds the way we think, might come from recovery in volumes. The margins may not necessarily be as strong at that point in time.

But I think in this sector, valuations do tend to get driven by what we see on the volume side and on the revenue side. And I think if that starts looking up, it would be after a fairly decent gap. The triggers could probably range from let's say, good monsoon coming through in the next some time versus let's say what we've had in the last couple of years or probably some policy changes, which start to address some of the low to mid segments of the income pyramid.

I think those are things which can probably resuscitate the sector as such. But, we'll have to wait and watch. So like, I said, there are some triggers in mind but we don't have a choice but to kind of wait for them to manifest a little more strongly before we move in a lot more confidently than we are today.