Zomato IPO expected to do well given the investor interest, but doesn#39;t seem like a multibagger story: Naveen Chandramohan of ITUS

Market Outlook

Naveen Chandramohan, founder & fund manager at ITUS Capital believes Zomato IPO should do well because of the supply-demand dynamics and interest among investors to own internet businesses. Although looking at the business today, it doesn’t appear to be a multibagger story, he said in an interview to Moneycontrol’s Sunil Shankar Matkar.

Talking about healthy sectors, ITUS has exposure to 6 sectors, including AMCs and chemicals, which the firm believes will continue to show strong earnings.

Edited Excerpts:-

Q: What are your broad expectations for June quarter earnings? Do you expect more upgrades than downgrades despite second Covid wave?

As a firm, we are concerned about our portfolio earnings alongside companies we monitor. From our portfolio’s perspective, we expect the quarter to be robust with our portfolio companies delivering a growth of mid-teens from a cash flow growth perspective. While we monitor the earnings of the broad ‘market’, our focus is on our portfolio companies.

Q: Which sectors are expected to report strong earnings and weak earnings in the June quarter period?

We have exposure to 6 sectors/themes which we believe will continue to show strong earnings – private sector banks, manufacturing based active pharmaceutical ingredients (API) Pharma, exchange and financial infrastructure companies, asset management companies (AMCs) and chemicals. I had spoken a few months back around pressure on margins from FMCG companies and I expect that to continue. In the short term, this should be offset by revenue growth (from the topline) but the valuations do not allow any room for safety as far as we are concerned.

In subsequent quarters, as supply normalises, we expect balance sheet of some of the companies to weaken as working capital increases (again this would not be visible in earnings but needs to be looked at from a balance sheet perspective).

Q: Should one lap up Zomato IPO? Also, is it a multibagger story?

Investors love stories and narrative around stories. Zomato is the first (and in our view likely to be the largest) IPO subscription equity markets have seen. Analysts have already started comparing the business to Doordash and Meituan (though I believe this cannot be far from the truth – the pricing power of Zomato as a platform is yet to be seen). As we see things today, the IPO should do well because of the supply-demand dynamics and interest among investors to own internet businesses.

At our end, we would be happy to stay on the side-lines as I do not like the economics of the business today (This does not mean the business cannot go 2x from the IPO price). Is it a multibagger story – the way I look at the business today, my answer would be no. However, we need to watch the execution and growth and be flexible enough to change our minds, if we are proven wrong.

Q: What is your view on the tech-based startups hitting Dalal Street? Do you think every tech-based start-up turns successful in the beginning will be a good investment in the long run?

Feels like we are entering the early stages of the mid 90s in the US, doesn’t it. Everyone wants to own tech today. We are strong advocates of tech companies which enable a business or eco-system. This gives you an ability to build a network based infrastructure as you scale (this can come from banking, communication or financial – the spaces we like). However unless you are growing cash flows (it’s important to distinguish between cash flows and PAT), we would be skeptical of the business. When a theme translates into a story, it’s easy to get carried away – we are not there yet, but we very well could in the next few years. It’s important to realize Apple was a tech startup when it listed and it transitioned into a consumer company over the next 15 years. One needs to be open minded when you evaluate companies rather than work with pre-defined biases.

Q: Do you think banking is the only sector that can drive the next market rally as it (up 11 percent) is the second underperformer after FMCG (up 8 percent) in current year 2021?

I believe we are getting into an environment where we expect quarterly returns as a given. Again to put things into perspective, banking has been one of the best performing sectors (specifically – private sector banks) over the last 1.25 years, considering they were the worst hit (since March 2020).

For banks to do well, you would need interest rates to normalise and move higher and more importantly for the capex cycle to revive significantly (where the credit growth picks up). We do not see that yet from a structural perspective yet. Again, our portfolios are constructed around cash flow growth over the next 3+ years rather than for the current year.

Q: What is the reason for underperformance in FMCG space? Should one avoid the sector or be an investor?

The beauty of investing is there cannot be black or white answers (as investing is around probabilities). FMCG (Discretionary and Non-discretionary) have given returns in excess of 22 percent internal rate of return (IRR) over the last 4 years. The underperformance we are talking about is more recent (in light of some of the cyclicals outperforming significantly – it’s important to put things in perspective when one looks at returns – remember, equity is not an asset class which is meant to give quarterly returns, but that’s how we measure our portfolios, which result in skewed narratives).

We have very little exposure in the space primarily because of valuations. These are great franchises, but one must remember that a great franchise does not translate into shareholder returns if valuations are ignored.

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