Anil Rego of Right Horizons
“In the pharma space, we are bullish on companies available at reasonable valuations with CDMO segments since it supports pharmaceutical companies in the process of making medicines by providing services in the research and development stages, offering support in manufacturing, and providing formulating and finishing processes,” Anil Rego, Founder and Fund Manager at Right Horizons PMS says in an interview to Moneycontrol.
Among others, the chartered financial analyst with more than 30 years of experience in financial markets is optimistic about the building materials demand outlook due to increased investment towards infrastructure, urbanisation, and a recovery in the housing and commercial real estate markets.
“The building material segment in India can be broken into paints, tiles, plastic pipes, wood panels, etc. These segments are anticipated to grow between 8 and 12 percent for the next five years due to urbanisation, real estate market recovery, and increased discretionary expenditure,” he said.
Do you see any kind of slowdown in earnings growth for the coming quarters?
The third quarter earnings were a mixed performance, with BFSI and the auto sector continuing to report a healthy performance. The gross margins of the consumer sector improved sequentially due to softening of some commodity prices and the chemical sector faced challenges due to the challenging global environment.
Double-digit growth in the top and bottom lines was witnessed in automobiles, IT, power and capital goods. At the same time, iron and steel, non-ferrous metals, crude oil, cement and textile dragged down the overall profitability. Excluding BFSI 9MFY23, we have seen adverse effects on the margins front, impacting the overall earnings.
We expect corporate earnings for the following quarter to be supported by the improvement in the global environment and the normalisation of input costs.
Do you see any threat to the 6.4 percent growth estimates for FY24?
RBI has projected real GDP growth for 2023-24 at 6.4 percent taking into account factors such as a likely boost in rural demand due to stronger prospects for agricultural and allied activities, urban consumption supported by discretionary spending, rebound in contact intensive sectors, strong credit growth and government’s continued thrust on capital spending and infrastructure while external demand affected by a slowdown in global activity, with adverse implications for exports.
The threat remains largely external; slowing demand for exports is the downside risk.
Do you think the RBI will continue hiking the repo rate if the Fed remains hawkish for longer?
The repo rate increases that were undertaken since May 2022 are working; it is important to be attentive, so inflation can eventually come down to the tolerance band and align with the target. We expect RBI to increase the repo rate to 25 bps in April as the MPC is of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored and break core-inflation persistence.
The aggressive rate hikes by the Federal Reserve have made it difficult for emerging economies’ central banks. We expect the rate hikes to peak in 2023 and remain at the levels during the year, and we are closely monitoring the next policy as it remains crucial for the monetary stance worldwide.
Should one start focussing on pharma sector, which was one of the underperformers since last calendar year?
We are bullish on companies available at reasonable valuations with CDMO (contract development and manufacturing company) segments since it supports pharmaceutical companies in the process of making medicines by providing services in the research and development stages, offering support in manufacturing, and providing formulating & finishing processes. CDMOs have been on the rise and will be of further importance in the next decade.
Hospitals, a branded business because of their consistent performance, growth, improved metrics and earnings momentum, are favoured within the space. We expect double-digit growth for the healthcare sector in FY24 even as occupancy recovers and is yet to reach pre-Covid levels. We are seeing companies paying off debt and improving cash flows and higher average revenue per operating bed, reduced average length of stay, and higher speciality surgeries.
We prefer companies at reasonable valuations with drivers such as improvement in bed occupancy rates and increasing bed capacity with ROE above 15 percent.
How will the market look in the next financial year in terms of returns and what are the most expected challenges?
The production-linked incentive (PLI) scheme plays an influential role in the government’s contemplation to make India a global manufacturing hub and the free trade agreement (FTA) a propeller for increasing exports. In FY24, capital goods, FMCG, pharmaceuticals, consumer durables and logistics are likely to see a stronger capex.
India’s share of global exports is below 2 percent as against China’s 15 percent. The conducive policies are incentivising exports, and the government’s focus on signing FTAs with larger economies will present valuable opportunities and is likely to increase the share of currently exporting key commodities.
These two levers will set off a multiplier effect and are likely to emanate demand in exports of petroleum products, automobiles, chemicals, pharmaceuticals, electronics, engineering goods, iron & steel and textiles in the forthcoming years.
We expect a softening of exports due to a slowdown in the global economy in the short term. We are concerned about political and geopolitical shocks that might affect the global economy leading to tighter financial conditions or adverse effects on commodity supply and higher uncertainty. We are optimistic that growth in the domestic economy trumps the cautious global economic outlook fraught with numerous risks.
Any theme/s that must be part of the portfolio for FY24?
The overall credit growth remains robust for the banks and NBFCs across all their segments with healthy expansion in the NIMs (net interest margin). We expect NIMs to peak in the coming quarters and banks with strong retail liability franchises to likely benefit. Low corporate leverage and slippages are resulting in a consistent decline in GNPA (gross non-performing assets) ratios across banks. Credit costs are expected to remain below long-term averages because of a high Provision coverage ratio and healthy recoveries.
We are bullish on quality auto & ancillary names and expect commercial vehicle (CV) growth momentum in FY23 to continue with the government’s infra push and replacement demand and the passenger vehicle (PV) volume growth to beat the FY19 peak of 3.4 million units in FY23 driven by new vehicle launches, especially in the utility vehicle (UV) segment.
The 2W ICE demand growth depends on the rural economy’s pick-up and export demand. Electric vehicle (EV) volume will continue witnessing growth in the coming quarters as it gains traction from urban and semi-urban consumers. Auto OEMs (original equipment manufacturers) and ancillary companies are to see improvement in margins as a benefit of the drop in commodity prices in the mid of 2022.
We are optimistic about the building materials demand outlook due to increased investment towards infrastructure, urbanisation and a recovery in the housing and commercial real estate markets. In the recent Union Budget 2023-24, the government has proposed to increase funds for the PM Awas Yojna by 66 percent making it a Rs 79,000 crore boost for affordable housing segment in India.
Additionally, the government has proposed investing heavily in transport infrastructure projects benefiting the real-estate markets across India, especially in Tier-2 and Tier-3 cities. The building material segment in India can be broken into paints, tiles, plastic pipes, wood panels, etc. These segments are anticipated to grow between 8 and 12 percent for the next five years due to urbanisation, real estate market recovery, and increased discretionary expenditure.
Residential and commercial real estate organisations have been slowly recuperating since 2021 and are anticipated to expand. Even though interest rates have risen, they are still below past peaks, making home loans affordable and likely to grow.
Are you betting big on PSUs, including banks?
Over the past few years, public sector banks (PSBs) have operated with low levels of capital and due to poor operating performance were unable to approach the markets resulting in slower balance sheet growth. Return ratios of PSBs were under pressure for many years with quality names taking a significant stock of provisions towards stressed accounts and reported losses over FY16-20, resulting in negative return ratios.
However, we are witnessing that the profitability of most of the PSBs has improved significantly and a few have also been able to raise capital from the markets. This and continued moderation in risk-weighted asset density have led to steady improvement in capitalisation ratios. PSBs, especially the good quality names, have been witnessing a recovery since FY21 and we believe they are on track to undergo normalisation in earnings aided by lower credit costs.
PSBs have focused on strengthening their balance sheets and consequently, their GNPA/NNPA ratio improved sharply from the peak in FY18. The provision coverage ratio over a similar period improved to 72 percent from 45 percent in FY18. The asset quality of PSBs is expected to strengthen further over the coming quarters as the NPA cycle is mostly behind and no large-ticket corporate accounts are under stress.
The current RoA, despite a lower treasury income forecast, is significantly lower than the average during FY04-13, and the current credit cost estimate stands higher than the 10-year average for most banks, which is expected to be moderate. As the quality of earnings improves, it will enable PSBs to sustain RoA and likely improve.
A sustained and consistent performance on delivering healthy return ratios is expected to result in further re-rating of the stocks. The improvement in RoE (return on equity) has been encouraging and a sharp moderation in the NNPA ratio has increased the adjusted book value. We are optimistic about the valuations of quality PSBs considering the growth and profitability outlook.
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