portfolio breakdown: overweight automotive; Beware of banks focused on corporate investment spending: Nilesh Shetty
How do you position yourself in deep cyclicals such as the automotive and automotive auxiliary segment in your portfolio? Have you started increasing your weights here?
We believe in value styling and the automobile is one of the deepest pockets of value available. Valuations there are trading near the bottom of their valuation ranges and we actually continue to have a significant weighting there, particularly in the two-wheeler sector. We have a large oversized position there.
Again, the numbers are back to where they were ten years ago, mainly because the market has had to digest the price increases that have happened over the last three or four years. We’re kind of on the cusp of a recovery in volumes there and if your volumes generally go up. One of the main drivers is the replacement cycle which has lengthened due to economic shocks.
Maybe we’ll see some of those seated buyers come back and replace some of their old vehicles. And of course, a lot of offices are still hybrid and colleges still haven’t returned to 100%. Once that need for mobility kicks in, a combination of factors will cause auto demand to pick up, especially where valuations sit. We expect this bucket to do very well over the next two to three years. So we have a fairly large overweight position.
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What about capital goods, especially mid-level capital goods, carrier companies? , and all those mid-cap engineering companies that are good feeders for a larger investment cycle. How do you like this universe?
Unfortunately, many of them do not meet our liquidity criteria. We have minimum liquidity criteria and most of these companies tend to trade below this for us, so they did not enter our filters. But there is a cyclical recovery ahead and we will see this bucket do just fine.
You have to choose the quality of management because it is full of companies whose quality of management is not so great. You have to be very careful who you want to buy from in this bucket. I expect that if there is a generally bullish economic cycle in India which we believe is due primarily, you may see a strong recovery in infrastructure spending and the investment cycle again. I expect the capital goods as well as the attachments of those capital goods to do much better.
The CEO of was referring to the return of the credit cycle. He told us that capacity utilization in the system had increased to 75% and that inquiries about new loans related to capital expenditures had increased. Does it reassure you to hold more corporate-focused banks in your portfolio, whether PSUs or private banks?
We have some allocation there, but we have to be careful because of the price inflation you’ve seen over the past two years. Replenishing working capital alone will stimulate credit growth. So it may not be a true reflection of the underlying demand for capital spending, but simply the inflation-induced replenishment of working capital that is causing the this credit growth figure.
But we expect that over the next 12 to 18 months, at some point, companies will get serious about capital spending. We see anecdotal evidence of this in one or two sectors, but whenever I have met with banks, there is no widespread need felt by Indian companies to show strong improvement in capital expenditure. They are still very cautious and vigilant and sitting on the sidelines, but I expect that to change over the next 12-18 months once usage levels reach a certain threshold.
We have banks, but most of them are on the retail side. We have to be careful with banks focused on corporate investments, as many of them are backed by services and the quality of management there is highly suspect. We tend to stick more to the private side at the moment.
GRMs have reached record highs and now refining inventories have started to pull back. The commodity cycle appears to have peaked and lead, zinc and copper are all at multi-week lows. Did you manage to reduce your weight on the pure raw materials in time or do you expect a rebound and a healthy average achievement and therefore keep it?
Sometime late last year, we began to reduce many of these holdings. We don’t have a lot of commodities, but whatever we have, we’ve reduced a significant portion of their weightings primarily on valuations because during cyclical rallies their valuations started trading at higher valuations relative to their historical ranges.
We have reduced this and are patiently waiting. They have corrected quite sharply and in many companies, although the price correction may not justify the kind of stock price correction we have seen. If the price holds and there are opportunities for us to add more, we will have to wait and watch where commodity prices end up. If they end up going down, you might see a little more pain in that bucket, but we’ve reduced our positions in the commodities space.
We know that small and mid caps are more of a bottom-up opportunity, but has the average valuation of this universe corrected enough to start looking for value there?
We have a significant weight on corporate governance and getting quality management at valuations we are comfortable with has been a big challenge for us. So even after the corrections, the best managed companies with excellent franchises or commercial quality continue to trade at higher valuations.
We’ll get value in companies where maybe the quality of management is suspect or the business models aren’t that good and it’s not a space we want to own. So I will be careful. I don’t think much value has emerged in that bucket yet. As they had a massive rally, they are now seeing a correction and investors should still be cautious in this bucket.