I want to touch on the microfinance institutions because within financials, a lot of companies are coming forward and highlighting that in the next two quarters, they are looking forward to better numbers, better industry growth outlook and some of the issues with their balance sheet should be over by then. Do you believe in this particular story?
Dhiraj Agarwal: Yes, microfinance is bottoming out and it is turning around, that is our house view at this point of time. Banking in general is looking fairly solid because there is just no NPL stress. So, banking comes under problems only when there is a rising credit cost or NPL stress. There are no signs of that right now. A little bit of pressure on banking is coming from the fact that the credit growth for the system has declined from 15-17%, run rate down to almost 10%.
There is hope and expectation that this will pick up in the second half of this year. But if the trend does not pick up, then the earnings growth remains tepid and the banks might just remain in a range. But I do not see any risk or issue there. There are fairly solid reasons to believe that in the second half, there could be and should be an economic turnaround, better economic activity and hence a pickup in credit.
There is a lot lying on the capex front from the private sector. This whole uncertainty on tariffs and trade deals, etc, will completely go away hopefully by mid-July, early July, or if it drags on a little at least by the end of first half. And uncertainty going away is always better for companies to restart their project plan. So, the plans are already there. They are not getting commissioned. As soon as these uncertainties fade, the project plans will restart and the economy and the credit growth will start to rebound. So fairly optimistic from a longer-term point of view.
Last time we interacted, your stance or your strategy was to ignore valuations at the moment and look at earnings. Now that we are past that Q4 earnings mark, where it has not been all that bad and in the last six months, we have seen the market swinging in both directions. Do you believe this strategy continues or there’s a different approach to stock or sector picking?
Dhiraj Agarwal: I never say ignore valuations. I think one has to be cognisant of valuations. Maybe I said it in the context of polarisation which is happening. So, whenever the investable universe starts to shrink, which is only a smaller percentage of companies, while 30% or one-third of the companies are able to deliver fantastic earnings numbers, the entire liquidity tends to shift towards that particular end of the spectrum and that is what sometimes drives valuations to astronomical levels. We saw that between 2015 and 2020 when the investable universe really shrank. It just came down to literally consumer companies and private sector banks and not even all private sector banks, just a few private sector banks.
We saw valuations in a number of these stocks go to astronomic levels because of which there was a three-four-year consolidation post 2020 and absolutely no price performance. It can happen again if the polarisation continues for a bit longer and maybe in that context, I would have mentioned that, because there is difficulty in bulk of the companies delivering solid earnings growth. For the few companies which are outliers, valuations might not matter in the near term.Somebody is looking at let us say, taking a three-year view. Do you think there is a difficult chance of getting a double digit return or is there a reasonable probability that if the starting point is today, the CAGR over the next three years could be 12-15%?
Dhiraj Agarwal: At the index level, it is honestly difficult to get 10% plus. At a portfolio level, it should be possible.If one has to make a portfolio, let us talk about some of these powerful themes; some are calling it narrative, some are calling it future theme, some are calling it the next wave. EV, solar, drone, AI, these are popular themes not only in India but globally also. What do you like within these three-four themes?
Dhiraj Agarwal: These are all long-term structural trends. For example, let us take defence. Defence spending is a long-term structural trend. I just read this morning that Nato has finally agreed to increase their defence spending to 5% of GDP and this was under 2% before this entire geopolitical mess started to happen. So, under 2% to 5% is a huge jump. So, that theme continues. Renewable energy, solar, themes also continue.
So, in terms of businesses, some of these are structural 5- to 10-year trends and I do not see too much risk in this trend getting stalled or upset over the next few years, including energy. India is very close to being very finely balanced on the electricity production and consumption side. We need more investments. We have not invested enough in electricity generation in the last 15 years, those investments also need to go in.
So, while the business trends are secular and more long-term in nature, in terms of converting it into stock ideas, one will have to pick and choose which companies are able to participate in a smart way, deliver earnings without diluting ROC and ROE and where the valuations are also in a range where one should be buying. So, stock picking and sector trends might be slightly two different cups of tea.
By
