Ravi Dharamshi: Antifragile India: If World Markets Rise 1x After Fall, We Will Rise 1.5x: Ravi Dharamshi

“We are on the cusp of a manufacturing renaissance, a revival in capital spending and the credit growth and property cycle in India,” he says Ravi DharamshiFounder, ValueQuest Investment Advisor.

When markets fall, long-term investors get good entry levels. So will you smile now?
Honestly, the smile isn’t because the market is falling, everyone makes the mistake of extrapolating US inflation onto us and the way US interest rates are rising on India and believing that we’re falling as well become as the US markets fall. We proved last year that India is antifragile. I use the word carefully because a lot of people use the word decoupling, resilience and other terms, but I don’t think we’re decoupling. We cannot go in any other direction than Mothership USA. We also show no resilience in terms of falling less than the world. But when the decline stops, if world markets go up 1x, we’ll go up 1.5x. That’s the kind of resilience and outperformance we’re showing in the face of macro headwinds.

I would say India is antifragile and there are good reasons why we are showing this kind of outperformance. The smile is more that India will do well in this world where there are all kinds of insecurity.

The price development was downright breathtaking. Last time we spoke, you said that if you buy autumn in May and June, you will laugh in the second half of this year. That happened. But what happens now? In the event of an energy crisis in Europe, there will be a major attempt by the Fed to cut demand. It will have an impact on global growth.
There is no denying that US inflation is proving to be far more stubborn and if inflation remains stubborn then interest rates will rise in the US and when that happens then there will be a risk aversion environment around the world.

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However, the impact will be more direct on India on the export front, but more on the services export front. India is in a different cycle be it manufacturing cycle, investment cycle or real estate cycle. We are in a very different cycle than where the world is. A few days ago, Akash Prakash also wrote an article saying that we are at the opposite end of the real estate cycle compared to China. I think that’s absolutely right, but that’s not just true for real estate, it’s also true for the manufacturing cycle. The crisis is nothing new. We have experienced so many crises. So many things have gone wrong in the last 10 years – be it a self-inflicted wound or something external, but India has found a way to survive and thrive in this environment and thankfully things seem to be working out to be like that also in the geopolitical context on the spot.

I’m not sure how much credit should go to the government, but I’m definitely enjoying the benefits of it. In a scenario where people from China are looking to shift their manufacturing supply chain into an environment where energy bills are skyrocketing in Europe, all indications are that India is the only choice as a manufacturing base big enough to take the kind of shifting going on in this world.

So every earthquake that happens elsewhere in the world makes people look at India even more positively. I am really very excited about this fact. We are on the cusp of a manufacturing renaissance, a revival in capital spending and the credit growth and property cycle in India.

Given that you talk about India being a bright spot, is now the time to avoid the export dependent sectors like IT, pharma etc and probably look into capital goods, capital goods etc?
Yeah, so I don’t want to generalize, but this is where the pharma industry definitely has its own challenges. Buyers in the pharmaceutical sector are consolidated. IT will definitely rise to this challenge as we have seen tremendous margin expansion and strong growth spurt. To some extent this growth has been lumped together because of Covid and now that the Covid situation is normalizing some of that growth may go away and some of the costs that weren’t there during the Covid times, like travel, can come back and therefore the margins get impacted. So IT is definitely facing at least two to three quarters margins and a slight slowdown in growth.

Pharma has been in a challenging environment for most of the last three to four years, with the exception of a few quarters during Covid where there was some temporary spike in demand. Again, I’m not saying this is the export market to avoid, but there are other export markets that are doing well. So, manufacturing, engineering and defense exports are increasing. Those are the places to focus on from an export perspective.

Basically, I look at companies that are more domestically oriented; if they have an export business, fine and dandy, but you should look at companies that are linked to the domestic cycles because that’s where the revival is happening.

So what would fit this bill? Would it be defense companies or some soft capex issues, capital goods or infrastructure, real estate?
Capacity utilization is increasing across the board. Whether steel, cement or mechanical engineering or energy – utilization rates are increasing everywhere. For example, Power had 69% PLF last month, which is the best it’s been in a long time. This tells us that even with thermal energy, a certain amount of investment will be incurred soon enough.

Yesterday someone in the industry said that by the end of this decade we’re going to need an additional 32 gigawatts of thermal power if you want to accommodate all the new renewable capacity coming on. So the investment cycle this time differs from that of the 2003-2008 cycle, in the sense that investments in thermal energy are quantitatively much lower compared to this cycle.

The larger part will be occupied by renewable energy, but although thermal energy investment, which has been declining for the past 10-11 years, will see a small revival with the annual addition of 1 GW, it will increase to 5-6 GW Art an addition in the next four to five years.

Capacity utilization is increasing sector by sector, new companies are being registered and the number of environmental assessments is increasing. All of these are early indicators that the investment cycle will pick up soon. One of the things we track is the cash flow from operations to investments made by the company, and that number is almost two to three decades high. We haven’t seen any companies of this type make a profit in the last six to eight quarters. But they don’t invest in Capex accordingly.

Part of this could also be because investment intensity in this industry may have fallen as more automation is taking place. At the same time, I believe that this number is unsustainable and that some investment must be made. So yes. sector-specific investment spending will pick up. The overall numbers may not look that attractive for a year or more.

If you look at the underlying score, the overall picture you shared is 110% valuable. Capital expenditures and utilization rate are all picking up but some would argue they are trading at a PE multiple of 50 plus, 60 plus. Some of these stocks are at multi-year highs?
No doubt the market has a sense of this way back. It’s not like they’re thinking about it today. Today is the real event in terms of capital spending or rising order books for these companies, but the market recognized this much earlier. However, these 50, 55, 60x multiples can be a bit misleading as they are based on a low win basis.

Corporate profits are at or just above the peak reached in the 2007-2008 cycle. The winnings still have to be picked up. Overall utilization is low. Material prices are falling now so we still have some improvement in gross margin and operating leverage ahead of us and the tailwind or industry visibility is in place for at least three years. That tells us earnings will get better and better over the next 8, 10, 12 quarters. If that’s the case, there may be some degradation in performance, but absolute prices will still go up from here.

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