Market Sans Entry Points Despite India Inc.'s Goldilocks Phase, Says Kenneth Andrade

Kenneth Andrade: So the environment is fairly robust still and we are at a point in time where corporate utilisation of capacity utilisation is now very close to 90%. So the profitability growth of the broader market should be fairly healthy for this financial year also.

There are two parts of the conversation, one is the economic condition and the corporate profitability. No arguments that we are probably having a Goldilocks period. The second is, how do we participate in it and finding pockets of value in this marketplace. So if you're looking for value in this marketplace, my simple recommendation is don't, because it doesn't exist. So it's a market where you will have to align with businesses where you think growth is there and it's fairly obvious into this one year where it will be.

So I don't think you are going to have too many disappointments coming up this year. The problem remains, how valuations are and how they trade. So I am fairly bullish as far as the economic conditions are concerned and as far as where profitability is. I might be a little circumspect on the other hand on how to generate returns from this buoyant economy.

Kenneth Andrade: So let’s put it this way—it's very hard to find an industry which is struggling. Everyone is profitable. Everyone is generating cash flows. It means that some of these industries will not be at the peak of the cycle but they are still generating some amount of cash flows.

And we are looking at any industry that is going through a correction in this entire space. To be frank, over the last couple of quarters, we haven't had a new inclusion into the portfolio for quite some time. So we stay with what we have, because this is what you know. There will be some businesses that are outside your portfolio which are doing well and you could put them on your radar. But I think you'll get opportunities maybe this year, maybe the next year sometime to buy them at a fairly comfortable valuation.

So in terms of executing what we have, very few spots where there is trouble, but wherever there is, it necessarily needs to be on the radar because again, even those places are fairly well-priced. They are not cheap. Wait for an opportunity. We've all seen multiple cycles. There's never going to be a case where this market will not give you an opportunity to allocate fresh capital.

Kenneth Andrade: FY25, you shouldn't have a problem, like I said. In most corporates that we engage with, or have a conversation with, everyone's running at full steam. So there, there's no challenge and when you have capacity utilisations run at this level, profitability growth will start. Then you have the next capital creation cycle that will start. So the narrative is extremely strong. I don't doubt it at all.

Kenneth Andrade: I think everyone's doing it. Infrastructure is on a roll. Any industry, which is linked to those businesses is doing extremely well.

We have a very large exposure to pharmaceuticals, and that includes businesses that are facing the international market. So basically manufacturing pharmaceuticals. And they have a really robust pipeline that is there plus profitability is also at its all-time high, and you've seen the back of capex out there. So that's the second place that we've seen.

In the chemicals space, I think, a lot of capex is already going on the ground and in some cases, utilisation levels have fallen off, because new capacity is coming on. So I think over the course of the next two or maybe the next three years they could rebound with a fairly strong cycle that is there.

As for the automotive cycle, I think, there are more from the ancillary part rather than OEMs. You could get a select few that will break out into the international space and do a reasonably large workflow.

So these are isolated cases that are there but the one that got the maximum amount of momentum in terms of headline numbers or sales numbers, and continues to remain infrastructure which is a very domestic business and very linked to the government spends. I think that's probably the biggest sweet spot that the market has at this point in time.

Kenneth Andrade: So, if you cut across the value chain, there is the developer at the top end and then there's a commodity basket at the bottom end. And companies are seeing profitability right through that entire value chain. So developers are bidding for larger projects. Contractors are getting bigger pipelines of orders and it's translating into a lot of commodity demand that's happening at the other extreme. This is the workflow that is there at this point in time. So you will have to pick and choose where the sweet spot is, to participate with this marketplace.

So we have got a commodity basket, which we have spoken to a couple of times in the last one year. We have got a few contractors and the reason why we got these contractors is basically they're now peaking at their margins, which are at their historical high.

So we've come from distress of 2–3 years back to peaking margins, which is at an all-time high, but the workflow is still there. So as long as you participate with the narrative, it's fine. If you want to ask me, am I putting a new position into play in the contracting business? No.

In the commodity cycle, I think it still probably has some legs to go because we've got volume growths that are still fairly robust. Then the last part of it all is that the government in this cycle has been an extremely good client customer compared to the previous cycle, where working capital cycles ballooned. This time around, it is much more manageable. The risk that is also there on most of these companies earlier was very centric on state governments. Now most of the companies have been able to distribute their risk across multiple projects, multiple governments and the size of these opportunities are significantly larger. So that's the context as you lay it down.

Obviously, the power market is extremely robust. That's where the developers are, that's where all the capacity creation that is happening, which is also linked to infrastructure. So power capex is one of the largest piece of infrastructure creation...

But when I put all this in play, I basically isolated two places that are there. One is the contractors and second is the commodity market, where we feel there's an element of safety as far as the valuations are concerned but the other part of the market, which is capital goods to a very large extent, seems to be pricing something that I would not be able to quantify or justify by aligning with some of these businesses out there. They trade like they are consumer non-cyclical businesses.

Kenneth Andrade: So as long as the narrative remains strong, I don't think the valuations will correct.

Kenneth Andrade: I will try to be a little specific. In our individual portfolios, we have large IT companies. So when I break up the portfolio and look at businesses that are tilting towards the large cap part of the entire segment and then there's obviously a mid cap and a small cap part of the segment. A lot of IT businesses trade significantly lower than most of the other mid caps and large caps. So you've got a very solid business out there, which has got mature visibility out there, trading lower than the marketplace itself.

So that's one element of why I think this sector trend has reemerged, because if I have to put incremental amount of money that's coming into the system and I as an industry has to put an incremental amount of money in the system, they will look at opportunities which are not done very well, have an element of valuation comfort on a relative scale to the marketplace, and then look for the element of growth.

Now, if you go back a couple of years till today and if you look at all my key services, businesses, they have all been talking about, and they've all been building up a robust pipeline of order books, which has not resulted in the element of execution that everyone was waiting for. But that is around the corner. It was to come last year. Whether it will come this year, some part of it will come this year, or 2025-26, it will definitely come through. That gives the element of growth and that’s where I think the majority of all the ideation is converging around.

So valuations first, and it's a large cap for allocation, which is there, fairly steady in terms of performance and could get an element of growth because they've already booked a significant amount of orders that are in the pipeline already out there. I think that's what is playing through in the sector having revival just now.

Kenneth Andrade: I don't have a crystal ball into this sector but everyone loves to border fish at this point in time… And I think we also have a couple of businesses on the radar. I am not too sure that we are anywhere at the bottom of the cycle yet and it will probably take another one year before things become significantly clear, especially in the agrochemical space.

There are reportedly some closures coming up in a couple of countries that are there, which is aiding this conversation around the segment of the market bottoming and volumes will emerge. If that happens, yes, it will. But will they demonstrate returns like we've had in the previous cycle? Very unlikely. At best they will just participate with the rest of the market and that's my sense. So there's no significant valuation comfort despite this industry not doing very well.

On volumes and capacity, I think both of them will exist for this industry. What it may not have, at least in the near term, is any real pricing power. I'm not very sure that prices are going to bounce back compared to where we left them off about two years back. So I think that's where it is. You will get moderated returns, but nothing significantly close to what we got in the previous cycle.

Kenneth Andrade: So we're at a juncture in the marketplace where everything is fairly discovered and everything is fairly priced. We're just looking at opportunities which have not done well till now or have moved sideways and are probably finishing either a time correction or a price correction and then the fundamentals of the business.

As I said, the time correction and the price correction is happening in a number of sectors where the fundamentals are not really improving or it would improve in six months, in one year or two years, probably two years. But this may just be a place where you could allocate some capital to and continue to increase your exposure over the next couple of quarters or a year or two.

Kenneth Andrade: I think it has already done quite a bit and the way companies have access to capital today, which is basically raising a lot of equity, it is completely changing the fundamentals of the business right now because whenever businesses like this get incremental amount of capital, there's usually capital deployment to creating a land bank.

So, we're in the very early stages of the industry cycle, actually topping out. I said it's a very early stage of an industry cycle, actually talking about the industry. I think you've already raised Rs 15,000 odd crores or some such number that is there. A very large part of this number is now going into buying land banks that are there, which was not the business model that has brought the industry to this level or to this juncture.

So this is a flipping point, wherein when you have new inventory coming in, the new inventory at new landbank prices, there is a price rise in real estate that will come through. That price rise will taper sales for a while. So volume will give way to price.

In short, I think we're in the early stages of this industry topping up. While companies are getting capital today, the leverage cycle of some of these companies will start maybe in a year’s time, which means more capital comes into play and then we'll have to take it from there. But the best, I think, is behind us.