Nimesh Chandan on where to find better returns than largecaps
Smallcap companies going through some cyclical downturn because they are more connected to the economy.
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On the valuations front, are you now willing to dip your feet more towards the broader market as well?
In the past one-and-a-half to two years, quality and visibility combined as a theme has done extremely well. While people say it is only quality premium that is going up, I would say quality companies which are in cyclical sectors have not really seen that kind of flows getting attracted in those stocks. We as a house have always been tilted on quality. Two years back, we shifted more weight towards companies where we see good visibility or more certainty and we have benefited through that trade in the last two years.
At this point of time, we are seeing green shoots on one side. The international environment is turning more positive or bottoming out. On the other side, we see in many of the cyclical companies especially in the midcap and the smallcap segment, the prices are already factoring in or discounting the slowdown. In fact, the narrative will change domestically. We had a good festive season. People will wait for all the efforts that the government has taken in the last two months to start showing results. May be, in the first leg, in metal stocks or international cyclicals, we will see upturn in these companies’ profits.
Where do we lie on the market cycle versus the macro cycle?
I will just give a perspective over a slightly longer cycle. The slowdown today that we see today is a result of all the events that have happened in the past six years. We saw most of the macro parameters peaking at somewhere around 2012 or 2013. The excesses that were created in the previous cycle, took some time to get erased. After August 2013, the experience of the monetary policy in India has been quite tight in terms of interest rates as well as in liquidity terms. We had a tight fiscal policy. We had a fiscal deficit of 6%. We have brought it down to 3% and during this period, we also went through a banking cleanup where historical NPAs were written off in a very short period of time.
The impact of these changes and also GST, demonetisation, implementation of RERA, all these changes impacted largely the informal sector. In the formal sector, the corporates did not consider adding more capacity as they already are at low capacity utilisation and they do not see demand visibility because of the changes. They would rather look at deleveraging rather than doing more capex for the future. The government has also kept its purse strings tight during this time. I think all these factors affected growth.
We had to sacrifice growth. But all these factors are now changing for the positive. We are probably in that interim phase. The monetary policy is on the easing side. In the last two months, the government has taken steps which will probably start showing results by April or May.
After the implementation of GST, RERA, demonetisation, the business cycle is now right for an upturn. It is just that you cannot pinpoint this is the month which will possibly start this festive season. This quarter may start seeing some improvement already.
Talk to us about the research which you have conducted in the broader markets, What are the key takeaways in terms of how attractive that pocket is valuation wise?
We are taking a stand that the narrative has now changed for the international markets and will start showing changes in the Indian domestic economy also. For the last two years globally and even in India, money has moved towards largecap, low beta, more visibility, defensive stocks. On the other side, people have been selling high beta, smallcaps, midcaps and cyclicals also.
We did a study for the smallcap companies which are below Rs 10,000-crore market capitalisation and we did an average ROC for last three years. We found that there are at least 100 companies which have ROC of more than 16% average in the last three years and within this basket of companies, there are a lot of companies actually have cash rich balance sheets instead of debt. If you take note of five years’ or 10 years’ growth rate in their sales and profits, it is just that they are going through some cyclical downturn because they are more connected to the economy today.
These are the times when you can pick these companies which have good corporate governance, good balance sheets, have demonstrated leadership in a particular segment either by brand or market leadership. These have good ROC and so their business models are good. The valuation is debatable here because some of them are at a cyclical lower names. You cannot give them low valuation on a cyclically low earnings itself. That space becomes very interesting and possibly this is the space which will give better returns to investors than just the largecaps.