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    Play agriculture, healthcare and IT themes for long-term durability

    Synopsis

    Market nervousness can have some bearing on the valuations of smallcap and midcap stocks. But over a long period of time, stock prices tend to follow the fundamentals and earnings growth, says Vinit Sambre.

    ETMarkets.com
    If investors are looking for a clear immediate short-term up move, expectation should be tempered down. The small & midcap category is good and remains attractive only with a long-term view, says Vinit Sambre, Head - Equities, DSP Mutual Fund.

    Are smallcap and midcap stocks in for good days?
    As far as the small and midcap space is concerned, I have always maintained that this is a category where we find opportunities and where businesses showcase potential to grow at a rate higher than large cap companies. Over 4-5 years, as companies grow and find more opportunities, the potential for the mid and smallcap space tends to remain pretty good. The only caveat is that coming from a very smart recovery in the past six months, which has taken place not only in the large caps but also the smallcaps and midcaps, the valuation is capturing the optimism to some extent. Hence if investors are looking for a clear immediate short-term up move, expectation should be tempered down. The category is good and remains attractive only with a long-term view.

    Everybody wants to buy companies which are gaining market share, which are adopting digital and which are benefitting from Covid. A lot of smallcap companies do not have the ability. While smallcap is a sector where one finds higher beta and greater return potential, but the texture of the economy is very different.
    Even within the smallcap space, we have a lot of businesses which are not available to play in the large cap. We have been holding on to some of the speciality chemicals plays. Many of the small building material companies are category leaders but they are within the smallcap universe. They have also showcased leadership qualities in terms of growth, capital efficiency and good quality of accounting and management conduct. We keep looking out for companies where the visibility of growth is higher irrespective of the market capitalisation.

    We find opportunities even within the smallcap and the midcap space where companies showcased those traits and in the last six-seven years, a couple of smallcap names in speciality chemicals are almost getting into the largecap zone. So good opportunities can emerge, but one has to be patient and remain invested into these businesses. Volatility tends to remain high because the narratives keep impacting the short-term volatility. The nervousness can have some bearing on the valuations in the small and midcap stocks. But over a long period of time, stock prices tend to follow the fundamentals and earnings growth.

    Would you be looking at some micro themes, even real estate? Or is it stock specific?
    Broadly it is more stock-specific but we try to look for opportunities where the potential for the companies and businesses to grow for a long period of time is there. Our sense is growth potential within some categories tends to have a long duration. Agri theme is a good long-term play. We have a lot to achieve in terms of productivity as far as agriculture is concerned. The mechanisation as far as the agri market is concerned and we are subscale when it comes to our output norms compared to the global norms.

    I would say there are certain themes which we believe have good long-term durability. These are agriculture, healthcare and IT space. We also tend to remain bullish on consumption space because the generic penetration story is still to play out. We have seen that happening in the last 10 years. There have been instances where one or two years have been dull but those are just consolidation phases for these businesses and as the economy grows, the consumption theme will become stronger.

    Even before the Covid breakout, the economy was losing its growth momentum and in a way we are in a zone where for the last two or three years we have not seen adequate growth taking place in corporate India. So, we are lying low. Valuations look high on the low earnings and hence on the assumption that the economic recovery will pick momentum at certain point in time over the next two or three years. Some of these businesses will really look attractive from that standpoint.

    Anything that you would want to avoid, that you feel is just a risk segment?
    The elimination is around the businesses where we have seen inefficiency in terms of managing the business and capital allocation. Our biggest learnings have been that the capital allocation remains one of the most important factors which determine how much cash the company is going to generate, what will be the return on capital employed. Companies and businesses which have destroyed value have been typically the companies where they have mismanaged capital and not made the best utilisation of the capital and where they have not kept the control of the balance sheet to show growth.

    I can generalise by saying that companies across the sectors which display these negative characteristics have been an avoid for us as also capex heavy industries and businesses which keep requiring cash or capital and where the balance sheet becomes an issue.

    It is Bharat which has won over India at least in consumption and two-wheeler recovery. Most other patterns across sectors are the same when it comes to small caps. Would that be a leading thought while picking up any of the small and midcap themes?
    Yes, even we were quite positively surprised by the broad-based recovery which took place and in a way, across many segments, resilience has been seen even within the smallcaps. Remember that most companies have been pretty upfront in terms of the cost economics and cost-cutting measures which have helped with strong profitability growth.

    As we move forward, if the resurgence does not take place as the economy normalises, the cost is going to come back up and it is how much more growth can these companies capture versus the cost increases, which is going to determine the operating efficiency level. We have seen broad-based recovery across various categories and we were quite positively surprised to see the performance of many of the companies within our coverage.

    What is the story to avoid right now? IT as well as pharmaceuticals have taken a bit of a pause. Do you think the beta is to be caught in other sectors like cement, automobile, banks, specialty chemicals within smallcaps as opposed to IT and pharma in the near term?
    Some segments are in our avoid list because of valuation dynamics. While the consumer story remains very strong over the long term, we have to be cautious about the valuations at which some of these businesses are trading.

    Many consumer names both within the discretionary and the non-discretionary space they have gone past their pre-Covid valuation zones and whether they become buys at these levels is something we try to remain cautious about. Let us wait for decent valuations in some of these names.

    Likewise, even within the banking space, most of the banks have clearly shown that the capital provisions which they have made to cover up potential credit losses seems to be adequate and the guidance has been very strong. But as an economy, we are still in the recovery mode where the impact of the restructuring is still to come out.

    Some clarity will emerge even within the banking and financials and hence being selective and slightly cautious is something which I would like to be. By and large, in terms of cyclical plays, automobiles and cement sectors have been lying low in terms of their cycles. As the business cycle improves over the next two to three years, there is a good opportunity here/ Both the businesses are showing positive trends. In cement, the pricing power is pretty good. The automobile sector has been in a low cycle for two years and hence the set up is good where the companies would still look to benefit as the demand recovery takes place.
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