Duggal’s approach is to give higher weight to earnings visibility while not disregarding valuations. Their bias is towards largecaps. 75% of their model portfolio is in largecaps. Maybe this is a time to increase weight on Reliance a little bit after moving HDFC Bank to overweight from underweight.
Where are these clusters of growth where re-rating is still left? Now it is hard to find too many treasures in this market. But are there any growth pockets where markets can still re-rate those stocks, both in terms of EPS and in terms of PE?
Gautam Duggad: So, PE re-rating looks very difficult now or maybe very limited in a few pockets here and there. We are right now trading at 30 times one year forward on midcap, 24 times one year forward on smallcap and about 19.5, 19 to 20 times on Nifty. Clearly, the market has been very generous, especially in the broader markets in giving much higher PE multiple. If I give you just one example, if you look at the EMS companies, the large ones and mid ones, in the last one year, some of them have gone up 3x to 4x while earnings might have doubled.
So, while they started with expensive valuations, given the extended visibility of growth the market has re-rated them even higher from where they began a year back. Today, if you look at the possibilities of PE re-rating, it looks very difficult. So, the most obvious sector, which I am sure your other guests over the months, weeks, quarters have been talking about is financials, which is where growth is decent and valuations are cheap, especially the largecap banks. Mild possibility of re-rating in my view still exists in capital market stocks. We have just put out a very detailed thematic report covering 15 new stocks about two-three weeks back.
I think this is a segment which has emerged very strongly in the last 12, 24 months and all the mid to large long-end factors for this sector are very favourable, whether it is the financialization of savings, the adoption of technology, the proliferation in Demat accounts. So, various sub-segments in the Indian capital market space, whether it is exchanges, wealth managers, AMCs, the intermediaries, depositories, brokers, we feel quite positive about this space. While there could be some intermittent jerks because the regulations keep coming in here and there, but from a three- to five-year perspective, we think there is some possibility of re-rating and good compounding returns that you can still expect in capital market space.
What is the view on real estate after the run-up and is it better to play the sector directly through the real estate stocks or maybe cement and building materials is also something which looks better on the value parameter?
Gautam Duggad: So, that has not worked out for the last three years actually. The best way to play real estate is through real estate stock, that is what we believed in the last two years. We have a massive overweight on real estate in our model portfolio for the last three years now. And the problem with playing through the roundabout way of using cement or using a building material is that the visibility of real estate growth in some of these ancillary spaces sometimes gets delayed depending on the pace of the construction. So, people have been expecting the rerating or maybe even earnings growth first of all, forget rerating, in some of those building material stocks for the last two-three years now. Real estate and hotels both have very similar characteristics in terms of the duration of the cycle. 2008 was the peak of both the real estate and hotel cycle and it took them 12 years to come back to that up cycle.
If you look at the largest hotel company in India and check their EBITDA of 2008 and 2018, they are virtually similar. Our view is that in both hotels and real estate, we are somewhere in the middle of the up cycle. The demand-supply dynamics in terms of demand CAGR versus supply CAGR is predominantly tilted in favour of demand, which is why a year back also when a lot of the people were raising questions on valuations of these two sectors, we were of the view that given the duration of the up cycle which is still left in the space, we continue to like them. We have a preference towards both hotels and real estate, which occupy more than 5-6% in our model portfolio. Clearly, the fundamentals of space have been very strong and given the way things are unfolding, at least two-three years of up cycle is still left in the spaces.If somebody has to build a portfolio for 2025 and there is a strategy note which you have come up with, what should be the broader framework one should work with?
Gautam Duggad: 2025 looks to be a difficult year ahead given the way macros, both domestic as well as global are shaping up and the scarcity in earnings growth in 2025. At an aggregate level, earnings growth is just 5% for 2025 FY. If you are to be a little more generous, you will look at ex commodities and growth looks slightly better at 10-11%, but 10-11% is still less than 20% ex of commodities that we eked out in FY24.
Let us assume that FY26 gives you 15% earnings growth, which is an EPS of somewhere close to Rs 1,240 that we are working with right now for FY26 Nifty. Now, given where markets are, the possibility of rerating looks very difficult, though one should never say no given the way the flows are. This year, we have already crossed $60 billion in domestic flows even though FII flows are as good as zero.
If the 60 becomes $50 billion also in CY25, you are talking about a possibility of at least 10% to 15% kind of a return from a 12- to 15-month perspective. Now, with that as a broader top-down brush, if you have to construct a portfolio, you have to look at two things. One is within an overall moderating earnings growth regime which are the sectors where earnings are slightly better. We already discussed three to four sectors where earnings are better, which is financials, IT, EMS, industrials, real estate, and some bit of consumer discretion.
Consumer is an ocean, while staples are going through a prolonged period of slowdown, some parts of discretionary sectors within the consumption basket are still doing reasonably well. Names like jewellery, hotel, and some of the other discretionary segments. So, my approach – and which is what we have been doing now for a few years – is to give higher weight to earnings visibility. I am not disregarding valuations, but it is not the starting point for us when we are constructing our portfolio.
Second, incrementally, our bias has been more towards largecaps. Today, if you look at our portfolio, 75% of our model portfolio is in largecap. That is a broad framework with which we will work and then try and add some incrementally more defensive names. So, we have Bharti, maybe this is a time to increase weight on Reliance a little bit and HDFC Bank which we have already moved from underweight to overweight. We think there is a possibility to raise weight further on HDFC Bank. That is the way with which we will look at constructing a portfolio for CY25.
