Healthcare is one of your tactical trades right now and we have seen that the Q1 performance from a lot of companies was quite better than estimates. What within healthcare would be your pecking order? Are you looking at hospitals, diagnostics, and manufacturers with a bit of an export exposure or domestic exposure? How would you break it down?
Rajiv Batra: Tactically, we have added much exposure to pharma at the current juncture. We have been structurally overweight on the hospital space and we do believe the hospital space will keep on growing, not just on the bottom line basis, but even on the top line too. In terms of pharma, looking at the demand from the US side, where services are still a key and even pharma is still key, we believe formulation companies, and contract manufacturing companies will keep on growing.
Taking that into account, we believe the pharma space along with hospitals makes overall healthcare quite a lucrative bet. Remember, this sector was almost dead or not doing for a good amount of time and after a long time this sector is making a comeback, so this sector will still have some leg. Tactically, pharma should be considered more over hospitals right now.
Let us look at a sector where there is a divided opinion and that divided opinion is about autos. Channel checks are indicating that the slowdown has started, discounts are coming back, waiting period is over. The big picture is that a huge EV migration is happening. The Indian middle class is under-penetrated in terms of owning personal vehicles. Indian automobile companies are getting ready to become export hubs now. How should one look at autos?
Rajiv Batra: I will make it quite simple. For me, the two metrics are very important, competition and pricing power. So, in the case of auto, we are seeing that the competition is rising and that has started impacting even the pricing power also. Here, I am not just focusing on the price cut, but I am also seeing the discounts that companies have started offering are higher than what they were offering 12 months ago.
So, taking that into account, micro structures are looking weaker compared to macro. Macro argument of the EV adoption or the lesser penetration in India and the growth story turning, that all remain in place. But we need to marry both macro and micro together. Micro is showing me that there is some amount of a weakness or a breather coming in the near term and hence, this is the reason why we thought it is an appropriate time.
The longest-running overweight call in the sector needs some profit booking and hence, we shifted the passenger vehicle down the pecking order with a larger preference on the two-wheeler side at this juncture.What should be the return expectations according to you in absolute terms from Indian markets on a CAGR basis for the next three years?
Rajiv Batra: I will keep it in line with my nominal growth because, on a longer-term basis, earnings growth or markets track the nominal growth of the country. So it should be at the mark of around 13 to 15 odd percent on a compounded annual term. But I will not rule out the further valuation re-rating. Remember, we have not seen the rate cut cycle yet. We have not seen the re-leveraging cycle yet, not just for India, but for other emerging markets also. Once the rate cut cycle starts, the re-leveraging cycle starts back, which will lead to further re-rating. Yes, Indian valuations are rich and expensive, but they are no longer in a bubble territory. The bubble territory in Asia is at a range of around 36 PE and 40 PE. In three or four years, India may see that kind of valuation, so that will give some additional return. But to play safe, let us go with an earning growth with close to 13% to 15% compounded annual return.
You are okay with the earning season because hardly any upgrades have come. Energy has been a big disappointment. Select autos have been a big disappointment. Do you think the case for earning upgrades is now getting over?
Rajiv Batra: At least for this fiscal year, the ask is going to increase from here. I will not extrapolate the last quarter’s trend for this entire year because there have been too many anomalies. We had extreme summers and heatwaves. We have lower government expenditure due to the budget overall, higher base effect from last year’s first quarter, and then some demand fluctuations.
So, taking that into account, if we take that out, having a stable earning growth or maintaining the trend was okay for me. In terms of a revision also, we have just seen on MSCI India a 50 basis point marginal downward earnings revision on EPS for FY25 and FY26. I will say that the second quarter of this fiscal year also will not give great joy because the extreme heatwaves season will be replaced by torrential rainfalls which could be impacting some amount of demand.
But that does not mean that India’s earning story is over. Maybe the acceleration of earnings, which we have seen a high handle for the last two or three years, will change. But the high teens earning growth will make India look attractive on the global equity chain or even at an emerging market or Asia level also.
It is surprising that despite looking attractive in global and emerging markets, we have not seen the FII flows come back. The election has come and gone by, the budget uncertainty is out. What then is impeding the flows into India?
Rajiv Batra: Now, there is a cycle within the cycles. I will say post-election, there was a period for a couple of months where India got close to $8 to $9 billion in inflows. But since 22nd July, India has again seen $3.2 billion outflows. Now, there are some reasons external and some domestic. So, on the external side, we have seen a severe bout of global market volatility where the concerns of the US recession came, and the yen carry trade started hitting over there. Domestically, people were looking for an excuse or a reason and finding out what could be the big negative.
People started positioning when earnings are bad or people started worrying about whether state elections are approaching, should we have that kind of high exposure in equities? All these reasons are making FII either stay on cash or increase the exposure on the long-dated asset like US 10-year or US 30-year side, that is where we have seen some amount of reversal this month of $3 odd billion outflows seen in the market.
But if you take that account, post-election and budget, FIIs were quite encouraged to see that the government is still keeping the handle on capex, the government is still talking about fiscal consolidation and the policy continuity is happening. If we now take this couple of months out going into the US election, normal FII investing in India should start from November, December onwards.
But have we not discussed for the last two years that FIIs will come back? Two years ago, it was about China. Then, it was about the Fed. Then, it is back to China. Now, it is about the yen carry trade. FIIs have not been coming to India for the last two or three years and that very well may continue.
Rajiv Batra: Of course, it can continue, but it requires the other asset class to keep on performing in the same manner. Right now, in MSCI All Country World, which global investors track, 70% weightage is towards the US. We have seen how phenomenally, the US equities have performed with the Magnificient 7 and even the tech stock.
If that kind of performance keeps on continuing, why will they need to look at the other 30% part of the world, that is anything non-US over there? But in case some slowdown or correction or consolidation starts hitting to that 70% allocation, people will run for refuge in other growth heavens, that is what India is offering.
At the same point of time, it is getting a bit easier to get your licenses or ODI limits. This was a problem and we have discussed in the past with foreign investors. They always give an excuse, that they do not have access to local Indian markets, they have licensing issues, and this one. But slowly and steadily, policymakers are addressing that. These people’s queries are getting solved. India might look beautiful again on relative global terms to the investors.
