Ganeshram Jayaraman, MD & Head, Avendus Spark, says “we have a barbell approach to portfolio construct, which is two segments. One is the defensives, the quality names across sectors, managements who have a track record of performing across cycles, that is one side of the barbell and the second is industrials and where we think corporate capex picking up will be drivers for some companies. We also are positive on pharma as a sector, but a fair bit of it has also run up over the last six months. One last point is, we have been recommending building up some dry gunpowder. So, basically some cash in our construct and recourse.”What is your market assessment? This has been a year where we have seen more choppiness and after yesterday’s move, it looks like volatility is also back.
Ganeshram Jayaraman: Yes, we have been cautious for a while now and the crux of the reason has been when we did a bottom-up exercise a couple of months back and tried to estimate how fiscal 25’s earnings can take shape for our coverage universe of about 250 stocks, we kind of sliced and diced the whole expectation. Our assessment is that there is not much market share upside for companies, there is not much pricing upside, there is not a lot of raw material prices led tailwinds upside left, there is not a lot of EBITDA margin or operating leverage upside left, there is not a lot of valuation upside.

The core key call is, can volume growth recover?That is the key potential driver left for earnings growth. And for volume growth to pick up, you need a strong macro and for strong macro, we are not too confident of saying of thumping the table. We think it is a very binary macro. We are not very bullish on overall macro outlook for this year and there are multiple reasons for it and the main part for that is in consumption. Consumption has been weak. We are not seeing jobs or wages. If the retail unsecured credit slows down, we think consumption can remain weak and has been weak but it can get weaker and we are a little watchful on that space, that is one.

Second, we think post elections, the government’s capital expenditure which has been a very strong driver of overall growth for the last four years, we think it can start moderating. I am not saying it will decline, but I think it will become 5-6% kind of growth in the next two-three years. So that is also something which could slow down our earnings growth expectations. So, corporate capex will pick up.

We are working with that in our expectations. But we think when consumption, exports and government capex slow down, at the broader level, we will be a little more defensive, more watchful than we were earlier. So, we have a barbell approach to portfolio construct, which is two segments. One is the defensives, the quality names across sectors, managements who have a track record of performing across cycles, that is one side of the barbell and the second is industrials and where we think corporate capex picking up will be drivers for some companies. We also are positive on pharma as a sector, but a fair bit of it has also run up over the last six months.

One last point is, we have been recommending building up some dry gunpowder. So, basically some cash in our construct and recourse.

So, if your view on macro and consumption and other demand trends is not bullish, that means the market could see earnings disappointment and PE compression could happen. So, when you say put some gunpowder, why just some gunpowder? I mean, one should have a lot of gunpowder because then if the economy slows down, which is what nobody is pencilling in, then we could be looking at 15-20% easy downside.
Ganeshram Jayaraman: I do not take a Nifty call. I take sector and stock calls. But what we do is also keep imperatives in mind, how much cash can anyone maximum go to, institutional investors is. So, a fair sprinkling of defensive stocks also needs to be kept in mind in that context.

Let us talk about consumption. Now, we can look at two-wheeler sales, we can look at the FMCG sales and talk about the K-shape recovery. But there are a lot of macro callers and economists who are making a case that luxury has done well in 2022 and 23, urban has done well in 2022 and 23, it is a rural economy which actually will make a comeback because inflation is settled and hopefully we will have a good monsoon. So, what are the chances that what has not done well in last two years could do well and what has done well may not do well?
Ganeshram Jayaraman: Actually, there is a slightly different view that we have. I will still not say that rural has been weak over these few years. Actually, if you look at how tractor sales done, not the current year, but the preceding three years, tractor sales were good actually. So, I think consumption patterns are changing, even in rural areas quite significantly. Look at e-commerce companies, even the likes of Flipkart or Amazon and they give you pin code wise data. Actually, they are growing very well in rural pockets. So, I do not want to fall into this trap of saying that rural has been slowing down. I actually think that consumption patterns have been changing there as well. The incremental spend of the consumer has been more towards categories that were historically not a large proportion of the spend. It could be on say certain categories of electronics, more towards say mobile phones or accessories related, AirPods and earphones and the likes, spend on that has become a very-very large line item, in excess of five lakh crores actually.

So, those are things that are changing the historical patterns of consumption that we are used to seeing, which are more FMCG, two-wheelers or QSRs or footwears and apparels. I think the consumer has evolved a lot differently to how they are spending and we need to be watchful of that as well.

Let us also understand your take specifically on PSU banks. Do you believe that despite the fact that we have seen a sharp re-rating within this space, would the concern emerge from the fact that valuations do not look reasonable or are there any other lingering factors as well owing to which there is a negative stance on this space?
Ganeshram Jayaraman: The way we are looking at it is, who is more vulnerable if unsecured retail credit moderates. The Reserve Bank has already nudged the banks to be a little more watchful of lending to unsecured retail, especially below 650 credit score kind of customer segment. You can call it the sub-primes category. If that kind of plays out over the next 12 months, we think banks who have grown in that category over the last two-three years can face some challenges.

More specifically, they will moderate their growth. That segment is very profitable, so that will have an impact on margins and credit costs are so abnormally low today that you will start a mean reversion on that. Put the three together, growth margins, credit costs, you have to be keeping that in mind, for sure corporate credit will start picking up and banks which are focused on corporate credit will start seeing that but keep that in mind that that is not your highly profitable, highest yielding segments. Keep the two in mind when we are preparing our financials or banking stocks preferences.

Now, you believe government capex will come down, which it could, considering that they have been going at about 3-3.5% of capex as part of GDP, that has to stall somewhere. Capital expenditure cannot grow at 30% every year. If that happens, which sectors will see a markdown both in terms of earning and PE multiples?
Ganeshram Jayaraman: So, you have seen the benefit of that on construction or cement. You are also seeing it in terms of the railway spend beneficiaries. Defence spend is not really a new spend. It is more of import substitution so that could kind of sustain. But working capital cycles there can get a little elongated. So, we will always keep the payment periods on check. We have seen in the past when fiscal deficit considerations come, payment cycles get delayed and that has an impact on working capital and cash flows and that is what we will keep watching there.

But at a broader level, let us look at one key thing. Where did the government predominate? What does capex mean? What about if you are spending on roads or railways or even airports? Keep in mind 70 new airports are coming up in some part of the country. Where was the spend predominantly on? It was on land. They were buying land and that land was going into somebody’s pockets as income and monetising their assets and that would have recycled either into some categories of consumption or it could have gone into the second derivative impact of if lesser land is procured then what happens, that is what I am keeping a track of.

Keep also one thing in mind, I am not saying government capex will come down, I am saying government capex growth will come down. It will still be growing. Instead of 25% CAGR, it could grow at 5% CAGR and that is the impact you could see on multiples, on companies which have been beneficiaries or segments which have benefited from this growth.

When you say defensives, what is your definition of defensives? I have grown up knowing the definition of defensive is IT, pharma and FMCG. FMCG is slow, IT is volatile, pharma is hard to call. So, what is the new defensive in this market?
Ganeshram Jayaraman: So, the defensives are quality management. Not sectors, but within each sector, there are balance sheets, there are managements, there are companies which are a lot more insulated than others, whose strategies are not just meant to benefit in an absolute friendly sky. It could be even in a cloudy sky, they have a track record of performing, gaining market share and benefiting. Many of them have also underperformed because there has been a tilt towards the more cyclical nature and so these stocks have kind of gone sideways over the last two-three years. So, I think it is keeping in mind quality names within each segment, that is what I am referring to as more defensive in character.