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Vikas Khemani, Founder, Carnelian Asset Advisors, says: “ Our portfolio valuation, on a collective basis, is lower than the index valuation. The mantra we follow is faster, stronger, cheaper. My portfolio should be growing faster than the index. It should be stronger in terms of ROE and debt to equity, and it should be cheaper in valuation. If you follow this, I think even in bad times, you should be able to manage your risk and if you manage your risk in a shorter term, in long term it should come out very well.

Khemani also says: “ I continue to believe that we are in the middle of a very big omega bull run and for 5-10 years, mid and smallcaps will outperform. But having said that, overall wealth will get created and largecaps also will do very well.

This year again is off to a good start. The big trend is that Reliance is outperforming. Largecap stocks are making a comeback. Will this comeback from smallcap to midcap and midcap to largecap magnify going forward?
Vikas Khemani: In a market cycle, these kinds of intermittent sort of moves are natural. We had a sharp small and midcap rally in the last eight-nine months and largecaps were underperforming. Now they are catching up, also due to the flows from the foreigners because last year we saw slightly higher outflow and that had taken a toll on the largecaps in some sense. But a large part of domestic money was coming more towards mid and smallcaps. We are seeing that bit of change happening. We are seeing a bit of negative narrative getting built around the mid and smallcap valuations.

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I think this kind of intermittent shuffling is possible, but I continue to believe that we are in the middle of a very big omega bull run and for 5-10 years, mid and smallcaps will outperform. But having said that, overall wealth will get created and largecaps also will do very well.

I guess the big eyesore from within largecaps continues to be private banks. We have not seen any performance from HDFC Bank, even after it hitting the 52-week low. It somehow dragged itself a little bit higher.
Vikas Khemani: There is a stock specific issue in the overall banking sector. Since HDFC Bank is a very large component of that, it appears that private banks have not done well. But many private banks, including ICICI Bank, Axis Bank have done very well over the last one year. Of course, in between, a consolidation happening because there was a narrative that NIMs might come under pressure, which is possible and which will happen, so this kind of consolidation is very natural, but I do believe that banking and especially the private banks will continue to do well over a long period of time because it cannot happen that Indian economy grows to become $10 trillion economy, but banking sector does not grow.

So, both private and public sector banks will do well. Of course, HDFC Bank is going through a bit of a consolidation phase because of the merger and a lot of deposit raising they have to do and bit of a shuffling of shareholding happening from HDFC Bank to other banks, including private sector bank and public sector bank and because of this, it has underperformed. I am sure in the next 6 to 12 months’ time, that will kind of get settled and things will make a comeback.

Why do you feel that pharma is at an inflection point?
Vikas Khemani: I think pharma is at an inflection point if we see the last one year. Before that, for almost seven-eight years, there was hardly any return, especially led by a lot of overhangs in the US markets. Over the last year, we saw that getting lifted and the pricing scenario improving. Of course, India has a leading market share in the global medical generic space which with pricing pressure going away, is doing very well. Domestic pharma, no doubt, was doing well and continues to do well.

So, if we look at a combination of these two things, we will see a good structural growth in pharma as a space for the next four-five years and valuations are not as demanding. Of course, recently some run-up has happened, but still valuations are not very demanding. If we compare it to consumer play, pharma and consumer profiles are not very different. But valuations in consumer stocks are far more demanding than pharma and it was an under-owned sector. So, all these things are changing slowly and as they are changing, we see the sector is doing very well. We are in the middle of a very big bull run in the entire pharma pack.

It is a very complicated sector. I can start with an MNC pharma company, talk about a generic company and complicated generics. What is the right spot in pharma? Is it CRAMS? Is it generic? Is it Europe? Is it India?
Vikas Khemani: You are right. It is a very good question that you should just not look at broad-based pharma because pharma is very…, a sort of nuances to it. As a house, we have been quite bullish on API space for quite some time and we have made a lot of money in that. We continue to remain very bullish from a China plus one shift strategy. A lot of API companies are going to do well. Likewise, pharma companies that have recently picked up are those where domestic pharma business is good, but the US is seeing a turnaround. So, the delta on the returns would be far higher. Ideally you want a combination of business, which is good, domestic business growing at a steady pace and turnaround coming from US business, those are the kind of pharma in generic space we like.

We have also bought companies like Syngene, Neuland in the CDMO space. One has to look at specific companies because each company has nuances. Some companies are exposed to emerging markets which are doing very well. In general, pharma is very well placed but within that, each model has to be understood and looked at from a risk-reward perspective.

Given that you believe that India is one opportunity wherein there is a plethora of alpha generation ideas, where else in this market, are you seeing opportunities other than pharma?
Vikas Khemani: Again, stock specific activity has to be looked at. Generally it is all bottom up, but India is a very wide market and the width in the market is amazing. As the economy grows towards $8-10 trillion over the next 8-10 years, we will see very widespread growth happening across financials, manufacturing, consumer, infrastructure and in IT also. Within that, one has to identify the niche spaces.

Within IT, midcaps are doing very well, especially ER&D companies which are set to grow at 20-25% over many years. So, those specific spaces will do well.

In manufacturing, there are niche companies which are growing and doing very well. Last year, it was very bad for chemicals. I feel that chemicals will do well over a period of time, and for the last six-eight months, we have been buying a lot of chemical stocks, especially specialty chemicals, not commodity chemicals.

Within financials, look at non-credit places where a lot of opportunities are seen in capital market-focused AMCs. I can only say that India will surprise everybody. India will surprise people who talk about valuations and get worried about it, on growth over the next five-seven years. Of course, if your time horizon is three-six months, I do not know. But if you have a long-term perspective, India will surprise on the growth and hence worrying about valuations early on will be quite risky.

Manufacturing is a great theme. Everybody knows that things are moving as per the script. But if one looks at EMS stocks, PE multiples are higher than that of consumer stocks. ABB, Thermax, PE multiples are 50 times! Can real wealth be created if the stocks are trading at 50 times plus and then the underlying growth is 15-20%.
Vikas Khemani: Absolutely. Buying at any price is a stupid strategy. We do not believe that at all. So, in any wealth creation, buying at a reasonable price is very important and hence our mantra has been quality growth at a reasonable price and hence we do not own any of the names which you mentioned.

In the capital goods space, we recently bought BHEL, which I think has done very well and continues to do very well. So, in the same market, you go with the broader narrative and look at the same beaten down stock which may be large AMCs or foreigners buy or you want to buy stocks where the risk is very well placed from a long-term wealth creation perspective.

The second point I am talking about is where a lot of money can be made.We find there is no shortage of ideas at a reasonable price. Our portfolio valuation, on a collective basis, is lower than the index valuation. The mantra we follow is faster, stronger, cheaper. My portfolio should be growing faster than the index. It should be stronger in terms of ROE and debt to equity, and it should be cheaper in valuation. If you follow this, I think even in bad times, you should be able to manage your risk and if you manage your risk in a shorter term, in long term it should come out very well.

You got a name which has really worked well for you, that is Aditya Birla Capital, AB Capital. It is one of your top holdings. You think the entire big picture thesis of a turnaround and getting efficiencies right and change of management, has that thesis played out at Rs 200?
Vikas Khemani: I think it is early playing out. It is like what ICICI Bank was in 2019, Aditya Birla Capital was at Rs 100 in 2022-23, but now the journey has begun. I feel that in the next three-four years, it is likely to walk that kind of path. Today also it is a reasonable evaluation. Growth is very well sorted. The company is transforming digitally.

We are in a very early stage of a transformation journey for the company we feel and the leadership is sorted. There are very few NBFCs where the borrowing profile and leadership are sorted, and the market is huge. MSMEs, to which they are exposed, is a very fast-growing segment. The digital capability is just amazing. I feel that it is a long way to go. We do not buy stocks from a short-term perspective. I think it can multiply from here also, provided the horizon is slightly longer and I think it will beat , in my opinion, the entire NBFC pack.

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