There is one bit of surprise which is something I have been thinking through. If I look at the outperformance in the last one year, ITC is followed by Britannia and HUL. At a time when the market has taken a decisive relook at value stocks and cheap is suddenly attractive, why have some of the consumer staple stocks which are expensive are still hogging all the limelight? They are owned by FIIs and FIIs are selling!
I would not read too much into that. These kinds of things keep happening. The market is never predictable and it is always going to surprise you with something or the other. But maybe it has also been a little bit of a flight to safety given all the other pressures that we have had in the system recently.
I think gradually the pendulum is starting to turn and the period of sharp increase in interest rates which we have seen over the last 12 months, both in India as well as by global central banks, is now behind us. What this does is once you raise the cost of capital so aggressively, the focus has to come back on businesses, which blow the lights out in terms of return capital. But they have to have some respect for cost of capital and therefore some part of the value trade which got a very aggressive bid somewhere during the Russia-Ukraine conflict and thereafter, is going to start to run into headwinds.
Many of those businesses do not generate a high return on capital. They got a tailwind from commodity prices, supply chain breakdowns but in a higher cost of capital regime which is where we stand currently, some of those business models will come under pressure in terms of valuations whereas in the higher ROCE businesses, the setting is slightly more neutral for them.
What is your take on the capex cycle because we were just talking about Tim Cook’s visit to India, the manufacturing renaissance really picking up and this is a theme that a lot of experts have been very bullish on. How are you looking to bet on the capex theme in India?
That is an interesting question. Certainly, when I think of the capex theme in terms of the initial conditions, it is extremely favourable. Bank balance sheets are the strongest that we have seen in a long time. Yes, some pressures in terms of their credit deposit ratios but in terms of their risk appetite or willingness to grow credit, a strong balance sheet is what drives that appetite and therefore we have that in place.
We also have some of the strongest corporate balance sheets seen going back almost to the era of 2003-2005 when balance sheets were very strong. So, the initial conditions are there but I am yet to really see a very strong pickup in appetite for corporate investments. When we look at the aggregate data, it is hard to put my finger on what is holding it back but maybe some part is animals spirits. Remember we are going through unprecedented times in terms of the increase in cost of capital. We are looking at a fracturing of global supply chains, companies are having to reconsider what it means when they operate in this kind of an era. I think the missing element is actually the animal spirits of corporate India. I do not really see the kind of animal spirits we have seen in the past which is what has driven extreme capex cycles. The replacement capex cycle will obviously continue; we are a three-and-a-half trillion dollar economy, the investment rate is well about 20% and it is not that no investments happen, it is just not clear to me that we have a significant acceleration happening and that is simply because the entrepreneur animal spirits is the missing ingredient.Tata Steel will raise $400 million in offshore green loans. Some of these companies are now getting a lot of green loans. Two years ago, no institutional investor wanted to buy anything which had coal, tobacco, cigarettes, liquor. But now ITC is at an all-time high, Coal India is rocking, NTPC is marching higher. Where are all the ESG proponents?
The ESG proponents may well be holding on to their positions, though very grudgingly, because they are seeing the other side of the market do well. There is a bit of a conundrum over there but the pressure that we see particularly from global investors in terms of their unwillingness in many cases to look at areas which they now see as being challenged and threatened is for real.
The point that I will make over there is that yes the world will still need fossil fuels, it still needs cement, it needs steel but now we have to start to worry about how much regulatory pressure might come to bear on them in terms of raising pollution standards, in terms of meeting much stricter greener norms, in having to invest just to replace a fuel source without necessarily a better selling price.
So, a lot of the investments that these companies have to make might not actually create incremental shareholder value because they are only having to replace their existing business model with a much costlier business model. So, there are some genuine concerns. But you are absolutely right. There is a conundrum here that we have not yet necessarily found the alternatives, but playing those cycles may be tricky and it may be challenging and they could be very brief.
Each investor will have to decide what is their tenure, what is the kind of period they are looking at, what is the kind of thought process they have and many of the longer term investors will stick to their thought process of saying we do not want to take the risk associated with the disruptions that business models are likely to face because societies, governments, and regulators are forcing companies to go greener but it is not clear that they will make incremental return on capital for the investments that they have to make.
