You liked cement in the past and you have said, look, the cash flows in the cement sector are getting better. It is a sector where pricing power should improve, but the reverse is at play. Even though decent consolidation has happened after the Adani’s entry into ACC and Ambuja, I looked at the numbers from Dalmia, even for that matter UltraTech, they do not look impressive. Why is cement not coming back given the economy is growing, roads are getting built?
See, clearly demand has continued to remain strong but we have not seen price growth as you rightly mentioned, but we should also look at how costs have moved down in this sector. So, net-net, I think there is going to be benefit in terms of profitability for the entire sector. It may not have been visible in the recent quarters because there is a lag impact between how raw material costs or input costs behave and what happens in terms of the P&L in the companies. So, we expect that in the September to December quarter somewhere you will see a significant improvement in the profitability of the cement companies.
As you rightly mentioned, we have seen a huge consolidation and it is not easy to put up new cement plants in our country. There is a gestation period, there are a lack of availability of limestone which is a key raw material.
So, overall, I do not think the incremental capacity is going to grow at a pace which is higher than the incremental demand.
So, to that extent, a consolidated industry structure and input costs which are definitely coming down over the next few quarters, definitely remain a positive and that is what we are excited about in this particular industry.
It may not have showed up in the June quarter, as you rightly mentioned, but clearly September and December are going to be much better for this sector.
What is the view on the entire capital goods space and I am talking about the broader theme here, right from industrials, the likes of ABB, Siemens, to defence names so this entire electronic manufacturing sector given the fact we have seen a lot of government push for indigenisation as well. Would you still look at positively the likes of Kaynes, Dixon despite the expensive valuations?
See, the entire industrial space has run up quite significantly over the last couple of quarters. Valuations do not leave too much of comfort at this point of time when you actually look at the immediate short term.
However, if you look at the long-term growth, it is going to be very-very strong for this sector either driven by the kind of capex that we are going to see in the economy or due to the kind of indigenisation levels that are going to increase in the defence, for example, so various factors.
So, one, you are going to see significantly higher level of growth over the next five-year block as compared to past five years and margins should also improve as you get a higher scale as well as commodity costs moderating in the recent times.
So, overall, this sector will definitely deliver much better earnings growth as compared to its own history, as well as as compared to the market.
But the question is whether you are comfortable about the valuations. I would rather say that you may not be comfortable with the valuations of the entire sector here but there are still opportunities, one has to be carefully looking at it.
I do not think at these kind of valuations whether it is for capital goods or for any other sector, there is going to be a uniform rally across the sector, I think the rally will shift towards stock specific in nature.
So, to that extent, I mean, I am repeating myself, whatever is true for the market in terms of earnings delivery and the flows would be critical for this sector also to sustain current valuations.
What is your view regarding large cap versus midcap because, of course, there were a couple of funds that stopped the flow into the midcap saying that it is getting difficult to deploy the money there, how are you viewing the entire large cap versus midcap universe?
Clearly, relative valuation comfort is much more in case of large cap basket. It is probably trading at about 19.5 to 20 times one year forward earnings which is higher than the long-term average price to earnings multiple.
But otherwise, you cannot say that it is very-very expensive, but in some pockets of midcaps and small caps especially those which are not so liquid, we have seen valuations reaching to quite alarming levels.
So, to that extent, yes, there is a bit of a caution that is required when you are entering in mid and small caps from a short-term perspective.
If you are staggering your investments, if you are taking a three- to five-year call on this basket, yes, there is still money to be made but definitely the volatility is going to be much higher in this basket as compared to large cap. So, on a risk reward basis, I would say probably large caps are better placed.
So, what is the house view then with respect to the Nifty target? Do you think it is just going to get toppish around 20,000 if I can hold you to the levels there?
We really do not work with any targets on either stocks or Nifty levels. But clearly, at these valuations which are higher than long-term average, probably you are going to see a slightly lower market returns than the earnings growth. We are expecting about mid-teens kind of earnings growth over the next two years so that should be the thing.
