An oil refinery stands in Golaghat, India (Photographer: Adeel Halim/Bloomberg)

‘Don’t Believe Capex As A Theme Can Catch Fire Over The Next One Year’

As core sector revive industrials and consumables will do better.

Capex cycle unlikely to come back in the next one year.

Defence opportunities to be a small growth driver for large companies.

Online marketplaces disrupting distribution models for consumer durable companies.

The markets are likely to consolidate at the current levels and retain the upward bias, Nilesh Shah, managing director and chief executive officer of Envision Capital, and Prateek Agarwal, chief Investment officer at ASK Investment Managers, told BloombergQuint in an interview, as the Modi government completed three years in office.

The next phase of market rally could be led by consumables and industrials. With revival in the core sectors, industrial consumers companies would perform better, said Shah. Electric cars could be the new disruption, and that could have an impact on new refineries and retail fuel network, said Agarwal.

Here are the edited excerpts of the interview with Niraj Shah:

Almost 95 percent of the respondents of a BloombergQuint market poll said economy-related sectors will make a comeback over the next 12 months. Nilesh starting with you, what is your favourite economy-related theme?

Nilesh Shah: Industrials and consumables. The companies which basically make consumables that finally get consumed by the core sectors, the industrial sectors, I think that’s a pretty sweet spot. As core sectors revive and do better, you will see that the industrial consumers will do even better because there are only a handful of them, they have pretty good balance sheets, they generate cash flows and have nice strong leadership. So, that would be a favourite spot.

The second is the pure engineering companies. They again should be in a sweet spot – engineering, capital goods. Priority should be given to companies with strong balance sheets and cash flows but I think to me these two would be very strong areas.

Then, selectively, you can keep looking out for some of the housing companies, the cement companies, these are all plays on the domestic sector where earnings growth, over the next three years, could be better than some stocks in the defensive space. In addition, auto component makers, auto-ancillaries look attractive, given that the automobile industry is doing well.

Prateek what about you?

Prateek Agarwal: In terms of economy related sectors, the economy is expected to come back but which parts of the economy will drive growth faster going forward…Look at the Budget, look at how money will be spent, look at capacity utilisation in the industry...I don’t really believe capex is a theme that can catch fire over the next one year. As capacity utilisation moves up, that is a good way of playing it. Cement, logically, yes. So, whatever construction happens – railways, houses, etc –it gets built in. It helps. But that’s not a wide spectrum.

There is one more thought I want to leave you with: Government may spend Rs 100 rupees on Capex; markets will benefit if those Rs 100 is given to the Indian companies. If we buy a bullet train from Japan, some company there is going to benefit. Part of the Capex that the government is also doing is less India-focused and more export-focused. So, that really doesn’t help.

The change is probably defence, right? All that I read is [that] the government is trying to make defence a lot more indigenous. Does it benefit companies out here?

Agarwal: We looked at that very closely. The issue that happens in defence is that it becomes [has] extremely long gestations. First, you shortlist an area, you develop capabilities, you showcase capabilities, then you are qualifying for a project, you will bid for it, and you know there will be two to three entities which will bid for it. The chances of getting it is one by two or one by three.

And, then the scale-up that happens, happens in a manner that it at best gives you 10-20 per cent uptake in sales. So, it is extremely difficult to play it. At best, seen to be a small growth driver for some of the larger companies. Smaller companies probably….

Get a higher bid but it is difficult to say whether they get the order or not?

Yes, very difficult.

The large companies neither move too much on the earnings and for the smaller companies there is no certainty that they will get the order or not. Nilesh, you look at disruption in a big way—in every industry, where is it happening, and may be some of your investment decisions are also based on that. Where within the domestic space, either led by the government or otherwise, do you see disruption?

Because, frankly, this government is doing its bit in bringing out new themes that are disrupting models in a big way. Probably, Aadhaar is the single, biggest example I can think of. But, is there any investment related opportunity due to disruption caused by what the government is doing?

Shah: If you really look at disruption, may be, two areas where it is happening in a really big manner: one is the entire financial space, the ability of companies to basically assess credit, to identify customers or borrowers. That itself is a huge opportunity. It will be an opportunity for the adopters. Any financial company which adopts technology to reach out and then, of course, assess credibility, recover money and all of that, I think it will be a huge beneficiary. If you don’t do that, you could pretty much be out of business.

Not giving out recommendations here…but the models that are adopted by Bajaj finance, Capital First or others?

Shah: Absolutely. You have clearly seen these kinds of companies like these grow faster and again, I think, for private banks as well, this will be an opportunity. Gone are the days when you could just sit in your branch and hope that business will come. I think those days are over.
Two, the consumer appliances space. Few years back, you had to create a pan-India network. An effort that would’ve gone on for 10 years. You wouldn’t know whether at the end of 10 years you will be successful or not. Today, you tie-up with online marketplaces. And you become a pan-India player overnight. If you are already an incumbent, a market-leader and think that you have the offline model, which is good, and you will be in a kind of omni-channel world, but don’t be surprised if suddenly a new player comes in and gets a pan-India access virtually on an overnight basis. Obviously, at the end of it, the product, the brand, the performance, the after-sales service, the pricing – all of that matters.

All the conventional Ps of marketing will matter. All I am saying is that this is how technology will…anybody who adopts it is very vigilant about it, cognizant about it, and acts upon it. For them, it is an opportunity. But if you don’t, you will suddenly find yourself out of business.

One of the largest consumer durables players in a particular category, the world leader, I would say, doesn’t have a single brick-and-mortar office outside its hometown, which is such an amazing thing.

Agarwal: I will just add that solar focus is a big disruption that is happening. One, the focus. Second, the way prices are dropping. So, the conventional whole-based power plant - when there will need to be base-load power plants forever, at least for the foreseeable future.

But, for anybody who is putting that kind of power projects needs to keep an eye on solar, which is renewable and the power of the future. These are early days but electric cars are something the policy-makers have started to talk about. That’s a big disruption.

Positive, I don’t know. Negative, well, what happens to the new refinery projects which will start now or build-up now. By the time they get built-up, the growth and demand will probably evapourate. What happens to the fuel pumps etc. I do believe in the concept. It is good. It is good for the country as a whole because we are such a large oil-importer.

Let’s hope we have a Tesla in our backyard. Mahindras are trying their bit. Hope we will have one.