Current Investment Cycle Is On The Cusp Of A Turnaround, Says Spark Capital
The current investment cycle is on the cusp of a turnaround and industrials should be judged by their earnings profile and not valuations, according to Ganeshram Jayaraman of Spark Capital Advisors.
“Demand recovery, industry consolidation and inflation have come together for the first time in 20 years, and this combination should lead to pricing power,” Jayaraman, managing director at the financial services firm, told BloombergQuint’s Niraj Shah in an interview. “Companies are also de-leveraging, so all of them combined translate to better margins and hence, earnings.”
Capacity utilisation of the top 5 players in cement, metals and refining are well above thresholds which may be key for a pick-up in corporate capex, according to Jayaraman. “In cement, for example, companies have no choice but to expand capacities to protect their market shares because the demand is high,” he said. “And balance sheets allow them the luxury to expand as they are de-leveraged.”
Jayaraman cited a second factor that would be crucial to the investment cycle—rising bank deposits. “The balances in current and savings accounts, which banks tell us, haven’t just expanded during this period,” he said. “They’ve actually materially jumped up, versus how it grows every year.”
The Reserve Bank of India said in June, bank deposit growth had remained strong through much of the pandemic year because of precautionary savings, limited avenues to spend and government relief measures. Break-up of deposit data, released by the central bank, showed metro cities led the growth.
As a result, Jayaraman said, people have materially more money in their pockets. “Today’s savings is tomorrow’s demand and consumption,” he said. “We get excited with the quantum of money lying around.”
The fund manager thinks the current situation is reminiscent of 2003, a period that was followed by an explosion in consumer demand. “The excess statutory liquidity ratio the banks are sitting on, more than what regulations mandate, is around Rs 17-18 trillion, which is incredible.”
What Investors Must Do
Investors, in Jayaraman’s opinion, need to look at sectors and sub-sectors where this money will go. “We’re looking at the industrial consumer space, capital goods manufacturers, engineering, procurement, and construction contractors, corporate banks, global companies with exports, industrial cooling solutions and many other sub-segments,” he said. “PLI schemes and government spending in sectors also needs to be kept in mind as they too drive benefits for companies.”
He urged investors to go by what the top companies have achieved in the recent past. “Over the last decade, these companies have seen a weak top-line growth, only about 2-3% CAGR, but have worked extensively on improving underlying revenue character, more products, newer markets, divested weaker segments and market shares have consolidated.”
But their profit margins are down a third from their peak and returns on equity have fallen significantly though their cash flows and balance sheets remain healthy, he said. He advises looking at valuations while factoring in normalised earnings.
Jayaraman said there's risk of consumers and banks not spending and hoarding their money remains, ahead of the pandemic’s impending third wave. Since that doesn’t translate to GST collections and income tax, it might affect government spending, he said.
Watch the full conversation here: