Last time we discussed battery stocks and the storage angle of the EV or energy transition space and then onwards we saw Amara Raja, Exide getting completely re-rated. Big targets are coming in and some tie-ups also came in. You were among the early spotters of that theme. A quick update on that. Is the story still left to be factored in or is it in the price?
Ishmohit Arora: These are sunrise industries and how the EV ecosystem gets created in India remains to be seen. But over there, we need to track how many new capacities are being announced because one of the large battery players already has capacity on the ground. The other large battery player has applied for a PLI and it remains to be seen how large of a capacity they are going to set up. But definitely, these are sunrise industries and one must always study sunrise industries even if you are a bottoms-up stock picker.
Let us take the discussion forward and electrification or electricity theme, I want to talk to you more about that. Again, part of transformers, wires and cables, some of the power generating companies including legacy and new age got re-rated already. How are you reading this electrification theme now with new data points coming in? Which end of the value chain are you playing this theme from?
Ishmohit Arora: There is a broader thesis on how the market cycles have shifted, that the cycle has gone from asset-light businesses to asset-heavy businesses. Because all over the world we are seeing there is a pickup in inflation over the last two to three years caused by supply shocks, too much of printing money etc, etc.
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So, what happens is that asset-heavy businesses in such an environment get pricing power. In that case, if you already have an asset-heavy business, the cost of replicating such assets is also really difficult in an inflationary environment. As these businesses get pricing power, we will see across the sectors whether it is a telecom, hospital, power sector, metal sector or a hotel sector – all asset-heavy businesses and it takes a lot of time to replicate all these assets that currently have pricing power. They are sitting on operating leverage, financial leverage, and we will see a non-linear jump in profitability.
Now, coming to the electrification theme, on Tuesday, a draft document was released by the power ministry and it said that a 4.5 lakh crore capex on power transmission is expected between FY23 and FY27 and till FY30, this capex on power transmission will continue.
Goldman Sachs came out with a report, where it says that by FY50, it is expected that there will be almost $500 billion of power transmission capex. So, here there are multiple players. The capex in the extra heavy voltage pie of the value chain especially will be much higher. So, there are players who are available right from conductor space. These are dominant players in conductors to players within cables and wires and then there are also companies which have monopoly over the power grid itself. All these players will likely see pricing power benefiting them.
Since we are in a positive cycle for these industries and these industry cycles are a bit long dated in nature, we have to realise because the last time we saw such a cycle was between 2003 and 2008-2009 and that lasted for five to six years.
Currently, we have seen the starting of the cycle from 2021. Yes, some of the stocks have run up. But we need to realise that bottoms-up there are still a lot of opportunities over there. Sometimes the PEG ratio even in some of the businesses is still below 1.5 to 1.7 times. So, as a stock picker, you need to de-anchor yourself from the stock price and you need to anchor yourself with the value and the growth of these businesses.
Are we in the middle of the real estate cycle? How are you playing among the real estate stocks? Are you playing via the top tier category A builders or the mid-tier ones?
Ishmohit Arora: In real estate, we are coming back to the long-dated and short-dated cycles. This is a sector which has started doing well again. After 2008-2009, we have seen almost a breakout on the Nifty Realty Index itself. So, data-wise, the organised real estate players in Q3 had grown their pre-sales at a rate of more than 40% even though the industry overall has grown at 8% to 9%. What this signifies is that the organised real estate players or the listed real estate players are actually gaining market share. As per my understanding of this cycle, some of the national developers like some of them are based out of Bangalore and now they are going to Hyderabad, Mumbai, Chennai and Delhi also, some of these national real estate developers will see a consolidation that we have not even seen in the jewellery industry because smaller players do not have the balance sheet heft to take larger projects.
Now everyone wants a good apartment to live in or entire townships are coming up and that requires a lot of balance sheet heft and an ability to raise capital. So, unlike other industries where the smaller the player, the better it is in tailwinds, in real estate you have to be the opposite. The larger the player, the better it is because they have more balance sheet heft, muscle power and the brand power with themselves. One of the businesses is based out of Bangalore which is now currently going through a build-up of its annuity portfolio. If the annuity portfolio comes in, combined that business has a higher pre-sales and DLF and Lodha as well. I think in FY24, these types of opportunities are what we are looking at. We are still maybe two years into the cycle and these cycles in the past have also lasted for five to six years. So, these are some of the sectors we are tracking bottoms-up.
Let us also scratch that point you are making that this is the time where you should have more asset-heavy stocks and sectors which are represented in your portfolio than asset-light ones. Why exactly are you making this point and is the earning visibility higher in asset-heavy names?
Ishmohit Arora: Actually, in a lot of asset-light businesses like IT services or classic FMCG businesses, what has happened is that a lot of those categories are fully penetrated, meaning you cannot keep using four or five soaps in a day. You cannot basically brush your teeth five times in a day. Similarly, you cannot have chyawanprash four or five times a day. So, those categories are fully penetrated and because they are asset-light in nature and along with IT services, currently in IT services there are headwinds which they are facing from the developed world. In asset-light businesses, this is a problem that we have been noticing top-down on an index level.
When it comes to asset-heavy names, the first thing to realise is that in an inflationary world, the cost of replication goes up really high. For example, today if anyone wants to set up a hospital, a greenfield project in a city like Noida, Gurgaon or anywhere else, minimum for a 400 or 500 bed project they need to spend Rs 500 to 600 crore and this amount used to be 60% to 70% of it three-four years back. So, again, the increase in the amount is because of inflation.
So, the incumbents in the hospital space, whether it is an affordable healthcare chain from Bangalore and all these businesses, have already established their centres because for a greenfield project to break even, it takes six years. For someone to throw in money today at an inflation-adjusted price and sit for six to eight years for the project to break even, is really painful. This is why the incumbents in some of these industries are enjoying a lot of advantages and during such periods of inflation, the cost of services also goes up. On the same asset I am able to earn higher, as it leads to margin expansion, financial leverage, it leads to ROC expansion, it leads to ROE expansion. So, all those financial ratios basically start matching up with the macro analysis of the industry.
Are you getting confidence of visibility on earnings growth front or are these companies sounding a little wary of the trajectory from here on?
Ishmohit Arora: In some of the businesses we are tracking bottoms-up, the managements are really bullish at the moment. All of them are saying that the government has incentivised manufacturing and incentivised creation of an ecosystem in India. Just to give you one more small example, there is a stainless steel pipe industry that we track and the government in 2021 enforced a five-year anti-dumping duty because nearly 40% to 50% of the industry volumes were being imported from China. Now there is an anti-dumping duty on Chinese imports.
This has led to a lot of domestic players expanding their capacities by two times, four times, five times and over the last two-three years, some of those companies have gone from Rs 200 crore top line to almost Rs 800 crore top line and they are talking about Rs 2,000-2,500 crore top line. That shows how an ecosystem is being created and maybe this is the time where earnings growth for the next two-three years remains solid and if we listen to the market, if we listen to the businesses bottoms-up without worrying too much about what will happen to the market today and tomorrow and if you keep reading businesses bottoms-up, growth is broad based this time instead of just being focused on five or six names which happened in 2017 to 2018. This cycle will last for maybe two-three years and then the cycle will again turn.
