DIIs Understand There Is Buying Opportunity In Dips, Says Demeter Advisors' Ashwini Agarwal

Ashwini Agarwal: It would appear so. If you look at the market trajectory, from the bottom of Covid, there was only one sort of meaningful correction that you saw. It started sometime in June or September ’21 and then lasted till March of ’23.

And even in that period, if you break it down, you saw one big decline from September ’21 to June ’22. Then again, from about January ’23 to March ’23. January ’23 to March ’23 was also a fairly mild correction.

Though, you know, that was a point when the whole Adani stocks and Adani group was under a lot of pressure. But barring that, you know, there has been no meaningful correction and partly the reason is that the macroeconomic outlook for India has never been better.

I mean, if I look back at 32-33 years of my investing career, I think the long-term prospects for India had never appeared to be brighter. I mean, you don't have any macroeconomic imbalances. You have a very pro-business policy tilt and I think, you know,on a global stage, India is set to continue to grow well.

So you know, what's happening is that the domestic investors have kind of understood that this is a long-term trajectory for India and this is how it's going to go. So use every dip to accumulate and further still don't just bother about the short term. Just keep investing for the long term and the mutual fund flows are telling you that.

So you know, a value investor like me can keep despairing that the bond yield to equity yield differences are at all-time lows. All indicators are telling us that the market is super expensive, but you know, I really don't see how there is going to be a very deep correction.

You could always have an 8-10% correction events for which will unfold as we go along, but I really don't see how it's going to be much deeper in the current framework, unless of course the election delivers a surprise or something goes wrong in the rest of the world. Then we'll have to see.

Ashwini Agarwal: I think that's the right word, it's okay. There is no positive surprise and yes, you know, that can turn out to be a headwind for the market.

If you recall, both the September ’23 quarter earnings in aggregate and the December ’23 earnings in aggregate surprised the street. They beat the consensus numbers and the beat was probably not led so much by the large caps but the mid-cap and small-cap cohort did exceptionally well and aggregate earnings actually did reasonably well.

In the quarter so far, we literally have had a handful of results. So, we don't know if this is a reflection of things to come. But till now, we haven't had a very strong positive beat so far, with the sole exception being Bajaj Auto. Even there, if you look at how the stock behaved, post the earnings, clearly the earnings surprise was well-baked into the stock price.

So yes, I think, if the earnings season doesn't kind of lead to reasonable earnings upgrades, you could have a situation where the market could drift down from here. But again, you know, it might be a correction similar to what we saw last year between July and October ’23, which was of the order of about 8% or thereabouts. I don't see anything deeper than that, for the time being unless something bigger comes to pass, which I spoke about earlier in the conversation.

Ashwini Agarwal: No, no, I don't think so. I think, the bottom line, at the end of the day in India, is earnings growth which is a primary driver of stock price and the secondary driver of short term momentum is earnings surprise or earnings upgrades.

Now in the case of HDFC Bank, a new disclosure for your viewers, I do own a position there being a value investor and you know, obviously it hasn't kind of done well for me the last few years.

But the point in HDFC Bank is that the merger has led to a situation where it will take some time to fix the liability side of the balance sheet and get to a loan-to-deposit ratio of about 90% which is where they need to get to, over a period of time. In this interim period, you will see the kind of below industry loan growth or higher than industry deposit growth being forced upon them and resulting to NIM compression.

Now, the March quarter was reasonably constructive. It wasn't so bad but I mean that's what the street is pricing it. Coming to the rest of the financial sector, I think, the question that I'm struggling with is that you will have very decent loan growth but you will have some compression and margins because deposit costs are on the higher side and liquidity is on the tighter side.

Now, the two will compensate each other and below that, I think on the PPOP side, which is pre-operating profits, the bank should be able to meet analysts’ forecasts, but there is no pickup left below the PPOP line in terms of lower credit costs. Low credit costs are already in the base. So from here on, it's business as usual and over a period of time one should expect that credit cost will normalise to long-term trend.

So you know, you can't build an earnings case of very superlative earnings. Barring some of the PSU banks, which might see some significant writebacks on account of massive provisions and writedowns they've done over the last three or four years, for the large private sector cohort, I really can't expect that.

And valuations have kind of also been ho-hum. They don't leave a lot of room for the upside. So there's no room for earnings surprise. So what's going to drive these stocks, I am not very clear.

Ashwini Agarwal: Absolutely. I mean, you know, if price increases come through, and the competitive intensity from a price perspective abates, whether it's, three reasonable players or whether it was the case up till now which was essentially two very strong players and the third player struggling because of limited balance sheet, whichever way you think about it, so long as the pricing power can be exercised by the players, you will see earnings upgrades and you will see the stocks doing well and the entire ecosystem, which includes the tower companies and so on and so forth.

So obviously, this is very good for the industry, if the price increases come through. We have the cheapest data in the world. We have the lowest cost of mobile connectivity in the world. So you know, a little bit of price increase is possible and if that comes to pass, I think you know, all these stocks will do very well.

I think, that's really the case and which I think is why everybody jumped at the opportunity to make this investment in Vodafone Idea, which was priced to bankruptcy at some point in time in the recent past and now you know at the offer price it still offers substantial upside, if the sector economics were to improve in aggregate.

Ashwini Agarwal: Think about both the stocks that were highlighted by Anushi, which is Tejas and then Hatsun Agro.

I think, the two themes that are staring out at us is that India is starting to do things at scale and Tejas’s acquisition by the Tata Group has allowed it to exploit the scale that was possible for the business. India spends a very large amount of money on telecom equipment, the hardware side of mobile telephony and data services and this was a very, very small company but with a very strong technology backbone.

I think, the ownership of Tata has allowed it to win at scale. I think, what we've seen in the latest quarter is simply a small window into what the future might look like. So that's one theme.

What you're seeing in Hatsun Agro is the other theme, which is normalisation of margins after the kind of boom and bust cycle that we went through during Covid.

Now, I could go into why milk went through this boom and bust cycle. But I think, the point I'm trying to make is that the opportunity decides exactly here. One set of companies are going to be companies that will go from being small, midsize players to very large companies because the opportunity set is extremely large and there will be another set of companies in the mid-cap space, small-cap space, which have been hit by very high raw material prices and the margins are compromised where you will see certain amount of normalisation of margins.

I think, both these will continue to offer some earnings surprises in the time to come and I think that's where I'm trying to kind of find ideas. So upstream chemicals, agrochemicals is one industry where I think you will see more of a margin normalisation coming through. And of course, you know, the scale business is there in a variety of industries such as railways, defence, manufacturing, etc., but where valuations are very, very challenging. So one has to participate with some care.

Coming to consumers, I think there are two factors at play. One is that the rural demand has been fairly soft for the last couple of years, driven by soft commodity prices, agricultural output prices, and by a limited amount of spending, that has gone into rural India and rural India hasn’t fully recovered from the upheaval in urban jobs, that happened during Covid. So that's one.

The second is in urban India, you're starting to see a lot of innovation, a lot of direct to consumer sales by new startups, which is at the end of the day eating into the potential revenue of the big boys. So you know, the large companies in the consumer staples area are not able to produce the kind of growth because some of that growth is getting eaten away by new startups—Mamaearth or Nyka or whoever else it is. So you know, that is playing out.

So I think the urban consumer demand is not so bad, but I think there are far more people vying for the consumer's attention.

Ashwini Agarwal: Well, I think there are various ways to do it. I mean, you try and look for an industry, which is very large relative to the size of the player. You try and make an assessment of whether the company has the ability to exploit that size. The story is not entirely forecastable at the outset and you have to take a leap of faith and slowly it unfolds.

For example, in recent months, we've seen news of BrahMos missiles being exported from India. Over the last two years, we've seen significant focus on the success of India's space programme. While it has been successful over the last few decades, I think it is coming to focus in the last two years or so.

So you know there are a lot of industries which have a lot of scale possible to them, and innovating at scale has become possible in the last 8–10 years. I think the Indian industry probably lacked the confidence, lacked the bravado, I don't know, and possibly even lacked the policy support previously, IF you were to look back at India’s history up untill 2014-2015.

So I think, one difference that this administration has definitely made is that through policy support and through the organic growth of the Indian market, per se, has made people aware about the opportunity of scale.

So it's a very difficult question—how do you size the opportunity. It is a bit of a leap of faith, it is a bit of just kind of, you know, zooming out and thinking about how big the opportunity can be and then placing your bets accordingly.

Look at batteries, for instance. Exide, something which I don’t own but they signed up an agreement to supply EV batteries to Hyundai. Everybody knew that they are investing in EV. They have a very strong balance sheet, after some asset divestments that they had done. They have a very, very strong brand name and very strong manufacturing backbone.

So you know, then the rest is just multiplication and trying to figure out who wins.

Ashwini Agarwal: I think, the latter, easily. The earnings growth is quite lukewarm and I think if you look at the valuations despite the correction and severe underperformance on a relative basis, valuations are still expensive.

I mean, if you look at just the last decadal valuation range of something like Infosys, it has traded at lower multiples in the past. I tend to agree with the argument that if you don't see earnings momentum and earnings growth, is there really a need to be here.

Now I will just make one provision that IT services and stocks like HCL Technology and Infosys have a very decent dividend yield at this point in time. So if the market were to go through a correction, for reasons that are not made clear to us right now, these stocks will probably outperform supported by the dividend yields, strong cash flow profiles, and, you know, obviously best-in-class scores that they generate from corporate governance and so on.

So I think, they are good companies to protect you on the way down but if you are really bullish on India, and you want to invest for the next 5–10 years, my suspicion is that there are better stories to play.