Consumer Discretionary Firms Seeing Robust Volume Growth, Says LGT Wealth’s Rajesh Cheruvu
The CIO at LGT Wealth India also said electronic manufacturing service firms are at an advantage.
Consumer discretionary firms—particularly in jewellery and hotel sectors—are experiencing a significant uptick in volume, according to Rajesh Cheruvu, chief investment officer at LGT Wealth India.
"In the consumer discretionary sector, sub-segments like hospitality are witnessing a notable volume pick-up. While the low-value segments are seeing a gradual rise, it's the high-value consumption areas that are showing robust volume growth," Cheruvu told NDTV Profit, during a televised interview. "We're quite optimistic about the next four to six quarters."
Cheruvu’s comments come at a time when the S&P BSE Consumer Discretionary Index rallied 11% so far this year, as compared with the benchmark S&P BSE Sensex’s nearly 2% returns during the period. The sectoral index had jumped more than 39% in 2023, resuming its yearly rally after a decline in 2022.
Cheruvu highlighted a positive trajectory in segments such as jewellery and hospitality, indicating a sustained demand. Electronic manufacturing services are at an advantage, according to him. “EMS is another area benefiting from the indigenisation spree."
"As temperatures continue to rise, manufacturers supplying to branded air conditioners are expected to perform well in the coming quarters."
In terms of the strongest bets within the consumer discretionary space, Cheruvu said EMS and hospitality are primary areas of focus. "We have nominal exposure in QSRs, but we anticipate recovery in that sector to be at least two quarters away," he explained. "Our predominant exposure lies in EMS and hospitality, particularly hotels."
Watch the full interview here:
Edited excerpts from the interview:
At the outset, can you tell us a bit about your approach? I mean, are you bottom-up value investors? Do you guys believe in growth? What's the investment style?
Rajesh Chruvu: Just so if I need to start with my investment, philosophy and investment approach, we are predominantly growth oriented investors and in terms of the construct of the portfolios, we do it on a more bottom-up basis. In terms of philosophy and objective this particular strategy is focused towards investors who are actually having a medium to longer term horizon.The objective is to generate returns superior to nominal GDP growth over three years plus period of time. How do we do that? I think by primarily focusing on structurally compounding businesses and keeping volatility in the stock level as well as portfolio level under check. So this is our actual focus in terms of designing and constructing the portfolios.
Interesting that you're not shying away from having more than a 55% exposure to the SMID space, Rajesh, while you talk about wanting to control volatility. So how is this exposure coming through? Tell us a bit about this exposure to large, mid versus small.
Rajesh Cheruvu: This is mostly in terms of stock selection. We'll do whatever… actually the quality of the investment approach is a four factor formula. It is built on four pillars. There is a QSGBA approach we call it, QSGBA framework, Quality, Secular growth, Valuations and Active management. So these are the four pillars we use in terms of constructing portfolios, in terms of quality of the business, quality of the balance sheet and quality of the management. So we are actually focusing on the quality of the business and quality of the balance sheet.
That's where I think we could be able to identify certain names which are actually transforming from benefiting from the transformation from informal to formal, and whatever actual themes are going on in the marketplace, whether it is a consumption or whether it is formalisation or indigenisation. So that's where I think we tend to actually identify certain mid and small cap names. So that's where I think it is coming in from. Since we’re actually doing in depth analysis of corporate balance sheets for about 20 years plus data, we actually scrutinise this. We do it every year, year over year, we do it and we categorise companies into three types, one is Crown Jewel Horses and Treasure Hunters. So this particular strategy is largely built around war horses and predominantly on war horses. War horses are companies which are offering superior growth with the objective to actually gain market share from the market leaders.
So that's the kind of businesses they bring in P/E multiple ratings plus earnings growth. So that's where you'll see more of mid and small cap orientation in this, but there's not a fixed one, that actually changes with time. So offlate, we are actually building the portfolio that you're looking at on March 31st. As time passed by, we have been increasing the large cap because we are seeing certain opportunities in the large cap, especially in the Capital goods space. We are actually adding certain capital goods names in the ongoing connection.
Financials form 31% of your portfolio as of March 31. Materials about 9%, industrials about 9%. Would capital goods fall within this bucket and therefore has this overall exposure of either industrials or materials gone up from the 9% odd?
Rajesh Cheruvu: This industrial space actually we’re increasing it further because we are actually seeing a reasonable amount of activity there in terms of private capex is actually picking up. So we have been waiting for a right opportunity to add, as I mentioned, part of our four pillars: margin of safety valuations are quite important despite companies having great quality balance sheets or great quality business. Valuations should also do well for that particular business. So we have seen the Nifty has given about 3-4% at index level but individual stocks we have seen certain opportunities and we have started building on it.
So when you are buying into large-cap capital good names, where you might see value, is it in valuing growth or are you actually buying the non-blue chip names because their valuation multiples might be lower?
Rajesh Cheruvu: These names might not be non-blue chip names, but could be built to book ratio in terms of quality of balance sheet and quality of business are quite robust. But they may not be blue chip names or MNC parentage, they would not be having MNC parentage. But build book ratios of these businesses are quite good but valuations were earlier not comfortable. But now with whatever business updates have been released of late, I think we are seeing two to three years perspective these businesses are offering a reasonable amount of growth in terms of runway runway to growth plus valuations. Also around 18 months to two years forward basis, these companies are looking attractive. So we started actually using this new correction.
So consumer discretionary is 24% and consumer staples is 6.7%. Now before I ask Rajesh about what the pockets are out there, let me get in touch with my colleague Mahima to give us some sense of what's expected in the quarter from some of the consumption names. Mahima, give us a brief piece of what the brokerages are thinking about the consumer space for this quarter?
Mahima: So I start with how the demand will pan out to be where in terms of demand we're expecting a subdued performance. Well, we will see some kind of gradual recovery, however, a quick rebound is not expected in terms of demand. Now in terms of volume growth, we will see some kind of divergence in terms of volume and value growth because volumes are expected to come back to normal stage where they will grow in an average mid single digit level. In terms of margin expansion, well, the commodity inflation is kind of easing, so the margins will sustain at the same levels as they have been in the past quarters. However, gross margin expansion will likely be slow because a lot of FMCGs are now reinvesting the profits that they're earning into product innovation, distribution expansion and marketing spends. Lastly, in terms of rural recovery, what you can see is that rural recovery might be a bit dented because you know, the high inflation has really hit the income levels of the people in the rural area. So rural recovery will basically depend on easing inflation, strong festive season and higher government spending ahead of the elections. So this is the overall view of the consumer sector.
Interesting breakup there Rajesh. I mean, staples 6.7%. I would reckon it's not exactly overweight. Would you be kind of circumspect there and part two of my question is consumer discretionary. That's a very aggressive 24% weightage there?
Rajesh Cheruvu: So consumer discretionary. I think we are quite optimistic for the next 4-6 quarters basis range. They're actually segments if you look at the Consumer discretionary as a headline index, industry sector. But if you look at sub segments, like EMS, or hospitality. So these segments are the high value consumption names, if you see whatever: slow volume pickup or volume growth is happening in a low value segment, whereas in high value, consumption, volumes, still holding robust including jewellery, hospitality, etc.
So we’re actually just optimistic in that space and EMS is another area which is actually getting benefited out of ongoing indigenisation spree and whatever heatwave I think they expected to actually rise further, temperatures likely to rise even further. So with that I think manufacturers of air conditioners or EMS manufacturers supplying these branded air conditions. So actually we think this quarter or next quarter will augur well for these companies.
Is EMS within that pocket the strongest bet, or is there something else. QSRs, the online players, what is the strongest bet?
Rajesh Cheruvu: In QSR we have some nominal exposure but we think that it is at least two quarters away in terms of recovery, there we have very nominal exposure predominately I think EMS and hospitality.
So in your top allocations there is a Varun Beverages, there is an Astral, I mean significant weightages there, they're not exactly cheap. In terms of headline valuations. So is there merit in growth that you see I mean, do these form a part of consumer discretionary per se for you as well?
Rajesh Cheruvu: Not necessarily, these names, our portfolio construct actually, if you see the way how we construct portfolios, as I mentioned, four pillars of my investment approach, four pillars active management, we segregated portfolio into three parts over tactical and satellite. There are certain names that form part of my core allocation. If there is an opportunity, we add additional tactical allocation to those core names, which these names tend to hold for a three to five years kind of horizon and there is a price opportunity in terms of a short span of time. Actually the stock prices move ahead of fundamentals. We release some amount of capital from those names. That’s how we play tactically in and out of those names.
Whereas satellite is companies which are actually showing some amount of fundamental improvement or change of management or overall where the business fundamentals are improving etc. So we actually started as a satellite allocation and they give good price opportunities that have just been actually seeped into the portfolio gains and eventually I think it is fundamental improvements. I think they become more secular and I think they're turned out to be secular and steady growth companies, and eventually they could become core allocation.
That's our approach for a portfolio construct. So the names that you have shown, most of them are actually my core allocations at this point in time. From there other than Varun, I don't have any consumer names. So most of them are whether it is part of the industrial allocations or BFSI allocations. Varun is actually part of our consumer staples allocation. Discretionary side, we don't have any names for this.
But financials, you mentioned that 31.4% would mean slightly underweight. I just wanted to know the break-ups in lending financials. Do you also have a larger sprinkling of non lending financials?
Rajesh Cheruvu: Our BFSI exposure in this portfolio is dominated by lending businesses. We have two housing finance names also which are actually just below these are top 10 allocations. Two housing finance names, predominantly affordable housing names that we are actually seeing growth in, are quite good and their return ratios have been good and their actual stress in book is also in a controlled manner.
They have been managing it, got good quality business and good management. So we have two hosting financings and this NBFC as you have shown, that is also part of our portfolio and we have two banks, this one as well as PSU banks of India's largest PSU Bank, is also there in the portfolio. But PSU banks actually believe, more or less big gains are behind us. From here onwards I think their returns should track their earnings growth because provision reversals are actually whatever the multiple rating is more or less done for now. So we are actually just gradually using the PSU banks.
A lot of these names are large and I still see a 50% allocation to mid caps and small caps even if you started buying into large-cap goods. So where is this 50% hiding, what sectors and what themes? Where is the bottom-up idea?
Rajesh Cheruvu: Those are actually like the names I mentioned to be affordable housing, finance in BFSI space. Within consumer names also you'll find one of the panel companies, they're part of the portfolio out there, actually a unique tyre manufacturer which is actually an off-highway tyre manufacturing company, which means to have a significantly overweight debt or they can earn 6% given the ongoing rate fee. Logistic challenges and constraints we have reduced significantly to around 2.5 to 3%. We hope but profitability wise, this company holds strong work and profitability is far superior compared to the other tyre manufactures and these are actual names where you will find it there.
I.T.also forms 9.7%. So in some sense, slightly underweight relative to maybe the indices but let me first get in touch with my colleague Rucha to tell us what to expect from I.T. after the slightly subdued performance by TCS and before that a month ago by Accenture as well. What's happening in this space and what’s to be anticipated?
Rucha: So as you rightly mentioned, the street was expecting something incremental from the TCS management's commentary, but there was no hope of recovery of demand from the management last Friday. The uncertain macro environment still prevails, which leads to clients cutting down on their budgets due to pressure on discretionary spends. So there are fewer shorter deals rather than the long term deals, which have an impact on the pricing as well and which can affect the margins of the companies as well. Also, the hyper scalars are also cutting down on their workforce, which again indicates that there is no near-term demand visibility like Google did, cutting down on its workforce less than six hours ago.
As you rightly mentioned, global peers like Accenture are well cut off its FY24. guidance to 1-3% which is a very small range as compared with the previous range of 2-5%. However, on the flip side, there can be two positive aspects to this as well. Number one, the EBIT margins are being sustained as the bench which was created in the last few quarters is now coming into utilisation. This has led to lower sub contracting costs which is a major expense for the I.T. company and reduction of the same will help the company support their margins. Also, attrition is normalised but there is a hiring freeze across the industry. So there are mixed views on where the I.T., is going and apparently I think the clients are just waiting for the elections to happen and to you know, figure out where the demand will ultimately go because nobody is able to comprehend the near term demand as of now.
9.7% in I.T. just wondering, is it largely services even now or do ER & D or product companies also come into the fray?
Rajesh Cheruvu: So actually two parts to this one is this 9.7% Is that about 15-16 days back. So now that we have increased slightly here, number one. Number two, is one of the top five names. So services companies which we have actually prepared just before before earning previews coming in. It's just we have paid a bit and we have actually taken down to a 3.5-4% level because services, we think, at least we'll take another two quarters because of the U.S. Fed has to change its stance till the time you might not see the sentiment turning positive for I.T. services segment. But we are actually as you rightly mentioned, our focus is more towards ER&D as a segment.
That particular space has a very good growth runway for the next three to five year’s perspective. So that is one segment we are positive about. Another bottom up name we have actually just been building the portfolio there where one of the second rank I.T. company where change of management has happened and historically this company has done multiple acquisitions. Now with the new management has been actually just using a couple of those unrelated or actually the longer term strategy segments that they've been easing out. So there we expect this particular company will deliver quite a strong set of numbers with whatever change of strategy and change of leadership is happening in the business.
For the next 4-6 quarters this company could give quite stupendous returns as it is currently trading at a significant valuation to most of the I.T. services companies. So there is one company that should just be building a position in the portfolio and plus this ER&D this for I.T. services. IT services actually just think it is at least 1-2 quarters away in terms of recovery, but most of these companies, as you are aware, valuation wise they are trading compared to their historical multiples at a discount. But most of the narrative/ negative seems to be priced in already and now that we have seen TCS has reported a strong set of numbers whether it is in terms of margins, or at least it is the highest in recent times. But we are focusing more on ER &D and this kind of actually just one of the satellite name we have added in the portfolio as a change of management and change of business model.