In this market, 20% earnings growth for midcaps and smallcaps is something to die for: Aishvarya Dadheech

“Some of the low hanging fruits we are looking at for the future are include auto ancillary, midcap IT and also businesses which will be hit the most on account of commodity inflation; players like Asian Paints or Kajarias. We are increasing our weight there,” says Aishvarya Dadheech, Director & Fund Manager, Ambit Asset Management.

Largecaps have rallied but what about midcaps? Do you see froth being cleansed out in that zone and value emerging? Are you active there?
I would say that in the last one week, the whole narrative has changed, With the steep decline in the commodity prices and decline in the bond yields, the whole fear about that equity valuations were not justified. The kind of inflationary trend that will have an impact on the majority of those companies' earnings has somehow taken a backseat today.

We are still not out of the woods but the decline of base commodities as well as the agri commodities in the range of 15-20% to as high as 50-60% would give them much needed impetus for earning growth.

While we have seen massive selling in largecaps from FII perspective, midcaps and smallcaps have not been hit that hard. That is one of the reasons the market one year forward from the Nifty perspective is trading at close to 18 times but midcaps were still at a premium to that.

The only area where we can see value is smallcaps which at around 7-8 PE multiples is cheaper compared to the largecaps. We have actually moved from inflation scare to growth scare and that is the reason why we are seeing moderation in commodity prices. We have to be watchful about the midcap and the smallcap businesses.

My advice would be that it is the right time to invest into midcaps and smallcaps but stay invested in quality names only. Quality players are those which can protect their margins. What happened in the last six months is that with the rise in commodity prices, only players with pricing power have taken price increases to protect their turf. Those are the businesses one should look at to invest in because from here onwards, when the commodity prices are falling, the windfall that these companies will create will not only support higher earning growth but will also try to push that money into distributions or R&D or innovation. That will give a tailwind for growth for the next two-three years.

You believe that IT has started to look interesting once again. We have seen a good amount of valuation compression in IT on growth scare back in the US. Between largecaps and midcaps, where do you see better prospects?
IT midcaps were trading at crazy valuations a couple of months back and now we have seen a steep decline in the valuation by almost 30%. Majority of the midcap IT stocks are trading in the range of 22-23 to almost 27-28 times one year forward. But having looked at what is happening in the US and Europe which are major contributor to their businesses, our advice would be one should be cautious because what really matters in IT sector is the growth more than currency depreciations or other matters.

We believe the whole growth, digitisation story is still there but it will not get traction in the next four to six months. We have to see whether the technical recession in the US is actually converted into real recession in the coming quarters and if that is the case, IT can take further beating. That would be the time for investors to accumulate IT stocks.

A lot of largecap IT names are trading at very attractive valuations compared to midcaps. They are trading at around 17-16 times and those are the names one should look at in adding in the portfolio over the next four to six quarters. Coming to this quarter’s results, the expectations are pretty muted. More than the result, the commentary should be important because there is so much noise about the US going into recession and the growth taking a plunge.

It would be foolhardy to estimate that these projects will not be impacted much. We have to see how things go around the next couple of quarters and that would be the time to look at IT. We always believe that you buy things when there is much pessimism around. That is the way we have been buying auto. Consumer discretionary is another sector to look at. Also, we have always been positive about banks and we continue to believe that banking will do phenomenally well compared to other sectors in the coming quarters. IT could possibly be looked at in the coming quarters also.

What about commodity moderation beneficiaries? What kind of themes do you have in your portfolio which tend to benefit from moderating commodity prices?
We believe it is time to now focus on micro rather than macro and from commodity perspective, we believe it is time to focus on commodity consumers rather than commodity producers. We are very positive on sectors like consumer durables or consumer discretionary.

Just to give an example, whether it is a player like Kajaria Ceramics, which is the leader in the tile space or Astral, a leader in the pipe segment. These players have been hit hard because of the rising commodity prices from the raw material side. Now, when the commodity prices have taken a plunge, there is a strong reversal happening in that particular space.

These companies have taken a price hike to protect their turf, protect their margin. Now in all likelihood, they are not going to cut prices any time soon. These kinds of businesses look very exciting to us. We are going overweight on consumer durables. We still like home building and so players like Kajaria, Asian Paints, other home building players into laminates. We really like them because we believe in housing growth though we have already seen good one or two years in housing. But there is the scare about the interest rate going out of the comfort zone because of the rising inflation.

So we still like home building and the housing sector as a whole, consumer durables, auto and consumer discretionaries. We believe that there are two parts to the consumer demand. One is the discretionary and another is staples. We are very positive on the discretionary part. We are holding on to businesses like Page Industries, Bata and all that. We believe that that particular segment will continue to see very sustainable and higher growth compared to staples and they have a limited impact on margin because of the pricing pressure.

These are some of the sectors which we believe should do really well going ahead.

How are the earnings picture looking right now in the smallcap, midcap end of the portfolio.? Also, how is the earnings picture looking on a net-net basis 12 to 14 months far out? How is the blended earnings growth in your midcap portfolio now?
At least for our portfolio, we are looking at a growth of almost 25% for FY23 and another 20-21% in FY24. If we look at the way the market is positioned, Nifty is expected to see earning growth of 15% to 16% this next calendar year and possibly another 14-15% in FY24.

But midcaps and smallcaps are expected to see very erratic moments in earnings because they are expected to grow 20% in FY23 as an index but they expect another 35-40% growth in FY24. But at least for our portfolio, I believe any businesses which can grow 20% plus where they are available at 1 to 1.2 times PEG ratios are something which should be looked at and we are very confident about our earnings growing north of 20%.

We believe that the businesses that we are holding, the sectors which I spoke about, are growing very strong on revenue growth but the impact on margin is a little much. The margins are protected and so are able to deliver more than 20% earning growth. I believe in the current circumstances, 20% earnings growth would be like something to die for.

One quick view on valuation compression, This 25% growth which you are talking about of your midcap portfolio, how much has the valuation eased from peak? What kind of multiples were they trading at, now how much have they eased?
So there was a time at the peak, our portfolio was trading north of 30% so we were trading exactly at 33 times PE one year forward. Now because of the compression in the market in the last one-and-a-half years, especially one year, that valuation has come down to 27-28 times. So, we have not seen a very steep decline because as you are aware, we invest into quality names with strong leadership positions and businesses with strong pricing power.

The fall in our portfolio was much lesser compared to others but we are still trading at 27-28 times and for a 25% earning growth for the next year, the portfolio is trading at almost 1.2-1.3 times PEG. We have very less derating risk and we are poised to participate in the earning growth which is expected to fructify in the coming future.

What are the good themes which you are researching?
We have been very vocal about plays like PVR because that was one area where we invested heavily during Covid times and which has played out well for us. Similarly, we invested in plays like Safari during those tough times of 2020 and they have all fructified for us. Right now there are certain sectors which excite us. One of them is auto ancillaries. We believe that while there is risk from the Europe side, the auto sector could be a dark horse.

The auto sector is still trading at 10% discount to their last 10-year averages and the revival in the PV, CV. The tractor and two wheelers are still backing off. They have to see a lot of pickup but we believe that this is the right time to look at the auto ancillary sector because the commodity price inflation, deflationary trend will help them. The chip shortage situation has improved; the consumer discretionary demand growth is what we are really excited about.

So auto ancillary is one sector we are looking at. Midcap IT is another sector where we are really getting interesting data points. There are some companies which are now trading at 20 times, 22 times forward and where we expect that even if there is a recessionary trend, they can still manage to a 15% kind of growth. There are a couple of them which we believe can be looked at in the current situation.

Also we are increasing weights into businesses which will be hit the most on account of commodity inflation; players like Asian Paints or Kajarias. We believe the commodity prices are not going to go back any time in a hurry because of the growth scare. At the same time, there has been a tightening of the balance sheets by the central banks for the next six to nine months. A majority of these companies will catch up whatever lost market cap they have turned in the last one year or so. Those will be the low hanging fruits which we are capitalising on right now.