Overweight on auto; wary about corporate capex driven banks: Nilesh Shetty

“I will be careful. I do not think great value has emerged in that bucket as yet. As they had a massive rally, now they are seeing a correction and investors still need to be careful in that bucket,” says Nilesh Shetty, Portfolio Manager, Quantum Advisors.

How are you positioned in deep cyclicals like the auto and auto ancillary segment in your portfolio? Have you started raising your weights here?
We believe in the value style and auto is one of the deep value pockets available. The valuations there are trading at close to the bottom of their valuation bands and we actually continue to have a large weight there especially in the two-wheeler space. We have a large outsized position there.

Again, the numbers are back to a decade ago level primarily because the market had to digest the price hikes that happened over the last three, four years. We are sort of at the cusp of upturn in volumes there and if your volumes do generally pick up. One of the big drivers is the replacement cycle which has been elongated because of shocks to the economy.

Perhaps we will see some of those buyers sitting on the sidelines jumping back in and replacing some of their old vehicles. And of course, a lot of the offices are still hybrid and colleges are still not back to 100%. Once that need for mobility kicks in, a combination of factors will see auto demand pick up, especially where valuations are. We expect that bucket to do really well over the next two, three years. So we have a fairly large overweight position.

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What about capital goods, especially the mid tier capital goods, the bearing companies? Elecon Engineering, AIA Engineering and all these midcap engineering companies which are capital good feeders to a larger capex cycle. How do you like this universe?
Unfortunately, a lot of them do not meet our liquidity criteria. We have minimum liquidity criteria and most of these companies tend to trade below that for us so they have not come in our filters. But there is a cyclical upturn due and we will see that bucket do really well.

One has to pick and choose the quality of management because it is filled with companies with not that great management quality. One has to be very careful who one wants to buy in that bucket. I expect that if generally there is an economic up cycle in India which we believe is due primarily perhaps you will again see a sharp pickup in infrastructure spends and capex cycle. I expect capital goods as well ancillaries to those capital goods to do a lot better.

The MD of SBI was referring to the credit cycle coming back. He was telling us that capacity utilisation in the system has gone up to 75% and inquiries on new capex related loans have gone up. Does it give you comfort to own more of corporate centred banks in your portfolio – be it PSU or private?
We do have some allocation there but we have to be careful because of the price inflation that you are seeing over the last two years. Just the replenishment of working capital itself will drive credit growth. So it may not be a genuine reflection of underlying demand for capex spending but just inflation-led replenishment of working capital which is driving that credit growth number.

But we do expect that over the next 12 to 18 months, at some point, the companies will get serious about capex. We are seeing anecdotal evidence of that in one or two sectors but whenever I have met banks, there is no broad based need felt by corporate India to show a sharp improvement in capex spend. They are still very careful and watchful and sitting on the sidelines but I expect that will change over the next 12 to 18 months once utilisation levels hit some threshold.

We do own banks but most of them are on the retail side. We have to be careful about corporate capex driven banks because a lot of them are service backed and quality of management is highly suspect there. We tend to stick more to the private side at the moment.

GRMs went to record highs and now refining stocks have started retreating. Commodity cycle seemed to have peaked and lead, zinc, copper all are at multi-week low. Did you manage to reduce your weight on pure commodities in time or are you expecting a rebound and the average realisation to be healthy and hence holding them?
Somewhere at the end of last year we started trimming a lot of these holdings. We do not have a lot of commodities but whatever we had, we trimmed a significant portion of their weights primarily on valuations because in cyclical upturns, their valuations have started trading at premium valuations compared to their historical bands.

We have trimmed that and we are waiting patiently. They have corrected quite sharply and in a lot of the companies, even though the price correction perhaps does not warrant the kind of share price correction that we have seen. If the price sustains and there are some opportunities for us to add more, we will have to wait and watch where the commodity prices end up. If they end up lower, you might see a bit more pain in that bucket but we have trimmed our positions in the commodity space.

We know that small and midcaps are more of a bottom-up kind of opportunity but has the average valuation of that universe corrected enough to start looking for value there?
We have a big weight on corporate governance and to get quality management at valuations that we are comfortable with has been a big challenge for us. So even after the corrections, the better run companies, with great franchises or quality of business continue to trade at premium valuations.

We will get value in companies where perhaps the quality of management is suspect or the business models are not that great and that is not a space that we want to own. So I will be careful. I do not think great value has emerged in that bucket as yet. As they had a massive rally, now they are seeing a correction and investors still need to be careful in that bucket.