The business momentum continues to pick up pace
All time high revenue, all time high order books and no speed breakers visible for the next few quarters. This is common to most businesses in these sectors, not just the businesses that are represented in our dashboard. India has been underinvesting into gross fixed capital since 2010, the last time GFCF printed a number above 34% of the GDP. For the next decade or so we were largely a consumption led economy, which culminated in consumer businesses trading at insane PE multiples. The core economy facing businesses hardly had any takers, investors believed that 20 PE was generous enough for most businesses here. RBI has been indicating that capacity utilization crossing 75% can usher in a new wave of capex anytime, to some extent this is already playing out. Many banks are eagerly awaiting the prospect of increasing their lending book to worthy corporations if the opportunity presents itself.
What happens from here will have some dependency on how India votes in 2024.
Please go through the Q4 investor call transcript of Larsen & Toubro, the management was very vocal that in the run up to the election the Govt usually enters a silent period till the outcome becomes clear. There are chances that the pace of execution will pick up through the remainder of CY23 before PSU managements and Govt office bearers start going into “election mode”. If the current Govt retains power, we might see one hell of a run for the next 2-3 years. But that does not mean we should bet on it right now. Businesses in these sectors aren’t known to deliver 20% ROCE across cycles. When the going is good they look pretty good with balance sheet, cash flows, return ratios at healthy levels with order books providing multi year revenue visibility. But once the operating environment gets tighter (for whatever reason), a mini cycle plays out that can affect everything investors take for granted at the peak of the cycle. Any business that generates < 18% ROCE in average times and doesn’t have too many levers to improve margins should be seen as a tactical play. Play the cycle well, take your profits home in a timely manner.
For these reasons we are a bit wary of adding more exposure here, from here we would rather think in terms of risk than in terms of return. The market has a way of extending good runs till they start looking too good to be true, that may well happen here looking at the growing order books.
We also don’t want to turn conservative too soon. Let the trend play out but be clear about the exit strategy. Till 2 years ago most investors would have scoffed at RTML & TD Power trading at 32 PE and Triveni Turbine trading at 60+ PE, yet here we are. Some of the MNC names in these sectors are starting to enter the “insane valuation” territory. But do remember that private sector banks traded at 4.5x book, consumer businesses traded at 70+ PE for a few years before the trend broke. Good runs don’t end because the valuation is too high, they end only after something breaks fundamentally.
We believe that most of these businesses will deliver good results in FY24. Some of these businesses have long term tailwinds and will succeed irrespective of who is in power in India, their competitive position is that strong. Barring those few, everything else here is a tactical play in our book.