There is a sense in the market that maybe some amount of fatigue maybe actually coming in with all triggers playing out and there is, in fact, some concern that first quarter numbers may actually not be that great. Is that a legitimate concern?
Vinay Paharia: You will have to look at concerns from a different angle. From a broad macroeconomic perspective, we are clearly cruising at high speed. There will always be some slowdown or pickup in the economy, but I do not envisage a material and a broad-based general slowdown from a pure macro perspective. Economic momentum, we do not have any issue. What about valuations? Are they kind of fairly priced right now?
Vinay Paharia: Yes, so, purely from a valuation perspective the way we look at market is through the lens of three buckets and these buckets are companies which are low quality and low growth, companies which are either low quality or low growth, and companies which are high quality and which are high growth.
Now, in the last one year, we have seen a huge outperformance of companies in the low quality and low growth basket. It is in this space where the valuations have actually significantly re-rated and most of the companies are now trading at a materially higher level in terms of valuations compared to their longer-term averages.
Whereas the other basket, which is high quality and high growth, this is a basket of companies which are trading at very reasonable valuations or to slightly higher valuations compared to their longer-term valuations.So, I think there is clearly a dichotomy which is building up in the market and we are more concerned about micro bubbles which are brewing in the low quality and low growth segment of the market. That is a very important point. There are micro bubbles which are kind of already forming in the low-quality end of the market. Are you alerting your investor fraternity, the universe you speak to very clearly around that? Are some of them mostly in smallcap and midcaps?
Vinay Paharia: Yes, I think as far as our communication is concerned, we have been alerting our investors and community at large since the last three to six months now, ever since we saw the signs of these bubbles building up.
And with each passing month, the bubble is inflating, it continues to inflate. So, I think that is an area of concern. And of course, since small and midcaps are larger in number of companies, so there is a large number of companies which can be picked from this universe.
So, the number of companies which are in bubble zone are also higher in this segment of the market. Having said that, I would also want to highlight that even within the small and midcap space, there are a reasonably large number of companies which are good quality and high growth companies and are still trading at reasonable valuations relative to their long-term averages.
Let us talk little more specifics, not stocks but themes or some indicative areas, where you think for reason of their own, but market is neglecting and completely ignoring the positives?
Vinay Paharia: So, I think one of the areas recently started getting more attention and that is the large private sector banks. So, this is an area which was mostly neglected by the market in the last one year’s rally. Companies have reasonably performed well. The NPA cycle is almost at a long-term bottom. Returns on equities are reasonably healthy for this overall pack and the valuations are attractive. So, I think this is one space which stands out from both valuation and growth perspective. There are other segments, which I would say pockets in segments like healthcare, information technology, consumer discretionary, these are spaces where you can find lot of opportunities.
Coming to IT, I was just talking to Saksoft, a mid-tier IT company on their acquisition. I was observing that a lot of mid-tier IT companies are actually growing much faster and on profitability front compared to their largecap peers. Where do you see high growth and good valuations in IT? Will you actually stick with large ones or you are open to looking some mid-tier IT companies as well, which are catering to very specialised niche areas?
Vinay Paharia: So, your observation is right. Most of the high growth IT companies are concentrated in the midcap or smallcap segment of the market. But many of these so-called midcaps of yesteryear have now become largecaps. So, I think just segregating them by capitalisation may not be useful. But definitely, yes, you have to hunt beyond the top four or five IT companies to get higher growth.
In healthcare, where do you see more value? Typical pharma companies, that to either India-focused pharma or generic exporters or are you also looking to diagnostic companies, especially tier II, tier III diagnostic players or even hospitals, some regional hospitals because the largest hospital chains or the pan-India players are trading at the higher end of their valuation. So, where do you actually find more value?
Vinay Paharia: So, I think hospitals is a space which is looking attractive. But while your observation is right that many of them appear to trade at expensive valuations, but when you look at their long-term averages, when you look at their prospective growth rates and remember these are fairly stable businesses.
Unlike pure retail businesses or hotel businesses, these are fairly stable growing businesses and that is the reason why the cost of equity for these companies is also lower, which means that for the same growth such companies ideally should be deserving to trade at a higher valuation. So, I think in summary, some of the regional/national hospital chains are attractive, domestic formulation companies are attractive, and there are some other pockets within the healthcare space, of course, on a bottom-up basis which are also attractive. But net-net, this is a space which is attractive not for valuation reasons, but more from growth reasons.
Areas to nibble in as far as chemicals are concerned, either agri-chemicals, India-focused ones or even some of the exporting guys, especially the ones who do some complex molecule work because these guys have gone through very rough weather in the last three years or do you think it is early days?
Vinay Paharia: I think definitely this is a space which is neglected. I think we started our discussion on which are the neglected spaces of the market.
So, clearly, complex chemicals, companies which are dealing in speciality chemicals or agrochemicals which are speciality or patented contract manufacturers, these are spaces which have been reasonably neglected by the market in the last one year’s time.
These companies have consolidated their businesses. Some of them might have seen slowdown or macro challenges, which are behind us now, so I think clearly this is a space to watch out for.
