“We are bullish on the FMCG sector over the long term because of rising disposable income due to the structural story intact on India’s multi-decadal growth,” Anil Rego of Right Horizons says in an interview with Moneycontrol.

The improvement in the standard of living, changing preferences, and easier accessibility are all key drivers, he believes. He expects double-digit sales growth for most players in FY24 along with better margins in the paints segment.

The founder and fund manager at Right Horizons, a pioneer in the contrarian style of investing and a seasoned investor for over three decades is also bullish on the IT sector from a three years time frame driven by attractive valuations & strong earnings growth, and a demanding environment.

Q: Your take on the consumer staples and discretionary segments?

We expect most companies in the consumer space to improve with raw material prices corrected, input costs deflated, and margins to improve pre-pandemic levels. In the fourth quarter of FY23, paint and adhesives witnessed a strong revival in demand, with most players posting growth in volumes and expansion in margins due to lower raw material prices, favourable product mix and price hikes. We expect double-digit sales growth for most players in FY24 along with better margins in the paints segment.

We are bullish on the FMCG sector over the long term because of rising disposable income due to the structural story intact on India’s multi-decadal growth. The improvement in the standard of living, changing preferences, and easier accessibility are all key drivers.

The Semi-urban and rural segments were growing at a rapid pace but have remained muted for the past few quarters. Demand recovery is expected in the upcoming quarters, which will likely push growth further. The prices of most commodities moderated, and input commodities such as vegetable oils, packaging materials and others have corrected from peak levels, so we expect margins to improve further in upcoming quarters.

Q: Will the Federal Reserve consider a longer pause in the rate hike cycle after the June policy meeting?

The Federal Committee has decided to leave the federal funds target rate unchanged at 5.0 percent to 5.25 percent. The US has been fighting record-high US inflation since the pandemic. The decision pause marks its first meeting with the outcome of not raising interest rates since the policy tightening cycle began in March 2022.

Though the combination of interest rate hikes, slowing economic growth and a tightening credit market has helped in cooling it to 4 percent in May’23 lowest since March 2021. We expect the FOMC will likely raise rates one more time during 2023 and begin rate cuts by 2024 due to the lags with which policy affects the economy.

Q: Are you positive on the IT sector as valuations have seen sharp correction?

Digital transformation is a multi-year growth driver for the Indian IT services industry, making it a secular growth story for the sector. Historically a recession in US or EU has amplified the long-term growth potential, so we expect the weak macro environment as a positive sign for the long term. And with attrition peaking and margins bottoming out, long-term investors are recommended to accumulate as demand picks up, and the interest rate is cut later.

The demand environment will likely be driven by the need for cloudification and digitisation. We are bullish on the sector from a three years time frame driven by attractive valuations & strong earnings growth, and a demanding environment. Service vendors catering to both digitisation and cost-takeout initiatives, and having an entire ensemble of service offerings, are hence likely to outperform peers.

Deal flows have been robust in Q4FY23, showing some bit of softness but lower than anticipated. We expect growth to moderate in the first half of FY24; however, quality names in the Midcap IT space to lead the pack with sequential growth on a constant currency basis. Margins will likely expand for most companies in FY24 due to the easing of supply-side pressures and operational efficiencies.

We will be keeping an eye on the demand outlook, deal TCVs (total contract value) and pipeline, vertical & geography commentary, vendor consolidation opportunities, attrition & margins outlook.

Q: Do you think Q1FY24 will be a weak quarter for the chemical industry?

Demand slowdown due to liquidity tightening across the globe, higher inventory levels in the case of agrochemicals, and increasing competition from Chinese peers have resulted in pricing pressures in the last year. The deglobalisation of global supply chains is favourable for the chemical sector in India as companies shift from China.

We expect the pricing pressures to continue in the first quarter of FY24 and prefer companies with value-added products that are moving up the value chain.

Also read: Daily Voice | This investment advisor expects divergence in performance between large & mid-tier IT firms

Q: Do you see value in the logistics segment?

In the last quarter of FY23 for most companies in the sector margins slipped and price hikes were not completely absorbed, and performance was below consensus. Volume grew for surface logistics but slipped for rail companies. The imbalance in trades, along with lower EXIM volume, sequentially resulted in lower margins for the rail segment.

We expect margins to have likely bottomed out for most companies and volume growth to be a key driver for earnings and companies with better asset turns and profitability are likely to do better.

Q: Are the small private banks available at attractive valuations compared to larger banks and NBFCs?

Analysis of small finance banks (SFB) has shown that they have undergone a transformation with a decrease in the share of borrowings from 44 percent in FY18 to 13 percent in FY22 and an increase in the share of deposits. In comparison to public and private peers shows, this segment is paying nearly 1.6x times in terms of cost of funds at 6.36 percent compared to an average of 3.87 percent in the case of private and 3.98 percent by public banks and yet the average ROA (return on asset) is 2.85 percent nearly double of 1.67 percent for private and 1 percent for the public.

Despite catering to unserved and underserved sections, small business units, micro and small industries and unorganised entities, the average capital adequacy ratios of SFBs as of March 2023 end were 24.71 percent better than private & public at 18.34 percent & 15.46 percent, respectively.

The net NPAs for SFB/Private/Public were 0.23 percent/0.39 percent/0.78 percent, respectively, indicating that the segment has managed its NPA better than its peers. We prefer SFBs with diversified loan books, focusing on strong secured books, a full liability franchise and prioritising recovery processes, as these would be attractive in valuations relatively.

Q: Do you think the recent economic data points paint a Goldilocks environment for India?

Though recent numbers from macro indicators point to a conducive environment for growth. Credit growth has been in double digits for the past year and is expected to continue, corporate debt to GDP is at low levels, balance sheets of corporates and banks remain healthy, the domestic currency is stabilising relatively, commodities are cooling, inflation is moderating, and interest rates expected to be cut. This will enable this investment-led economic cycle to likely result incorporate benefits across sectors.

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