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Midcap IT to grow at a faster pace; huge global play in auto ancillaries: Varun Goel


As far as profitability growth is concerned, we see midcap IT companies growing at a faster pace. In our view, the top four-five names on the midcap side should be able to grow their profits at 22-25% on a CAGR basis for the next few years and which means we should see meaningful wealth creation in this space, says Varun Goel, Fund Manager, AIF & PMS, Nippon India Mutual Fund.

Reliance is one of the key names across your portfolios. We just heard from the management about their hydrogen cell and green energy mega plans which were unveiled at the AGM. There is also a near term trigger of Ganesh Chaturthi on September 10. In the last AGM, they had announced the unveiling of Jio Next, the low cost phone with Google. How do you see their various businesses pan out from here on?
As far as the telecom space is concerned, we are going to see it as just the beginning of a long phase of increase in tariffs. Between various players, the average ARPU is between Rs 130 and Rs 150 now. This is going to increase substantially in the next two to three years. What that means is that the two or three players that are left now would see significant improvement in profitability going forward.

So we remain quite positive on the overall telecom space. After four-five years of consolidation, most of the weaker players have been wiped out and now the remaining players should be able to see a phase where they can take continuous price hikes. Our sense is there will be another price hike by the end of this fiscal year and that should take the ARPU significantly higher from where we are at this point of time.

All of us have enjoyed one of the cheapest data tariffs anywhere in the world. It is time to pay a little more for all of that. As far as overall retail space is concerned, there has been a lack of demand in the last one, one-and-a-half years of Covid. Hopefully, as we come out of the Covid phase, if the third wave is under control, even the retail industry — be it consumer durables, apparels, footwear or groceries — will meaningfully bump up.

Hopefully this festive season would usher in happier times compared to what we have seen in the last six months. As the country approaches 50% plus kind of vaccination, the remaining parts of the economy can also be opened up and our sense is that the consumer space and the retail sector can also be opened in a meaningful fashion and that should help the retail focussed companies.

Your portfolio contains some home improvement/electrical names like Polycab, Bajaj Electrical, Havells. This entire range got re-rated because home improvement is becoming a big area. Upgrading consumer durables is a very large portion of houses now and people are going up the value and quality curves. What are your thoughts here?
After eight years of consolidation, we believe there is going to be a significant uptick as far as residential real estate is concerned. The reason why I say that is because affording abilities have gone up meaningfully while the prices have not really gone up anywhere. If you look at the EMI to take home salary ratios, it was 48-49% 2013. Today that has come down to 27-28%. The reason being mortgage rates are at a historical low of 6.6-6.7%. It is a very attractive mortgage.

Plus. a lot of people who were priced out of the residential real estate market in 2010-11-12, have come now to buy their first house and a lot of people who bought a smaller house in the last cycle, now want to upgrade that as people realised during the Covid that they need a bigger space.

We believe residential real estate is in for a strong recovery as residential focused real estate players with good corporate governance and good balance sheets should be a big beneficiary. Second, all the ancillary companies — tile manufacturers, consumer durable producers, wires and cables makers would also ride that demand. We believe that as the residential real estate cycle picks up, all these companies would see a very sharp run up in demand.

All of them have seen fairly muted top line growth in the last few years. As the demand picks up, we see pricing power coming back. Copper prices have gone up but the companies are able to pass on this price hike to their customers which would mean a strong improvement in both top line and profitability in the years to come. We believe this should be a three-four-five years cycle where all the residential real estate players, especially the strong corporate backed ones, whether it is cement players, building material, tiles, wires, cables, sanitaryware manufacturers should see a meaningful cycle.

IT got a very big push because of Covid but otherwise too, adoption of technology by corporate India or companies globally has gone up in the last 24 months. These companies have found their mojo in terms of hiring, margins, growth whatever. But the point is largecaps are rising as well as midcaps. Where do you see more margin of safety or earnings expansion growth?
We are seeing a very big IT capex cycle. Lot of companies, whether in manufacturing or banking, have realised that if they need to keep their business functional in times like this, they need to have a very superior customer experience as far as their production services are concerned. So everyone is automating, everyone is digitising and that is why we see a big wave as far as IT spends are concerned. India, of course, has been a big beneficiary.

In our view, this is the next big wave after 1999-2003. Most largecap, midcap, small cap companies will be a big beneficiary of this. Of course, the larger companies have seen the first round of spending. The second round of spending will go down to the second tier and the third tier companies because some of the larger companies are leaving some orders because they believe they are not as profitable and these are being picked up by tier II, tier III names.

We believe that as far as the midcap and smallcap companies are concerned, they will have a double benefit — not just top line growth but they should be able to increase their margins as well. As far as profitability growth is concerned, we see midcap companies growing at a faster pace. In our view, the top four-five names on the midcap side should be able to grow their profits at 22-25% on a CAGR basis for the next few years and which means we should see meaningful wealth creation in this space.

How to play the global auto rebound? Commentary coming in from some of the large auto component companies which cater to truck sales in the west is that preparations are on for a mega infra boost and that will also come here. Not only that, companies like Balkrishna which make tyres for very large earth movers or even general tyre companies that export like Apollo are giving good news. How do you see the global plays of auto ancillaries?
There is a very big play as far as the global opportunity is concerned. The domestic industry is going through severe demand headwinds. The two-wheeler space is right for a major disruption. We are avoiding most of the domestic oriented plays. As far as global space is concerned, as far as the capex activity in markets like the US is concerned, they have passed a big infrastructure stimulus plan which should get manifested in big orders for commercial vehicle players, forging players. Among tyre players, sectors manufacturing larger tyres used in offroaders and earth moving or construction equipment or tractors should see an increase in demand in countries like the US.

As far as the CV space is concerned, while the domestic market is slow to revive, we should see the demand coming back in the next few months. We believe that domestic infrastructure push could lead to revival in demand there. So gradually, even on the domestic side, CV demand could come back and that should be beneficial for domestic CV players.

How are the flows coming into your funds from your client side? I understand you are also in the middle of a fresh fund raise?
So we have seen good response to our AIF schemes. We are in the process of raising our sixth AIF and investor response has been positive. The markets have also been supportive and we hope to have continued support from our clients.



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