The one thing that stood out from the second quarter commentary was the inflationary cost pressures. How is India Inc. going to mitigate it and maintain the margin trajectory? From an investor’s perspective, should one be looking at inflationary sensitive sectors now?
The worst effect of inflation has been seen on the consumption names whether it is automobiles, consumer staples or consumer discretionary that has experienced the biggest impact. Otherwise, it doesn’t really matter in the banks or IT services sector barring whatever inflation being seen on the salary side. Commodity companies stand to benefit, given the big increase in commodity prices.
So other sectors are broadly fine. But consumption sectors have pricing power, especially consumer staples as well as discretionary. They will decrease prices over a period of time. Obviously, it is not possible to raise prices significantly in one quarter alone and many of them are gradually raising prices from April itself and announcing small price hikes every one or two months. Given these are essential products, consumers have no option but to absorb them. Otherwise, if consumer staple companies can’t raise prices, they probably shrink the grammage.
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So I am confident that most consumer staple companies have pricing power to fight the big price increases on the raw material side. In the case of auto companies, it is a little bit more challenging because the demand environment has not improved in some segments but there too, over a period of time, price increases will take place. Another good thing which has happened is the government did cut excise duty on diesel and gasoline quite significantly and there is also a lower cost of ownership as far as automobiles are concerned. All together, automobile companies might be in a better position to increase prices. Broadly speaking, it has been a challenging time. The second quarter saw a bit of compression in gross margin and EBITDA margin for most of the companies in the sectors. But over a period of time, sufficient price increases will be done to mitigate the negative impact of the other increases.
The other thing that I wanted to talk about is the reopening trade. From multiplexes to hotel industry to even aviation, some of these stocks have recovered from their 52-week lows, but is the story in the theme still under priced and can it stretch beyond the obvious names?
I suspect a lot of good news is getting priced in now because the multiples these companies have got may be significantly beyond what they used to be before the pandemic. For example, the kind of multiples many of the hospital companies are trading at currently looks like a lot of good news is also taking note of the potential value creation in online pharmacy space.
Apollo used to be a 40 PE stock on a 12-month forward basis before the pandemic. This has gone to 70-80 now on a 12-month forward basis. Some other stocks that used to be 35 PE, have now become 75 PE. The multiples have just expanded beyond the comfort level in many cases.
I do not know how much of the recovery in volumes the analyst committee is betting in currently. In our case, we are still conservative on the volumes assuming travel, tourism and hospitality would come back significantly in the next financial year. The Covid situation in India has improved quite dramatically. The theme is pretty much intact. There is no question about that but a lot of the good news and more are getting priced in in some of the parts of the opening trades.