Mumbai: Anish Tawakley, chief investment officer (CIO) of DSP Asset Managers, believes investors should no longer expect the double benefit of simultaneous revenue and margin expansion. Instead, he said, the next phase of growth will be driven primarily by a healthy revenue environment as profit margins have already peaked in most sectors, leaving limited room for further expansion.
Tawakley favors financials, cement and autos as direct beneficiaries of robust domestic spending and credit growth. While he also likes the cyclical earnings outlook for capital goods, he advises strict selectivity given the sector’s elevated valuations.
Edited excerpts from an interview:
How are you reading the markets right now amid the recent consolidation, talks of a US-Iran peace treaty, and the potential fallout of the war? Will we see earnings downgrades?
Our view on the economy is positive, and we expect healthy earnings growth. However, given that starting valuations are not cheap, we expect moderate returns from the market.
The domestic economy is in good shape: demand is recovering and there is still spare capacity. This is a good environment for earnings growth. On the external front, things are volatile and there could still be disruptions. However, the important thing to remember is that these are likely to be temporary disruptions, and the Indian economy, with its large foreign exchange reserves, has the ability to withstand these temporary shocks.
Where are we on the journey to recovery, not just in terms of markets but also earnings growth?
To understand the recovery, we have to look at where we are in the economic cycle. A typical cycle begins with a slump where there is excess spare capacity from prior investments. As demand picks up, you enter the “sweet spot” of the cycle—a phase where companies enjoy a double lever of growth from both rising revenues and expanding profit margins (as operating leverage kicks in with the increasing capacity utilization levels). We have largely moved past that initial sweet spot. Profit margins have already expanded significantly across several key sectors, particularly in capital goods and automobiles.
Moving forward, investors should not count on that double kicker of simultaneous revenue and margin expansion. Instead, the next leg of growth will be driven primarily by a healthy revenue environment, while further margin gains will likely be limited or negligible since they have already peaked in most sectors.
How do you view export-oriented sectors? With global markets opening up, is there ample opportunity or specific beneficiary plays there?
To be honest, we see export-oriented manufacturing largely as tactical plays rather than structural growth opportunities. It is crucial here to distinguish between actual growth and mere normalization. Normalization is simply recovering to a past baseline after a dip, whereas true growth means scaling to new heights.
We have never been structurally bullish on Indian manufacturing exports due to a fundamental economic principle: comparative advantage. If a country wants to attract foreign capital investment, it must naturally run a current account deficit; the capital account surplus and current account deficit are just two sides of the same coin.
Because India has a massive comparative advantage in exporting high-value services, our services surplus is strong. For the overall current account to remain in a deficit, our goods trade must naturally be in a deficit. Unless our IT (information technology) services exports completely collapse—which would devalue our currency to the point where our manufacturing becomes as cheap as Bangladesh or Vietnam—Indian manufacturing exports will face structural headwinds.
If you are avoiding manufacturing exporters, which sectors do you actually like right now?
Since we believe the domestic Indian economy is in great shape, we prefer sectors that directly ride the domestic growth wave. We are highly positive on financials, cement and automobiles as they are direct beneficiaries of domestic spending and credit growth. We also like the cyclical earnings outlook for the capital goods space, but we have to be far more selective and cautious here as valuations have moved up a lot.
You said you prefer domestic-facing sectors but didn’t name FMCG (fast-moving consumer goods) or consumer discretionary. How do you view those?
They are two very different categories. In an economic upswing, consumer discretionary performs well because it thrives on cyclical upside, whereas FMCG demand remains relatively stable. However, our main concern with FMCG isn’t demand; it is that these companies are over-earning. Their profit margins are unsustainably high because they have raised prices to a point that leaves them vulnerable.
When you operate at a 30% margin, you inadvertently provide a massive pricing umbrella for competitors. A rival can come in, undercut your price by 10%, still earn a very healthy 20% margin, and aggressively steal your market share. This high-margin environment is attracting intense competition, which makes us cautious. We view autos as part of consumer discretionary and are positive on that space.
What is your take on the power, transmission and distribution (T&D), and defence sectors?
We view the power and T&D spaces similarly to capital goods. They are fundamentally strong, and we hold positions there. Defence, on the other hand, is highly talked about but simply isn’t large enough to move the needle for a diversified portfolio. While you can find specific, solid component manufacturers within defence, we don’t view it as a portfolio-altering sector.
You like financials, but are you comfortable with all non-banking financial companies (NBFCs)?
One of my key learnings with lending businesses has been that one should not get too excited until one has seen a full cycle. I would not assume that these businesses will not have a credit downcycle—after all, they are lending to subprime borrowers.
Looking at market caps, do you have a preference right now between large, mid and small caps?
We have a clear and strong preference for large caps right now. As valuations rise across the board, corporate governance risks multiply, and we are seeing significant red flags in the mid- and small-cap spaces.
Promoters are smart—the massive wave of primary issuances, initial public offerings (IPOs) and direct promoter share sales tells you that insiders think it is a great time to sell and reduce their own risk.
Furthermore, the market is currently giving mid and small caps a free pass on their quality of earnings. A closer look at their balance sheets reveals a highly concerning buildup of inventories, ballooning receivables, unexpensed items hidden in “intangible assets under development,” and contract assets.
Because the market isn’t scrutinizing these aggressive accounting practices enough, we are being very careful and strictly favoring the safety of large caps.
What is your current asset allocation view on gold, silver and bonds?
We are actively trimming precious metals. Silver is an absolute avoid after its aggressive runup, and gold should be trimmed as it is no longer cheap. Conversely, we see genuine value in fixed income and view holding bond duration as a smart move.