Chemicals and pharma could be the theme for next 2-3 years: Ashwini Agarwal

Ashwini Agarwal, Founder & Partner, Demeter Advisors, says: “I have been sniffing around at IT for a while. I thought I would nibble into it prior to the June quarter earnings results and looking at the results, I was glad I did not. I don't quite understand what has driven the rally. The narrative has not changed. The growth environment still remains fairly challenging for the IT services companies but maybe the valuations have become cheap enough, and that is the reason why IT is attracting attention.”


Where have you been shopping of late?
In some of the larger financials. Taking money off the smallcaps and putting it to work there. With the hope that over the next three years-


That was two years ago you were shopping. That was the last sale. That was like two years ago, you bought it for sale.
No, no, no. I will continue to do it. If you look at the frontline banks like HDFC Bank or even Kotak Mahindra bank or some of the other names, they have done nothing for a period of three years. Valuations have come off purely due to elapsing of time. And the premium that they enjoyed has contracted significantly and it makes sense to look at names like these. I do have a position in HDFC Bank for due disclosure, but I would say that it makes sense to build exposure to names like these where you have downside protection and funded from smaller and midcap names where the pricing action appears to be extreme.

Having said that, I continue to look for ideas in the small and midcap space because the overall economic growth environment in India is going to be very conducive. And if that is the situation, many of these smaller companies will offer 20-25% earnings growth over the next five years and not all of it is priced in. So it is a combination of both. I do worry about the extreme price action in certain areas and certain sectors but at the same time, I continue to find opportunities both in the lagging frontline names with good prospects as well as select smallcap industrial names or even some of the services names.

Buying banks because they have not done much at least over the last many months. Are you buying IT as well with a similar thought process?
I have been sniffing around at IT for a while. I thought I would nibble into it prior to the June quarter earnings results and looking at the results, I was glad I did not. I don't quite understand what has driven the rally. The narrative has not changed. The growth environment still remains fairly challenging for the IT services companies but maybe the valuations have become cheap enough, and that is the reason why IT is attracting attention.

For most foreign investors who have poured in a huge amount of capital into India over the last couple of months, largecap IT is an area of extreme familiarity. Valuations are not expensive. There is a very good dividend yield support. It makes sense for a large institutional inflow to get parked there and that is what I am thinking, but I will still wait for the September results commentary before taking a position there. The challenges have not dissipated quite yet.

You are not alone in that. Even I am as puzzled by the rally as you are, because in terms of the commentary that I heard in the quarter gone by all the earnings, nothing to my mind warrants that kind of move. But you have also been positive about the textile stocks. Could you talk to us about some of the names there? Also, is it the entire value-unlocking real estate vertical kind of stocks that you are looking at within textile?
In textile, the export story is playing out, and it is a China plus one narrative also that is playing out. Towards the second half of 2022, we were all worried about the US demand slowdown. It was a little bit of a situation where the retailers in the US had prepared for a slowdown, and the demand slowdown did not happen. As a result, most of the shop shelves were low on inventory at the start of 2023, resulting in a fairly robust environment through the first half of this calendar year.

On top of that, the China plus one narrative is playing out. Some FTAs have been signed. Australia and the UAE in particular are offering some opportunities. Over the next three years, if the access to the EU and UK improves, then there is a lot more opportunity there. Again, valuations are attractive even now for some of the textile names. The risk of a US slowdown is very much there, but it is not visible yet.

So, does the US consumer continue to soldier on and keep worrying about it and nothing happens? It is quite possible, but I find comfort in valuation and that is one area where I had invested at the start of the year and even in 2022. Some of those stocks have done quite well. I am grateful for that but I continue to think there are value buys which are available.

In a market like India, private banks were a mega trend 10 years ago, and I am sure they will be a mega trend 10 years henceforth. But there are a lot of seasonal trends. For example, luxury, hospitality and defence were bombed out in Covid. Right now, they are the go-to spaces. Where are the ingredients now for making some cyclicality, a little bit of mean reversion which could be a theme for the next two-three years?
Chemicals, especially the downstream chemicals, is one area we should keep an eye on. I am a huge believer in the China plus one narrative, and India does have significant capability in chemical manufacture. Chemistry is something that we have done well historically, whether you watch the pharmaceutical space or whether you watch the bulk chemical space.

In India now, we have the capital and the capability to manage large size projects. If you put these things together, you might be early in a chemical cycle. The stocks got sold off over the last one and a half years because there was a massive Covid pop and the Covid one-off earnings have now been taken away.

Earnings have normalised, margins have normalised, but stock prices have also corrected significantly and have not done well. My view is that this is one area where you might see a positive surprise. I continue to be quite positive on the pharma space, where there are companies in the export-oriented space and a few in the domestic market space, which continue to look quite attractive to me. Again, the theme being that the margins have bottomed out and the China plus one narrative is here to stay.

The margins will remain fairly normal from a raw material price point of view for the next few years, given how soft the global economy is. These are a couple of places where I would be looking for opportunities.