Largecaps still offer margin of safety amid broader re-rating: Harish Krishnan

Economic Times

14-05-2025

Agencies
But is there a relative margin of safety built into these kind of franchises, we would like to think so.
"Markets do not work on the newspaper headlines for today. They work on what the likely newspaper headlines can be about six-nine months from now," says Harish Krishnan, Aditya Birla Sun Life AMC.
One month ago, everybody was complaining. Some were worried about tariff. Some were worried about geopolitical concerns. Some were worried about dollar. Everybody was worried about FIIs selling. And then, the general consensus view was that earnings would not be great. Today, no one is complaining. So, are we in that phase of the market where good news is there, but good prices have also gone?
Harish Krishnan: So, we were not complaining about two-three months back. So, clearly, we had gone quite aggressive into buying equities. Mutual funds are getting 24,000 crore a month. You guys cannot complain.
Harish Krishnan: No, but even within say our asset allocation products, we were at 38% in say our balanced advantage fund, 38% in net equities by mid of October last year when the market momentum seemed to go off and then, sometime by mid-February and March we were close to about 70%, so that is the kind of extent of increase in net equity that we did. When there was this opportunity where everybody, as you rightly said, was focused only on macro, there was only one talking point which is that of macro, which is that of how Trump tariff wars are going to derail the economy, or it could be about geopolitical considerations, etc. Markets do not work on the newspaper headlines for today. They work on what the likely newspaper headlines can be about six-nine months from now and which is where we were saying that there is an improving trend in earnings that we are seeing and it will be more visible as we get into the end of this fiscal year and possibly towards the next fiscal year and that to our mind with a lot of excesses of the froth going away in terms of valuation, provided us a good opportunity to get in, so that really is a context of how we have decided in terms of the opportunities that came through even amidst all this noise that was there.
So, what could be the next big headline for the market? Since you are talking about predicting a headlines now right, so what should one focus on?
Harish Krishnan: So, it is not about predicting headlines. It is about finding out the rate of change as to where it will be. So, we do think that from an environment of peak macro, we going to go into more and more into micro, which is that we going to go into earnings, we going to go into sectors where there is going to be an improving trend.
We are going to see into a trend of improving capital expenditure that is going to happen. So, that is really is what we are talking about. Secondly, today, there seems to be over pervasive environment wherein we are very focused on what Trump is going to do. One has to realise that there is a particular amount of pain that even politicians globally can take. I would be very surprised if they are wanting a very harsh Christmas on their own citizens and therefore, we are going to see in kind of these tariff wars which are going to come through by September-October. It is not going to be smooth sailing that everything is going to normalise as what it was before, but this extensive fear-mongering that seem to be all pervasive, I would think that that sentiment is going to go away quite meaningfully. So, like I said, it is not about prediction, I do not think any of us have got the accuracy to try and see what the headlines are going to be, but to try and see what the rate of change of each of these variables are and which is where we are far more constructive on markets as we speak.
The last time we connected with you, you were quite comfortable to place your bets within the largecap space and the valuations were not that comfortable for the smids. Do you still stick with that stance and the tilt of the portfolio is still within the largecaps or now is the time when you are finding and looking for some opportunities?
Harish Krishnan: So, it is always going to be more bottom-up and within various sectors. But broadly speaking we think that whenever there is a big dislocation in markets as we have seen in the last six months, sectoral leaders of the past are unlikely to be the sectoral leaders into the future next three-five years. And if we therefore, go by that kind of a framework, there were nine particular sectors which had underperformed over the course of the last three-five years and some of the leaders of the next three-five years are going to be from these sectors. These include private sector banks, include cement, metals oil and gas, FMCG, insurance, alcobev, textiles, and chemicals. So, these are the nine sectors where we are positive on from a reversion point of view that there could be potential surprises in store over the course of the next three-five years. Now, within these sectors, we then assess as to whether there is a right to win for larger companies or whether there is a right to win for mid and smallcap companies. For example, as far as banking is concerned, we do think that there is an advantage for the larger four private sector banks over there and therefore that is going to be more largecap biased. On the other hand, if we were to look at sectors like say chemicals where there is a preponderance of midcap and smallcap companies, we think it is more advantage for midcap and smallcap. So, when we look at it in totality in each of these nine sectors, we do still think that there is a greater bias of largecap within these nine sectors where there is a greater chance to perform and which is where I would not say that valuation is the only barometer to assess whether one should be in largecap or mid or smallcap, but this framework gives us a sense that largecaps can be equally as participative as many of the mid and smallcaps and given their better valuations and relative margin of safety, we think that that is where we will continue to be in our portfolios.
It is a great point. Nine sectors. So, I was able to note down only four.
Harish Krishnan: So, the private sector banks, metals, oil and gas, FMCG, then you have got insurance, you have got alcobev, you have got textiles, you have got chemicals and possibly I am missing out one of those. Cement and metals, these are the eight-nine sectors which have underperformed over a three-five-year period going into this dislocation and we think that these would be the sectors that are going to lead or within these sectors few of them are going to lead over the course of the next three-five years.
Across banks, you like banks that is a consensus trade, but I will single out FMCG, underperforming but expensive. So, even if I look at the best FMCG company and perhaps say midcap FMCG company, PE multiples are north of 50-60 times. The volume growth which we heard from HUL was not impressive at all. Competition has intensified and this whole monsoon story I am hearing from four years, this year it will be better because monsoons are going to be better, what makes you bullish on FMCG when valuation and growth they both are missing?
Harish Krishnan: So, the companies are doing the right thing which is that they are getting back to focus on volume growth. So, if you look at the largest FMCG player, their margins went up from about 15 percentage points to close to about 25 percentage points in a decade from 2014 to 2024. Now, that was a relentless focus on improving efficiencies and productivity and profitability levels, possibly seeding some amount of share and allowing competition to come in, be it in terms of direct to consumer competition that were to come through or in terms of other players who can operate at a far lower margin profile. Now what we have seen, in fact, that particular company itself has given a guidance that they want to actually tone down margins. To our mind, while this might be negative for earnings in the near term, this is actually what sets up for a good business decision which is that you want to focus on the long-term health of your consumer franchise which is built by improving sales salience rather than necessarily focusing only on margins. Let me give another example, I mean we have seen possibly one of these sectors which has been in significant distress over the course of the last almost two-three years has been the paint sector. Now, within the paint sector if you were to look at some of the larger companies, their revenue levels are lower than what it was in FY23 and FY24. There have been about six or seven or eight consecutive quarters of revenue decline. Now, in that kind of a timeframe where margins have cooled off from about 21-22% to 15-16%, essentially valuations which is just earnings or market cap divided by profits, where revenues are significantly lower than what it was, profit margins are significantly lower than what it was and we are in an environment where there is still a significant penetration opportunity. So, all of these wonderful stories that we kept hearing during the bull market when the stocks kept performing, those still come through over a 5, 10, 15-year period, it is just that there is a peak pessimism built in today with no ownership in the street, so which is where we think that that is where the potential sources of alpha can emerge over the course of the next three-five years. Now, which quarter will any of these catalysts play out, it is very hard to assess. But is there a relative margin of safety built into these kind of franchises, we would like to think so.