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3 sectors Vikas Khemani is bullish on for next few years

As and when that rate peaks out and starts turning back, emerging market receives that flow and we have been making this case pretty much same that our sense has been last four-five months that inflation has peaked out," says Vikas Khemani, Carnelian Capital Advisors

I guess the constant view what both of us have is markets are headed higher and the best of India is yet to come, I think that is the motto which you would endorse. But long term aside, let us talk about the current scenario. We have had a good comeback, a sizable comeback. Benchmark indices are at a new high. To your mind, what is driving this sugar/liquidity rush into India, and do you think this is here to stay?

As we have said that inflation, interest rates and dollar has peaked out, it is always coincided with the flow towards emerging market. Whenever Fed raises interest rate, for whatever reason, foreigners pull out money from the emerging market because most emerging markets are current account deficit economies and any rise in the interest rates in US impacts them through inflation and weakening currency, so that is a typical template most foreigners play over the last 30-40-50 years.

And same thing, as and when that rate peaks out and starts turning back, emerging market receives that flow and we have been making this case pretty much same that our sense has been last four-five months that inflation has peaked out.

Thereby, it means interest rates have peaked out and thereby most of the flow which went back over last two years, which is almost $40-45 million, will come back.

And in fact, I would say there would be more flow which will be coming back. The simple reason - in emerging market basket, India stands out. So, I see a situation where both as the interest rates, right now, the sense is peaking out and in my opinion over the next one to two years you will start seeing interest rates coming down.

So, you will see this whole money flow coming back to India and this time around, not only all emerging market basket is turning, but India will get larger proportion of the emerging market share.

So, what we have seen in terms of flow, it is just beginning of a very long trend and this you can go back and check history. So, I am quite optimist, I have been quite optimist, I continue to remain very optimist on the liquidity especially towards Indian markets.

Where is the red flag then, markets cannot go up like this. Correction and volatility would be par for course so to speak. What to your mind would be the red flag? For example, if somebody spoke about valuations in 2020, it had become a red flag. India was a great story, but valuations were haywire. How far are we away from euphoric/expensive valuations now?

Valuation is a function of two things. One is your earnings growth and second is interest rates. So, earnings, earnings growth and interest rates, these are three major factors in the valuation. If you look at earnings is reasonably stable, we are seeing 15-16% kind of range over at least next two-three years CAGR looks visible and interest rate scenario looking down.

So, it is very kind of natural that India will get re-rated and if it is backed by your liquidity, it will get further re-rated. So, I would like to say that a 2% drop in the interest rates increases the equity valuation by 35% and this is a very less intuitively understood factor and hence calling out market looking at only the historical levels will not be great.

So, I would say India is not expensive, India is not cheap, it is in a kind of fair value zone and as liquidity builds, as liquidity comes, because the thing is that Indian liquidity is not going anywhere, so Indian liquidity remains solid and at the top of it you are getting the international liquidity and that in my opinion over next two years will build a euphoria, there will be a situation where we are going to see much more euphoric environment than what we are.

Intermittent corrections will happen in this phase, there is no denial from that because that is what markets are made of, but I remain in a shorter term as well as medium term quite optimistic on the market.

As a theme, why is it that you are bullish on infra space?

As a theme I think if you see India is being built, a massive amount of spend is happening on infrastructure space, construction space. And over the last 4-5 or 10 years, a lot of consolidation has happened in this sector, many companies have gone out, it has become a very consolidated sector, there are very few good quality players who could execute, deliver on time.

And this is happening by the way in many sectors so these solid players who can deliver, who can build, who can execute are getting better and stronger. And same thing is happening to this space and I am assuming and then you have to work of course on the quality of the management, company's capability, which is a key factor from delivery perspective.

And you have time and again spoken about how India is set to become a manufacturing hub over the next decade. How else as an investor can you cash in on this?

I think Indian manufacturing is coming of age, it is only getting better in favour of India from cost competitive perspective, from demand environment perspective and what we have seen despite whatever returns have been delivered by the market stocks in this space, a very, very long way.

So I know one should not get discouraged by saying that stocks have already done well and how much more left from here. So all the companies in the import substitution space, export-oriented space, be it in auto components, specialty chemical, or defence, or garmenting, or footwear manufacturing, capital goods, I mean it is a very wide area which is going to benefit and that is the beauty of it.

And you will see many companies becoming in fullness of time, 10x, 20x, and that happens, by the way, I am not saying something new, it happens in every cycle and so would happen in this.

So I would say that companies who are with good capability, good management track record should benefit and will continue to benefit and I do see a scenario where there will be a lot more money coming into it and the interesting part is that manufacturing is never one way, it comes with a cycle like in 2021 chemicals was a completely euphoria, in 2022 we saw they are dying down and today there is very less interest in that.

But in my opinion, you will find many specialty chemical, chemical companies, APIs companies in a very, very sweet spot and you will see them doing well over the next two years because the trend does not change. So I think one has to remain very sane and balanced about how to build a portfolio but the trend is here to stay from a very long-term perspective.

Also wanted to understand your view on pharma because that is the dark horse we have been talking about and if I have it right you are positive on a couple of names like Laurus, , Syngene, etc. I know you cannot talk stock specific but nonetheless, the themes you are watching here?

I think see pharma is a very generic subject, it is very wide and there are lots of nuances in that. Within pharma, you have domestic pharma, pharma which is exposed international formulation, generic formulations, then API companies, then CDMO, CMO.

So I think they are very, very wide and each of them have many different business dynamics and return profile. So we have been quite bullish on specialty chemicals, bullish on API as a segment, CRO, CMO.

So all those segments we find very-very sticky in a long-term perspective. Of course 2022 was a year where a lot of corrections happened because 2021 was a very big year from margin expansion, inventory accumulation, all those corrections have happened and now these companies are kind of sitting on a very nice space.

So we continue to remain bullish, we have added some to our position where we felt that corrections were overdone. We remain quite positive on this from a medium term to long term perspective.

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