auto sector: Here’s why Vinod Karki is bullish on the auto sector

“If you see the list, we have gone across market. I mean, you will find companies from large cap, midcap, small cap over there where such factors are exhibited by these companies,” says Vinod Karki, ICICI Securities.

GARP, first walk us through how are these stocks screened and what is the rationale behind identifying this strategy?
Yes, that is absolutely right and it is growth at reasonable price, basically, that is the acronym. It is a global this thing and widely acknowledged as a strategy. So, basically, what we are trying to find here is companies which are showing sustainable growth but at the same time are at reasonable valuations because we have seen that sustainable high quality growth companies typically tend to trade at very high valuations and market seldom is giving out free lunches, so therefore, we have put in checks and balances to see whether these companies are indeed GARP but not value traps basically.

For that, we check whether they are undergoing any severe downgrades or the market is just ignoring their growth potential because it sees something else.

So, all those checks and balances are there. But broadly, it is trying to find those cohorts, those pockets where market is kind of maybe mispricing to some extent that the growth is good, sustainable, good quality ROE and things like that but the valuations are reasonable overall.

Is there a market cap bias or these bunch of stocks are across market cap categories?
If you see the list, we have gone across market. I mean, you will find companies from large cap, midcap, small cap over there where such factors are exhibited by these companies. So, there are a bunch of companies from small cap, midcap, large cap basically from all the categories.

So, let us start off with the large cap list and I can identify and access as well as IndusInd Bank there amongst the large cap names. Help us understand why is it that you find value in these names?
If you look at the companies broadly, be it large, mid, small cap one thing you will notice is the themes from where these companies are emerging and we firmly believe that stocks only reflect what is coming out of the broader economic demand environment. So, we have been saying that the economic revival is being led by the investment, manufacturing and discretionary consumption space largely and so these are the stocks which are kind of exhibiting the growth which is sustainable, reasonably higher than nominal GDP and as I said the financing part of the economy actually supports the investment and discretionary consumption so that is where the financials come in and we have not seen any major downgrades in these areas, nor have these stocks underperformed so that is the crux why these stocks are falling here in terms of GARP stocks.

And I want to also pick up on ITC especially in the light of not just the numbers but the hotel business demerge and now the swap ratio as well which is out. Does it qualify the rationale that you mentioned earlier avoid high optimism regarding the long-term prospects? I mean, ITC would surely qualify in that, would not it?
When we say, is the price indicating that it is very excited about the long-term prospects basically, so that actually translates into very high PE stocks. Why do you get some stock which is trading at 80-90 PE and something which is at 20-30, because for the 80-90 PE stock the market thinks that the long-term growth prospects will be significantly better.

So there, the market is speculating on long-term growth prospects because the multiple that we apply is on the short term, the next year or the year after that the multiple comes up on that number.

But since the number is so high, 80-90 PE is effectively telling you that the market thinks that beyond let us say FY25, the growth will continue to be very strong in the long-term. So, ITC, if you see, the PE is not as high as you have for some of the high-quality growth companies which are very high in PEs basically.

Just going through the list of the mid and the small cap GARP stocks, just want to pick out a few of them and understand the overall growth potential and rationale, say perhaps a CreditAccess, Kewal Kiran, Jyothy Labs here.
Bulk of these stocks, if you see the earnings growth, they are clearly higher than the nominal GDP growth trend rate that we have seen and they have also grown in the past and the good part is that they are not seeing incrementally earnings downgrade or that kind of a thing and the market is also willing to give them the kind of performance.

So, they are not underperforming with respect to the benchmark indices. So, these are the key factors that growth is higher than nominal GDP. Even the forecast is similar and the multiples are not too expensive and at the same time the forward multiple on which it is based on the forward earnings that is not getting downgraded significantly and it is not seeing significant relative underperformance. So, these are the factors on which these stocks are scoring.

And getting your take as well of the entire auto sector, we have seen a number of new launches as well coming about, a lot of these auto ancillary stocks have been in the spotlight and it has been a performing sector of sorts, is your sense that this traction is only here to stay?
Yes, if you see over the last couple of years they have undergone significant challenges in terms of chips or other supply issues basically and demand also is coming back to normalcy and the best part is the whole premiumisation effort.

If you see across, the excitement is only about new premium products basically and they are launching new products which are premium and has higher demand as we saw for some of these new products which were launched and the EV story continues.

So, a mix of low base, demand issues, supply issues and new product launches, premium demand for high premium products all these things augur well for the sector overall.

Only thing is the valuations need to be reasonable which are there for some of these stocks as we mentioned. So, yes, they look good overall.

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