Value migration from commodity cos to a whole host of industries possible: Harish Krishnan

Crude is on a massive slide, almost back to $108. That is good news. How do you see things pan out from the improvement in macros because other commodities were already cracking. Will the market respond?

Markets are interplay on three broad variables if we look top-down. First is earnings, second is sentiment and third is liquidity. And it is the interplay of all of these variables that drive the medium term outlook for markets. So if I were to look at each of these three variables and how they were about eight-nine months ago and how they are positioned today, as far as each of these three variables were at their peak about 9 to 12 months back, we see there has been a significant change in each of these three variables.

Starting with the earnings, we have started seeing some kind of earnings downgrades coming through over the course of the last three-six months, primarily because of elevated commodity costs that have impacted various companies and therefore specifically to the question that you asked of commodity prices falling off. It is welcome but I would still think that it will take a few more quarters for a lot of price increases that a lot of companies have taken to get back to where they were in terms of gross margins and eventually profitability.

As far as the earning cycle is concerned, there still is some more grinding down of earnings estimates that can potentially come through but it is on the other two aspects that there is a lot of panic when it comes to macro investing namely that of interest rates and of liquidity. So coming first to liquidity, we have seen close to about $30 billion being pulled out by FIIs. Now, there is still $600 billion that they have invested and they can pull out all of that money if they want to but I would imagine that a bulk of their selling has already happened and therefore it is unlikely that we are going to see the pace accelerate from where it was.

This can sustain the kind of FII outflow numbers that we see on a daily basis but I would not think that we are going to see a meaningful acceleration in terms of the FIIs selling. As far as interest rates are concerned, we have traversed a significant distance globally as well as within India. For example, the US 10-year has gone up by about 250-275 basis points over the course of the last 12-15 months.

While there can still be further increases by another 25-50 basis points, bulk of that move has happened. If you look at confluence of all of these three things, I would say that one should not really panic into this kind of a macro feature. This is possibly closer to the late cycle of the macro developments and we would like to benefit from the volatility that markets are presenting by increasing our equity allocations.

Lastly, the proof of the pudding is how we have managed money so for example in our balanced advantage fund, where we can move from 20% to 80% in net equities, we were at 30% in October of 21. Currently we are at 50% reflecting on the improved risk reward that equities have presented themselves in this correction over the last seven-eight months.

What are the thoughts on the commodity user universe? What kind of valuations do autos, auto ancillaries, select capital goods or even consumer stocks which have a lot of agri commodities in their inputs and crude in their packaging and transportation have?

I would say that if you have to look at say price to sales or EV to sales, that is a far better barometer across cycles rather than going down the line from a P&L into either EV/EBITDA or price to earnings. If you were to look at a lot of auto ancillaries, especially those having global exposures, their EV to sales or price to sales are similar to a commodity company.

Now, there is definitely volatility in their business model. Globally, a lot of things can go wrong etc but the reality is that the value addition that a converter brings in is possibly far more sustainable than just a commodity producer. Therefore, I would think that value migration going from a commodity company to a whole host of these industries is very much possible.

Some of these sectors that you mentioned have not performed for almost five years now, especially auto, auto components. Therefore in an environment where globally also auto have started doing well, a lot of these falls in commodity prices can potentially reflect in improved margin performance for a lot of these sectors like auto, auto ancillaries and in certain cases consumer discretionary, which can provide a faster earnings growth for these sectors.