The investment cycle in India after a decade is definitely shaping up for the better. The hope pins around capital expenditure (capex) over the ensuing three years in core sectors ̶ cement, metals, oil refining and power (especially renewables) which is pegged at about Rs 5 lakh crore.

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This should not only be the highest in a decade but is also likely to be more than 2x the capex over the previous three years. Moreover, the government’s production linked incentives (PLI)–led capex should be Rs 1.4 lakh crore in other sectors such as consumer durables, pharmaceuticals and automobiles.

Household capex, especially in residential property, and government infrastructure spend should also see the best growth phase in a decade. It appears more decisively that the governments globally are betting on fiscal stimulants, especially in infrastructure, to recover from the COVID-19-led economic challenges, which means reflation is a key likely impact.

However, Spark Capital believes that the ensuing investment cycle, as it appears now, is still a far cry from what was seen in the last decade, when capacities expanded fivefold in multiple sectors including thermal power, which appears unlikely now.

Given the macro construct, the main driver remains consumption demand revival, which is the underlying bedrock for the investment demand cycle to recover. This means the demand proxies for higher capacity utilisation as well as likely capex, viz. industrial consumables such as bearings, abrasives and forgings, should also see tailwinds.

From a portfolio strategy perspective, the brokerage house picks indirect proxies in financials, automobiles, logistics and general insurance.

A typical investor model portfolio should be tilted towards quality cyclicals across subsegments given the earnings potential and valuations.

SPARK Capital maintains an Underweight (UW) stance on IT, life insurance, consumer staples and oil & gas continues.

In its Model Portfolio, the brokerage has added Bharat Forge and Grindwell Norton, while it removed Mahindra Finance, Dixon and ACC.

Larsen and Shree Cement remains the brokerage’s preferred large-cap stocks within Industrials. Thermax, AIA Engineering, Carborundum Universal and Timken India are high on their watchlist.

In support of its recommendations, Spark Capital urged investors not to fall into the trap of searching for value in multiples when the real value is in the earnings profile of these companies.

“Over the last decade, these companies have seen a weak top-line growth but have worked extensively on improving underlying revenue character, more products, newer markets, divested weaker segments and market shares have consolidated,” Spark Capital noted.

However, their asset turns have more than halved, margins are down a third from their peak and RoEs 1m have compressed significantly though their cashflows and balance sheet remain healthy. The income statements indicate material operating leverage, it added.

"Paradoxically, pricing power is also cyclical in this sector. Valuations need to be seen from a prism of normalised earnings, which would be visible only in a demand upcycle," the brokerage said.

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First Published:Jun 22, 2021 4:41 PM IST