Ampersand Capital

Arun Subrahmanyam (Founder & Managing Partner) and Sanjaya Satapathy (Portfolio Manager)

At Ampersand, we consider earnings growth to be the primary driver of stock performance. We use valuation tools to assess downside risks, and will stay invested as long as growth prospects remain healthy.  Our growth focus also reflects India’s relatively stronger performance compared to major global markets, due to superior economic as well as earnings growth.

India corporate earnings growth is likely to remain strong over the next 5 years or more, as the government is putting policies in place to achieve ~ 7% annual GDP growth until 2030. However, earnings growth could be slower compared to the recent past, mainly due to possible moderation in margin expansion.

There will likely be a reduction in the number of companies delivering superior growth, and that will drive up the valuation premium of growth stocks even further. In this context stock picking based on growth will warrant deeper dive into financial analysis.

Last 3 years have been great for India:

In the last 3 years, India’s NIFTY is up 58%, compared to 22% rise in the global market (MSCI World). This has solely been driven by earnings growth of 93%, even as valuations have been derated.

Also, India’s NIFTY annual performance in the 3-year period at 16% CAGR is far better than 10% annual performance in the previous decade (2011-21). This surge in performance is also due to a jump in earnings growth rate compared to the previous decade.

Margin expansion has played a key role in India’s growth story so far…

  • Expansion of profit margin has contributed to around 65% of profit growth in last three-years. Post-covid, earnings recovery was aided by following factors:
    Market share gains from unorganised sector:
  • Listed companies gained significant market shares from the unorganised sector due to the latter’s weakened ability to access capital, and disruption in supply chain. Hence, corporate revenues and earnings were well above nominal GDP during this phase. Profit contribution of listed space to manufacturing GDP, currently stands at around 30%, up 500bps from 3 years ago.
  • Global reflation: 
  • Global trade and prices bounced sharply, due to sizable government stimulus in the western world as well as low rates by the US Fed.  This is the exact opposite of what prevailed pre-covid. Given the higher share of global tradeable goods in the listed universe (commodities, IT, manufacturing, etc), global reflation benefitted India Inc disproportionately.
  • Reversal of BFSI credit costs: 
  • Global reflation and the government’s credit guarantee scheme ensured lowering of provisioning requirements for banks. As a result, BFSI profitability shot up despite NII and PPOP growth being similar to pre-covid levels.

Key growth-related challenges ahead

  • Deceleration in sales growth:
  • Total revenue of the Top-300 listed companies is likely to decelerate to around 5% in Q3 this fiscal, compared to 8% in H1FY24. Also, only 25 companies or so will register revenue growth exceeding 25% this fiscal. This is on account of macro and cyclical factors, such as (1) high interest rates (2) adverse weather conditions, and (3) uncertain geo politics.
  • High interest rates: 
  • Extended high interest rate cycle, along with substantial liquidity tightening has started to hurt net interest margin of banks. India’s credit growth far exceeds deposit growth, and RBI seems concerned. Leading banks are looking to protect margin by raising lending rates further. This combination of tight liquidity and higher rates could hurt demand, mainly in rate sensitive sectors like automobiles and real estate.
  • Another poor monsoon: 
  • India has witnessed consecutive years of sub-par monsoon. This has resulted in higher food inflation, thereby hurting the rural economy and significantly impacting rural consumption. 
  • According to international weather bureaus, El Nino is likely to conclude by June., thereby raising possibilities of normal domestic rainfall in the coming season. However, the benefit of a normal monsoon will only be reflected in the Oct-Dec2024 harvest season.
  • Hostile geo-politics restraining sentiment:
  • Persistent war-like situations around Israel and Ukraine continue to impact global shipping rates, thereby adding to the threat of energy security. This in turn is impacting sentiment, most FPIs, and could possibly hurt corporate capex plans. 

Our preferred themes, when growth could be muted

Given macro risks, demand prospects seem subdued and leave no headroom for further cost reduction. As such, opportunities for growth investors will get narrower.   Companies which gain market share and/or improve their sales mix will be better placed for growth. We have identified the following high growth themes.

  1. Renewable Energy, as India is trying to become increasingly self-reliant in energy, as well as reduce carbon footprint. Manufacturers of renewable energy equipment and financiers will stand to gain.
  2. Premiumisation, with High end goods and services likely to sustain strong growth due to income inequality. Premium real estate, automobiles, Jewellery, Hotels and Travel should benefit from this trend.
  3. Exporters of Electronics and Engineering goods, which should register strong growth on back of rising government incentives, as well as increased cost competitiveness over developed countries which are facing manpower shortages.
  4.  R&D driven areas of IT, E-Commerce, Chemical and Pharma, being well placed for growth, as India’s pool of cheaper engineering talent is increasing faster compared to several competing countries.