Gautam Trivedi, Co-Founder & Managing Partner, Nepean Capital, says the Electronic Manufacturing Services (RMS) sector is expected to remain strong. India has the potential to become a global manufacturing hub. Companies like Dixon are showing significant growth potential. They could evolve beyond assembly to full-fledged manufacturing. Investors are optimistic about the EMS sector's future. High valuations are expected to continue, offering potential returns. Trivedi also says the power sector is a multi-decadal story in India. They also have a lot of focus on wind energy..
Your body language tells me that you have been having a lot of fun in the market. Gains have been strong, right?
Gautam Trivedi: Well, gains have been strong in very select stocks, but I am also smiling because I just got back from the US where I attended my first ever trip to Omaha to listen to Warren Buffett and little did I know it would be his last as a CEO. I hope he shows up next year, but yes, I am just back from there.
That got over a month ago. After that Omaha retreat, what did you do?
Gautam Trivedi: I did a lot. I spent time in New York. I met a whole bunch of fund managers, asset allocators, and went to Yellowstone National Park. There is a lot out there that I want to talk about as well if I may.
What should we start with?
Gautam Trivedi: So, a couple of things. The US economy clearly is robust and is absolutely thriving. I mean, whether it is hotels or restaurants, eating out, everything is not only expensive but full and I am not referring to just the city of New York because that clearly does not truly represent what is happening in the rest of America. But the fact is inflation in general is raging. I mean, a simple celery and cucumber juice, for example, cost me $15. There was a time eight-nine years ago, when I could have a full breakfast for $15, but for that one can only get one juice now and that is how expensive things have become.
But if you look at the overall economy, just like in our country, travel is booming in the US. For the Memorial Day weekend that just ended, AAA estimated that 45 million Americans drove or travelled 50 miles or more from their respective homes, which itself is a new record and that is the way they measure travel. So, every hotel that I took with my family in the three weeks that we were there, we took eight flights, every seat was sold out.
So, with respect to finance and economics, the ability of the Fed to cut interest rates in the US is quite limited at this point until inflation really does not cool down. I am talking inflation relative to pre-Covid. I am not talking year-on-year because that may optically look a little less, but that is not the right way to look at it.
Translate that for us in India because while global inflation indirectly is bad news for us, does that also mean that more flows will come back into emerging markets as the dollar will remain weak and will the search for yield start again? In that case a market like India would benefit. Am I summarising it correctly?
Gautam Trivedi: You are mostly right, but there is one other way to look at this as well. If you look at the domestic economy which I just explained, that is obviously strong; but if you look at corporate earnings, it shocked me and I am sure it will surprise most of us. While sitting in India, we pride ourselves for having 13% to 14% earnings growth, that is always the estimates at the start of a new fiscal year and obviously for the last few years we have seen them pruned down. But the first quarter earnings for the S&P 500 were as strong as 12%.
Now, you may ask me that, hang on, the Mag-7 accounts for a bulk of it. Yes, the Mag-7’s earnings growth was 28%, but the balance 493 companies reported an average growth of 9%, so that is still very strong for an economy that is as large as the United States. So, keep that factor in mind.
The other interesting report that I read was from a US sell-side firm. It said that 50% of the largecap mutual funds in the United States that have a combined AUM of $3.5 trillion and 50% of them have outperformed the benchmark year to date versus the long-term average of around 37% of the funds. So, things are pretty good back in the States both from an economic standpoint as well as performance from the domestic equity markets.
As you rightly said, one thing that will force money to leave the United States will, of course, be the weakness of the dollar. At this point of time, foreigners own 18% of US equities and that is a record high as well. So, any significant or a prolonged weakness in the US dollar will clearly have money flowing out of the United States into Europe and, of course, emerging markets.
The last time you connected with us, you believed it would take time for the FIIs to return. But that was back in January. But now, we are seeing that FIIs are again getting into the Indian markets in a staggered manner. There has been a bit of a buying in the cash segment. But are they here to stay and in which sectors do you believe the investment can trickle in?
Gautam Trivedi: I think they are here to stay for the longer term. Let us get real. Of the $5.2 trillion of India's total market cap, foreigners own almost a trillion dollars, so that is a huge amount in itself in absolute numbers. So, they are pretty much here to stay from that standpoint. The question really is the timing of returning back with a lot of money and the feedback that I got for the most part was that India has gone from very expensive to expensive. Will it go moderately expensive? I do not see that happening until domestic flows do not slow down.
Year-to-date, foreigners have been net sellers of about $10 to $10.5 billion, but domestic mutual funds and insurance companies have ploughed in about $32 billion. That is the velocity of the money that is coming into the equity markets from domestic flows and until that does not slow down, I do not see the Indian market getting cheaper unless, of course, there is a significant improvement in earnings growth which we have not seen as yet. So, the market remains elevated from a valuation perspective.
When I asked everybody about where they would put their incremental money, India or China, they said if the relationship between China and the US were to improve, incrementally China looks definitely more attractive than India because it is trading at half the valuation and also has pretty strong earnings growth.
But let us come back to India. The US-China relationship is conjuncture. But what we know is that there are a lot of themes in India. I was just looking at exchanges and financial themes ex banks, which is mutual funds, stockholding companies and brokerages. Where are you picking your spot in this entire financial inclusion theme now?
Gautam Trivedi: The NBFCs have had a tough run. We have invested recently in a gold loan company only because a large private equity fund is taking a solid position and pretty much where the promoter is stepping back. So, we are a special SITS fund and we look for that special situation in a company which makes it attractive for us and a potential for re-rating, so that is what we have done within the financial space. Having said that, financials are our largest bet as a sectoral allocation. 31% of our AUMs are in financials.
I am talking about exchanges – BSE, NSE. I am talking about mutual fund companies. There is Nippon, there is HDFC AMC, there is UTI, that is the other theme. Then, there are fee-based companies, wealth management companies, Nuvama, 360, and then last but not the least, some of the brokerages like Angel, Motilal Oswal. Are you picking up anything which is in the non-NBFC or the lending basket?
Gautam Trivedi: No, we have not actually and we find even their valuations are not cheap. So, we have basically stayed away at this point from venturing into any of these non-BFSI spaces, but within the overall umbrella of financials.
Any interesting sunrise theme which you would say right now is at a niche stage but has potential to become big? Three years ago, solar was a niche theme, defence five years ago was a very niche theme, EVs five years ago again were known but relatively unknown in terms of market presence. Today, they have become the mainstay for a lot of companies. Anything which is small, could become big, or anything that is young could become tall and strong.
Gautam Trivedi: I would love to say AI, but people ask me what is the best way to play it? Is it through Indian IT companies? Frankly, we have not seen evidence of that as yet of Indian IT companies developing expertise to a great extent in AI as yet and I am sure there is something that is happening behind the scenes, we do not know yet, but that could be potentially a story. Having said that, our sunrise sector, and again it is not new really, but the one sector that is our second biggest sectoral allocation is power which we believe is a multi-decadal story.
So, we are very strong in power. And the one thing that you forgot to mention is, that was also almost history but has had a huge turnaround is, wind energy. So, we have seen a lot of focus on that as well.
But like you highlighted that from India being very expensive, it is moderately expensive now and all thanks to the domestic fund flow. But there are some concerns on the valuations of a couple of sectors that have been trading at higher valuation, case in point being EMS, that was I believe also one of the stories that you have been liking. But do you believe that the valuations of these companies will be at these levels, there is not much headroom for the valuations to come back to moderate levels and investors should be really prepared for that.
Gautam Trivedi: So, let us talk about Dixon. We do not own the stock, but I just want to talk about it. It is really the poster child of the EMS business. We have seen a lot of copycats come in and people thinking they can match Dixon's execution, scale, and the ability to actually get some of the biggest customers that are out there. But the fact is that the market continues to reward a stock like Dixon, which is trading at north of 80 times one year forward earnings. And it is every quarter delivering 90% to 100% topline growth.
Now at what point would the market say hang on a second, this is way too expensive? The day or the quarter when we see the earnings growth falter, the market is quite unforgiving. In the last 12 months or so, even a slight disappointment has ended up with stocks getting punished quite ruthlessly. So, my view is that the EMS space is here to stay. Can India become the services factory of the world? Clearly, I think it can happen. Companies like Dixon have clearly shown that this is where Hon Hai was 20 years ago and look how big that company has become. They have grown from just assembling phones to actually starting to make the phones.
So, if you look at the evolution of where a Dixon or an Amber or any of these EMS companies could be five or ten years from now, it could be very different. The market to some extent is betting on that and second, of course, is rewarding the growth. I do not see valuations for EMS companies coming down. Question is are you as an investor comfortable at a 75 or 80 times one-year forward PE and if you are, you will make money in these stocks.
Your body language tells me that you have been having a lot of fun in the market. Gains have been strong, right?
Gautam Trivedi: Well, gains have been strong in very select stocks, but I am also smiling because I just got back from the US where I attended my first ever trip to Omaha to listen to Warren Buffett and little did I know it would be his last as a CEO. I hope he shows up next year, but yes, I am just back from there.
That got over a month ago. After that Omaha retreat, what did you do?
Gautam Trivedi: I did a lot. I spent time in New York. I met a whole bunch of fund managers, asset allocators, and went to Yellowstone National Park. There is a lot out there that I want to talk about as well if I may.
What should we start with?
Gautam Trivedi: So, a couple of things. The US economy clearly is robust and is absolutely thriving. I mean, whether it is hotels or restaurants, eating out, everything is not only expensive but full and I am not referring to just the city of New York because that clearly does not truly represent what is happening in the rest of America. But the fact is inflation in general is raging. I mean, a simple celery and cucumber juice, for example, cost me $15. There was a time eight-nine years ago, when I could have a full breakfast for $15, but for that one can only get one juice now and that is how expensive things have become.
But if you look at the overall economy, just like in our country, travel is booming in the US. For the Memorial Day weekend that just ended, AAA estimated that 45 million Americans drove or travelled 50 miles or more from their respective homes, which itself is a new record and that is the way they measure travel. So, every hotel that I took with my family in the three weeks that we were there, we took eight flights, every seat was sold out.
So, with respect to finance and economics, the ability of the Fed to cut interest rates in the US is quite limited at this point until inflation really does not cool down. I am talking inflation relative to pre-Covid. I am not talking year-on-year because that may optically look a little less, but that is not the right way to look at it.
Translate that for us in India because while global inflation indirectly is bad news for us, does that also mean that more flows will come back into emerging markets as the dollar will remain weak and will the search for yield start again? In that case a market like India would benefit. Am I summarising it correctly?
Gautam Trivedi: You are mostly right, but there is one other way to look at this as well. If you look at the domestic economy which I just explained, that is obviously strong; but if you look at corporate earnings, it shocked me and I am sure it will surprise most of us. While sitting in India, we pride ourselves for having 13% to 14% earnings growth, that is always the estimates at the start of a new fiscal year and obviously for the last few years we have seen them pruned down. But the first quarter earnings for the S&P 500 were as strong as 12%.
Now, you may ask me that, hang on, the Mag-7 accounts for a bulk of it. Yes, the Mag-7’s earnings growth was 28%, but the balance 493 companies reported an average growth of 9%, so that is still very strong for an economy that is as large as the United States. So, keep that factor in mind.
The other interesting report that I read was from a US sell-side firm. It said that 50% of the largecap mutual funds in the United States that have a combined AUM of $3.5 trillion and 50% of them have outperformed the benchmark year to date versus the long-term average of around 37% of the funds. So, things are pretty good back in the States both from an economic standpoint as well as performance from the domestic equity markets.
As you rightly said, one thing that will force money to leave the United States will, of course, be the weakness of the dollar. At this point of time, foreigners own 18% of US equities and that is a record high as well. So, any significant or a prolonged weakness in the US dollar will clearly have money flowing out of the United States into Europe and, of course, emerging markets.
The last time you connected with us, you believed it would take time for the FIIs to return. But that was back in January. But now, we are seeing that FIIs are again getting into the Indian markets in a staggered manner. There has been a bit of a buying in the cash segment. But are they here to stay and in which sectors do you believe the investment can trickle in?
Gautam Trivedi: I think they are here to stay for the longer term. Let us get real. Of the $5.2 trillion of India's total market cap, foreigners own almost a trillion dollars, so that is a huge amount in itself in absolute numbers. So, they are pretty much here to stay from that standpoint. The question really is the timing of returning back with a lot of money and the feedback that I got for the most part was that India has gone from very expensive to expensive. Will it go moderately expensive? I do not see that happening until domestic flows do not slow down.
Year-to-date, foreigners have been net sellers of about $10 to $10.5 billion, but domestic mutual funds and insurance companies have ploughed in about $32 billion. That is the velocity of the money that is coming into the equity markets from domestic flows and until that does not slow down, I do not see the Indian market getting cheaper unless, of course, there is a significant improvement in earnings growth which we have not seen as yet. So, the market remains elevated from a valuation perspective.
When I asked everybody about where they would put their incremental money, India or China, they said if the relationship between China and the US were to improve, incrementally China looks definitely more attractive than India because it is trading at half the valuation and also has pretty strong earnings growth.
But let us come back to India. The US-China relationship is conjuncture. But what we know is that there are a lot of themes in India. I was just looking at exchanges and financial themes ex banks, which is mutual funds, stockholding companies and brokerages. Where are you picking your spot in this entire financial inclusion theme now?
Gautam Trivedi: The NBFCs have had a tough run. We have invested recently in a gold loan company only because a large private equity fund is taking a solid position and pretty much where the promoter is stepping back. So, we are a special SITS fund and we look for that special situation in a company which makes it attractive for us and a potential for re-rating, so that is what we have done within the financial space. Having said that, financials are our largest bet as a sectoral allocation. 31% of our AUMs are in financials.
I am talking about exchanges – BSE, NSE. I am talking about mutual fund companies. There is Nippon, there is HDFC AMC, there is UTI, that is the other theme. Then, there are fee-based companies, wealth management companies, Nuvama, 360, and then last but not the least, some of the brokerages like Angel, Motilal Oswal. Are you picking up anything which is in the non-NBFC or the lending basket?
Gautam Trivedi: No, we have not actually and we find even their valuations are not cheap. So, we have basically stayed away at this point from venturing into any of these non-BFSI spaces, but within the overall umbrella of financials.
Any interesting sunrise theme which you would say right now is at a niche stage but has potential to become big? Three years ago, solar was a niche theme, defence five years ago was a very niche theme, EVs five years ago again were known but relatively unknown in terms of market presence. Today, they have become the mainstay for a lot of companies. Anything which is small, could become big, or anything that is young could become tall and strong.
Gautam Trivedi: I would love to say AI, but people ask me what is the best way to play it? Is it through Indian IT companies? Frankly, we have not seen evidence of that as yet of Indian IT companies developing expertise to a great extent in AI as yet and I am sure there is something that is happening behind the scenes, we do not know yet, but that could be potentially a story. Having said that, our sunrise sector, and again it is not new really, but the one sector that is our second biggest sectoral allocation is power which we believe is a multi-decadal story.
So, we are very strong in power. And the one thing that you forgot to mention is, that was also almost history but has had a huge turnaround is, wind energy. So, we have seen a lot of focus on that as well.
But like you highlighted that from India being very expensive, it is moderately expensive now and all thanks to the domestic fund flow. But there are some concerns on the valuations of a couple of sectors that have been trading at higher valuation, case in point being EMS, that was I believe also one of the stories that you have been liking. But do you believe that the valuations of these companies will be at these levels, there is not much headroom for the valuations to come back to moderate levels and investors should be really prepared for that.
Gautam Trivedi: So, let us talk about Dixon. We do not own the stock, but I just want to talk about it. It is really the poster child of the EMS business. We have seen a lot of copycats come in and people thinking they can match Dixon's execution, scale, and the ability to actually get some of the biggest customers that are out there. But the fact is that the market continues to reward a stock like Dixon, which is trading at north of 80 times one year forward earnings. And it is every quarter delivering 90% to 100% topline growth.
Now at what point would the market say hang on a second, this is way too expensive? The day or the quarter when we see the earnings growth falter, the market is quite unforgiving. In the last 12 months or so, even a slight disappointment has ended up with stocks getting punished quite ruthlessly. So, my view is that the EMS space is here to stay. Can India become the services factory of the world? Clearly, I think it can happen. Companies like Dixon have clearly shown that this is where Hon Hai was 20 years ago and look how big that company has become. They have grown from just assembling phones to actually starting to make the phones.
So, if you look at the evolution of where a Dixon or an Amber or any of these EMS companies could be five or ten years from now, it could be very different. The market to some extent is betting on that and second, of course, is rewarding the growth. I do not see valuations for EMS companies coming down. Question is are you as an investor comfortable at a 75 or 80 times one-year forward PE and if you are, you will make money in these stocks.
