Defence a good bet over the medium term; avoid auto for now: Rajesh Bhatia

If one is looking at understanding the market from here, what are the factors at play? Valuations are just about okay. Earnings are not greatWhat should one expect from here in next 12 to 18 months — very scattered returns, no returns, or low returns?
Rajesh Bhatia: I would really say control your enthusiasm. But my sense is that there is still opportunity in stock picking. So, you will have to find pockets. For instance, there is no point in doing any bottom-up on consumption, staples, or something like that. There are areas and pockets of visibility and predictability and that is where you ought to be going. My sense is it is going to be a lot more stock specific market. It is not going to be a trending market. On an overall market basis, I would say keep your enthusiasm low.

What is your take on the power space because even the power sector saw a very rapid rise in this comeback rally. Are you betting on this one?
Rajesh Bhatia: No, absolutely, we do. The visibility on the power capital expenditure is reasonably high. Now, the entire part of the value chain of power is not necessarily very strong. There is a challenge of distribution. SEBs are still very weak players. There is a challenge of transmission capacity and so on and so forth. But having said that, given where we are and given the growth rate of the economy, we are going to require a lot of power capacity, probably at 7% or 8% volume growth if not more, as you move forward.

The climate is getting warmer. The AC demand is rising very fast. People are moving to electric vehicles. We are encouraging manufacturing. Our GDP by itself is growing. Rural houses are getting power. So, my sense is that the power demand is going to continue to remain at elevated levels. We will require a lot of power capacity to come in. Again, the visibility and predictability is very high. The entire value chain may not be very strong, but over a period of time, it will definitely happen. We prefer the utilities where the valuations have come down to reasonably attractive levels.

What do you have to say about the auto sector? For select auto ancillaries and even auto players, there is the US tariff risk. Other than that, channel checks are also indicating weak demand. In the recent months, your PV and two-wheeler sales registrations are down 11% and 6% respectively.
Rajesh Bhatia: That is a part of the consumption play, but even commercial vehicle demand is fairly flat. So, PVs, two-wheelers, or commercial vehicles, all the three categories are actually showing very-very tepid demand and there is a challenge of inflation as well in terms of the metal prices have all gone up.

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My sense is that they will have to absorb those prices. Some of the auto companies have raised prices in the last one week or so. So, there is a question of margins as well. I see an absence of volume growth or visibility. Can they grow at a very attractive rate? Valuations are not necessarily very cheap. In my view, that is a sector to avoid for the moment. The companies are great, the profitability, the ROEs of companies in the auto space is great, but that is not really a space where you can make big alpha at this moment.
Interest rates will come down whether it is by 25, 50, 75 or 100 bps. Nobody knows what. Even the RBI does not know right now. But interest rates will come down. When interest rates come down, utilities, high debt companies and banks will do well. What is the best play in a declining interest rate environment?
Rajesh Bhatia: You would include NBFCs as well. The cost of borrowing for NBFCs will also come down. But my sense is that if interest rates are coming down, that should be good for credit growth. We already have a challenge with the government having to control the fiscal deficit. So, the G part of the GDP, in terms of C plus G plus I plus X minus M. The G, the government expenditure was the one which was really driving GDP and that has taken a backseat because they have to control debt to GDP. So, the fiscal deficit is in the consolidation mode.

Monetary policy is what you have to encourage growth and that is why banks are a good way to play that credit growth. The broader effect of that on the economy is that it encourages more credit growth and GDP growth. I would say NBFCs are also a good play as their costs are going down because interest rates are going down.Given that the Defence Acquisition Council (DAC) has now approved guidelines for faster capital acquisition process, does that give you any feeler that maybe defence stocks selectively are already on their recovery path and have come off quite a fair bit from those recent lows? Do you think selectively one can get a little bit bullish and add on to positions when it comes to defence because the order inflows are coming in?
Rajesh Bhatia: I have been more in the defence space where I can see a clear moat and those tend to be a little more larger companies. You are right and I have a challenge with predictability in terms of growth rate. I cannot really forecast what the next two years or three years will look like, what the order books will be, etc. But my sense is that as you move forward, the valuations have definitely corrected, the moats are intact.

So, we will have to take a longer term view as far as defence is concerned because all other factors that were tailwinds for defence in terms of indigenisation, capital expenditure being a priority, and exports do exist. I have a challenge with predictability, but my sense is that if you hold those stocks for the medium term, you will have to navigate the volatility that will persist with that. But these are good bets to have over the medium term.