The much awaited general elections is round the corner. Markets are already excited, and are in unchartered territories. As markets dance to the tunes of flows, and valuations become stretched, there is a fear that consumption stocks — that are driving growth — may be getting out of hand. RupeeIQ’s Kumar Shankar Roy caught up with Karthikraj Lakshmanan, Senior Fund Manager – Equities at BNP Paribas Asset Management (BNPP AM), to get a low-down on consumption stocks and what the future holds for the sector.
Lakshmanan, who has been with BNP Paribas MF since 2008, brings a wealth of experience of over 13 years including several leadership positions such as Senior Research Analyst in the Portfolio Management Services division of ICICI Prudential AMC, in the Global Investment Research Division of Goldman Sachs, and with the Wholesale Banking Group of ICICI Bank. Edited excerpts:
What makes consumption a good theme for mutual fund investors?
India has a large and growing consumer market backed by over a billion consumers across income segments. Close to 60% (according to CEIC, Macquarie Macro Strategy, Mar 2018) of the share of expenditure in our GDP is private consumption led. Rising household income, urbanisation, lesser dependency ratio, nuclearisation (of families) i.e. the decline in the traditional joint–family structures, are some of the key contributors to this growth. Individuals today are also consuming more compared to a decade ago; and this changing consumption pattern is expected to benefit targeted sectors and companies that cater to these needs, ultimately, benefitting the investors. We believe consumption led growth is more structural and likely to continue for long.
Most diversified funds have exposure to consumption oriented companies. Then, what is the argument in favour of pure-play consumption funds?
Consumption funds tend to focus on B2C companies which are likely to benefit from consumption. Diversified funds may also invest in consumer businesses but the proportion could be lesser when compared to consumption funds. However, in a thematic consumption fund there is an opportunity to invest 80%-100% in B2C companies, which could help give more exposure to the growing consumption story in India. In our observation, B2C companies in the past have generated superior business profits over medium to long term, as compared to B2B companies, which has reflected in their performance as well. We believe this is likely to continue in the future as well.
Consumption stocks are richly valued. Plus, they are cyclical. How do fund managers navigate these two risks?
In these volatile or uncertain periods, we believe investing in structural stories could be beneficial. From a long-term perspective, the volatility tends to be lower for consumer businesses. The companies on valuations may seem expensive but from a growth standpoint we believe they are compounding stories.
Also, the reinvestment required to bring growth is lower in consumption companies as they can have a long-term advantage in the form of brand or distribution which tends to be more sustainable, helping generate healthy free cashflows for the shareholders. However, for consumer cyclicals, the call is more nuanced.
At present we are underweight in consumer cyclicals, especially Auto, which has been impacted by weaker demand, higher insurance costs, NBFC liquidity issues as well as higher inventory in the distribution channel.
Is election a material event for consumption theme?
India’s consumption story has recovered from the demonetisation-led shock and we believe that it will continue to drive micro level growth for the economy, along with a continued thrust from the governments (both state and central) on infrastructure. In the second half of 2019, post the general elections, we believe the focus will be back on fundamentals.
We believe that earnings recovery, albeit delayed, will take centre stage post elections. Earnings growth is also expected in consumer focused sectors like paints, media, building materials, retailing and possibly telecom.
We will continue to focus on consumer facing companies considering their potential for superior growth and return ratios, positive cashﬂow, minimal leverage, strong brand, well-established distribution network and substantial moat.