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    Very big scalability in Reliance Jio and Retail not seen over next 3-5 years

    Synopsis

    It will not be very unrealistic to expect between 15% and 25% growth in pharma, CRAM & specialty chemical businesses, says Sachin Shah.

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    Export-oriented businesses like pharma, CRAM and the specialty chemicals will have exceedingly good growth even in FY21. But in FY22 and FY23, we expect a lot of these businesses to have very nice EBITDA and bottom line growth, says Sachin Shah, Fund (Portfolio) manager, Emkay Investment Managers.

    Some of the top stocks in your portfolio are from the pharma API space which is the hot favourite of the market right. Laurus, Divi's are solid companies. What is your understanding of the earnings profile versus the valuation some of these names are now trading at?
    As you must have already seen, we have a fairly decent allocation to the pharma sector and to be very frank and honest, have had these allocations for a while now. Each of these stocks have been in our portfolio for more than two to three years. In fact, Divi's has been there for more than five years and even Laurus Labs and Suven Pharma have been with us for more than a couple of years now. We have been very constructive on each of these businesses basically as there are very unique opportunities with each of these businesses -- be it contract research and manufacturing, CRAMs business, speciality chemicals and speciality API drugs.

    The kind of scalability, opportunity that these businesses offer is humongous in the global markets. We have also seen that in the last two-three years barring the last six months. In the calendar year 2018-2019, the pharma sector was trading at very low valuations. Whereas the underlying business trends were going in a very positive direction and a lot of that seems to be now accelerating post Covid. Some of these businesses have actually done very well.

    Not only that, the strategy of global majors de-risking from the Chinese manufacturing and looking at alternatives, particularly in the API space, in the contract research and manufacturing space, some of the Indian companies have already established themselves over the last few decades, at least in the last 10 years or so. They have demonstrated that they have the capabilities and the scalability to meet global demands. From that perspective, the Indian pharmaceutical industry has a huge opportunity and the last quarter results of some of these companies were very strong and the management commentary for each of these businesses is very constructive going ahead for at least next four to six quarters. That is where they have a very strong visibility.

    But not only that, if you talk to these managements, they will tell you about the kind of opportunities that they see over the next three to five years. They have not even scratched their surface at this point in time. So we continue to remain very constructive on each of these names and that is why they have become top holdings in our portfolios because of the stock price performance in the last six months. In the last six months, particularly the post Covid environment, pharma sector has been the best performing sector for multiple reasons.

    How are you reading the Reliance Retail opportunity? We all saw an unprecedented flurry of activity on the fundraising side in case of Reliance Jio. Now Reliance Retail has got its third cheque. How do you value the retail side of the business?
    One of the top holdings in our PMS is Reliance Industries. One of the big reasons we owned this business was that they have been more than five years in the new generation businesses or probably longer. But now they are trying to reach a very different scale and to my mind, the way they are integrating these businesses both on the Jio side and on the retail side is that it is almost like a paradigm shift in the business.

    A consumer spends a lot of time on digital and by offering retail services on a digital platform, it has been an amazing paradigm shift but still again, they have not yet scratched the surface. We are yet to see a very big scalability on both the businesses over the next three to five years.

    How are you playing some of these smaller manufacturing companies like APL Apollo, Sundaram Fasteners -- input providers to overall larger infrastructure/manufacturing OEM plays? How are these companies navigating the slowdown patch?
    It is very interesting. The market is a great leveller and we have seen that in 2018 and 2019, the midcap and the smallcaps have lost a significant amount of their valuations to the extent that the gap between the largecaps and the smallcaps was so large that it was very difficult to believe. Now we are seeing that in this post Covid environment, the midcaps and the small caps have started doing much better than some of the largecap companies.

    Obviously the valuations are catching up with the mean but in terms of business performances, there are two plays over there. One is a national play because as we know today, the rural part of India is actually doing much much better and so companies could adapt themselves where they could provide their products or services to the rural side of India or to the tier two, tier three cities in the country which have been able to bounce back much better. That is where companies like APL Apollo come into play.

    There is another thing which is on the auto ancillary front. One of the names here are Sundaram Fasteners. It is an auto global play because again they can service large global players -- be it in North America or European companies. Sundaram Fasteners has had nearly Rs 1,000-1,200-crore export turnover for the last three-four years. They have built good businesses with some of the global auto majors like General Motors, Cummins and Ford. They will have a huge opportunity as more businesses will start looking at alternatives to shift sourcing from China.

    After the pandemic, what kind of earnings growth have you factored in both of your portfolios, going forward 1-2 years?
    My sense is that FY21 is going to be a lot of mixed bag because in some of the businesses which are more domestic facing, the growth may not be there. In fact, there will be some kind of de-growth in FY21 but export-oriented businesses like the pharma space and the CRAM space and the specialty chemicals space will have exceedingly good growth even in FY21. But in FY22 and FY23, we expect a lot of these businesses to have very nice EBITDA and a bottom line growth. Even if the top line grows is at just about high single digit, the reason being that in most of these companies, the kind of the cost saving measures that they have enforced in these last six months are going to play out very strongly in the next financial year because as the top line comes in, the cost will not come back as fast and that will really percolate down to the bottom line in terms of the profit growth being much stronger than the top line growth.

    My view is it will not be very unrealistic to expect between 15% and 25% growth.
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