High-growth potential | EMS stocks: What could be potential high growth sectors in next 2-3 years? Hiren Ved answers

What are the areas where you can expect high growth over the next two to three years? Will you continue to be a platform company?
Hiren Ved: Yes, I mean, I think the structural changes are happening right. So, what happened is, after demonetization (DeMon) and GST, we saw consolidation. So the more organized we got, the bigger brands got bigger, the bigger companies got bigger, but then platforms came along and now we’re seeing fragmentation again.

Therefore, in the food and cosmetics sectors, there are small brands that are challenging the big players. So consolidation happened, but technology platforms made it possible, so fragmentation happened again. That’s where I think the challenge is and therefore where technology-driven financial services or technology-driven consumption is where there’s a lot of potential for growth. These people are very innovative. Once the platform is built, they will do food delivery, quick commerce and generate business. They are creating entertainment businesses on the same platform.

So here’s a little more innovation. We have all been saying that India’s tech stack is amazing, and this is exactly the advantage of the tech stack that enabled the first generation of entrepreneurs to come and build incredible businesses. But acquiring customers takes time, makes mistakes, and costs a lot of money. Some of them are now reaching the stage of achieving scale. They have 250-300 million customers. They have 50-70-80 million paying customers, and that’s where the real growth will be.

Many business models are changing in many industries. A few years ago, Uday bhai (Uday Kotak) said that all banks missed the UPI story because everyone thinks there is no money in UPI, why spend money on creating or adding customers on UPI. I distinctly remember saying, is there a need? But now people understand that UPI is just a hook. You get on the platform, you transact, you pay your bills, you buy things, and you keep coming back because you’re on the platform and the customers are sticky because they’re like a utility bill.

You can then cross-sell other financial services to that platform. What we’ve seen in the last three to four years is that while traditional ideas like big brands and deep distribution are being institutionalized, all of that is being disrupted at a very fast pace. is. Lever, ITC, and Maricos around the world have spent decades building deep distributions. Now, D2C brands can hire third-party logistics personnel, advertise on any platform, and get started. So a lot of businesses are in disarray and the old order can change, but it will take time and how it manifests itself is when those stocks go for years with nothing happening. There is. Very stable derating occurs. For us, it’s very clear where the growth is and where the consumer is going. Even if the overall consumer market growth is in the single digits, if someone can capture 25-30% growth, that’s where the value comes from. Naturally, these companies also need to generate cash flow, and all companies are now focused on profitability and cash flow. So that’s where it grows.

Does that mean I’ll buy Honcho?
Hiren Ved: no.

But are they doing exactly what you want…?
Hiren Ved: But again, just because it’s a platform doesn’t mean it’ll work. Platform is just a euphemism for these business models that are currently being disrupted, but still need to be executed well.

Can we find a winner in the consumer space? Ten years ago, it looked like Patanjali was going to eat into HUL’s market share. But today, HUL has added Patanjali turnover in 5 years. India’s largest FMCG company remains HUL. ITC has caught up. Britannia is still around. So there are a lot of small D2D brands that are great, but they haven’t really been able to make a mark. So, does that pose a challenge for the FMCG sector?
Hiren Ved: Bharat still has 400-500 million customers. So I’m not saying these companies will become irrelevant. However, I believe there will be a lot of confusion in this cycle. They have growth challenges. Their initial valuation was high. There was a time when levers compounded at 25% per year. They were making acquisitions like TOMCO. They were buying brands. But those were times when we could have strong compound growth.

They are still a great company. Unfortunately, consumers have changed. Penetration into soaps, detergents, etc. has now been achieved. Therefore, these companies do not become irrelevant. However, since the coronavirus outbreak, end consumers have truly lost their purchasing power, and it is taking time to rebuild it. Consumer preferences are also changing. They are now spending less on food and more on things that give consumers freedom of choice. Now, the question is, who can capture that client more efficiently?

The finance minister has mentioned somewhere that for the first time, the food items in India’s basket have fallen by 50%. Previously, the average basket spend for Indians was 50% on food. Now, for the first time, it’s below 50% and they’re happy with that. That’s actually true.
Hiren Ved: that’s right. Because when your income increases, you outgrow your needs and move on to the next big thing you want to do. There was a question about where we could see growth. Today’s ET has a leading article about the government’s desire to incentivize component manufacturing. EMS is a huge growth area. I know the stock price is doing phenomenally well. But this reminds me of how IT services have grown. All small and medium-sized IT services companies grew because the opportunities were so great.

Manufacturing is a big opportunity, and in the power T&D or electronics manufacturing sector, the largest company is Dixon, a $2 billion company. If it’s a $70 billion to $80 billion opportunity, very few companies will become $4 billion to $5 billion to $6 billion companies.

Again, be careful about what valuation you pay. However, I feel that growth is occurring in completely new areas. This is not an area we have traditionally focused on, which is both interesting and challenging. However, on the other hand, it also happens that there are areas that have been ignored for a long time. Expectations are very low. These companies remain high-quality companies, performing better than expected, and then there may be short-term medium-term bursts that allow these companies to achieve strong performance over time.

But the key is to create a portfolio that is largely about structural themes, and then also address some of the areas where that business is good, but also has some pessimism factored into those businesses. At some point, it becomes very attractive to own.

Indeed, the theme of EMS is very secular. Dixon went 3X last year, so how do you decide you want to get Dixon over Canes or Amber? Even the holdings of Torrent have tripled. How do you decide whether to sell it or diversify into other names?
Hiren Ved: It will take several hours to answer that question. But to use the analogy again, when you get a big opportunity, there are several ways to take advantage of it. In some cases, buying a whole basket works out better for you as a whole. I remember you acquired Wipro, TCS during the technology boom. At the time it was called Mphasis BFL PSI Data Systems, Visualsoft. Everything went well.

Over time, you’ll be able to differentiate as you start looking at more metrics than just simple growth. And since Dixon has the best working capital management of any other EMS company, you start to see why it should trade at that multiple. But then the segmentation starts. You said, okay, if you want to play EMS on consumer, play Dixon. But if I wanted to play EMS with an industrial product, I’d buy Kaynes or Syrma or something else.

So as you gain more insight into your business, you’ll eventually find that the returns start to spread out and that the better performers can earn much better returns. It happened in NBFC. Why did Bajaj perform better than others? There are many other NBFCs that tried to do what Bajaj was trying to do but failed. I don’t want to name names, but there was a great NBFC that tried to do what Bajaj was trying to do, but they stumbled.

So it’s really just run, run, run. The chances are great. There are 10 EMS companies looking to grow because there are growth opportunities for everyone. But which two or three people can execute that opportunity to the hilt with the highest margins, highest return on capital, and most disciplined capital allocation? There’s big money there. This is already old.

The reason why Trent outperformed the others is because they took their chances so well. What I’m saying is that you don’t just need to identify opportunities, you need to look at the balance sheet and open it up and see how each management team is performing. In general, the market is very smart.

If you create a table of 10 companies, they will be arranged from highest to lowest PER. Broadly speaking, the market has figured out who will perform exceptionally well. Because they end up with a higher PER. And what people are going to do is think something is very expensive and buy something cheaper. That’s true, but the cheap guy is rarely number one. Sometimes that happens, but usually the best people continue to do a good job.

Again, there is no one answer as each sector has different dynamics, but you need to start by identifying the larger trends. If you can’t tell the difference between A, B, and C, just buy the whole basket. Over time, you learn more about the field and begin to differentiate. If you want to play a secular theme, you’ll want to back a couple of these horses.

Are there two or three horses across your portfolio that are trading with confidence in their valuations?
Hiren Ved: Unfortunately, I cannot comment on individual names.

For declared portfolios.
Hiren Ved: Yes, I mean, we have contact with Dixon. But that’s not what we just bought. We’ve invested since COVID-19 and it’s worked out really well. Like Dixon on the industrial side, I believe that Keynes probably showed his colors where they seemed to have their activities pretty well organized. CG power is doing well, but we don’t own it. We own torrents. Again, that’s what we’ve wanted for 12 years. So don’t blame yourself for buying today at its current valuation.

So, when it comes to consumers, Torrent, United Spirits, Varun Beverage and Zomato are big bets. In manufacturing, we own Dixon. We own all capital goods companies across the value chain across ABB, Siemens, Hitachi, GE, power and cap goods. We own it. Among the platforms, we have MCX, which is doing pretty well. So Paytm is another service that we own.

Have you ever bought any of the new flashy solar stocks, so-called energy transition stocks, or green and clean stocks?
Hiren Ved: We have played out the energy transition story through capital goods companies. All of them feed into multiple sectors. When you buy Hitachi, GE, or ABB, you’re participating in several end-user industries, including renewable energy. So there are several ways to skin the same cat. So you just need to figure out the most efficient way.