Could you give us an example, just for the benefit of our viewers, where earnings expectations are low and valuations have really gone higher? I am trying to establish a point as a takeaway for our viewers that this is the reality in the market and this is where earnings are. Maybe you could provide an illustration, an example, or mention a company.
Sanjeev Prasad: Look at the two-wheeler companies, for example. If you look at their profitability, even though in percentage terms they may not have expanded that much, their EBITDA per unit has gone up significantly in the last two years. If I remember correctly, Eicher Motors' EBITDA per unit used to be somewhere around INR 35,000 per unit from FY17 to FY21-22. In the last two years, if I recall correctly, last year it was about INR 48,000 per unit. So, profitability has expanded a lot in sectors like this.
Many consumer staples sectors have a similar story, where companies aggressively increased prices even as raw material prices were rising in 2021-22. When raw material prices stabilized, companies maintained their prices, leading to significant improvements in margins and profitability across various sectors. This trend is particularly notable in the automobile sector, consumer goods, and capital goods companies.
Let’s start talking about the new themes in the market, such as EVs and manufacturing. What do you like within these new themes of manufacturing, EVs, energy transition? Anything that stands out for you?
Sanjeev Prasad: Again, you always have to overlay valuations. Everything looks good in India from a growth perspective. The penetration of goods and services is so low in the country that as income levels rise, volumes will naturally be strong. For new sectors and emerging themes, volumes are expected to be phenomenally high. I have no doubt about that. We have been big proponents of energy transition. I wrote a detailed report on this about two and a half years ago, highlighting how rapidly new energy sources, renewable energy, batteries, and EVs, will be adopted in the country.
This adoption is likely happening even faster than I predicted two or three years ago. For example, solar PV module prices have collapsed globally, and battery prices have decreased sharply. This should lead to much higher penetration levels and sector growth than anticipated. However, the real issue is how much we are willing to pay for this growth right now.
Many renewable energy businesses, such as solar electricity generation companies, are trading at about four times price-to-book, which is high. Currently, the return on equity (ROE) for most solar electricity generation companies is not very high compared to their costs, indicating that much of the future growth is already priced in. Companies like NTPC and Power Grid are trading at three to three-and-a-half times their equity book value, after adjusting for investments and cash.
Given that NTPC might make an ROE of around 8-9% and Power Grid around 10-12%, these valuations seem high. The struggle is not about whether growth will occur—it undoubtedly will. The question is, how much should we pay for it? This is where I struggle with some of the market narratives. Many of these growth arguments hold true at all price points, but valuations are rarely discussed in these contexts. There needs to be a balance between growth potential and valuation, which is currently missing in many discussions.
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