Portfolio Review – 1Q FY25

Reviewing Q1 FY25 at Itus (Jun 24 Earnings Quarter)    

The first quarter of FY24-25 have shown characteristics of earnings as we had discussed in our previous commentary we had written earlier in the year. We had spoken about FY24 being a strong year of growth, which meant that FY25 would see a revenue growth, which would be muted due to the higher base. Around this, we wanted to ensure that our portfolio construct had characteristics of strong operating leverage (companies, who have the ability to translate the low base growth into stronger earnings and cash flows, which invariably comes from companies with strong pricing power and margin profile).

Our portfolio continues to show exactly the above characteristics (as represented in the table below). The quarter went by (June 24 – Q1FY25) saw strong annual growth in revenue and profitability across our portfolio. While QoQ growth is seasonality driven, on a YoY basis, our profitability margins grew along with robust revenue growth. There were a few interesting trends in our portfolio companies which we highlight in further detail below:

Note: For the year-on-year (YoY) measurements, we have taken a rolling 4 quarter format, i.e., Q1FY24 to Q1FY25, as compared to Q1FY23 to Q1FY24. This helps us track growth of our portfolio better, removing dependence on cyclicality in the quarter. Our portfolio companies continue to demonstrate healthy growth and profitability.

We also measure the health of the portfolio with the following metrics, that give us a summary of the earning capability of our holdings.

As we have mentioned in prior quarterly notes, our portfolio is overweight Healthcare, Non-Lending Financials, Auto with a 2W focus, Oil & Gas, and Power. We continue to see tailwinds for growth and will monitor the trends on the ground for additional channel-checks to re-validate our thesis and translate this into our positioning.

Below we highlight a few key updates and themes worth monitoring:

Rural Recovery: Two Wheelers

As we have been highlighting over several quarters, the domestic registrations for 2W’s in the country have grown at over 10% over last four quarters YoY. The export units for the OEM’s have also been seeing strong enquiry and strong outflows. The management’s commentary on the ground also highlights, how after nearly 2 years, the rural demand is outpacing the urban demand. Given, nearly 50% of 2W sales come from rural India, it acts a proxy to outlook on rural demand. With rural pickup, we expect the 2W’s volumes to sustain and our investments in Two-wheeler OEM’S and ancillary are an extension of the same.

Our positioning in the space is with the company who continues to execute the best with respect to growth, margins and new models. Some of the conference call extracts highlights the growth we have been speaking about in the last few quarterly updates.

Q1FY25 Concall Snippets: 

“With expected normal monsoon, we could witness robust growth in Q2. For the first time we are seeing rural doing slightly better than the urban. I am of the view the first time you’re seeing the rural becoming better” – TVS Motors, Q1FY25

“Indeed, we are seeing an uptick in rural. It’s definitely a more balanced growth that we have seen overall of the 12% that we saw, led by rural” – Hero MotoCorp, Q1FY25

Fig 1: Domestic 2W registration data on a quarterly basis (VAHAN)

Natural Gas Imports: 

We have been highlighting natural gas volume increase as a theme over multiple quarters now. Between 2007 and 2017, the increase of capacity kept pace with the annual growth in demand for energy at about 8%. The government’s target to reduce emissions and reach renewable capacity to 500 GW by 2030 have come at the expense of minimal thermal power capacity expansion since 2017.

We have been seeing meaningful gas field discoveries in India, which should lead to gas transmission growth. Additionally, in order to cut carbon emissions, the government has taken stance on targeting the share of natural gas in India’s energy consumption to 15% by 2030 from 6.5%, currently – which would mean imports of Natural Gas have to grow meaningfully.

Fig 2: Import Volume over the last 2Y on a monthly basis (cubic sqm of LNG)

The above chart gives us a clear indicator of the trajectory of Natural Gas imports into India – with ~20% volume growth from the base a year ago.

Our investment in GAIL (which controls ~70% of India’s Natural Gas pipelines) and Petronet LNG (which operates as a de-facto monopoly in the import-end) is an extension of the trend we highlighted above and is supported by commencement of new pipelines that is expected to commence in the next 2-3 years. Incremental consumption of natural gas in India, would necessarily be beneficiary to Petronet LNG and GAIL.

Textiles: de-stocking

Over the last 2 years, garments as an industry had gone through a period of economic slowdown stemming from slower sales post-pandemic leading to an inventory build-up in retail stores – which further had an impact on the manufacturing and supply-chain.

Fig 3: Inventory to sales ratio in US retail (2019-2023)

As a major supplier of textiles to the US market, Indian manufacturers were directly impacted by the decline in demand. However, in the last several months, we are seeing retail inventories destocking with several businesses from Walmart, Target, Macy’s and Nike highlighting the trend.

Nike: “We maintained disciplined inventory management, ending Q1 down 15% year over year…returning to our goal of managing a healthy stock-to-sales ratio.”

Target: “…with inventories down 7% at the enterprise level.”

Fig 4: Textile export growth (Dept. of Commerce)

Over the last several months, we have started to see recovery in volume growth from Indian textile exports – which bodes well for finished-garments manufacturers like Arvind (~60% of their revenue comes from the US; and saw ~20% YoY growth in garment revenue in Q1FY25).

Additionally, clientele include major apparel vendors like H&M, M&S, and Levi Strauss have spoken on diversifying sourcing away from China – which provides an additional lever for growth. We have consequently added our position in Arvind and closely monitor the data we are seeing on the ground.

Consumer Durables:

The consumer durable space continues to show a strong growth in volumes over the last 2 quarters ( 25%+ at a sector level). Some of the reasons for the impressive performance of the consumer index have been – rural recovery, ongoing CAPEX thrust, intense heatwave and premiumisation. Below is the commentary on few segments in the consumer durable space and the road ahead.

“The room air conditioner market is estimated to have grown by 50-60% in Q1FY25, the strong growth was due to the intense heatwave across the country, companies did witness stock outs during the quarter. The Indian room air conditioner market was estimated to be 10 million units in FY24 and is expected to touch 11.5 million units in FY25, the overall industry growth in FY25 is expected to be 25-30%.”

Refrigerator market at the end of FY24 was estimated to be Rs 25,000 – 26,000 Cr. Growth rates over the last three years for the industry have been 0%, 8% and 10% respectively. The competitive intensity in this market is high as there are aggressive growth plans from existing players, for instance Bosch wants to grow by 3X in value over the next four years. New entrants like Reliance retail acquiring licenses to manufacture and market products under the BPL and Kelvinator brand will pose stiff competition to the incumbents. The top three players in this market are LG, Samsung and Whirlpool. Overall, the growth momentum in the consumer durable sector is expected to continue.

In terms of our exposure to the consumer durables sector – we do have positions in Blue Star for their consistency in growth and margins expanding through their segments– Electro-mechanical Projects & Commercial air conditioning systems, Unitary products and Professional electronics & Industrial systems.

Few of the factors that stand out for Blue Star are – consistent performance in the electromechanical project and commercial air conditioning business, which are not easy spaces to show consistency of margins in. Focus solely on the cooling and refrigeration segment and not entering into other white goods segments, market share gains in the room air conditioning business from 9% in FY23 to 13.7% in June, 2024 and average pretax return on capital (ROIC) of 22% over the last 8 years – the company has been able to achieve this through efficient management of working capital and generating higher asset turns on its fixed assets.

We believe that the above factors are intact, and the company has tailwinds in its favour to continue its growth.

IT – Staffing growth:

Data from staffing portals like Naukri and Foundit (formerly Monster Jobs) indicate the trend in IT staffing has turned around from a series of declining months to positive towards the end of Q1FY25.

Naukri.com releases the JobSpeak report, a monthly index that calculates and records month-on-month hiring activity based on the hiring activity of over 100,000 clients on its platform.  The JobSpeak index grew a notable 12% YoY vs July 2023 and a 11% MoM sequential increase compared to June 2024. Historically, periods of growth in hiring are a sign of strength and turnaround for the IT sector that had been cutting roles over the last year.

Fig 5: Data on IT hiring trends from staffing portals

The uptick in hiring activity points towards the peaking of the bench strength in IT sector companies. Higher utilization of employees is a positive leading indicator of the demand environment and bodes well in terms of projects pipeline of the industry players.

From what we have seen on the ground in data and commentary, we have added an exposure to Tata Consultancy Services (TCS) into our portfolio – where we see initial signs of growth alongside continuation in margins expanding.

To summarise, the below table gives an overview of the health of our portfolio as of Q1FY25 (with the snapshot as of July 2024):

Note: The sum of above weights would not total up to 100%; remaining would be our cash holdings.

Team Itus

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