India's equity markets have been through a roller-coaster ride in 2018, after what was a near-one-way rally in 2017. The looming elections and global geopolitical issues will also lead to some uncertainty among investors. In an interview with THE WEEK, Harendra Kumar, managing director and head of institutional equities at Elara Capital, shares his thoughts on how and where one should invest in the current market and what are the broader themes that one should watch out for. Excerpts:
Its been a fairly volatile ride in the markets this year. What are the trends that you are observing?
We are in midst of a change in the characteristics of the market. Till last year, we were in a deflationary cycle. You had stocks such as oil marketing companies, because crude oil prices were falling and they were making more marketing margins. You had NBFCs, because of falling interest rates. You had stocks that would do well in recession. Now that the QE (quantitative easing by the US Federal Reserve) has also been wound up, you are moving from recession to reflation. So, your reflation assets will start doing well: gold, capital goods, infrastructure, metals and consumption...
In the previous two bull phases, in 2000, IT did very well and then went into an eight-year under-performance phase. In 2008, it was energy, then it went into under-performance. Now, financial (sector) has reached that level. The amount of capital that it (the sector) is taking in (fundraising by companies, IPOs, etc.) is very high. Plus, you have structural problems, spreads are tightening. The US 10-year bond yield is up. So, there is over-ownership, plus few challenges on the macro front. Co-related to that you have tech, which is severely under-owned. As financials start to under-perform, money will flow to tech.
So, is it time to move away from the financials to some other sectors now?
Absolutely. Tech, metals, auto and consumption will be our very large themes. We also like aviation.
On tech, are there are any positive takeaways from the earnings reported this quarter?
TCS' earnings were good. Infosys, we are not quite enthused. In fact, we are contrarian sells on Infosys. TCS is doing well; HCL Tech has become very compelling and cheap at 11 times forward price to equity. There is an opportunity emerging for large players in digital, which is making people re-look at IT spends. There is an opportunity no one can deny. Everybody is aligned to that space. Who executes that better makes sense.
We will look at the large caps selectively like TCS, HCL Tech and Wipro and select midcaps. In mid-caps, you have these niche players who are doing good digital work like Mindtree, L&T Infotech... So, its a mix of interesting ecosystems developing and working in favour where IT companies will tend to do better.
How much of the recent problems at some private sector banks are going to drive this under-performance in financial stocks?
Purely on private banks, if you see Kotak or HDFC, to defend four times multiples is going to be difficult. So, you can't say there will be absolute price falls, but there will be relative under-performance. Kotak, when it was in the midst of this big consolidation exercise with ING, did not do anything as a stock. Fundamentally, the sound bytes will always be superb, but the stocks could remain flat for a long period for time. ICICI Bank is entering that phase where it will articulate strategies, change things around... This takes six months. Even at Axis, it's a search (for new boss)... So, two of the large banks, which have been investor favourites and have weights in the Nifty, will be going through it. Kotak and HDFC are expensive.
There has been a lot of restructuring in the metals space, particularly in the metals side, where there's a lot of M&A that's happening due to the insolvency process. What's your outlook on the sector?
If you look at the M&A activity on the NCLT side, there is a great demand for steel. That means, entrepreneurs, businesses are very bullish on the steel outlook. There are clean assets and there is only debt to be resolved. Assets are good and demand and pricing environment is strong. That is why you see the flurry of activity out there and you are cutting the lead time of setting up a greenfield capacity.
So, these are great assets that people are acquiring and they will reap the benefits of this. On aluminium, LME (London Metal Exchange) prices have shown lot of resilience. You have only two players—Hindalco and Vedanta.
You have been very positive on aviation as a sector, despite some of the issues including engine problems with two airlines, earnings pressure... Why?
One factor is that demand growth is extremely strong at 20-30 per cent. I don't think any industry is growing at this rate. Second, earlier, it used to be a cyclical industry as people thought of only one-off travel. Now one travel has become two-three travels. So, travel is going to be a staple for Indians.
Third, there is a floor to your airline prices and every year, the threshold moves up Rs 500-1,000 as per capita income goes up. Even if crude oil prices rise, you will have the increase in air fares. Crude oil is the only variable; there is no problem in demand, there is no problem in pricing and companies have become rational now. Your capacity at the airports is getting choked. Till the new airports don't come, the guys who have landing rights will do very well. With demand, your yields will also start to move up.
What the market is currently negotiating is to see the earnings for the next two quarters, whether these players are able to take the rising crude prices in their stride. Once there is this conviction, these stocks will double from here.
You also mentioned auto among your larger themes. Auto sales have largely done well over the past one year. How much has that been priced in the valuations?
Maruti Suzuki is perfectly priced. But, there are two-three names. Mahindra & Mahindra, for instance, because of rural, the tractor sales are doing well and its the most high margin business for M&M. So, now share price has started to deliver.
Tata Motors is off 45 per cent from the peak. Tata's Tiago (hatchback) is doing well, commercial vehicles have started to pick up again; there was deterioration in market share in CVs, and it's holding up. Hero MotoCorp is doing 700,000 units per month and is not getting re-priced in the market. So, beyond your Maruti Suzuki and Ashok Leyland and Eicher, which were leading, we have three-four other names emerging now.
So, now you will have to allocate your money from somewhere else and go overweight on autos.
And the consumption space, where many companies are now at high valuations?
Value (PE multiple) is a misnomer; companies they are cheap. There are two growth triggers... One is topline growth. Earlier, there was 4-5 per cent growth; there was no pricing power. Now, they will grow higher (as companies hike prices in the wake of input cost rise). There is a direct correlation of re-rating when my volume starts to grow higher.
Second, India is among the biggest consumption markets. So, there will be top-line growth and there are no structural problems, a move from unorganised to organised is under way... HUL (Hindustan Unilever) will lead out-performance as it is straddling the entire pyramid. Look at consumption in its various forms, even aviation, auto and eating out is consumption... Men's grooming has now become a new variable. There is a underlying change in consumption habits that is under way. So, to judge consumption companies with a historical framework will be a mistake and you will miss the rally.
This is an election year. There is also the fiscal issue. How much will all this impact markets?
Markets will reprice the new government. Fundamentally, the market is very convinced on the earnings print for 2020. Other variable is the cost of capital or risk premium. So, be it the Gujarat election or the northeast election or Karnataka election, market does become a little tentative. The day they get a sense on the potential rerun or a victory, the market will, in fact, go higher.
Currently, your worst is being priced in. In fact, there will be a relief rally the moment we come closer and know the outcome. This zone of 9,500-10,500 (Nifty) is like the foundational zone for the next rally. The day you get a semblance of conviction on the continuing reforms and the new government, the market will take off. There will be resumption of rally closer to December or January.
So, right now, would you buy stocks selectively or wait on the sidelines?
We are churning. We are giving shifts in your weights and sector allocations. The ideal strategy is to align yourself to the macro-realities. So, what worked for you in the last two years may not work for you in the next two years. So you need to change your strategy accordingly.