India's benchmark Sensex has been on a strong run this year, surging over 10.5 per cent. However, even as benchmark indices have hit record highs in recent weeks, the broader markets, particularly some of the mid cap and small stocks have seen a sharp correction. V. Srivatsa, executive vice president and fund manager of UTI AMC says the focus should be on value investing, and sees some money flowing from consumer stocks, that have seen a huge rally, into other sectors that show some consistency in growth going ahead. Overall, Srivatsa expects the markets to trade in a range given the election year, and feels the PE (price to equity) multiples could de-rate if the BJP government doesn't win the elections next year.
Excerpts from interview:
We are almost at the end of the first quarter corporate earnings season. Are you comfortable with the kind of numbers companies have reported?
One aspect is the headline number. The other aspect is what is actually happening. Just to give an example, banking is a significant contributor to the overall profitability. All those corporate banks, there is no point looking at the earnings number and getting disappointed. It is already in the price and its just cleaning up of your past sins. What I would look at is what are the further slippages that have happened and whether they are still growing and whether they have the capital.
Broadly, if I take the consumption part, that's doing well. If I look at the auto or the consumer, to some extent the pharma, whatever that relates to the India space is doing extremely well. In banking, the retail-oriented private banks are also doing well. Pharma, there is some concern on the export part, but that is also there in the base. So, if I look at all the parts, I think, qualitatively there is an improvement.
Every time at the beginning of the year, analysts forecast 15-20 per cent earnings growth, which is then revised downwards every quarter. This time around, is earnings growth sustainable?
Because of a low base, we will have growth this year. It will be more towards lower-double-digit growth. Last year, this quarter was badly impacted on account of GST, you are suddenly seeing huge growth in a consumer company, or you will see in automobile company. But, this may not be sustainable for sure. Your growth rates will taper off. But, I look for a direction and that is very positive.
We have seen Sensex/Nifty touching record highs over the past few days. But, the small cap and mid cap stocks are still trading significantly lower compared with the beginning of the year. What is your assessment of the broader markets? Are we in a sustained bull year, or is a correction in large caps on cards too?
Six months ago, you had a very big valuation premium of mid and small caps over large caps. That is correcting, though it has not come to zero. It has probably come down from 25 to 15 right now. Secondly, there is also a huge shift happening, even in the mutual fund side, a shift of flows from mid caps towards large and mid or multi cap type of funds. The SEBI classification (of mutual fund schemes) also necessitated a lot of changes. That probably impacted small caps more. Liquidity sentiments also have been very bad. While, the markets have been up theoretically, liquidity has been bad. On the FII (foreign institutional investors) side, there is a clear focus on reducing the India overweight, because they believe there is an election risk, they don't want to take. Even on the domestic side, the focus is more on the large and mid cap stocks. If you look at it, the top ten stocks would be driving the market currently. If you see the breadth of the market, still after the rally in the last few weeks, my guess is more than 50 per cent would be in the negative zone on a year-to-date basis.
Would you preserve your money right now, or is there a case building to shift some money to the small and mid cap stocks that have corrected sharply?
There is also a big divergence within small and mid caps. For instance, look at consumer stocks within small and mid caps or a retail bank, those haven't corrected at all, in spite of pricey valuations. Whereas, if you look at the other general mid-caps, say in the infrastructure side or PSU side, or a wholesale NBFC (non-banking finance company), those have corrected 20-25 per cent. I would still be comfortable with the mid caps right now. My focus has been on value. The allocation has always been 60-70 per cent in large caps and balance in mid and small caps. I don't see any reason to change right now.
Is there a valuation comfort to pickup large caps?
I follow a value style. I was massively underweight on consumers and I still continue to be. My belief is that if you make an entry in the consumer space or in any stock at 40-50 (PE) multiple two-year forward, one needs to be very sure of the growth. You may be showing high growth because of various factors. In FMCG category, I don't think showing 20 per cent year-on-year growth for six-seven quarters is possible. They may have shown it this quarter, they may show it next quarter. But, to show that for the next two years is going to be difficult. That is what you would expect conventionally, when you are entering a stock at 40-50 PE. It is very difficult to make long-term money unless growth is very consistent for many years. Today, the biggest comfort is in the private sector corporate banks. They have a good retail franchise, they have capital on their side and to a large extent, they have cleaned up the corporate book. You will probably see a pain this year on the P&L (profit and loss) side. Progressively, there will be a sharp improvement in the asset quality side and in a year to two years, you will have a normalised profitability and ROE, which these banks were enjoying. There is a big valuation mismatch, so I see a good amount of value in this sector.
Do you see any correction happening in consumption stocks?
Every investor wants certainty. The day you see others like a bank showing some kind of consistency, you will see huge money flocking in. It could be other sectors too. In pharmaceuticals you see a visibility of 15 per cent compounded annual growth. The pharma sector is trading at a 20 multiple. In pharma, you have the domestic consumption and the export story. If you get a clarity on strong visibility of growth ahead, you will see money coming in from consumer to this (pharma) space.
We are in an election year. How much of that will weigh on investors?
It is a concern, there is no two way about it. If you take a possibility that this government won't continue, the market PE multiples will de-rate in a big way. There will be a question mark then on the policies. In 2004, it contracted very sharply after the result (BJP lost the elections). But, after that you earned super normal returns for 3-4 years. In 2009, it was a reverse in a sense you had returns for six months to one year and then there was a big lull. In 2014 also a similar story played out.
So, between now and the elections, how do you see the markets moving?
It will be in a range, as such, the valuations are not cheap. My guess is, there could be a shift in the leadership from the sectors, which have done well in the last year, giving way to other sectors. You may not have meaningful returns coming from the markets, but yes, sector wise it could be different. We are at a level where the PE expansion is difficult.
Look at the automobile space. While sales volumes have been good for some time, there remain a lot of regulatory uncertainties. How do you view this space?
Structurally, I am positive, because we still have decent scope of growth. Unlike, other consumer oriented sectors, the valuations are not very expensive. Today, the way valuations are, I would find more comfort in two-wheelers in the auto space or on tractors, agri (equipment) space. In commercial vehicles, I would be circumspect, as apart from the regulations, we have had three years of solid growth. My guess is, we are anyways towards the fag end of the cycle.
Software services companies have reported good earnings in the quarter...
It is (April-June) seasonally the best quarter, plus you have the benefit of the (depreciation in) rupee. There was a big valuation mis-match a year ago. Today, that is not there. I still see pharmaceutical sector growing 12-15 per cent for the next ten years. For IT services, it is going to be a challenge, simply because of the base. The other argument for IT sector is that it is a hedge against any kind of political risk. Any new government coming, this is a sector least impacted. May be investors are looking at the sector from that angle, building up a position. But, in terms of whether there will be a earnings surprise, I doubt on that.
On the economy front, how worried are you on the challenges, be it the rise in crude oil prices or the depreciation of rupee or on the deficit front?
On crude oil, I believe its close to topping out. It may not come down drastically, but remain range-bound in the $70-80. What is needed is stability in prices. Fiscal deficit could be a little more challenging because this is the last year of the government. More importantly, I am not sure of the impact of GST. They have taken a chance and cut rates recently, that needs to be watched out for. The biggest concern would be on the fiscal deficit.