This week on Thank God It’s Friday, Sridhar Sivaram, investment director at Enam Holdings says earnings growth has been better than expectations. The return of foreign flows into emerging markets, including India, and the strength of domestic flows are two factors leading the Indian equity market higher, he adds.
Sivaram is betting on a BJP victory in the Uttar Pradesh elections, which again could serve as a positive trigger for the market, he says.
Here are edited excerpts from that conversation.
Indian equity indices continue to inch higher. What is your take on valuations now considering the perception that markets are overheating?
The Indian market has gone up almost 10 percent along with emerging markets which are also up 10 percent. We are seeing emerging market flows come back his year after a scare sometime in November. India is performing roughly in line with emerging markets right now. Barring the foreign portfolio investor (FPI) flows, domestic flows are also very strong right now. So a combination of these two could be a major reason behind the markets going up the way they are. Also, at the margin, we have to accept that earnings have been much better than what people anticipated. Even a marginally better than expected performance has had a disproportionate impact on the stock price performance. I would agree that margins look a bit stretched but it’s possible that given the low base this year, earnings for financial year 2017-18 may be slightly better. I would expect a possible 15 percent earnings growth.
India Fund Flows
In the past many have complained about the lack of depth in our markets. We’re finally seeing flows coming in from domestic institutions and retail. But will that sustain?
This is a great second or third leg for the market because in the earlier days FPIs were very dominant in terms of their positioning in the market. The market would move in line with anything that the FPIs did. We have been seeing since last year since domestic and foreign flows have been moving in opposing directions. And there is a lack of opportunity for domestic investors. Look at fixed deposits – they hardly give you 7 or 8 percent. Gold has not done anything for three years. Property has stagnated for almost five years now. Generally, Indians are not happy with 5 or 6 percent returns. At least the hope of double digit returns keeps them happy. This is why we are seeing flows into mutual funds and insurance, predominantly Unit-Linked Insurance Plans (ULIPs). I think it is here to stay for the moment. We will have to see how it goes. If the market trends sideways or upwards, we will continue to see flows. If we see a major global shock, then it is difficult to predict.
State Elections Trigger
Do you think the outcome of the upcoming state elections could have any implications on the direction of the market?
The Uttar Pradesh election is the only major question here. It has been broadly accepted that it is a tight contest. In my view even if that were to happen, that is assuming that the Bharatiya Janata Party (BJP) were not to do well, it may be a temporary setback. We have seen much negative newsflow this year and last year and the markets have shrugged it off. And at times on the same day. I would expect a similar reaction even if BJP does not do well. I don’t think people are expecting it to be a clear majority. There are a lot of polls which suggest it could be a hung assembly or a close fight between the Samajwadi Party, Congress and BJP. My bet is that the BJP will be the single largest party.
Strong Primary Market
We saw large subscription numbers for BSE’s initial public offer (IPO), suggesting there is huge investor appetite. Is the better part of the hunger yet to play out?
I think this flow will continue considering that the benefit of demonetisation we got was close to Rs 15 lakh crore which has come into the banking system. From there, people will want to put it in various avenues and put it to use. Maybe at this point not all of it has been withdrawn or gone to the right destination. Eventually people will realise that there aren’t enough avenues to invest. IPOs have done well this year and last year, and there is a craze for IPOs right now even though the allocations have been poor. But listing gains have been 20-30 percent. So the craze for IPOs will continue for a while. I hope that the valuations do not go berserk; some of the valuations have been reasonable, including the BSE. If valuations are reasonable, we could continue to see craze for primary market offers. And the secondary market will also continue to see inflows on account of systematic investment plans (SIPs) and those plans themselves bring in Rs 3,000-4,000 crore a month. So that is here to stay.
Hunt For Earnings Growth
How long do you think investors will really wait for the double digit growth in earnings to come through because there is a chance we may not see those kind of numbers even in FY18 because GST implementation will have unforeseen effects on earnings growth?
The market has been disproportionately rewarding companies which are showing double digit or slightly better than expected growth. If you actually see the Bloomberg consensus for FY18, it is currently close to 20 percent for FY18 and I do see that number coming down closer to 15 percent. Even if that doesn’t happen, there will still be companies which would have grown at 20 percent. What we are seeing currently is that those companies are getting disproportionately higher valuation and they are getting re-rated constantly. Given the fall in interest rate that we have seen because of demonetisation, we are seeing benefits of lower interest rates now come to even some of slightly stretched balance sheet companies because of which we will see lesser interest cost – and as a result higher earnings for the markets in general – and those seem to be some of the interesting plays right now. We are invested in many of the high-growth, high PE companies; we are constantly on the lookout for companies like that because that’s where re-rating is possible and earnings surprise waiting to happen.
What are some of the areas of opportunities in the broader markets?
There are many growth stocks which you can argue are mispriced, but as I said, currently the combination of lack of opportunity in the market and flows which are coming back very strongly, both from the FPIs and the domestic investors, is leading some of these stocks to continuously move higher. I would question some of the NBFCs right now; I would want to see how cashflow-based lending has been impacted because of demonetisation. We’ll have to wait and see how that plays out. Keep in mind that RBI has given some sort of dispensation to some of these companies in terms of recognition of NPAs. I would be careful at some of the NBFCs which trade at high valuations, especially the cashflow based lending in NBFCs. In terms of opportunities, domestic growth stories look much better. If I look at global stories both on IT and pharma, there are challenges especially for IT, and pharma is a stock-specific bet that you are taking right now. Among domestic plays, we do see some interesting stories especially in roads and construction. The discretionary consumption space is also looking interesting.
Consumer Discretionary: Valuation Bet?
Do you think valuations have fallen to reasonable levels in the consumer discretionary space?
It’s possible that, especially for (consumer) discretionary, we have seen some impact on growth because of demonetisation. It’s possible that we see a recovery in this. In staples if you have lost your sales, it is lost forever...you can’t really use more soaps or more toothpaste. For discretionary, it is possible that there is pent-up demand, so we do expect discretionary to come back. It is very difficult to predict whether it is going to be U-shaped or V-shaped but it is highly possible that we see a comeback in discretionary spend. Which is why I said discretionary is looking interesting; if you plug in a slightly higher growth, then the valuation starts looking much more reasonable.
Consolidation In Banking
There has been increasing speculation on a prospective merger between two large private sector banks, and in yet another case, between an NBFC and another private sector bank. Your view on consolidation in the banking space?
I think consolidation is great, India has too many banks. I would have been happier if there was more consolidations on the PSU side.There is a mandate to do this. Mr Vinod Rai has publicly stated some of these objectives. I sincerely hope that we see some consolidation on the public side. The private side is speculative right now, I can’t comment much.
What would your pecking order be right now among PSU and private sector banks?
I would prefer the private sector banks but selectively some PSU banks as well. So we do have some PSU banks in our portfolios where management quality is effective and we know that the chairmen are going to be there for a while, and we see some definitive effort in terms of resolution of NPAs.