‘FY19 earnings should expand in mid-teens’

KENNETH ANDRADE, founder and chief investment officer, Old Bridge Capital Management, discusses the road ahead for equity markets, earnings and his sector preferences with Puneet Wadhwa in the backdrop of rising interest rates and escalating global trade wars. Edited excerpts:

KENNETH ANDRADE

Founder and chief investment officer, Old Bridge Capital Management

With the indices at an all-time high, how difficult has it become to find investment-worthy opportunities?

We have been in this cycle of elevated multiples for an extremely long period. Valuations have not been cheap — the only relief in the last couple of months is the corrections that have set out in the mid- and small-cap segments. This has created opportunities. Some of the stocks have recently reached valuations we have not seen for some time. For portfolio managers, we need to use such opportunities (corrections) to find stocks with right valuations.

What has been your investment strategy thus far in CY18?

Our strategy is to find de-levered balance sheets where valuations are comfortable. This has not significantly changed over the course of our existence. Two factors deliver compounded returns—valuations that are low and companies with growth. We need to find companies which map both these trends. Our favourite hunting

ground has been businesses at cyclical lows, a process we have not altered.

The recent rally in large-caps has been led by only a handful of stocks. Is that a cause for worry?

Last year, the polarisation was in the small-caps, this year the reverse has happened. Investors shouldn’t excessively heed to these short-term moves.

Do you expect the mid- and small-caps to catch up with their larger peers?

We need to look at businesses selectively. While smaller businesses will grow faster because of a low base, sometimes they can get expensive in the near term. That said, valuations across capitalisations have converged. At present, we have no preferences.

What are your projections for corporate earnings growth in FY19?

Earnings should expand in mid-teens. We have been adding to industrials and a bit of infrastructure. We have a few businesses that we have carried forward from 2017, which are businesses with a large rural footprint.

Infrastructure and housing stocks have lagged in CY18 despite government’s investment plans as regards these two sectors. What’s your view?

Infrastructure is available at reasonable valuations. And we are seeing momentum in both order bookings and execution. Should this sustain, this is an opportunity. All we need to see is the sustainability of earnings over the next couple of years. Housing sector remains very fragmented and devoid of pricing power. While the scale opportunity exists, the return on equity may not meet investor expectations.

How many hikes do you expect from the Reserve Bank of India (RBI) over the next one year? What’s your advice to investors in this backdrop?

While we cannot quantify the hikes by RBI, the trend is clearly up. This does have an impact on equity valuations. As investors, we need to adjust to lower price-to-earnings (P/E) multiples. This, however, will be made up with earnings growth that has reversed.

Are the markets prepared for an early general election?

No market is ever ready for an event. We will have significant volatility closer to elections and post the results. No government can sustain a very high fiscal deficit for long periods. But as history dictates, this being an election year, government balance sheets will expand. Markets are unlikely to react negatively to the number unless this spending is carried over to next fiscal.

What’s your view on public sector banks (PSBs)?

While we are not invested in this space, from a macro point of view, PSBs are at a low of their cycle. Most of the bad news has been in the price for some time. There has always been a trade in PSBs — the question is will they come back to their prime valuations? These are not secular trades, most of these companies have return on equity of under 10 per cent across two decades. Private sector banks and NBFCs have capitalised on the weakness of PSBs. The only challenge here is we are paying a reasonable premium for these set of business.

Does the consumption theme still hold promise given the inflation trajectory and valuation of these stocks?

Valuations are daunting in consumer stocks. But, these are secular trends and some of these stocks give a significant time correction rather than a price correction. Consumption on a whole and good companies therein have rarely underperformed markets.

WHILE WE CANNOT QUANTIFY THE HIKES BY THE RBI, THE TREND IS CLEARLY UP. THIS DOES HAVE AN IMPACT ON EQUITY VALUATIONS. AS INVESTORS, WE NEED TO ADJUST TO LOWER P/E MULTIPLES. THIS, HOWEVER, WILL BE MADE UP WITH EARNINGS GROWTH THAT HAS REVERSED