‘There is Money to be Made in Large Caps; Like Real Estate’
Indian markets have bounced back strongly from post-demonetisation lows, but they are merely playing catch-up after underperforming EMs in the last two months of 2016. In an interview to Sanam Mirchandani, ahead of a Kotak investor conference, Sanjeev Prasad, co-head, Kotak Institutional Equities, says he believes the US economy is recovering well and the US Federal Reserve may hike rates twice this year, which could reverse the recent outperformance triggered by a weaker dollar. Edited excerpts:
Indian markets are near the life-time high. What would you attribute this to? India has outperformed emerging markets by about 3% in the past month. That is basically a catch-up as India underperformed EMs in November and December post demonetisation. In fact, over a three-month period, India has still underperformed the MSCI EM index and performed in line with the index on a six-month basis. Some attribute the recent gains to clarity on taxation on FIIs in India but EMs are performing based on how the US dollar is behaving in the short term.
What is your take on the valuations of the Indian market? The yield-related trade is largely over for India. We have seen a large re-rating of ‘growth’ stocks based on low global yields over the past seven-eight years ever since global central banks started with policy accommodation. In the future, the monetary policy of global central banks will become less accommodative. Most sectors are trading at significantly higher multiples compared to historical levels. The broad market is trading at 17 times FY18 earnings, which appears quite fair. The performance of the market will largely depend on earnings growth now.
FIIs seem to be returning as net buyers in Indian equities. Will this sustain? It depends on where ultimately the US is headed in terms of economic growth. It looks like the US economy is recovering reasonably well and the US Fed will raise rates two times this year, if not thrice. In that case, US yields and dollar are headed higher. Thus, the whole trade on the back of a weaker dollar could reverse and EMs including India cannot rely on foreign flows alone to drive the markets. In such a scenario, each EM will perform based on its individual macro-economic fundamentals, economic and earnings growth.
Experts have cut India’s growth estimates post demonetisation. What’s your view? We expect growth in the range of high 6%-low 7% for March 2018 (FY18) and around 6.5% for March 2017 (FY17). The impact of demonetisation will probably linger for some time. We have to couple this with the implementation of the Goods and Services Tax, which will be implemented most likely in July 2017. The latter will result in a fair degree of disruption in the informal economy, which will affect overall GDP numbers. Any disruption in the informal economy because of the long-term impact of demonetisation or because of GST will have fairly long-lasting consequences on the overall economy.
The RBI has changed its policy stance to neu- tral from accommodative... We were anyway coming to the end of the interest rate cutting cycle. More cuts are possible but that would depend on inflation trajectory and what kind of positive real interest rate framework the RBI is comfortable with. If inflation is above 4.5% by March 2018 then there isn’t much scope for rate cuts. If it is in the range of 4-4.5% and the RBI feels it is due to sustainable factors, then one can expect another 25-50 bps cut.
How will the outcome of elections in some states affect market direction? These things become topical closer to state elections but I would not attach a lot of significance to politics. A bad outcome compared to market expectations will not derail the macro-economic fundamentals of India or the economic policies of the government. In the budget, people were expecting pop- ulism but the government has more or less stuck to the path of fiscal consolidation and given whatever concessions it could to rural and infrastructure spending within the constraints of fiscal prudence.
Is there more money to be made in large caps or mid caps? I think large caps. The few areas where I see some amount of mispricing are corporate banks, maybe in the telecom sector if we start seeing some amount of rationality in the sector based on either faster-than-expected industry consolidation or rational pricing by Jio.
Which sectors are you betting on this year? We are looking at some improvement in nonperforming loans cycle, which should be positive for corporate banks. Their valuations are quite inexpensive at 1-1.5 times FY18 adjusted book. In Axis Bank and ICICI Bank, some NPLs are still there, but that may peak by end of March or June quarter. NPLs of large PSU banks have been stable for the past twothree quarters. We like the real estate sector and the mortgage finance companies. We may start seeing some recovery in real estate sector over the next three-four quarters once demonetisation impact goes away.
IT and pharmaceutical stocks have corrected sharply. Do you see value there? In IT, there is value but the way forward depends on how US visa and border adjustment tax issues pan out. Pharma has been an underperformer but stocks are still quite expensive at about 20-22 times March 2018 basis.
Cement stocks have rallied, betting on demand recovery. Do you see more upside? I would be a seller of cement stocks. The valuations are outlandish at three to six times book for the large caps and about 2.5 times for the midcaps. Capacity utilisation is still in the low 70% range. There are serious challenges on the demand side. Financials of cement companies have been disappointing in the last four years. Profits in some cases have halved from FY2012-13 levels.
Should one exit the metals space which has seen a big rally? I don’t see a lot of value in the metal names also given the fantastic run they have had. But from a valuation standpoint, they look more attractive than the cement sector.