‘We See More Value in Large Caps than Midcaps’
Domestic institutional inflows, which have propelled the market to near lifetime highs this year, are likely to get stronger going ahead, said Navin Agarwal, managing director, Motilal Oswal Financial Services. In an interview to Sanam Mirchandani ahead of the firm’s Eureka India investors’ conference in London, Agarwal said he sees more value in large caps than midcaps. Edited excerpts:
Foreign inflows have been tepid even as the market is close to its lifetime high. When do you think they will pick up? The market is trading at about 22 times trailing earnings. If you assume a 20% earnings growth for the next year, which is what our team is modelling, then it is at 18 times forward multiple, which is in line with the historical averages. From a short-term perspective, the markets are fairly valued. However, foreign investors are not investing in the Indian markets for the short term. Whenever corporate earnings actually deliver that 20% growth, you will see potentially more inflows coming into the Indian market. Till that time, I don’t see FII flows really coming to India in a strong way.
How long will DII support continue to hold the market? The corporate results that have come out for the December quarter are still muted but they have turned out to be a little better than expected. The resulting enthusiasm has driven up the markets back from 8,000 to near 9,000. Domestic flows into equities have been very strong. Left to FII flows, our markets might have stagnated at 8,000. With real rates of interest going up, the proportion of savings allocated to financial savings has gone up to 40% in FY16 from 30% in FY12 and we expect that it will be at 43-44% in FY17. Within that, we expect equities as a proportion of financial savings to rise to 15%. The combination of these will lead to continued strong flows of retail savings into equities.
In the last few years, market has started off with double-digit growth expectations and gradually lowered them. Will FY18 also be the same? In the past two-three years, every time we started the year with 20% earnings growth expectations, there have been some unexpected headwinds from commodity side, asset quality or investment cycle. In FY17, the analysts may get used to predicting a muted growth and the reality may be different. The market rates of interest have come down. Also, the commodity companies which had seen complete collapse in profit, are seeing improvement in their profitability because of some uptick in prices. All of these will con- tribute to improvement in profits besides credit costs starting to come down. We are expecting a net profit margin of 9.5-9.6% for FY17 and going up to 10.4% for FY18.
Have we seen the worst in terms of demonetisation impact on earnings? The demonetisation impact will not be fully eliminated in the March quarter. You may see some small impact continuing into the following two quarters as well but the impact will be diminishing by the passing quarter. Combination of demonetisation impact and GST in the second quarter of FY18 are sizeable or meaningful changes which impact corporate earnings, economic growth, consumers, and businesses. I see both of these factors producing long-term benefits despite the near term pain.
How are foreign investors viewing change in RBI’s policy stance to neutral? Most investors are no longer assuming any fall or cut in interest rates over the next 12 months. Our own economist is estimating inflation at 5.8% by FY18 end. In fact, a cut or a rise (in interest rates) is the new debate and not the quantum of cut anymore. However, market rates have fallen a lot. If you look at the year as a whole, there will be benefit in this full year compared to the previous year.
How are investors reading the global headwinds like protectionism? Rising protectionism is a new dynamic that investors will have to reconcile to in the coming years. This could have impact both on the growth rates as well as profitability of the companies which have been big beneficiaries of globalisation. How much of the rhetoric finds way into policy making remains to be soon. We are all in a wait and watch mode. We still like a few companies which are very well positioned in those respective sectors but we feel that we will have to budget for slower growth rates and constrained profitability.
IT stocks have fallen sharply. Would you be a buyer in this space? These companies are improving their payout ratios via dividends as well as buybacks which will in turn improve the residual return on equity. Indian technology companies will be able to ride the wave of digitisation as well. The recent underperformance of the sector has improved the risk reward and present double-digit money-making opportunity.
Where do you see more valuelarge caps or midcaps? We definitely see more value in large caps compared to midcaps. The valuation differential between large caps and midcaps has improved the risk reward for large caps.