‘Too early to say that the financial sector is out of the woods’

Indices have gained steady ground since the government cut corporation tax in September, despite global and domestic headwinds. MANISHI RAYCHAUDHURI, head of equity research for Asia Pacific at BNP Paribas, tells Puneet Wadhwa that the present liquidity-driven rally does generate some concerns about the market moving ahead of fundamentals. Edited excerpts:

Has the rally since September put the markets much ahead of fundamentals?

In the context of continuing macro-economic slowdown and declining corporate earnings estimates, the present liquidity-driven rally does generate some concerns about the market moving ahead of fundamentals. That said, the equity markets have been strong over the past five-six weeks all across emerging markets, not only in India. The rally has been driven by strong inflows into emerging markets —engendered by increasingly benign monetary policy stance by global central banks and declining concerns about key geopolitical issues like the US- China trade conflict and a no-deal Brexit.

Can the mid- and small-cap segments outperform their large-cap peers in the next one year?

We have a BSE Sensex target of 40,500 by 2019-end. It’s difficult to paint the entire mid-/small-cap universe with the same broad brush, but we think select mid-caps could outperform because of the valuation support they have. We look for steady positive free cash flows, steady generation of “excess return” i.e. return on equity (ROE) exceeding cost

of equity (COE), and good management quality and corporate disclosures.

Are they factoring in the possibility of a wider fiscal deficit going ahead?

The government’s budgetary divestment target of ~725 billion seems set to be met. However, to partly neutralise the revenue shortfall from the corporation tax cuts and any other fiscal stimulus to support consumption, a higher quantum of divestment could be necessary. The market is watching whether such an outcome is feasible.

Your key takeaways from the September quarter results season?

As of now, the September quarter looks better for India than the past three-four quarters. The situation is similar in the rest of Asia. In India, in the July-September quarter, overall revenues have been in line with consensus expectations, while aggregate earnings have been 4 per cent to 5 per cent higher. Positive surprises have been led by consumer discretionary, consumer staples, materials, and select healthcare companies. While this is partly because of beaten-down expectations on part of analysts, margin improvement because of beaten- down raw material cost —

especially for consumer staples and discretionary — has been a notable driver.

What are your overweight and underweight sectors?

Earnings per share (EPS) growth for the frontline Indian indices shall be in low single digits in FY20\ and n low-to-mid teens in FY21. The current consensus estimate for FY21 seems to indicate EPS growth in early 20’s but we are apprehensive of some decline in earnings estimates in a few sectors. We remain overweight on consumer staples, private banks, insurance, and energy in India and have a neutral stance on information technology (IT).

Is the financial sector out of the woods?

It’s too early to say that the financial sector is out of the woods. Over the past several years, public-sector banks (PSBS) were afflicted with the bad asset problem — that problem has now shifted to non-banking financial companies (NBFCS), particularly those that lent to the real estate and the infrastructure sectors heavily. The problem of unfinished properties is not only adding to the problem of non-performing assets for NBFCS, but also depressing the broader consumer sentiment. Investors should watch out for some resolution of unfinished projects in the property sector and the kind of solution proposed by court verdicts on some of the assets in the metals and mining sector.

What’s your view on the consumption segment?

In the consumer staples sector, investors have to be cautious about valuations because many frontline stocks’ valuations don’t leave much room for error. That said, that’s the only sector that has had significant EPS estimate upgrade of late — driven by margin expansion — and that tailwind could continue as long as commodity prices remain benign.

How are foreign investors viewing India as an investment destination amid slowdown concerns?

While foreign investors are positive on India over the long term, in the near term, they are concerned about the likely extent of the economic slowdown and the valuation premium that most sectors are trading at. Most investors are looking at the quantum and form of consumption-supportive measures that the government could engage in and the steps that the government and the central bank could take to resolve the bad assets problem in the financial sector.

What’s your view on global events?

While investors were severely concerned about geopolitical issues (Brexit, the Us-china trade spat, a possible recession in the US) about a month ago, they are now less worried as the possibility of a “Phase-1” deal between US and China and the probability of avoidance of no-deal Brexit appear bright.

WHILE FOREIGN INVESTORS ARE POSITIVE ON INDIA OVER THE LONG TERM, IN THE NEAR TERM, THEY ARE CONCERNED ABOUT THE LIKELY EXTENT OF THE ECONOMIC SLOWDOWN AND THE VALUATION PREMIUM THAT MOST SECTORS ARE TRADING AT