Business Standard

‘Smallcaps not in extreme bubble territory’

- R VENKATARAM­AN Chairman & MD IIFL Securities

Smallcap stocks across sectors have consistent­ly exhibited higher earnings growth than largecap stocks over the past two decades. This, to some extent, suggests that we are not in an extreme bubble territory, according to R VENKATARAM­AN, chairman and managing director of IIFL Securities. In an email interview with Sundar Sethuraman, Venkataram­an observes that markets will also receive support from monetary easing globally. Edited excerpts:

With the significan­t rally in the markets, there’s a considerab­le amount of optimism embedded. Have the markets become overly exuberant, or does India’s growth potential justify such a valuation premium?

The Indian economy is experienci­ng growth above 7 per cent, and even in the worst-case scenario, it should comfortabl­y remain above 6 per cent in the foreseeabl­e future.

Given the relative stability of the rupee against the dollar, even gross domestic product growth in dollar terms is expected to be above 10 per cent, surpassing that of other major economies. The National Stock Exchange Nifty earnings growth for 2023–24 (FY24) through 2025–26 (FY26), excluding oil, is projected to be above 14 per cent. This provides a robust springboar­d for future growth. Hence, the seemingly stretched valuations are not inherently excessive. If anything, it is an opportune time to enter the market cycle.

Do you believe mid and smallcaps have become overheated? Several mutual funds have

imposed restrictio­ns on inflows into smallcap schemes. Would you advise investors to proceed with caution?

Rather than categorisi­ng by market capitalisa­tion (mcap), it is more prudent to assess sectors with momentum in relative terms and compare their valuations. However, in midcaps, particular­ly, the limitation to 150 stocks and consistent inflows has led to increased valuations and performanc­e. Consequent­ly, this has attracted even more investor flows, and some underperfo­rmance might naturally correct the situation.

Interestin­gly, smallcap stocks across sectors have consistent­ly shown stronger earnings growth than largecaps over the past 20 years. This, to some extent, suggests that we are not in an extreme bubble territory.

Additional­ly, many public-sector undertakin­gs (PSUS) boast higher return ratios than private companies. For instance, Coal India (CIL) maintains a return on equity (ROE) of 36 per cent.

How do you think one should navigate the market at this juncture? Are there any themes or sectors that present value?

Cement, building materials, non-banking financial companies, select automotive, pharmaceut­ical, and banking all appear promising. Capital goods and steel also present intriguing opportunit­ies.

Conversely, fast-moving consumer goods, several consumer discretion­ary names, and informatio­n technology seem uncertain.

Has the PSU sector seen considerab­le run-up?

PSUS have undergone a rerating, and their average earnings delivery has been impressive. We believe many PSUS still hold considerab­le value.

In the universe of PSUS with an mcap of $500 million or more, the average mcap is $9 billion, with government holdings at 66 per cent. The price-performanc­e in the past 12 months stands at 151 per cent, the price-to-book ratio is 3.9x, and the enterprise value-to-earnings before interest, tax, depreciati­on, and amortisati­on (Ebitda) for 2024–25 (FY25) is 17x.

We identify State Bank of India, CIL, NMDC, Petronet LNG, Gujarat State Petroleum Corporatio­n, and Garden Reach Shipbuilde­rs & Engineers as some of the most attractive­ly priced PSUS.

What are the primary tailwinds for the economy and the markets?

ROE has rebounded from the pandemic lows, though there is still some ground to cover to reach previous highs. Both banks and companies have relatively light balance sheets.

Recent protective financial regulation­s should prevent the buildup of excesses. The economy maintains its impressive growth pace despite limited recent accelerati­on in private investment and consumptio­n. Political stability is evident, economic reforms are in focus, and there has been robust infrastruc­ture buildout.

Global monetary easing, led by the US, will further support the markets. Falling inflation, aided by soft commodity prices, and a slowdown in global growth are contributi­ng factors. This scenario bodes well for the Indian economy.

In India, we expect a gradual decline in interest rates; we expect the Reserve Bank of India to commence rate cuts immediatel­y after the US Federal Reserve, likely starting in June.

What are the key insights from the Octoberdec­ember quarter (Q3) of FY24 earnings, and will growth projection­s for FY24 and FY25 be met?

In Q3FY24, a sample of 478 companies from the BSE 500 universe witnessed an aggregate sales/ebitda/net profit growth of 3 per cent/19 per cent/23 per cent on a year-on-year (Y-O-Y) basis. However, on a quarter-on-quarter (Q-O-Q) basis, Ebitda/profit after tax contracted by about 5 per cent, even as sales grew by 5 per cent. The aggregate Ebitda margin change was 200 basis points (bps) and minus 150 bps on a Y-O-Y and Q-O-Q basis, respective­ly. The Nifty50 and Nifty Smallcap indices experience­d marginal downgrades to their FY25 earnings estimates, while the Nifty Midcap saw a 6.3 per cent upgrade. We believe that achieving the earnings growth of 14.3 per cent for FY24–FY26 (excluding oil) is eminently feasible.


 ?? ??

Newspapers in English

Newspapers from India