In 2019, India’s stock markets seemed to have shrugged off India’s economic slowdown, with the Sensex and Nifty hitting life highs. The growth though was largely driven by investors buying select large-cap stocks, while the mid-caps and small caps continued to underperform.
In an interview with THE WEEK, Shibani Kurian, head of equity research at Kotak Mahindra Asset Management says that valuations in the mid-cap space are fairly comfortable now and investors should start increasing their allocations to multi-cap funds and mid-caps, with the latter offering a far better risk-return to investors from a two-year perspective. EXCERPTS:
Q. Despite the falling GDP growth, Sensex and Nifty hit fresh highs. Are the equity markets overlooking the slowdown?
If we look at what’s happened over the last one-and-a-half years, while markets have clearly moved up, we are looking at the headline Nifty or the Sensex numbers. The midcap index has underperformed the large caps almost 25-30 per cent over the last 2 years. Therefore, there has been a considerable polarisation at the market level. Even if you look at the Nifty 50 index, the top 15 stocks have actually contributed to the up move, while the bottom 35 stocks have actually underperformed the index.
There has been a slowdown, specifically in the consumption-led growth that was driving the economy. Investment growth for the last many years has been absent too; investment to GDP ratio has come down quite sharply. People are deferring large-ticket consumption, the impact that can be seen on something like auto sales. So you might be OK buying a mobile phone, but not OK with buying a vehicle or a house. When you have a situation where growth is slowing down, there is a flight to safety tendency. So, where you see quality, you see money flow through. This is why the expensive stocks, which are the better quality stocks, have become more expensive.
Q. How do you see the equity markets from here on?
Mid-cap valuations have now gone back to 2014 levels, from when the BJP government came to power the first time. So, on the valuation front, we are fairly comfortable on midcaps and the risk-reward is favourable. For market breadth to improve, broader economic growth outlook needs to improve.
It is not going to be a sharp V-shaped recovery. It is possible that Q2 forms a bottom in terms of GDP growth and there on you start seeing some improvement. But, it's going to be a gradual improvement in growth outlook as a country as a whole. There will be benefits from the corporate tax cuts. After a long period of time, for FY20 we will end up with close to double-digit earnings growth. So, the most important part is the pace of earnings downgrades has now ebbed and you will start seeing some degree of earnings growth, which overall bodes well for the markets from a valuation perspective as well.
If you take an 18-24 months time period, as you start seeing improvement in terms of growth and a lot of companies focus on deleveraging balance sheets, the valuation gap between midcaps and large-caps will likely narrow. Therefore, incrementally, what we are advising investors is you start shifting asset allocation from just owning large-caps to increasing a bit of multi-cap allocations. If you already have multi-cap portfolio, increase some amount of allocation to midcaps. If you have a two-year kind of horizon, then the midcap space offers far better risk-return for the investor.
Q. Where is the next phase of growth going to come from, the consumption-led sectors or the core sectors?
We are looking at capital goods, industrials, cement, infrastructure. These are some of the sectors that we believe in for an 18-24 months period, where valuations are fairly attractive and the overall profitability and growth outlook can start to improve. The structural measures that the government is taking are aimed at bringing investment growth back. The corporate tax cut is one step in that direction; the expectations are that this will be followed by land and labour reforms at some point of time, which will ease the overall investment cycle and pump prime investments.
Q. The telecom sector has gone through a lot of stress. Now with companies raising tariffs after a long time, and the government proposing some relief, how do you see things panning out?
Our reason for being cautious on telecom sector last many years was that until this market share game goes away, the sector can’t return to profitability. Today, it does appear that this market share issue has been finally put to rest and focus on profitability is returning. As tariffs go up in this space, it will flow through in terms of EBITDA (earnings before interest, taxes, depreciation and amortization) improvement in this sector and therefore the kind of stress that you are seeing starts to alleviate at the margin. The question remains whether it will still remain a three-player market or a two-player market.
Q. Aviation sector too went through troubled times, with a major airline shutting down. Do you see signs of a turnaround here too?
Aviation is a tough industry to operate in. The player who will be finally successful will be the one who has the lowest cost model and who has consistently kept costs under control. Despite the fact that one large player went out of the industry, the pricing power is still not there in the hands of aviation companies. This is because the aviation market in India is fairly price-elastic. So, if you hike your fares significantly, you will see an immediate impact on demand. Therefore, even though one large player went out of the market, yield movement has not been sharp.
Q. Despite the slowdown in rural consumption, why are some of the consumer goods companies trading at very high Price to Equity multiples?
While consumption growth has come off, the companies are still able to grow volumes at least in mid-single digits. They have also benefited significantly because commodity costs have been under control, as a result of which, even as the revenue growth has been muted, margins have improved. They have also benefited from the corporate tax cuts. So, bottom-line growth has been faster than the top line.
Consumer companies, which have high return ratios, have had earnings growth improve due to corporate tax cuts and therefore, valuations have become extremely expensive. Whether these margins can be sustained, the room for error is low. So, we are cautious on the consumer side. Within the consumer space, the momentum is still better in terms of growth outlook on the consumer discretionary companies, where you are still seeing growth and market share gains and shift from the unorganised to the organised segment. We are clearly worried about valuations on the FMCG side.
