India's equity markets have continued to move up and this week the BSE Sensex hit a new record high of 81,587.76. While the large cap index has surged 20 per cent over the past year, the midcap and smallcap indices have jumped around 55 per cent. Shibani Sircar Kurian, senior executive vice-president and head of research at Kotak Mahindra Asset Management Company feels large caps and some of the larger midcaps are better placed on risk reward compared with some of the smallcaps and microcaps. With mid and smallcaps having delivered better earnings than large caps in last couple of years, the expectations are elevated and so earnings delivery becomes very important there, she told THE WEEK in an interview.
Q. With markets at a record high, are there are any concerns or risks that you see?
Three things have been responsible for the markets the way they have moved over the last 12-18 months. On a relative basis for India, macro stability has come to the fore, where growth has been higher than most of the emerging market peers and this comes at a time China is struggling on growth. Even if you look at other macro parameters, whether it be our external sector, fiscal or inflation, all are under control.
Corporate profitability has improved considerably. Today we are close to 5 per cent in terms of corporate profit to GDP ratio from about 2 per cent in FY2020, when COVID had happened. So, that's where a sharp upmove you see, where corporate profit has grown at a much faster pace than nominal GDP growth. In FY24, if you look at EPS (earnings per share) growth, that was about 24 per cent, compared to the 20-odd per cent in NIFTY earnings expectations at the start of the year.
Then, domestic liquidity has been strong in terms of flows. While FII (foreign institutional investors) flows have been erratic, off-late we have also seen FII beginning investing and turning net buyers.
The concern and the risk is on valuation. While, you have better earnings growth, you also have to contend with the fact that valuations are higher than what they have been as compared to the history. Nifty valuations are 8-9 per cent premium to its own history, but remember earnings growth is also higher. So, in that context, Nifty doesn't look to be super expensive. It is reasonable in terms of context of earnings growth.
Mid and smallcaps are trading at a significant premium, both to Nifty and to their own history. Typically, we have seen that mid and smallcaps have actually delivered better earnings than large caps in last couple of years and therefore the expectations are very elevated and earnings delivery becomes very important.
We continue to believe that large caps and some of the larger midcaps are better placed on risk reward vis-a-vis some of the smallcaps and microcaps. Within small and microcaps there are pockets of opportunity. But, we have to look at growth versus valuation even more closely in this segment.
Q. Economic growth is strong, domestic flows are strong and FIIs are also buying again. So, markets can only keep going up from here?
The most important factor driving the market and valuation is earnings. We now have the government formation behind us. We are going into the Budget and that will set the overall tone from a policy perspective. We expect that the policy will remain largely unchanged in terms of investment-led growth. We also believe that today the government has little bit more manoeuvrability to fund the bottom of the pyramid.
RBI has given higher dividend to the government, plus tax collection continues to be fairly buoyant. Therefore, if you have extra revenue, while you can continue to focus on investment and capital expenditure, you do also have some room to spend more on the mass consumption, rural economy and to support demand there. That is one thing you will have to watch out for.
They will continue to focus on 4.5 per cent fiscal deficit by FY2026, which means fiscal consolidation is here to stay. So, the policy part is intact, though we will have to look at the fine print. When it comes to markets, in a medium term, if the policy continuity is there and if corporate earnings remain strong, then the markets can continue to remain strong.
Q. You touched upon valuations. Are there sectors that still give you some comfort on that front?
First of course is some of the larger banks. There has been a lot of concern about net interest margin of banks coming off because of tight liquidity and deposits growing at a slower pace than credit and therefore costs of deposits rising. Now, you are coming to a situation where deposit growth has started to inch up, although there is still a gap between deposit and credit growth. But, banks are no longer hiking deposit rates at an aggressive pace. So, a lot of the repricing you are seeing on deposits has been more or less factored in. You may possibly see one more quarter of margin pain and then start to stabilise. Over the last few years, banking sector has seen balance sheet improvement, non-performing loans have come down, capital position, especially of larger banks, is fairly comfortable and there has been actual improvement in ROE (return on equity) profile of banks. Despite this, valuations are at long-term average, in fact they are slightly below that.
The second sector we are comfortable with from a valuation perspective is consumer staples. Our belief is that there is a turnaround that is underway, where rural income is concerned and demand therefore will follow through. Monsoons have picked up and therefore farm income should be better this year, given better output on kharif. Input cost pressures for farm side have come off to an extent. So the rural wages on real basis should start to see an uptick. Also, anecdotal data like two-wheeler sales suggests the worst is behind us. Therefore, if there is any improvement in budget from an outlay perspective towards the rural side, that should help in terms of driving volume growth in staples.
The third sector, where we still think valuations are still reasonable are some of the large cap tech names. If you look at technology as a sector, especially the large names have underperformed over the past 1.0-1.5 years, primarily because of slowdown on growth and discretionary tech spends. The midcap companies are trading at multiples significantly higher than large cap companies and therefore from a large cap perspective, if there is improvement in discretionary tech spends and some stability on the macro front, where US and European geographies are concerned, then we believe valuations are favourable and we are keeping a close watch.
We also think valuations are in the reasonable space in specialty chemicals. This is a sector that has gone through significant downturn because of slow growth and demand globally, as well as China dumping significantly in the global market, which has impacted prices. Here, we believe there is still some pain left, maybe another quarter or two, but we are coming close to the downturn in cycle.
Q. Looking at the recent earnings announcement by top software firms, what is the signal you are getting?
They seem to suggest that the worst is behind us, especially slowdown of discretionary tech spends. There are still large verticals like BFSI, for instance, where there is some pain that continues. But management commentary, at least from what has been reported seems to suggest that at the margin, FY25 will see some uptick in terms of discretionary spend. It will not be a sharp revival, but it will possibly be better than what we saw last year. This time, the expectations for the first quarter were muted. On those expectations, companies have delivered slightly better.
Q. The other sector that was in the news recently was telecom, where the private players have hiked prices. Do you see a positive momentum there?
If you have seen sectors that have seen a consolidation, and telecom is a prime example, consolidation has brought about improvement in profitability. If you look at pricing discipline, that is an outcome of consolidation, We went through a period, where players were fighting for market share. But, that fight is now behind us. Price hikes will help in terms of improving profitability in the sector.
We believe the sector dynamics are such that most of the companies will continue to focus incrementally on profitability over market share gains, which means that from a sector perspective, it is beneficial and helps in terms of balance sheet and profitability. We will now have to wait and see if companies want to take future price hikes or not.
Q. When we talk of valuations, we have seen a significant run up in the PSU space as well as defence. How much can that continue?
We have always said one needs to look at PSUs in terms of their profitability. We had a period of time, when most of the PSUs were trading at very cheap valuations in context of private sector players. Now, there have been a considerable set of PSUs where profitability and return ratios have improved; you also saw improving governance and disclosures and these companies saw the big re-rating that took place.
From here on, one has to also see if there is incremental possibility for the earnings to grow for PSUs. If there is a case for that, then there is a case for multiples expansion. However, if the PSU has just run up on the back of either it being just cheap and low public float resulting in multiples moving up and going significantly ahead of fundamentals, that pocket we will be careful about.
Within the basket of PSUs, power is something we remain positive. Defence is another sector where we are cognizant of the fact that multiples have run up significantly, but there are still pockets of opportunity. Some of the large public sector banks are better placed on liability franchise and hence valuations are reasonable and also some pockets of oil and gas, gas utilities, gas transmission and the like.
