'There is value in capital goods and banking sectors'
In conversation with Sheetal Agarwal, Krishna Kumar Karwa, MD, Emkay Global Financial Services, says he expects markets to hold on to these levels. He remains positive on sectors which are under tremendous pressure at present. Though he is ruling out further earnings downgrades for FY13, he expects margins to continue to be under pressure. Edited Excerpts:
Where are markets headed?
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Both local and global factors are weak and the challenges are likely to continue. So we expect the markets to be range bound. I think investors should be more stock specific and not try to play the markets from an index perspective. The uptick we saw in first quarter of 2012 was more a case of active inflows. Nothing has changed from there till now. The markets are fairly valued so unless there are extraneous negatives and substantial negative flows, markets should broadly hold out.
Why has the market been directionless? What are the key concerns for the markets?
There is no direction because of policy inaction. In a tough economic environment, despite the pressure on fiscal deficit, current account deficit as well as weak IIP numbers, there is no policy initiative to move things forward. So how will we see a revival? We have also had the rural economy story which seems to be weakening as the net surplus with farmers is not as high as it used to be. So finally, even that domestic consumption story may take a breather. If that happens, then all your expectations on numbers in terms of consumption, in terms of GDP growth may be under challenge. I think the speed at which the rupee has depreciated will create its own challenges for corporates. Government’s inability to execute necessary reforms and manage coalition parties is a major concern. Finally, all this is reflected in poor capex cycle which will limit GDP growth going forward. Global challenges persist and simultaneous weak domestic policies and policy flip-flops and overzealous regulatory authorities are also negatively impacting investor sentiment.
According to you, which measures are needed to improve sentiment?
I am not too sure if any of these legislations on FDI in retail or banking sector reforms will come in the current political set up. I think if implementation at the ground level improves (in terms of quick environmental clearances, regulatory permissions, etc), sentiments will improve and corporate India will want to take more risks and resume the capex cycle. Fiscal deficit is a major challenge and initiatives to control that by reducing subsidy burden for e.g. increasing diesel prices will help improve sentiments. Policy initiatives to begin the process of attaining consensus on GST will go a long way to improve sentiments.
How is the earnings season panning out? Are further downgrades on cards?
For the March quarter, disappointments have been broadly on the PSU banks where the slippages have been on the higher side than expected and there have been some more challenges than expected. If you look at IT companies, it has been more stock specific and you cannot paint the whole sector with one brush. Auto numbers have been in line, but, major growth challenges are there on the domestic consumption growth front. Our earnings estimates for FY13 have been below the average. We are not assuming more than 5-7 per cent growth on the Sensex earnings. We are already on the lower side than the consensus. Broadly you are seeing reduced margins being the impact of rising costs and the inability of corporates to pass on the same.
What is your take on midcap IT companies which have done very well this time around, contrary to their larger peers?
Midcap IT companies’ valuations are almost at a 50 per cent discount to the large IT players. But they have decent cash-flows and decent dividend payout policies. Many of the mid cap IT players have grown by 40-50 per cent in the last 6-9 months, but from current valuations I believe that they should give you decent returns in the next 12-18 months. We like Mindtree, Hexaware, NIIT Technologies and KPIT Cummins.
What is the strategy that you are adopting in current markets?
The strategy is a function of investors risk appetite and their time frame. So if an investor has a sufficiently long time frame of at least two years plus and the ability to take some notional mark to market losses on their portfolio, then obviously you should be buying into stocks and sectors which are currently facing tremendous headwinds and where valuations are very reasonable. buy into the large caps i.e. the number one or two player in that sector because you want to pick the best managements with the best balance sheets in sectors like Cap Goods, infrastructure , banks etc--- sectors which are currently facing headwinds. If the investor does not have that kind of a risk appetite and time frame, he can continue to stay invested in defensives such as FMCG and Pharma stocks. But given that most FMCG companies are trading at 25 and 30 times earnings, they may not give decent returns on a long term basis.
Which are the stocks that you like?
For a longer term investor, I think big value will be there today in capital goods, banks. These are the sectors which could see further pain but then hopefully will give better returns. On a medium term basis, I think Auto is likely to make a comeback as the domestic consumption story makes a comeback. So Maruti, M&M could do well. We are staying away from commodity stocks as there are a host of global factors influencing this space which remain unpredictable.
How do you rate the prospects of the midcap companies?
Midcaps have not done well in the last 4-5 years. I think it is very stock specific. In the last 3-4 years, markets have primarily been driven by FII money and FII money has again been more ETF kind of money that typically goes into large caps. So, large caps have given much better returns than the midcap indices. But within the midcap indices many stocks such as Jubilant food , Rallis, Indusind bank etc have given phenomenal returns to investors. We like select Pharma, FMCG and IT companies in the midcap space. To sum up, midcaps is all about bottom up investing.
Recently, some big IPOs have failed. Is investor appetite for IPOs reducing?
I think market has an appetite if the issue price leaves something on the table and there is something unique about the company along with good business prospects. It’s all about valuations, valuations and valuations. I don’t think anything else matters.