What would be your preferred plays given that the environment is shifting?
In the last three or four months, we have been very constructive on financials and part of the reason is that even as Covid hit, the financial sector had consolidated quite a bit. Corporate credit in the banking system has declined 10% in the last five to six years. That is a substantial amount of consolidation and speaks to the asset quality on the book of the banks and the financials. Even on the retail side, India is the least penetrated market in the world. So, both on the corporate and the retail side, there is no question of over leverage in the system and as we were coming out of this, IPO valuations were looking attractive and we were fairly constructive on the sector.
When we speak about the midcap financials, the situation has not changed. Most of these companies continue to trade at distressed valuation and we are recommending investors to go in for substantial returns this year.
Would you be staying away from the PSU names altogether?
There is a lot happening there. The government is talking about privatisation that has been spoken about in fits and starts in the past. As the PSU banks’ financials stand today, they have not made a consistent return of equity over the cost of equity for a substantial period of time. If there is restructuring, if there is privatisation, if there is significant consolidation across these banks, there could be a story emerging but at the moment we look at them as cyclical trades where credit cost will come down, cyclical return will increase and we will get reasonable returns there. So unless something changes drastically in the way they operate and there is cost cutting, we do not see these as secular stories going forward.
Do you think this entire change in the market dynamics from pharma and IT to banks is still a work in progress or are they also fairly priced?
In terms of relative valuations, banks still look better. Pharma and IT are two very different stories. Both are defensive exporters. Pharma tends to be more company molecule specific; there is more valuation, dispersion within pharma. We are discerning in these two sectors and cyclical sectors as well. For instance, in our last report in December, we had recommended investors to selectively own pharma whereas we were asking people to be relatively more cautious on IT. In IT, the upgrade cycle is done.
There is more risk of earnings to the downside and in general on IT we have been cautious in the last few months. Pharma is stock specific and we are constructive on some leaders which are still under appreciated based on how the businesses are doing. There is a reasonable amount of innovation going on now in this sector. So, stock-specific in pharma and still positive on IT though we are a little cautious on the pack as a whole.
More than earnings growth, names like have been a case of valuation rather than the growth story. From the earnings view point, what are you going to be watching out for?
We are not allowed to comment on individual names but I can broadly tell you that earnings have been good across the board. Some good stories in the FMCG space have seen some disappointment because there was a lot of hoarding or consumption of packaged foods during the pandemic and the base has been set very high. Sequential growth has not been good in some of the packaged food companies. But having said that, overall numbers have been fairly okay and this is reflecting in the valuation of all these companies.
What needs to be watched for is how is the risk reward looking because the best is more than priced in and any small disappointment does lead to a significant correction. We are not very constructive on the packaged food side because of tough sequential compares and aggressive valuations partly based on low interest rates globally.
Cyclicals, when it comes to valuations as well as earnings momentum, is probably a better story to play despite the recent outperformance.
The one theme that is working out very well in the market is the global auto recovery seen in , . Should one stay with this theme or would you say it is a well discovered one and the stocks have already run up too much?
Cyclicals in general and global cyclicals. I would probably keep commodities out of that because it is very difficult to predict where they go once average valuation comes. But global cyclicals like autos and auto suppliers levered to global cyclicals like autos remain good spots to be in because the developed world did go into a second Covid wave. So numbers have still not fully recovered. The recovery is still one or two quarters away and a lot of that is not priced in. It is a good space to stay invested in because numbers and sentiment will get better. There are some companies in India which are suppliers to these companies and those have also become good plays.
Are you telling your clients to invest in some of the IT product companies like OnMobile, Affle, Intellect and Tejas because that is where the real pot of the gold has been discovered?
Some of these companies are a little small to fall under our investors’ radars. So, not very, very active there.
What about the internet companies because this year PolicyBazaar, Zomato will go public. There is only one Info Edge but is it a strong theme for this year?
Absolutely. We have looked at some of these companies quite closely. They are phenomenal businesses. PolicyBazaar is not listed. I can maybe speak about it but some of these companies are excellent businesses with dominant positioning. The internet space typically is a winner-take-all one because once you have established reasonable revenues and leading positions, you can invest more, you can advertise more and it becomes a self fulfilling prophecy. It is a very exciting space for listed investors this year. People should keep a lookout for these names.
