In this interview, he also explains why he continues to remain bearish on consumer stocks and bullish on large private banks. Edited excerpts:
Are you comfortable with Nifty’s current valuation? Do you see any comfort zone pockets within the bluechips?
After the recent correction, the valuation of the stocks and Nifty50 (PE index) has become reasonable, given that there has not been a sharp drop in earnings by consensus during the current earnings season in the fourth quarter. from FY22. Downgrades in sectors like cement, IT services, automotive and NBFC were offset by upgrades in metals, energy, banking and industrials. Comments from management across all sectors appear optimistic about the demand scenario as pressure on margins persists. Nifty50’s rolling PE ratio is around 20x, which is in line with its long-term average and therefore current valuations provide investors with a higher margin of safety against any potential earnings downgrade.
You previously downgraded the consumer goods sector to underweight with a negative bias on consumer staples, food and paints. Do you still remain bearish in this pocket amid inflationary pressures?
Most reported earnings at consumer goods, food and paint companies saw a contraction of around 200 to 300 basis points in gross margins year-on-year. We remain bearish and selective in the consumer space. Near-term headwinds are higher raw material costs, consumer downgrading, weak rural demand, and aggressive competition from D2C brands. The first quarter of fiscal year 23 should experience further difficulties on gross margins.
Companies have been compromising on short-term media/marketing spend to protect the bottom line, which is likely to continue for some time. Most paint companies have seen demand plummet due to relentless price increases over the past 9 months. Paint companies also need price increases of around 4-5% to bring their gross margins back to normalized levels. Valuation multiples have not contracted significantly given the headwinds in the sector and scenarios of rising short-term interest rates. Upside risks are market share gains and rising per capita consumption across all consumer categories.
What stocks or sectors are you betting on in a rising interest rate environment?
In the higher interest rate scenario, large banks with a higher CASA ratio (or higher public deposits) are favored by the spread expansion. Rising interest rates in the United States will likely cause the dollar to appreciate against other currencies, which will benefit IT companies. The recent correction in IT companies offers an opportunity as valuations have become reasonable. Companies with a negative working capital cycle (FMCG / consumer durables) should benefit as they are the least affected due to rising interest rate scenarios. Companies with strong balance sheets (lower debt ratio) are likely to outperform highly leveraged companies within the same sector.
With valuations looking favorable at large private sector banks, do you think they can start to break out of their sleep zone over the next 1-2 years and start to outperform?
Most major private sector banks outperformed public sector banks in the fourth quarter of FY22 with credit growth around 15-22% year-on-year. Retail banking continues to show robust growth, while wholesale and corporate banking appears to be on the mend given rising working capital requirements across all sectors. Recent M&A deals should open up more credit opportunities for large private banks and PSUs. The consensus remains concerned about shrinking margins and rising operating costs. Controlled slippages and well-provisioned restructured books offer comfort on the reduced cost of credit in the years to come. GNPA, NNPA and additional provisioning requirements continue to drop slightly. Banks are likely to pass on further rate hikes (given that much of the portfolio is pegged), leading to higher growth in interest income going forward. Large REIT holdings and selling around global macro concerns led to valuations correcting to reasonable levels.
For someone who invests with a horizon of 1 to 2 years, which sectors seem attractive?
We are positive on the finance, health, chemicals, telecoms and media sectors. Large private banks are likely to be the main winners from the higher interest rate scenario as valuations turn reasonable. The healthcare sector is trading at reasonable valuations, with companies having higher exposure to India as they stand to benefit from price hikes allowed by the regulator. The telecommunications sector is benefiting from the rate hikes taken in recent months, which should keep earnings momentum intact. Agrochemical companies recorded strong domestic and export growth without any significant pressure on margins. In addition, a selective approach to companies in other sectors (bottom-up strategy) is likely to generate good returns for investors.
The IPO failed to deliver the dropdown when it debuted. What does the road ahead look like for investors at this point?
We do not comment on individual actions. Overall, we remain positive on the life insurance sector with a positive bias in favor of private sector life insurance companies. The life insurance industry is likely to see annual premium equivalents increase by around 15-20% CAGR over the long term, driven by a) low penetration and heightened awareness post COVID, b) increased financial savings and innovative products and c) digital initiatives by most companies. Private insurance players continue to gain market share in the individual life insurance sector.
Where do you think Nifty will end in December 2022? Is it worth taking the guesswork?
Nifty has fallen from pre-pandemic levels of 12,000 to 18,500, approaching “endemic” levels. The recent correction from highs of around 18,500 (October 2021) to around 15,750 (May 2022) is technically a 50% retracement of the gains seen for the Nifty. We expect the Nifty to consolidate in a wider range between around 15,500 on the downside and around 17,500 on the upside and endure the weather correction more than the price correction for the rest of the year. Our reading of the long-term technical chart suggests that the Nifty50 index ends the calendar year on a flat note (y/y) plus-minus around 3% from the 17,600 levels.
Given all the bad news around us, is it better to sit on cash and wait for further declines or start investing in a staggered fashion? What should be the ideal strategy now?
“The greatest risk is not to take it”, as Mellody Hobson said. Long-term investors should use the increased volatility as an opportunity to build the long-term portfolio. After deciding on the broad asset allocation, investors should try to avoid timing the markets, as lows will likely only be known after the fact. We suggest investing in a laddered manner with each drop available in the long-term markets. Short-term volatility is expected to remain high given the uncertain global macroeconomic conditions. However, we expect markets to continue to surprise on the upside once volatility settles over the next 9-10 months. As the global supply chain returns to normal (likely post-geopolitical resolution), inflation concerns should subside. Investors should focus on large-cap stocks rather than volatile small-cap companies. Companies with a strong balance sheet, a leadership position in the industry and a proven track record of strong execution by management remain our preference.
