Even as the market waits for a factor to surge, DSP BlackRock believes that earnings growth will be the key to any upside. “Valuations are stretched, but you want to be with companies with good earnings growth,” Anup Maheshwari, CIO Equities at DSP BlackRock Mutual Fund told CNBC-TV18.
Speaking on sectors, Maheshwari said that pharmaceuticals is a great long term sector, which is just going through a bad phase. Pricing pressure doesn’t look like it is abating anytime soon, while regulatory resolutions will take about 12-18 months to be solved, he said.
“We have seen valuations and earnings compress. As valuations come back, there is a good chance to see good returns,” he added.
Meanwhile, on consumer durables, he believes that the valuations are currently stretched. He observed that there is low penetration in the sector.
Simultaneously, PSU banks was a positive, Maheshwari said, adding that it will only expand from this point. “You will have books in much better shape in about 12 months,” he said. He also said that one had to look at the shape of PSU banks after the merger talks.
Placing a slight contrarian view than others, he believes that the rural demand may not be as strong as others were hopeful. While farm loan waivers could have a positive effect on consumption, the negative or low inflation could hit farmers’ earnings too.
The fund house is also bullish on financial services. Among them, housing finance is a big area of growth; smaller banks that have cleaned up books are ready to grow again.
Below is the verbatim transcript of the interview.
Anuj: I was going through the list of funds that have doubled the money quickest over the last three or four years. The DSP Blackrock Microcap Fund of course is on top of that list, but the next logical question now is in smallcaps, midcaps, microcaps, are there still enough opportunities which are available to buy at these levels?
A: There are bottom-up opportunities at all points in time in all markets pretty much but I think the natural tailwind that a lot of these stocks had in terms of valuations is behind us. So, you got to get your earnings right and catch companies coming out of particularly bad cycle or some interesting point that is driving their earnings growth at this point. So, it is not going to be as easy in terms of the returns that we have seen in the last three years.
It will be very difficult to replicate going forward and that is one of the reasons why we had shut the microcap fund as well simply because as funds get larger, those sort of wide spread opportunities are not easily available. So there will be sporadic opportunities, but it is difficult to build a very large portfolio around them. So, we have seen this clearly, as you go down the market cap chain over the last three years, stocks have become more expensive and now we are clearly seeing a lot more interesting ideas as we keep heading up the market cap chain.
Latha: What is the recipe with which investors should approach the market? Should it be like let us look for places to hide because there are valuation challenges generally or should it be that growth is catching up and therefore stick with the boys that are already showing that sign?
A: Growth is clearly the bias of our market so for long periods of time I think companies that have delivered earnings growth do tend to keep performing. I think this market continues to have a very strong growth bias so you want to be in companies where there is visible earnings growth over the next couple of years.
Valuations are to that extent perhaps running a little ahead or maybe a little stretched but as the earnings growth comes through, people are willing to pretty much hold on to those positions. So, I think the key ingredient right now for this market to look forward to in terms of stocks particularly is those which are demonstrating fairly high growth and a good runway of growth over the next few years.
Latha: You would look at topline growth, what would be the key parameter?
A: Profit growth essentially. The key is earnings growth; that is the key at the end of the day.
Sonia: The one sectoral call that you guys got bang on, I think about three-six months ago was pharmaceutical when you mentioned that the underperforming sector that you need to look at right now is pharmaceutical and since then many of these stocks have gone up about 15-20 percent. What is in it that you are looking at right now, is it just a rebound from lower levels or is there a stemming of the rot in this sector?
A: I am not sure we got it perfectly right because they went down after that as well and have just come back, but beyond the short term, six months or so, I think we are looking at it as two elements in pharmaceutical. One is the situational problems that they find themselves in from a regularity standpoint, and b) the more structural challenge on pricing and pricing pressure in the US.
So, the pricing pressure does not look like it is a abating anytime soon, but the resolution of regulatory issues seems to be coming through in some cases and we are quite confident in the next 12-18 months a lot of the cases will get resolved. So, we do feel that just from that standpoint and they are both slightly intertwined with each other in some ways. So, from that standpoint, in the next 12-18 months most pharmaceutical company would be in a slightly better situation from where they are today.
We have already seen both valuations and earnings compress. So, as both of them come back, there is a good chance that there is some absolute returns to be made in that sector. So, we have been saying this for many months that it is a great long term sector going through just a bad phase. So, it presents an opportunity.
Anuj: I am also looking at your note and you are positive on select consumer durables. Most of the ones that are listed actually don’t have valuation comfort though, most of them trading at life high in terms of valuations as well. What makes you positive on this space?
A: The way to see this is in some cases we are just going through a totally different growth phase for some areas. The whole consumption story is clearly coming through in consumer durables in particular where low interest rates, more options available and higher aspirations, higher standard of living is driving a very secular shift in the consumption of certain consumer durables and their penetration still is incredibly low. The base is so low that this sector and stocks in the sector can expand their businesses quite dramatically through time.
I think valuations are pretty much in that sense will probably continue to be on the higher side as they keep demonstrating growth and again it qualifies as a very long runway of growth. So, from that standpoint, I agree valuations are not cheap by any standards, in fact they are very stretched, but as long as these companies continue to deliver earnings growth, we are quite happy to hold on to some of them.
Latha: Will you play the PSU banks at all?
A: Of course we will. It is a bit opportunistic in the last many years now but the fact is that from here return on assets (RoAs) will expand, eventually you will have 12 months from now the books in much better shape, incremental loans are not as bad, the bad loan problem, so all of that is there.
Now we have to look at that also in the context of some of these mergers and what the eventual shape of these PSU banks will be. However, wherever that is not an issue, it is definitely probably we see the worst being behind. So, we do have couple of PSU banks in the portfolio and we will look to add slowly through time.
Sonia: What is your view on whether there is actually a pickup as far as rural demand is concerned because many of these sectors have played out very well, some of them even you have recommended like agriculture, tractors, etc. However, is there genuine pickup as far as demand is concerned?
A: Two things here, one is this whole farm loan waiver seems to have one collateral benefit in terms of consumption because to that extent the debt obligations have gone down. However, on the other hand, inflation being very low and commodity inflation and food inflation being very low is a bit of a negative in terms of farmer earnings. So they are sort of two factors that play here contrary to each other.
So, we think rural demand may not be as strong as people are hopeful of right now. However, let us just wait through the season and let us see. We are a little more circumspect and would rather see the earnings over the next couple of quarters and then take a call.
Latha: What about the GST theme, everyone’s expectation is that the organised sector will capture territory from the unorganised sector, are there still some plays left?
A: Again it will take a long time frankly. None of this is going to be visible in a hurry. I think these are again being seen as things that will play out over multiple years. In the short run you will only see the negative effects of GST in the next two quarters almost like demonetisation. So you will have some very erratic earnings across the entire spectrum.
However, it is a great long-term measure and this trend of unorganised to organised is a trend that cannot really be reversed. I think that will just keep continuing and GST will help it along the way but I don’t think you will see something very dramatic in the next six months.
Latha: Like in FMCG, what should be on our gaze?
A: Again it is a whole range of sectors where we have seen the unorganised still being a fairly large part of the market. So most of that comes under building materials. FMCG I would say again in the larger segments it has been well penetrated by the organised players already. So there would be pockets of FMCG, very niche areas, but not a broader level.
I think you would see it more in the building material space particularly, that is where there is a lot of unorganised to organised market share shift still possible.
Anuj: In the past whenever we have analysed the bull market and the corrections, the issue which has been different this time is that we haven’t had the kind of domestic liquidity in the past bull markets that we have this time around. That has not been perturbed by anything over the last six months or nine months. Do you think that has kept the nature of this bull market slightly different because we have not seen any major correction?
A: However, it is no different globally. I think again we are pretty much fitting into a global framework of the way markets are behaving and added to that of course you are right, the liquidity factor has been quite strong and the good thing clearly that everyone is talking about is the fact that there are a lot of SIP type of flows which gives a lot more stability to the nature of the flow.
So, all that put together clearly acts as a very good buffer for corrections. At the same time we have a scenario where interest rates seem to be gradually trending lower. So, that also helps valuations in some way. That whole combination I guess is keeping markets going and while valuations are definitely ahead of their averages but in the context of lower interest rates and if we look at on a market cap to GDP perspective, it is not totally out of whack at the moment. So, it is manageable.
Latha: Would you want to look at IT, how debilitating is the problem, is it a buy in distress?
A: It is still a difficult sector. Right at the start we talked about earnings growth as a key measure for stock price performance at least in this type of a market scenario and IT is at the other end of that spectrum in terms of earnings growth. I think we still have a lot of earnings challenges.
So the stocks are cheap on conventional parameters but till the time earnings growth does not really pickup, I think it will be difficult for these stocks to perform. So, we need to keep a close eye on underlying trends and which quarter the commentary starts changing for people to get a little more optimistic on IT. So, for now we are still underweight.
Anuj: Looking at your portfolio of small and midcap fund, and a disclosure here that personally I have invested in this mutual fund, but a lot of NBFCs here and small banks as well, the likes of Federal Bank, Manappuram, Repco Home, all of them have done well. Is this a theme that you are still backing at these levels and adding more here?
A: Absolutely, we are very bullish on the financial services as a theme overall in terms of again growth. Within that definitely a lot of very interesting pockets, housing finance obviously is being talked about as a big area of growth, but a lot of the smaller banks that have gone through cleaning up their books and are ready to grow again, I think they will do quite well.Some of the NBFCs still look interesting. So, that is the space where we still see a lot of companies demonstrating earnings growth and the valuations are not unreasonable or totally out of whack. I think valuations are also quite reasonable in that sector.