Moneycontrol
Aug 07, 2017 05:26 PM IST | Source: CNBC-TV18

Look for firms with strong earnings; see cheap valuations in IT, pharma and telecom: Kotak MF

Nilesh Shah of Kotak Mutual Fund believes that there are divisions in the market — one which has froth, cheap valuations, expensive valuations and the ones with good earnings.

As the strong momentum in the market continued, with the Nifty clocking levels of above 10,100, several participants have pointed out the pace of earnings growth does not commensurate with the rally.

Having said that, Kotak Mahindra Asset Management Company (AMC) believes the earnings scenario in case of Nifty companies is divided into half and is a matter of perception.

Given that 25 companies saw poor earnings, while the rest posted strong numbers, one should look at sectors and companies with strong profit growth, Nilesh Shah, Managing Director of Kotak AMC told CNBC-TV18 in an interview.

In such a scenario, what should be an investor’s approach? Shah added that the market is divided into four components and one must choose the strategy accordingly.

Firstly, there is a section where froth is visible. The second part has high valuations due to low floating of the stock, largely seen in IPOs and defensives. “One must have a 5-8 year horizon, in this case, to invest at current levels,” he told the channel.

This shall be followed by companies such as IT, pharmaceuticals, PSU banks and telecom, where valuations are cheap. “Here the stocks are cheap for a reason…unless there is a trigger or catalyst, these stocks are not going to see value unlocking,” Shah explained, adding that one should have a bottom-up approach in this kind of a setup.

Among these, he said that the telecom was seeing lower than historic valuations, while US pricing pressures remain a worry for pharmaceuticals.

Lastly, there are consumer-facing stocks where earnings growth is coming through, but one has to be careful of valuations. Opportunity lies in this compartment as well, he added.

Below is the verbatim transcript of the interview.

Latha: What is your sense? For you, whether it is your fixed income guys or whether it is your equity guys or your balanced guys, you have an equal hand towards all of them, are you on the board asking your gilt fund guys to push the product more than equity?

A: There is always this adage which says glass is either half full or half empty and for the FY17, Nifty is actually half full or half empty. There are about 18 companies in Nifty which has declared losses for the last three years and there are about seven companies which have declared profit which is less than 10 percent. So effectively glass is half empty for pessimistic which will look at this 25 set of companies and say that look where is the earnings growth.

On the other hand, there are another set of 25 companies where three companies have declared more than 40 percent compounded pofit growth for the last three years. There are 14 odd companies which have declared more than 20 percent profit growth. So as a fund manager, I am being paid for being optimistic. I am looking at those 25 companies where profits are coming and I am ignoring those 25 companies where losses are coming or moderate profit is coming.

Anuj: In your own words, you are neither pessimistic or optimistic, you are realistic, so what is the sense right now? Is it still good time to buy into this market?

A: This is market which can be compartmentalised into four components. One component is where froth has already set in. It is almost reminding you of Harshad Mehta days or Ketan Parekh days where business value is 10 or 20 percent and market value is 80 or 90 or 100 percent. These are the stocks which my cousin brothers can recommend to me, saying that rather buy these stocks and they will go up. This is not the stock where we should invest into.

Then there is another compartment of stocks where valuations have gone up substantially because of the low-floating stock. Now these are some of the initial public offers (IPO), these are some of the fancied sectors. If you want to invest in these companies at today's valuations, you must have more than 5-8 years horizon to make money out of this. So this is the compartment where businesses are good, management is good, but valuations are sky high because there is such a limited floating stock. There are no sellers, only buyers and prices have lost its meaning in the near-term.

Then there is another compartment of stocks which is comprising of IT, pharmaceuticals, PSU banks and telecom where stocks are cheap for a reason and unless and until some trigger comes, some catalyst comes, these stocks are not going to become from cheap to valued stocks. So, in these kind of sectors, be bottom-up, do your homework, have the patience to invest into, do not go lump-sum, all kinds of things which will work over here.

And finally you are left with another set of compartment where there are mostly consumer facing stocks. Their earnings growth is still coming through. Valuations, one has to be careful, but you can still generate return over there, obviously not as much as what you generated in the last 2-3 years, but with little moderate return expectation, the opportunity lies in that compartment. So there are pockets which are completely avoidable, there are pockets which will require catalyst and then there are pockets where you can still generate moderate return if you pick up stocks correctly.

Reema: What about picking up stocks which are currently cheap, where we are awaiting catalysts, because that is where we could get perhaps the multi-baggers? Any such sectors or themes or stocks which you have identified where there could be catalysts in the offing right now and the stocks are cheap?

A: As of today, there are four sectors where there is historical valuation. The current valuations are lower than historical valuations. They are IT, pharmaceuticals, PSU bank and telecom. Unfortunately, the catalysts which are required to unlock value in these sectors are missing right now. In IT, companies have to invest for the future and they have to kind of marginalise their past. The process has begun, but it is picking up speed as much as is required by the investors. But the valuations do give you comfort that these companies, if and when they start achieving investment in future, will start getting rerated.

In pharma, a lot depends on external environment, the pricing pressures are huge, the approvals from US Food and Drug Administration (FDA) is becoming sketchy. So unless and until we see those things coming through, pharma does not see rerating possibility.

In PSU banks, non-performing asset (NPA) recovery is an issue. One, have we recognised all the NPAs? Second, the NPAs which we have recognised, will there be recovery over there and what will be the recovery versus what is the provision? Lots of uncertainties over there.

And telecom today, there is severe competition and unless and until that competition kind of stabilises and there is a sort of equilibrium in the market, telecom sectors will not provide return to the investors. So all these four sectors keep looking at the factors which can turn out to be catalysts. If ever you want to invest into these sectors, you will have to be very gradual and calibrated rather than lump-sum.

Latha: I was looking at your list of stocks that are very good, but where the valuations are high. I am getting something like 10 stocks, Bajaj Finance, Bajaj Finserv, maybe an L&T Finance thrown in here and there. Are these stocks not getting very expensive and there is no quarrelling with the performance of an HDFC Bank or a Bajaj. But really, valuations and therefore, again my first question to you. Are you, as a house, advising people to think of sovereign gold bonds, to think of gilt funds for maybe 5-10 percent of incremental systematic investment plans (SIP)?

A: We have been always advocating asset allocation to our client. And even in the bearish market, we advocate the same. Even in bullish market we advocate the same. There is no one standard size that fits all. Everyone has to take a call based on their risk return profile, their investment objective and then make investments. We have been going out of our way to tell people now that if you are underinvested in equity, this is the time to invest in equity but no lump-sum. This is a fair value plus market.

Please invest via systematic transfer plan, please try to invest more when there is correction. If you are neutral weight to equity, then you have to do systematic investment plan, your future income can be invested into equity market, not from your current wealth. And if you are over invested in equity, we have advised customers to book a little bit of profit because this is fair value plus market. So, each one according to its need should take a call.

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