Ashmore India has recently set up a fund in India and CNBC-TV18’s Latha Venkatesh caught up with Ashwini Agarwal, Co-Founder & Partner of Ashmore Investment Management India LLP in a special series Crystal Ball to find out if Indian equities will not be as dependant on foreign flows going forward.
“Globally we are interested in large domestic markets. We have operations in Indonesia, Saudi Arabia and now we have launched a fund in India and we would like to do such kind of things in other countries. We are interested in local markets where operations are scalable,” he said.
India fund is a select bottom-up fund from a medium to long-term perspective and despite the market being very strong, we are able to find ideas, he added. Through this fund, Ashmore is looking for 20-22 ideas to build a small portfolio and hold it for three-five years.
According to him, valuations are challenging in many areas of the market so one has to be cautious and careful.
In fiscal 2019 and 2020, he expects to see much better earnings growth. Maybe not in fiscal 2018 itself because Q1 of FY18 will see a lot of upheavals because of de-stocking from goods and services tax (GST), he further mentioned.
Below is the verbatim transcript of the interview.
Q: Since you have just stepped into attract Indian investors, are you seeing this as a seminal change that India is not going to be dependent on FIIs as much as it was but it is a big domestic story?
A: It is a very interesting question and this is true for all large local markets, whether it is China, whether it is India, whether it is several large countries elsewhere in the world. Local investors are always a very important source of savings, an important source of money management for people like us.
So globally we are interested in large domestic markets. We have operations in Indonesia, for example, operations in Saudi Arabia and of course, now, we have launched a fund in India and we would like to do such kind of things in other countries. We have presence in select markets in Latin America and in Eastern Europe. Much of our operations are based out of London, but we are interested in local markets where operations are scalable.
Q: What kind of an earnings growth are you giving for the current year, FY18 and therefore, at the moment, how overvalued is the market compared to its mean valuations?
A: If you just looked at Nifty for example and Nifty is now trading at about 19 times one year forward earnings based on our calculations. And if we look back the last 15-18 years, the only time the market has been expensive relative to today has been 2007-2008. So in that context, it is a little worrying. It is trading well above T1's standard deviation positive mark and if you look at the midcap valuations, they are even higher. So midcap valuations today are comparable to what we were seeing in 2007.
So the interesting thing is what happens to earnings. Obviously, you have gone through almost 3-4 years of no earnings growth. There is a fair amount of work that the government has put in. things have been lucky for the government as well, in the sense energy prices are low, food prices are benign because you have two good monsoons back to back and so on.
But, suffice to say that there is a lot of operating leverage embedded in Indian businesses because they have not seen any growth. They have cut costs down. Cost of borrowing has come off. Free cash flow is positive and now, GST implementation from a medium-term perspective should actually be better for organised players than for the unorganised ones or for the smaller players. So from that perspective, one expects that in fiscal 2019, fiscal 2020, you will start to see much better earnings growth maybe not in fiscal 2018 itself because the first quarter will see a lot of upheavels thanks to destocking GST.
Second quarter, I am not sure how much restocking will happen and year-on-year comparisons will be very tough to make because of the way you will report your earnings because you will be reporting net of GST compared to just net of excise earlier. So the topline numbers itself will be harder to compare. So I am not sure what happens in the September quarter. So I am thinking about fiscal 2019, fiscal 2020 as probably more the years in which you will start to see very good earnings growth.
Q: And yet we will have a couple of advantages in the second half. One is the pure arithmetic that it was demonetisation quarter and therefore, a good rebound can be expected optically. So will we still manage about, the market is sitting at 18-20 percent, fair estimate?
A: There might be a little bit of downside bias to that. Maybe it is 16-17 percent is what we are thinking at this point in time, but honestly, we do not know. It is very hard to say because a lot of the initiatives that the government has taken are yet to feed through.
So I will give you a few examples. On December 31, Prime Minister Modi announced the subsidy scheme for the first time home buyers. That has not really resulted in a pick up in real estate purchases even in Tier-II, Tier-III towns where on an affordability basis, real estate is probably at 5-8 year lows. It is very affordable. Rates have come off, nominal real estate prices have not gone anywhere, so in real terms, it has become cheap. But we have not seen that pick up.
Similarly, if you look at the capex on roads, capex in railways where the numbers are pretty large, we are still to see that effect feeding through to demand of cement for example or demand for steel or growth in transportation, growth in demand for trucks. So some of this is still work in progress.
Now, assuming a lot of this starts to become visible by the later part of this year then you could actually see very good earnings growth for the December quarter, March quarter, but very hard to make an estimate today whether all of this will happen.
And mind you, as you said, a lot of this is built into the expectations as well. So buy on hopes, sell on news is quite possible. So even when the earnings come through, it is possible that the market does not do anything. It is almost like, if you look at the markets, in 2014, we saw a huge rally anticipating a win for the BJP and for two years the market did nothing. When all the good news actually started to come through the market actually did nothing.
Q: Let me marry the two things that you have said, one that Prime Minister Modi's Awas scheme, what we now learn is only 250 houses have been constructed or funded so far in that scheme. The other point that you spoke about midcap valuations being more frothier or more scary. The obvious leader of the midcap rally has been the NBFC space including the housing finance space, is that a no-no generally - NBFC including housing finance?
A: We find them very expensive. We are value investors and I find valuations very challenging in the NBFC area especially in housing finance where you are seeing a significant amount of competition from state owned banks, from private banks, from all sorts of players wanting to grow that business. So, the pie is very large but I don't think that margins can expand, margins will probably contract from here. So, if you have got a business which is giving you RoE of maybe 17-20 percent, how much can you pay for it? 2.5 times book, 3 times book, beyond that what? Some of these stock I believe are trading at 6 times book or even 12 times book. So, I find that a little challenging and little hard to explain on the numbers. So, we are being cautious in this area and we are not hugely optimistic on these stocks given the valuations. The business is great but the valuations are very challenging.
Q: What about their counterpart in the banking space? The obvious category everyone goes with is private banks and public sector banks, so let me ask the tougher one. Do you believe the time has come to put in public sector banks?
A: Public sector banks, I am still a little bit cautious about because I worry about the terminal value for these public sector banks. The reality is that while these banks are beginning to fix their problems and their balance sheets, their cost to income ratio structurally will go up, maybe not this year, maybe not next year but on a 5-7 year basis the cost to income ratio will gradually increase because I think that there will be significant amount of competition on their topline which will lead to compression of margins and given the kind of organisations they are, I am not sure how much room they have to manage their costs beyond a point in time. So, I worry about the public sector banks and I have often wondered if there is a terminal value available for us in these banks. So, whenever you look at any valuation metric, you always think about what is this business worth 5 years from now, 7 years from now and I have a big question mark in my head. Maybe I am not being fair to the public sector banks, clearly State Bank of India will be a survivor. So, maybe we are being very conservative in our thinking but I need to find an answer to that question before I can buy any of those names.Watch accompanying videos for entire interview.