Feb 16, 2017, 03.48 PM | Source: CNBC-TV18
The stock market has digested most of the news post demonetisation and emerged relatively unscathed, says S Krishna Kumar, CIO Equity at Sundaram Mutual Fund.
S Krishna Kumar (more)
CIO-Equity, Sundaram MF |
In sector-specific moves, IT companies -- despite many global headwinds and likely single-digit earnings growth -- will create value for investors using the high cash on books, he said.
Some capital goods companies, he added, are seen getting better in terms of order flow with profitability holding up. There are initial indications of companies wanting to invest after many years of conserving their balance sheet, he noted.
Below is the verbatim transcript of S Krishna Kumar’s interview to Latha Venkatesh, Sonia Shenoy, and Anuj Singhal on CNBC-TV18.
Latha: What do you make of the markets inability to parse good news at this juncture, is it looking like a market that is fully valued, are you a buyer at all at these levels?
A: I think the market has kind of digested all the news flows that has kind of come post demonetisation, with also the change in presidency in the US, etc. I think we have relatively come out unscathed on the demonetisation, I think a lot of estimates on the sell side had kind of predicted disaster in the second half and while the reality has been that the Q3 numbers have been pretty good and beating expectations in many cases. We continue to see that improvement happening in to the Q4.
We are definitely seeing that there are new sectors which are showing up in terms of good numbers -- energy, metals, commodities have been pulling back and we have seen that sectors like chemicals, agro-chem, auto, continue to be doing well. So, broadly the economy is setting itself for a better growth in the next couple of years barring unforeseen circumstances. So, we believe that every dip in the market has to be invested into at this point in time.
As far as market valuations are concerned, we were at probably around 9,000 around September last year and kind of went down up to 7,900 and have come back up to 8,700-8,800 on the Nifty. In this period, what has happened is there has been improvement in visibility into FY18 and FY19. It think the second half has been better like I said. So, from a valuation standpoint, market continues to be around fair levels in terms of long term averages.
However, one should not look at a long term average at this point of time because we are at an inflexion point in terms of growth. We are seeing a broad based recovery in the market in terms of performance. Also, the capital goods and other sectors also are starting to show some green shoots here and there. So, broadly I think we will have a great 2017-2018 where we have broad based growth that kicks in.
Latha: Your street cred was playing as you were speaking, you are an REC Trichy graduate then I must ask you about your fellow alumni N Chandrasekaran. N Chandrasekaran just has announced a buyback for Tata Consultancy Services (TCS), what is your view on IT stocks in that case?
A: I think there has been some amount of headwinds that has kind of seeped in, in the last couple of years from slower growths that has kind of come through because of more automation, etc. and also after Trump is come in, the issue on H1B visas, etc. So, I think at this current valuations, given the kind of free cash that the company is generating and many of them have about USD 5 billion of cash in the balance sheet, I think there is a lot of value at these prices. Downside is very much limited and the companies have to use the cash either to acquire or to kind of return some of it back to the shareholder to enhance shareholder value.
I think given the current environment, many of the companies may be quite cautious on what they acquire given the changing technology environment and the disruption that is happening. So, people would probably go in for smaller technology acquisitions and not for size at this point in time. So, our belief is that a lot of tech companies would continue to follow suit even in the midcap space too and we have already seen Mphasis doing that, Hexaware I think has announced a buyback too.
So, we are going to see a lot of action in terms of shareholder value enhancement here although the growth maybe something which is very tough to come by. We will have typically single digit earnings growth, but I think stocks will see action from a buyback and value creation perspective and many Indian companies also if you see have good amount of cash chest and we think that this can happen a little bit across the board basically where Indian companies also, the other sectors also could participate in buybacks.
Anuj: The other thing that stands out in your street cred is your midcap and small cap fund outperformance. You have of course been a maverick in picking up some of these midcap and smallcaps, I know it is a big category and there are always opportunities available, but we have seen massive outperformance of the smallcap index this year; it is up 13-14 percent already this year. Do you get a sense that things are getting a bit ahead of themselves in the broader market?
A: I would actually caution you not to look at BSE smallcap index for example because these indices have about 600-700 companies and it is actually kind of a broad brush risk-on kind of a trade that has happened on the space. However, what one should be looking at is some of the better quality companies where you would like to look at the kind of earnings growth potential in them and the kind of relative valuations which would make it far more attractive to look at from a portfolio construct perspective.
Definitely, there is a lot of optimism and that is clearly reflected in the wholesome move across the board on a particular smallcap index. However, we need to also kind of try and differentiate ourselves into stocks that you would like to hold. So, we kind of look at from a portfolio construct, look at the portfolio growth and the portfolio valuations relative rather than looking per se at a smallcap index where hardly 10 stocks have weight of more than 1 percent and everything is well spread out basically. So, it is a little difficult to look at that from that perspective.
Sonia: Do you see a lot more money to be made in the non-banking financial companies (NBFC) space, that is one space that you have got a lot of the stocks right whether it is Bajaj Finserv or a whole host of others, is there still value here?
A: I think the public sector undertaking (PSU) banks will take a lot of time to be aggressive in lending and in a significant manner they are not going to be more retail asset driven but more wholesale. So, that part of the market is still open. If you look at the private banks, I think they are definitely accelerating, but I think the kind of niche areas that these NBFCs are into in terms of the penetration levels that these companies have exhibited, I think these companies will continue to benefit from the opportunities and the environment and they are the last mile service providers in the sense and clearly good managements backing these companies and businesses would make them clearly lower in terms of risk and higher in terms of quality of business.
So, we have believe that there is a huge opportunity still for the NBFC space in the country in different pockets, be it truck financing, home mortgages, loan against property (LAP) or consumer financing, or rural financing. There is huge potential and NBFCs will target niches to kind of keep growing their business.
Latha: Let me come back to that one dramatic point you made that even capital goods merit look in, what kind, would it be like Larsen and Toubro (L&T) of the world or would it be the much smaller companies that you have in your portfolio, Ador Welding, Grindwell Norton, V-Guard, are these the kind of companies you are referring to when you say capital goods?
A: One is that on the infra construction side, definitely in the last 12-18 months there has been a lot of improvement in terms of visibility, in terms of ordering and more and more sectors like railways, sports, etc are adding to the construction activity that is much significant in the road sector. So, some of these names we mentioned on the engineering, procurement, construction (EPC) side will benefit.
The other area is the short cycle capital goods basically and the industrial consumables like Grindwell Norton, Kennametal just to take some examples are some of them which will see some growth kind of accelerating at this point in time. I am more referring to some of the product companies like Thermax, or ABB, Siemens, etc. where we have seen these guys get a little bit better in terms of order flow and also from a profitability perspective things have been holding up. When we speak to a lot of other industries, we do find that there are some initial indications of people wanting to invest basically after many years of conserving the balance sheet.
If you would see, I think on the defence side, there is a huge amount of spend that is happening, on the aerospace there is a lot of activity happening. So, we see that these are big investments that will come to the country and that will require a lot of engineering capital goods that are needed to setup these lines. So, next two years there is a huge potential for a good revival which is more also driven by foreign direct investment (FDI) investments really taking shape and taking off on the ground at this point in time.
Latha: What are your thoughts on drug companies, they are also available cheap, but of course there is no sectoral call there, is there something that interests you?
A: As you rightly mentioned, we need to look at the individual companies in terms of portfolio mix and the markets that they are targeting relative to the product pipeline that they have. I think the headwinds continue to be there, I think the industry has to invest a lot more in order to be compliant with the US food and drug administration (FDA). So, we have seen that happening across the board with all the top tier companies and even the smaller ones. So that is going to always continue.
On the generic pipeline, we are kind of coming to -- we don’t have too many big drugs basically and hence the opportunity size is going to be a lot smaller and the existing market is going through a price correction. So, there are tough times for some of these generic companies at this point in time. We will see probably a little bit more consolidation that will happen on the generic space too. The focus should probably be on the domestic pharmaceutical market where the opportunity set is also expanding.
I think with more healthcare insurance awareness, etc. I think the domestic market could be the next big value creator for the Indian pharmaceutical companies. I think that has been one area where these guys may be increasing their focus on as things get better. However, we kind of are underweight on the sector broadly and we have couple of niche plays that are there in the fund. We are choosing to play it through the hospital segment, the healthcare segment, where there is a lot of shortage of beds and incremental growth there.