DAILY VOICE | A blockbuster year for IPOs, we see another Rs 1 lakh crore being raised in 2021: Hemang Kapasi of Sanctum Wealth

Hemang Kapasi, Head of Equities, Sanctum Wealth Management, says that we have already seen over 25 corporates raise about Rs 37,000 crore through public issues and another Rs 1 lakh crore is expected to be raised in the rest of the year.

Kapasi has over 14 years of experience in the industry, 11  of which were in the Indian equities market as an Equity Research Analyst and Fund Manager. His last assignment was with Canara Robeco Asset Management Company as a Fund Manager.

In an interview to Moneycontrol's Kshitij Anand, Kapasi said that, after a long time, we are seeing earnings getting upgraded and as long as earnings growth remains strong, investors will reap the rewards.

Kapasi:  There is no particular indicator that points to the end of the bull market. However, corrections are part of the bull market, and we will see them at regular intervals.

If we track the markets very closely, we will miss the forest for the trees. The market is acknowledging the broader recovery in the economy and changing sector participation, based on incoming data.

In the last two months, midcaps and smallcaps outperformed the Nifty by about 700 bps and 1,500 bps, respectively.

In the current month, largecaps are leading, especially the Nifty heavyweights which underperformed during the same period.

Of late, China's selloff, led by a government crackdown on internet-based companies, made investors rethink about China as an investment destination. In fact, if India does well on the economic front, the share of fresh allocations from FPIs will go up.

There are multiples triggers indicating a revival on the economic front. The revival in the housing sector, government’s focus and spend on  infrastructure development and the increasing shift of manufacturing to India, due to diversifying supply chains, keep the prospects buoyant.

Kapasi:  Many experts are saying it’s the end of the bull market in bonds as economic growth recovers and inflation picks up. But equity markets have slightly different connotations.

When interest rates are rising from extremely low levels and reacting to improving growth outlook, it is actually positive for the equity markets. Growth will compensate for the small increase in discount rates.

How can one say it is a hope rally when data points are signalling improvement? In the US, corporate earnings of S&P 500 are expected to rise by about 30 percent in 2021 from the 2019 levels, while from the high point of 2019, the S&P 500 index is up about 33 percent in 2021. It’s largely tracking the earnings trajectory.

Yes, there are sectors/pockets that benefit from a move to safety and their valuations are high. You can say high expectations from those businesses have some hints of hope-based expectations. But this cannot be generalised for the market as a whole.

Kapasi: The question is when not if. Though electric vehicles (EVs) have been around for a while now, the level of innovation and interest has accelerated over the past couple of years in India.

With the government’s effort to push EVs to reduce the dependence on fossil fuels to meet climate change commitments, several policy measures and incentives have been announced over the last 24 months.

Despite the compelling reason for adopting EVs, their success has been arrested by weak customer appetite and charging infrastructure roadblocks. However, 2-and 3-wheelers have come a long way in EV adoption, followed by e-buses and passenger taxis.

The development of battery industry, charging infrastructure and local supply chains are critical for EV adoption. With the objective of enabling EV adoption and also transforming India into a manufacturing and exports hub, the government has been promoting the localisation of production across the EV value chain.

The level of localisation is low, primarily because of insignificant volumes of EV sales in the last few years.

The government has outlined plans to set up battery manufacturing plants in India, and it is expected to attract industry giants by offering several capex- and opex-led incentives. The government is expected to tender a 50GWH end-to-end battery cell manufacturing facility.

Other than batteries, there are EV components, in which India has the potential to emerge as a hub for manufacturing as well as exports. These include harnesses, BLDC motors, AC induction motors, thermal and cooling management systems, electronics (other than semiconductors), plastics etc.

India’s EV story shows great promise as a host of factors such as policy measures, infrastructure development, TCO parity, and a market buzz come together to drive long-term growth.

Kapasi:  Despite a stellar run, small and midcaps are trading just above 10 percent and 30 percent from their January 2018 highs, while Nifty is trading nearly 60 percent higher.

We keep on hearing about the stellar returns, and, hence, need to be cautious on cutting exposure, but one needs to distinguish beween the 2017 rally and the current rally.

This subset is coming out of a downcycle, corporate balance sheets are far stronger than the 2017 levels, with the lowest debt to equity seen in the recent decade.

Cash flows have been better due to lower tax and interest rates, and reducing working capital cycle in the last one year, resulting in superior return ratios which generally attract better valuation.

We remain optimistic amidst the broader recovery in earnings trajectory as larger upgrades have been seen in this subset of equities in the last year.

However, post this super rally, there appears to be a case of some profit- booking and consolidation before the next upmove.

Kapasi: The truth about the quality of a business is revealed in its return on capital (RoC).

Higher the RoC, better the business. It’s even better when such businesses can reinvest more capital at attractive rates of return and not many businesses can do this.

As with every business, various factors need to be considered like high barriers to entry, efficient and clean management, technological edge, sustainable market share, strong balance sheet, sustainable growth, etc.

All these traits eventually lead to a common characteristic these businesses possess - high RoC.

With the overlay of top-down and bottom-up approaches to stock selection, we consider the three-year average Return on Capital Employed, keeping in mind that there are good businesses that might be going through a temporary downturn, either due to industry-related issues or due to company-specific issues that can present future opportunities for investment.

Every business undergoes a cycle. It is important to have a competent management that capitalises on the upturns and protects its franchise and returns during downturns.

We prefer investing in companies with managements that have integrity and a proven track record with rational capital allocation strategies.

Most managements fail on the capital allocation parameter, since ambition takes over rationality and leads to investments that lower the overall returns of the business.

Lastly, about valuation, we believe it’s not something that can be ignored. However, valuation is not just about a number or a multiple.

Two primary factors drive valuations - one is earnings growth, and the second, I would bucket as ‘other important influences’.

Earnings growth is, no doubt, the key driver for valuation, but one needs to also factor in the relative aspects about available opportunities, cost of capital and economic environment which may also lead to valuations that look either over- or under-valued, in comparison to the historic average.

Kapasi:  Often investors refer to the Nifty P/E multiple and state that the market is overvalued or undervalued. A closer look at the numbers reveals that from the pre-pandemic levels, the Nifty has risen about 30 percent.

This was supported by the Nifty earnings growth of 14 percent in FY21.  Hence, almost half of the Nifty gain is from the earnings increase of FY21.

As markets are forward-looking, the remaining gains are, to some extent, discounting the 30 percent growth expected in FY22 and 16 percent in FY23. On an FY23 basis, the Nifty is trading at 20x P/E.

When we compare with the long-term average, the index is in a reasonable valuation range. But how good is this comparison? The comparison of the Nifty P/E of the last decade with the current index, which has evolved over a period of time, is not correct.

The decade-old index composition was of cyclical companies whose average P/E multiplies are lower. In the current form, when the contribution to the index earnings is from high-quality structural businesses, the valuation range is higher.

After a long time, we are seeing earnings getting upgraded, and till earnings growth remains strong, investors will reap the rewards of being invested.

The comparison with the rest of the markets might give us a relative figure, but it’s of less relevance. India has always traded at a premium.

India is one of the larger emerging markets in the world, the third in terms of GDP based on Purchasing Power Parity, have diversified sectors to invest in with high return on equity, it’s consumption-driven, moderately leveraged, and have favourable demographic advantage.

Post-pandemic, the importance of large and developing economies, like India, has come to the fore as companies and nations saw the negative impacts of high dependence of supply chain on one economy could have on their requirements.

Kapasi:  For IPO investors, 2021 has been an exciting year thus far. The long queue of IPOs and record amount of fund-raising (the highest in the last two decades) reflect investor confidence.

Globally, in the first six months of the year, a whopping 1,070 IPOs came to the markets, the highest since 2000. These companies raised about $222 billion, which is higher than the average annual raise of the past three years.

India is moving in tandem, too. We have already seen over 25 corporates raise about Rs 37,000 crore through public issues, and another Rs 1 lakh crore is expected to be raised in the rest of the year.

As per reports, more than 60 percent of the money raised has been used by promoters and investors (PE/VCs) to liquidate their holdings through IPOs and only the balance has gone towards fresh capital for business growth.

Kapasi: We have a positive view on economic recovery, and, hence, we see fewer worries on cyclical companies currently.

However, in the past year, investors being cautious during the pandemic, may have overpaid for safety in some companies/sectors. Even if their prices don’t correct, they may experience time corrections for some time.

Kapasi: The infrastructure bill that the US senate passed is touted as the largest federal investment in infrastructure projects in more than a decade. Its biggest allocations are for transportation, including roads ($121 billion), rail service ($66 billion), public transit ($39 billion), and airports ($25 billion).

Other notable allocations are for power infrastructure ($73 billion), water infrastructure ($50 billion), and high-speed internet ($65 billion).

The bill also recognises the importance of investing in increasing access to digital assets with its allocation for high-speed internet, and in clean energy with an allocation for electric vehicle infrastructure, such as charging stations and electric buses ($15 billion).