Shailendra Kumar, Chief Investment Officer at Narnolia Financial Advisors feels there is enough headroom for sustained superior performance by mid and small-cap companies.
"Nifty Smallcap 100 index was 0.89 times of Nifty50 during early 2018 but after underperformance during 2018-2019 and the first half of 2020, Nifty Smallcap 100 index came to just 0.41 times during April-May 2020. Currently, with some outperformance by Nifty Smallcap 100 Index, this ratio is at 0.61," he explained in an interview to Moneycontrol's Sunil Shankar Matkar.
Shailendra Kumar co-founded Narnolia Securities in 1997. He is known for his deep understanding of investment theories, stock-selection and portfolio allocation.
Here are edited excerpts from the interview:
Q: The market gained more than 10 percent in the first half of CY21. Do you think the benchmark indices can gain another 10 percent in the second half?
The Nifty has added more than 10 percent during the first half of 2021 and is up by more than 50 percent in the last one year. Market participants who look for market direction based on price movements are skeptical at this point in time due to recent sharp appreciation. But if you look carefully, Nifty is up by less than 50 percent in the last 3 years that means less than 15 percent annualized return over the last three years and that in itself is less than the long term return that the Indian market has produced. So, from the price return perspective market looks a bit stretched in the short term but in the medium-term perspective, there is a good upside ahead.
Also, from the earnings point of above, things look very bright. Due to falling margins, corporate profit to GDP has seen a consistent decline over the last 5-6 years but there is a clear turnaround. Corporate Profit to GDP consistently fell during the last decade from highs of 7 percent to 2.5 percent in FY20. But now that has reversed and we are already seeing improved corporate profitability implying higher corporate profit growth than nominal GDP growth in the years to come and that in turn implies an above average annualized return over the next 3-5 years from Indian equities. In the very near term, the market will be tracking the trajectory on interest rate movement and worry around the third wave of the pandemic.
Q: The BSE Midcap and Smallcap indices gained more than 25 percent and 38 percent, respectively, in the first half of CY21, smartly outshining benchmark indices. Do you think the same can continue?
Current outperformance by mid and small-cap companies during the last year has come after three years of sharp underperformance by mid and small-cap space. Nifty Smallcap 100 Index was 0.89 times of Nifty50 during early 2018 but then large underperformance during 2018-2019 and the first half of 2020, Nifty Smallcap 100 Index had become just 0.41 during April-May 2020. Currently, with some outperformance by Nifty Smallcap 100 Index, this ratio is at 0.61. So there is enough headroom for sustained superior performance by Mid and Small Cap companies.
Another way to look the same is how BBB- bond spreads are behaving. BBB and BBB- rated bonds spread had increased post IL&FS crisis during 2018 but the spread now is at 4 years low suggesting balance sheet issues that these smallcap companies were grappling with are now things of the past. But yes one must take stock specific view here.
Q: Delta plus variant cases have gradually been increasing and Maharashtra contributing the most in India. Do you think third wave will be stronger than second and first wave considering the current vaccination progress?
This is an evolving situation and very difficult to take a definitive view but my own sense is that the ongoing vaccination drive and preparation and alertness post-second wave will help us pass through the third wave with lessor damage. But the consumer side of the economy will take time to come back at least by another one-two quarters. Already consumer durables and discretionary companies are witnessing down trending in terms of people preferring lower priced items. This trend will continue for some more time and that makes picking consumer stocks challenging. One should buy only those consumer stocks that are raising their market share riding on the formalization theme.
Q: Metal was the leading sector in terms of returns, followed by Power, PSU, IT, Capital Goods, Banks and Auto, in first half of CY21. What could be leading sectors in terms of returns in second half of CY21 and what could be underperformers?
Metal rally has happened on the back of rising steel spread on account of change in stance by China triggering improved terms of trade and margin profile of metal players. Till more supply does not come to the market, we can expect a continuation of good times by metal players for further 6-12 months.
IT too would be showing a strong performance as IT companies have a very strong order book pipeline and margin profile has consistently improved. So, in sectoral terms, the second half of 2021 will be similar to the trend seen during the first half.
Q: What is your view on the telecom space. Do you think there could be one more tariff hike before the end of CY21 and could that take the ARPU to around Rs 200 per subscriber per month?
Yes, we are expecting a secular growth in ARPU (average revenue per user) for telecom players. India is a settled 3 players market with a very settled market share implying reduced competition. At the same time, Idea is struggling with balance sheet issues and Reliance Jio is focusing on higher cashflow generation implying better pricing discipline. We prefer taking exposure to Bharti Airtel in the space as we expect it to generate improved cashflow over the next 4-5 years.
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