We find large Insurance companies being part of most global Indices, so we also should traverse a similar path and see two or three insurance companies being part of Sensex or the Nifty in the future, says Rusmik Oza of Kotak Securities.
Life insurance and asset management companies (AMC) are likely to be high-growth businesses due to the financialization theme that is playing out, Rusmik Oza, Head of Fundamental Research, Kotak Securities, says in an interview to Moneycontrol’s Kshitij Anand.
Q) What is your assessment of the September quarter earnings? If you had to describe them in one word, what would that be? What were the highlights?
A) If one has to summarise the September quarter results in one word, it would be ‘Decent’. Further, if it needs to be summarised in a sentence, it would be ‘Optically healthy on earnings, due to corporate tax cuts, skewed on EBITDA due to adoption of Ind-AS 116 and weak on revenue due to economic slowdown’.
Numbers on a year-on-year (YoY) basis are not comparable as many companies moved to lower corporate tax rates and reduced their deferred tax liabilities or assets to account for the lower tax rate.
The adjusted net profit of the Nifty declined by 3.2 percent on a YoY basis. Private sector banks reported poor earnings due to adjustment towards deferred tax assets, while SBI reported a significantly higher net profit as it continued with the earlier tax regime.
Hence, if we see Nifty50 adjusted earnings growth excluding banks, then it has fallen by 10.5 percent in Q2FY20 on a YoY basis. Among the Nifty-50 companies that outperformed our estimates on the PBT basis are: Cipla, Dr.Reddy’s, Maruti Suzuki, NTPC and Tata Motors.
Similarly, the Nifty-50 companies that underperformed our estimates are: GAIL, Hindustan Unilever, Indian Oil Corp, Tata Steel, UPL and Ultratech Cement.
On sectoral performance, banks, diversified financials, healthcare services, media, and transportation delivered strong growth in net profit on a YoY basis, while automobiles & components, gas utilities, metals & mining, oil & gas, and telecom sectors declined on a YoY basis.
Q) In October, fund managers increased stake in insurance and AMC companies such as ICICI Lombard, HDFC AMC and HDFC Life Insurance in the largecap space. In the midcap space, The New India Assurance also got attention. Can these be the next Sensex stocks investors can look at?
A) Yes, in the future we can expect some of the leading life insurance companies to be part of the indices like the Sensex or the Nifty50. Both life insurance and asset management companies (AMC) are likely to be high- growth businesses due to the financialisation theme that is playing out.
We expect financial savings to increase in the future on account of high real interest rates and growing financial inclusion.
We find large insurance companies being part of most global Indices, so we also should traverse a similar path and see two or three insurance companies being part of the Sensex or the Nifty-50 in the future.
In the case of the asset management sector, we have only two listed players as of now, with HDFC AMC having a market cap of around Rs 73,000 crore and Reliance Nippon. As few more AMCs get listed in the future, the interest in them will only go up.
As per AMFI, the AUM of the mutual fund industry has increased three-and-half fold in the last 10 years (from Rs 7.75 trillion in October 2009 to Rs.26.33 trillion as on October 2019).
Also, the monthly SIP amount of above Rs 8,000 crore adds close to Rs 1 lakh crore to the industry AUM on an annual basis. As the AUMs go up and the market cap of companies goes above Rs 1 lakh crore, we can expect one or two AMC companies to also join the Sensex or Nifty-50 sometime in the future.Q) The macro data is far from rosy, it is getting worse by the quarter. At the same time, benchmark indices are trading near record highs. Is it time to act on Warren Buffett's advice and buy the ‘fear’ because small and midcaps are down 20% from their record highs?
A) Most of the high-frequency monthly indicators are indicating further deterioration. We are not sure when the convergence between the economy and market will take place.
Looking at the current rich valuation of the Nifty, it seems the street is factoring in swift recovery in the economy. This is a big risk factor for the market, as we remain sceptical about any quick recovery in the economy given the structural challenges.
Broader indices are close to near highs because of a faster recovery in earnings led by corporate tax rate cut and lower loan-loss provisions for banks.
The underperformance of the smallcap index relative to the Nifty has come closer to its three previous instances seen in the last 15 years. This portrays the future upside potential in the small-caps vis-a-vis the large caps.
Similarly, on valuations, the Forward PE of the midcap index is trading at a 14 percent discount to the Forward PE of the Nifty. On a standalone basis, the Nifty is trading at 19x Forward PE leaving very little room for any re-rating from here on.
For the mid and smallcaps to outperform the largecaps, we need a broad recovery in the economy, with improved credit offtake, better print of IIP, and GDP growth.
If the forthcoming Union Budget provides some incentives to taxpayers and investors, then we could see a broader rally in the market which could then revive interest in the mid and smallcap space.
A base for future outperformance of the mid and smallcap has been set in this calendar year, which could fructify in the next calendar year as and when we see a broader recovery in the economy.
It is ideal to increase exposure in mid and smallcaps vis-à-vis largecaps in one’s portfolio with a two to three-year view.
Q) After Moody’s recent downgrade of India outlook and growth, all eyes are on the GDP numbers. Do you think we will slip below 5 percent for the September quarter? Has the Street factored in that number?
A) Most economists are projecting September quarter GDP growth to be 4.5 percent, which, if it comes, could be quite sub-optimal.
The market has not factored in such sub-optimal numbers and if the GDP growth slips to 4.5 percent in Q2-F20, then it will be taken negatively by FPIs, who follow a top-down approach and give higher importance to macro factors while making investment decisions.
We are expecting GDP growth to slow down to 5 percent in FY20, compared to our earlier expectation of 5.8 percent projected after Q1FY20 GDP print.
Considering that the Nifty is just 250 points below its previous peak, we could see it sliding to around 11,500 points if the GDP numbers disappoint.
The current valuations of the Nifty have already factored in the higher earnings growth coming from lower tax rates and are trading close to its previous peak of around 19x on a forward basis
Q) Gold has been volatile, thanks to mixed signals on the trade war front and rupee depreciation. What are your views on the yellow metal and should I make use of corrections and buy?
A) International gold prices crossed the $ 1,500/ounce -mark this year when the fear of trade war was at the peak. As the rhetoric on the trade war has subsided, international gold price has corrected to $1,468/ounce.
Central banks led by China have been adding gold to their reserves, which has driven the demand for gold. Fed & ECB have again turned dovish and changing their monetary policy to avert any slowdown.
If we see any resolution of the trade war, then the uncertainty factor will take a back seat and it could lead to further correction in international prices. Based on today’s assessment, we feel international gold prices could correct further.
If the trade war subsides, then we can expect the yuan to stabilise and other emerging market currencies, including INR, should trade in a range. Keeping these factors in mind, one can look for a 5-10% correction in the gold price to turn buyers.
Q) The rupee recently broke above Rs 72/dollar. What is the way ahead for the currency?
A) In the last two months, the government has been actively coming forward and trying to address the key concerns facing the economy and sectors. The effective tax rate of 17 percent for companies setting up fresh investment in the country should be a good incentive for attracting fresh FDI into the manufacturing sector.
Capital flows have resumed on the equity side and if the government can finalise some of the big-ticket privatisation of PSUs, then it could attract heavy FDI flows.
India is preparing to get included in the JP Morgan EM Bond Index. As and when this materialises, it could lead to large inflows into the Indian bond market.
If the crude prices average $65 bbl in FY20, then we could have current account deficit of around 1.9-2 percent of GDP and a surplus Balance of Payment situation.
Based on the future course of a trade war, if the Yuan stabilises against the dollar, then we could expect the INR/USD to stabilise and average around the 71-mark with a range of 69 to 73.Q) We are almost at the end of 2019. What stood out for markets during the year–is it the FM’s proactive reforms initiative or the Moody’s change in the outlook for India?
A) The Union Budget was a disappointment for the market and we were witnessing continuous correction in stock prices after that event. The series of interventions by the Finance Ministry in the last two months has changed the mood of the market.
After the reduction in the corporate tax rate, earnings have picked up in Q2FY20 and FPIs have turned positive on India. There has been a disconnect between the macroeconomic environment and markets, which could stay for some time as high-frequency indicators are not showing any signs of improvement.
Sentiment and flows are driving markets, even though most leading macro indicators are weak and the slowdown looks more structural than cyclical.
The recent downward downgrade of India’s rating by Moody’s is a cause of concern and could impact future FPI flows if things don’t improve on the ground.Q) How can investors balance emotions and remain invested during testing times like the ones we have seen in 2019?
A) The year 2019 has been a testing time for investors in mid & smallcap space, as they continuously underperformed the Nifty for the second year in a row.
There has been a remarkable difference in the performance of the Top 20 stocks of the Nifty and the rest of the market.
The fear factor was at its peak, with a severe slowdown across many sectors. Although monthly SIP flows have been consistently rising in 2019, only a handful of good quality midcaps have been able to deliver healthy returns.
Fund managers still prefer to stay with high-quality and richly valued stocks; 2019 has thought lessons on many fronts.
When there is a severe slowdown in the economy and various sectors are reeling under pressure, then one needs to be nimble and shift investments to high- growth sectors and slightly larger market cap oriented companies.
Have a negative list of companies having poor corporate governance, weak financials and promoters with high pledged shares.
Go for quality stocks that are available at reasonable valuations, though they may not have delivered the desired returns in the last few quarters. Keep revisiting the investment thesis every quarter/half yearly based on numbers and management’s future guidance.
Reshuffle the portfolio, throw away dud companies and increase exposure in beaten-down companies where comfort is very high and prices have fallen due to down cycle.
Efficiently run mid and smallcap companies with decent RoE and RoCE of more than 15 percent will surely get rewarded in the next up-cycle.
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