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Even a double-digit earnings growth would not be enough to support mid & smallcap valuations

Indian federal budgets are either overly populist or surreptitiously populist. Given how poor consumer spending has been, selective fiscal pump-priming is expected.

December 21, 2017 / 05:21 PM IST

Given broader valuations within mid and smallcap names, we do not think ‘big events’ will be needed to derail this space, Piyush Sharma, Co-founder & Co-Portfolio Manager, Metis Capital Management Ltd, said in an exclusive interview with Moneycontrol’s Kshitij Anand.

Q) Work on Modi Sarkar's last full Budget has already begun. What are your expectations from the big event, do you think we will see a populist budget this time around?

A) Indian federal budgets are either overly populist or surreptitiously populist. Given how poor consumer spending has been, selective fiscal pump-priming is expected.

In the current environment, other than de-emphasizing subsidies, there really isn’t anything particularly ‘anti-populist’ that we would ask for. From where we stand at the end of 2017, kick-starting household spending got to be a fiscal priority.

Q) What would you have done if you were the finance minister? What would be on your priority list?


A) Given where industrial capacity utilization is, it is unlikely that private capex cycle is going to revive materially in the near-term and it’s hard to foresee solid job growth unless this happens.

Potential informal sector disruption from GST implementation further risks some job losses at the bottom of the pyramid.

Given that backdrop, it wouldn’t be a bad idea to offer deeper tax sops within industries that can absorb new technology or upgradation such as alternative energy, healthcare etc. or highly labor-intensive industries such as apparel in order to accelerate job creation.

Along similar lines, entrepreneurs that are creating jobs should get extended tax holidays (without revenue caps), and not be subject to minimum wage requirements etc.

Q) Which sectors are likely to see a ray of light in the coming Budget?

A) If we were to pick a sector, the focus on infrastructure spending would continue

Q) It has been a splendid run for markets throughout 2017. What are your expectations for the year 2018? Any big events which could derail the equity rally or market participants will be in a wait and watch mode ahead of general elections?

A) Given broader valuations within mid and smallcap names, we do not think that ‘big events’ will be needed to derail this space.

Valuations are such that anything under 20 percent earnings growth (ex-financials) cannot sustain them and you’ll arguably need back to back years of such stellar numbers just to reconcile with the largely indiscriminate rally we have had in 2017.

We strongly believe that 2018 would be the year of truly bottom-up managers since incremental broad-based multiple expansion is unlikely.

Q) The September quarter results were not that bad, in fact, there were more positive surprises than disappointments. Do you think we could see a double-digit growth in FY19?

A) For top-50 midcaps (ex-financials), average earnings grew at about over 13 percent pace in September quarter and would have grown at over 15 percent (ex-Pharma).

Given that the Indian listed universe has very limited below the operating line earnings leverage and materials cost is a clear headwind, earnings growth (outside Industrials and Financials) will have to be driven at the topline.

While double-digit earnings growth is very gettable, we don’t think that is enough to support small and midcaps at current levels.

Q) Which sectors are looking attractive or a possible play in 2018-19?

A) We are sector agnostic managers and don’t evaluate picks from a top-down perspective. However, from a top-down perspective, industries that would benefit from the public spending push and concomitant improved utilization levels in 2018 could be pockets such as Commercial Vehicles, Cement etc.

Q) Equity truly outsmarted every other asset class barring Bitcoins. What are your views on this buzzing asset class? Do you think it is a bubble?

A) It is hard for us to comment on something we don’t invest in. That said, investing in any asset where underlying cash flows/variables are hard to quantify, is fraught with risks.

When you add in the extra element of heightened volatility, the situation is closer to speculation than investing.

Q) What are you recommending to your clients? Top five stocks for the year 2018?

A) As always, we are telling investors to focus on quality businesses where we can identify solid long-term growth potential and intrinsic values aren’t stretched even as headline earnings multiples might be optically high.

Needless to mention that in the near-term clean earnings performance will have to back up such situations. We aren’t comfortable discussing specific holdings of ours.

Q) India Inc. raised over Rs70,000 crore so far in the year 2017. What is the kind of fundraising you expect in 2018? Any particular IPOs you watch out for? And, which sectors are likely to dominate IPO activity next year?

A) IPOs were never a focus area for us. As for the capital raise, we are still behind what we saw at the beginning of this decade. While we have an almost unprecedented pipeline of privately held assets on the sideline, IPO volume would predictably follow how secondary market valuations move and it’s therefore hard to see an encore in 2018.
first published: Dec 20, 2017 11:01 am
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