HSBC Global AMC backs ITC, says NBFCs to continue sustain show

Pradhan said that HSBC does believe in the inherent earnings capacity of ITC as it gets diversified across different products and services.

Below is the verbatim transcript of Tushar Pradhan’s interview to Latha Venkatesh, Sonia Shenoy & Anuj Singhal.

Anuj: The real challenge in this market is to find good stocks at reasonable price. Do you think we still have some stocks, if you apply that screener?

A: I have a little bit of different take on valuation. What tends to happen is you look at one year forward earnings and you tend to extrapolate the most recent quarter to say that that is what the next year's earnings are likely to be. However, there is variation in every quarter and it is very difficult to extrapolate what has been seen in the first quarter to say that is the average increase in earnings for the rest of the year. And what appears then is that in the interim you have earnings which have not really picked up and stock market which actually sense an earnings recovery for the entire year or maybe in the year after. So, there are periods of expensive valuations for the market which may tend to give you this impression that markets are expensive. But in the long run if you take the much longer average multiples that the Indian market have been trading at, it appears that we are probably multiple or too higher than the average but if you think that the earnings growth rate, which have been pretty flat for the last few years, is actually going to come back to the longer term average then the market is not really as expensive as they appear to be today. So, given that caveat there are plenty of opportunities. But they are not obviously cheap or in the value range by traditional financial parameters.

Sonia: We have been having this debate about whether the money that has come into India is purely exchange traded fund (ETF) driven money or is there a lot of long only funds that are investing into India now as well. What is the consensus and what is your own view?

A: Actually not really hard data but anecdotally it is a little bit of mix of both. We have seen significant ETF flows come into the country right from the beginning of this year. Somewhere down the line there is a realisation that all emerging markets are not the same. There is some circumspection in terms of saying that there might be better emerging markets and clearly India has been identified as a bright spot.

So, in a sense asset allocators are scrambling to kind of relook at their asset allocations and to say not have a blanket ETF purchase, but at the moment we still haven't seen very significant inflows in India specific funds as well. So, it begs the question, is it just anecdotal, is it something that people discuss. But the money has still not been seen through these channels yet. So, it is a little wait and watch for now.

Latha: Do you think the market should beat to the Goods and Services Tax (GST) tune now? It is a distance away?A: Clearly, what has happened is there has been a lot of debate over this point. So, it is not a surprise. However we know that once an announcement is made or the GST bill actually does get passed I am sure the markets will rally. But a day or so later the markets will conveniently forget this because as we all know the real impact over the GST will make in the corporate earnings picture is not likely to be seen at least for a year or maybe two years and especially from the fiscal side the impact of the GST leading to pretty significant increase in revenue that is going to take even longer. So, what we need to do is to understand that we don't get excited about this event as such.Of course it is very important as when it gets passed we are setting ourselves up for a much better regime. But the fact is that these events have played out in the markets in a very short term manner and eventually when it does get passes we will experience some sort of rally and I am hopeful for that. But I don't think that is a very sustainable news flow after which - because we know all the problems related to the execution whether they will be ready by the end of this financial year, whether the companies are ready so on and so forth. So, all of these debates will take over and that is the end of that story.Anuj: I take your point that maybe we are looking at one year forward valuations right now. But even if we were to look at two or three year forward valuations do you think there are pockets of bubble or exuberance in the market. Non-Banking Financial Company (NBFCs) for example, trading at four or five times price to book. How would you approach them now?A: That is a very interesting question. The debate is always between earnings growth and valuation and what is the valuation discounting and what is the expected earnings growth. So, I will take you back to a similar example many years ago when IT companies were producing earnings growth rates of upwards of 80 percent or a 100 percent and they used to trade at close to 80 times the near term multiple and many people didn't really realise what was the point and then of course it lead to a bubble which again collapsed so on and so forth. But the earnings growth rate if you look at especially the IT companies over the last 10-15 years it is an astounding rate of compounding and maybe the market doesn't even understand the kind of earnings growth which will continue to sustain and at that time even an expensive stock will have made you money over this period of time.The question here is that we don't know the futures. So, it is exciting to see in hindsight and say, that was justified. Even at that price you would have made money in a company like Infosys for example. But is that true for the NBFCs today, only the future will tell. But the fact is obviously the market thinks and if you look at the delivery of earnings on a Y-o-Y basis these companies are reporting very significant improvements in earnings growth and they will continue to require capital and this whole game which will continue for a while. So, again to take a judgement on what the price is today or a price to book is today to say that it is expensive or not is asking a little bit of a very narrow vision of what you think this investment is likely to give you in the future.No one is arguing one knows the future and so whether it is expensive or not. I am not arguing that they might be cheap. All I am saying is that earnings play a very large role in eventually deciding how much money you make in a stock and sometimes we use conventional logic to say 15-20 percent but in a very high growth phase for any company these things are very easily bested for a few years and which makes the valuations even attractive at the elevated levels that you see today.Latha: Are those justified for the finance companies you are saying?A: As I said I am not making a value judgement whether they are justified or not. I am just saying that in hindsight when we go maybe go travel two or three years into the future and look back and if any one or two or three of them actually deliver the promise what the stock price today carries then you would argue that was not too bad a price to pay knowing what it did but at this point of time it is very difficult to imagine or understand or even to estimate what these earnings are likely to be and of course not all companies are going to deliver either.So, it is a call and as an asset investor or a portfolio manager as long as you make the right checks, as long as you have a portfolio approach to these companies it is interesting to be invested in this but specifically to say whether they are cheap or expensive right now really depends on the delivery of earnings as we go along. So, it is a risk that you have to take.Sonia: I was going through some of your funds and you have a relatively high exposure to the FMCG space, one of your top holdings in your funds is ITC and that stock has got rerated after its number. It is up 30 percent in the last three months. Is this a space that you see a lot of value in or do you think it will have to be very bottom up in this sector?A: Apart from being bottom up about our stocks we also have something called as portfolio construction to look at. So, the way we approach building portfolios is that we do look at what the index is all about. We understand what our relative position to be versus the weight of that sector in the index. We have remained very off staples all this while because they continue to remain very expensive versus the rest of the market which means as far as consumer staples as a sector go in our benchmarks we are underweight that.However we want to make sure that we don't miss out on the opportunities in that sector and do have enough diversification across all sectors that we don't become very skewed and very risk in our portfolios. So, as a sense of making that portfolio construction bit work we do have selective exposures in staples and of which ITC is one of the more relatively better off when it comes to valuations versus every other company in that sector. Yes, we do believe in the inherent earnings capacity of this company. It is getting diversified across a range of products in goods and services and we are quite positive about this company in the long run.However I just wanted to point out that we are underweight staples at the moment and ITC seems to be relatively in the ranking across all of that in those companies are much better bet to take given where its valuation is vis-à-vis other companies in that sector.