India attractive for long-term; like financials: Templeton

On the global front, he sees US recovering backed by no major pick up in growth nor any collapse happening in Europe and Japan. Overall, he does not see global stability threatened.

Below is the verbatim transcript of the interview:

Q: Indian markets where they stand today you have been bullish; you have been going in for long picks. At current valuations what is the risk reward ratio? People are talking about a seven-eight year bull run from here today but can we see the kind of return that we have got in the last 11 months in the next years?

A: Basically the prospects are returns will depend on the earnings expansion for Indian companies. Currently the margins of Indian companies are quite low compared to historical levels and their potential. So, as long as the margins expand and the earnings growth can be very healthy and the market or the stocks can continue to perform lot of performance will depend on the ability of the companies to live up to these expectations.

Q: What is your expectation of earnings, I think this is very crucial to where valuations are right now, the next leg of this bull run, is all benchmarked or underpinned by where or how quickly will we see earnings pick up from hereon? What is your assessment when we will see that happen?

A: The last 20 years the revenue growth and earnings growth for Indian companies have been in excess of 15 percent, which has been higher compared to the nominal GDP growth rate for this period. So, the companies in the long-term tend to grow in emerging economies they can grow faster compared to the nominal GDP growth.

When you are looking at the shorter period of time then the margin has a bigger impact on the earnings growth compared to the fluctuations and the revenue growth. So, under normal circumstances I would expect that the revenue growth for Indian companies over the next five years would be at least 12 percent probably in excess of 15 percent. With margin expansion there is a potential that the earnings growth will be higher compared to the revenue growth during this period.

Q: You wouldn’t say then that the market has run ahead of itself at this point in time given that you are now talking about a five year period in terms of the kind of earnings growth or revenue improvement that you hope to see to support these markets hereon?

A: My view is that the market is still very attractive for long-term investors.

Q: When you say very attractive for long-term investors we want to talk to you about specific sectors and stocks that look most appealing to you. Most fund managers are hesitant to talk about specifics so let me start with an open ended question on what looks most appealing to you at this point in time both based on current valuations and on future fundamental performance?

A: We don’t look at stocks from a very short-term point of view. So, we look at the quality of the businesses and we like to invest in companies with very good long-term potential of generating good return on capital for the shareholders. So, our portfolio doesn’t change very dramatically from quarter-to-quarter or even year-to-year.

Portfolio turnover for some of the large strategies that we run tend to be much lower than 50 percent and some years it might be even lower than 20 percent. So, currently if you look at our positioning we are overweight some of the financials, industrials and consumer discretionary and we are underweight consumer staples, we are underweight information technology. I should warn you though that we don’t take a active top-down view. So the sector overweights and underweights are function of stock specific calls that we make.

So, we see a lot of good ideas and financial sector that is why we are overweight financial. It is not that we are overweight financials because we are taking a very active top-down call saying that the interest rate will go down and so all the financials will do well over the next one year. So, we find value within the financial space and we find good long-term ideas and that is why we are overweight there.

Q: You were originally extremely bullish on tech; I am talking about almost a decade and more ago. You say you are not so bullish today. What is the reason, is it valuation or is it something else?

A: We have a sense of value for every company based on our view of their long-term growth, where their margins are going to go, where their free cash flows are going to go and so on. So, when we see a big upside to the intrinsic value from the current price then generally we have higher exposure to those type of companies. Within the IT space we still have fairly good absolute exposure but compared to the benchmark we have lesser exposure because we find better ideas in other sectors with better risk adjusted return potential.

Q: Pharma is 7 percent of your portfolio. I know you have earlier said for instance that Sun is not a core holding even in your pharma portfolio does the outperformance of Sun surprise you? Can it sustain?

A: Sun is a very good company. It has been extremely well managed. They have delivered very good return on capital over a period of time. So, I can't tell you specifically what our current investment view on Sun is because that is generally not what we do because we might be trading in a particular stock and we don’t want to speak about what we currently think about the company. However, I think it is a good company and it has a very good chance of delivering good value to the shareholders over the long term.

Q: You spoke of industrials being one of the sectors that you are currently overweight along with financials. Curious to try and understand what is your outlook is in terms of when you expect earnings improvement or fundamental improvement to kick in over a period of time because the last two or three months have not been very kind to many industrial stocks and there is a sense of underlying disappointment that may be the economic recovery will take a lot longer to sort of help revive some of these stock prices or move them higher to the next level?

A: There are two issues here. One is to do with economic recovery, the expectations to do with economic recovery. The second is the quality of the stocks that some of the investors have been betting on. We have to separate out these two issues -

For high quality companies, I don’t think there has been a huge disappointment but for a poorer quality company which had a big run during the previous bull market and people were expecting a repeat of that and when they did not see that happen neither in the ability of the stock price to sustain or the company to deliver something in terms of news flow or order flow or financials. So, there might be a higher disappointment. So, our view is that the capex cycle is a long cycle. It doesn’t change in one quarter. It is going to be long drawn affair. So, we hit the low point recently and from there we expect things to improve gradually. For the capex to materially increase, it is going to be at least two years from now. However stock prices move in advance of the actual improvement in the profits of these companies and not vice versa because stock markets always discount the future.

Q: For purposes of illustration, can you tell me what you consider high quality companies and poor quality companies? I am not asking you for what you are invested in or not but there are several good quality companies if I may put it that way that are desperately trying to sell assets, deleverage their balance sheet.

A: I can speak about the parameters. The parameter that we are looking at is combination of their capabilities, whether they have capabilities, which are substantially differentiated. For example whether a company can take a large contract, has a lot of engineering capabilities, then we look at whether the company has the balance sheet and the management bandwidth to deliver and then we look at corporate governance. So, these are some of the stuff that we look at.

The companies that have gone through our filters, some of them might not have seen much of an improvement as some of the investors might have expected in terms of order flow or the quarterly performance reported numbers and so on. However, we are seeing evidence that their business conditions are improving. We are seeing advance indicators that their business conditions are improving. So, we don’t have any big concerns that it will not happen.

Menaka: Talk us through where you rank India right now in terms of investment opportunity across the world and I mean not only in the emerging market hierarchy but also compared to lets say money moving into the US now that we are seeing signs of an economic recovery there?

A: India in my view is one of the top destinations. In fact some of the Asia strategies is run it is biggest single overweight market. It is because of a combination of very strong long term fundamentals of the economy and also I find a lot of interesting opportunities in terms of interesting stocks to invest in. So, clearly India is probably the most attractive opportunity among all the markets that I follow at this point of time. I think that view is spreading among wider section of investors at this point of time.

Menaka: When you say wider section are you seeing definitely more interest amongst global large investors in terms of topping up their India investments or at least beginning to invest in India if they had ignored this market earlier on. Can you give us a sense of whether you expect FII flows to continue with the same momentum into this market or an increased momentum, how do you see them approaching India?

A: Over the last six months the confidence in the economic prospects of India has improved substantially. Today there are very few people who are skeptical about the sustainability of growth or improvement in the economic parameters. There are some people who are questioning whether the market has run up too fast. However my view is that the earning growth is going to be very meaningful in the next 3-4 years. Currently the PE multiple of the market is close to the long term average. So, even if we do not have a substantial expansion in the PE ratio for the market the returns can still be very attractive because of earnings growth for the stocks. I think the most interesting part of the Indian market is the variety of stocks that are available. In the last 20 years our funds have done much better compared to the benchmark and that is because of wide variety of stocks that we could pick from and many companies which could do much better than the market and that holds true even today. So, if people can pick really good stocks then those companies can probably deliver much better returns even compared to the market returns which in itself might be very attractive.

Menaka: You watched these markets for several decades. You are amongst the first few investors or fund managers to call the tech boom in India. How would you describe this bull market? We have had domestic investors like Rakesh Jhunjhunwala or Ramesh Damani call it the mother of all bull markets. Would you agree that this is an unprecedented bull market? Where are we in this bull market phase if that is easy to call at all and do you think or how would you differentiate or how do you think this bull market will distinguish itself from the other big runs that we have seen in Indian equities in the past?

A: In terms of index performance in this bull market I wouldn’t expect as strong a performance as the previous market. In the previous market it was a synchronous global boom and many of the markets went into bubble valuations. I do not expect that to happen in the next five years. So, the index returns for this bull market might be substantially lower compared to the last one but I think it is going to be a healthier market and probably fewer people are going to burn their fingers as badly as they did in the previous market.Senthil: There is lots of money especially HNI money and maybe small investor money looking for the next big multibagger and most of that money is looking at what people think or what they like to think are well priced midcap shares. How wary are you about this move into midcaps?

A: We try to segregate the midcap universe into companies which can sustain growth at a high rate for a long period of time and the ones which are gaining bigger of the current rerating of the midcaps.

So, we find that less than a quarter of the midcap companies would fit into the first category and the companies which can continue to grow very fast ultimately emerge as largecap companies. So, we have to be very selective in selecting midcaps at this point of time.

Menaka: On the challenges that this market faces given that we have spent the last 15 minutes building out the bull case, there are many investors who are a little skeptical about how reform oriented this government will be and therefore some of the things that need to be done with regards to let us say the aggression on disinvestment, we haven’t seen that play out as yet, privatisation of public sector companies this government clearly doesn’t seem to be in favour of that. What are the chances where we stand today given what they have already done and what is yet to be done of there being some big disappointments on the domestic front and I cannot ignore the global scenario so we have got great bunch of worries on where Europe is headed, whether Japan will succeed in abenomics or not so what would you consider the big challenges to this bull market and how eminent they are?

A: On the expectation from the government I would expect that they would be administratively very efficient and tap the low hanging fruits that are available. So, doing so can push up the economic growth rate somewhere between 7-8 percent and to sustain the current bull market that is probably sufficient or more than enough.

If they can do something much more than that big administrative, big legislative reform for example if they do a total revamp of the labour laws and there is going to be hundreds of billion dollars invested in railways that improve transportation infrastructure and so on then the rate of growth can go to much higher levels; then of course the story changes very dramatically. Then probably we might see bigger bull market of all times.

However, I am not building that at this point of time. I think there is no political consensus to do so in the next two to three years. I am looking at tapping the low hanging fruits that can push up economic growth rate to somewhere between 7-8 percent.

On the global challenges I am not expecting a very meaningful recovery in Europe. In the case of Japan Abe has gone very far and I don’t think there is going to be reversal of the economic policy insight in the immediate future. His popularity continues to be too high and their mood too far in one direction to change direction at this point of time. So, I see relative stability in the policy framework in Europe and Japan; not a big pickup in growth or neither do I see any collapse in Europe or Japan happening though there are going to be some fears from time to time. So, I would see a stable situation in these two economies.

I would expect US to recover earlier compared to these two. Already the unemployment has reduced and US was ahead in the debt restructuring cycle. So, I would think that US recovery should happen first and then we would see some recovery in these economies. However, I don’t see the global stability being threatened too much.