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Last Updated : Jul 30, 2013 04:14 PM IST | Source: CNBC-TV18

Will bet on IT, pharma on rupee depreciation: Vetri

Vetri Subramaniam of Religare Invesco Mutual Fund said the macroeconomic policy candidly pointed at the government asking it to come up with short-term solutions to cover the CAD.

The RBI has already fired on possible targets to control rupee's continuous fall. This time the central bank will reserve its ammunition in case the currency resumes its downward journey with a force, says Vetri Subramaniam of Religare Invesco Mutual Fund.

Also read: RBI likely to keep rates unchanged: CNBC-TV18 Poll

Speaking to CNBC-TV18, Subramaniam said the macroeconomic policy candidly pointed at the government asking it to come up with short-term solutions to cover the CAD. There is a lot more that the government needs to bring to table or else the Reserve Bank will resort to the only way it knows, i.e., raise rates which will definitley hurt growth. He suggests deisel price hike or selling SUUTI as immediate measures to curb CAD and is vehementaly against issuing of soverign bonds.

Talking about earnings and growth, Subramaniam said this would be the third straight year of single digit growth and Indian market is facing a valuation risk. The market is not expensive but it is tough to see gains, he said.

He believes the IT has become competetive after rupee depreciated. Interestingly the IT sector is not trading at premium to historic multiples. The same reasoning applies to the pharma sector as well. Subramaniam is willing to bet on both these sectors.  The banks have not found any favours in his books as he sees distict signs of a pick-up in NPAs.

Below is the edited transcript of Subramaniam's interview to CNBC-TV18.

Q: How does the turf look given Reserve Bank of India (RBI) policy for the equity market now?

A: Hopefully, RBI has already fired the few bullets that it wanted to ahead of this policy meeting today. So, atleast the consensus appears to be that they will not do anything dramatic today. The rupee is not making life easy for them given the fact that it is still continuing to remain under a fair deal of pressure, but I think they may just keep their ammunition in reserve for a point in time where the currency is coming under even more pressure to respond with any further steps if they so deem fit.

The very valid point that they made yesterday in their report which was released was that it is now time for the government as well to consider what it needs to do to try and basically address the fundamental problem that we have which is of trade account gap.

They have obviously done something to reduce or quantitatively limit the imports of gold, but I think now there is a case that they need to go much beyond that to directly start to target imports as well as try and ramp up exports through various tax measures. So, there is a lot more that the government needs to bring to the table to try and find short-term solutions to this trade gap, otherwise RBI will continue to respond in the only way that it knows which is to continuously try and hike interest rates.

Q: How does the turf look for stocks now? Does it look like we are consigned to this grind range for many more quarters?

A: The challenges are only mounting, because at this point of time we have not seen any sign of recovery in the kind of high frequency data that comes out of the last few months. There is no sign that any of the economic indicators are turning up and whatever few companies have reported earnings so far in the earnings season, they too are indicating very poor traction in terms of revenue or sales growth.

There is really no visible sign of traction in the economy at this point of time and it is not very visible that we are going to see any tick up in growth going into elections which are due next year with everything stuck in limbo at some level or the other.

With the RBI having to defend the currency, it has chosen to do so and their interest rate policy will certainly not help growth in the short-term either. So, as far as growth is concerned, it is looking to be a very challenging environment. It is certainly looking like a grind.

There is one set of stocks in the market, sort of growth oriented companies which have been doing quite well over the last year or so, but actually the rest of the market is not trading at 19500 or wherever we are. It is actually trading maybe 20 percent lower than that in terms of where it last was when the index was maybe at 15000 or even lower than that. So, it is a very strong dichotomy which is there in the marketplace at this point of time and given the current growth environment, it is very hard to see how the market can breakaway from this.


From a valuation standpoint, we are now trading somewhere just marginally below long-term average valuations. So, it is not an expensive market, but if one has got single digit earnings growth for the third year in a row, one has to worry about whether the market can continue to trade at these kind of valuations. So, that is a bit of a concern at this point.

Q: Do you expect the next few months to see a correction of this bipolar nature of the market? The first signs of sectors like Fast Moving Consumer Goods (FMCG) etc. correcting are now coming through. Do you expect that contraction to start?

A: At the end of the day, these companies start to see their own growth rates affected, then it is very hard to see how they can continue to see valuation expansion. Even if one looks at the stock price performance over the last year or so, it has been driven more by PE multiple expansion rather than by earnings growth coming in significantly ahead of expectations. Under those circumstances, I find it hard to see how these set of companies can continue to drive the market.

We have seen in the past where one particular sector for a variety of reasons starts to trade up in terms of valuations and trades up at levels which can be described as ridiculous before starting to correct. So, are we there yet? I do not really know. From a portfolio point of view, it is very clear to us that we cannot really afford to allocate money to some of these companies and sectors anymore, so we have been happy to take money off these areas and gradually keep rotating it into areas where we think the valuations are a little more favourable if one has been a  more medium to long-term view on the market.

Some of these companies maybe struggling for earnings growth in the current year. I still think these are the set of companies where one is more likely to earn returns over the next three to five years because the starting valuations are now quite attractive.

Q: That is dangerous for the market's overall valuations over the next few months, isn't it? Things like FMCG are the last bastion, so if they start correcting the markets probably are also headed for a sharper correction on valuations that have been held up almost unrealistically by spaces like FMCG, pharmaceuticals?

A: If the question is if there is a valuation risk to the market, certainly there is. Trough valuations for India are almost 20 percent lower than where we are. If one goes back over the last 15-16 years and looks at how low has low actually been for India in terms of valuations. It is at least 20 percent lower from here.

What could cause the market to actually go to that level is completely an unknown. When it might go there is also an unknown. So, one just has to deal with that uncertainty at this point of time.

If for whatever set of reasons we are able to see some signs of an economic turnaround and earnings growth accelerate, that is most probably the only scenario in which the market can continue to hold on to this level of valuations. Otherwise certainly the pressure is continuously building on the equity markets given the fact that growth prospects are just not improving. So, there is a lot to be worried about and concerned about.

Q: In the past, instances of these kind of trough valuations have fundamentals really been much worse than they are today? We are talking about single digit earnings growth after five years of hardly any earnings growth in this market, with the macro, the currency being where they are, so it is probably only flows that have held us 20 percent above that trough valuation. If they start tapering off as the signs are for the last couple of months, could we go back to retest those trough valuations?

A: It is hard to say what eventually causes markets to do that. If one goes back and looks at history one will find that every time the reasons were a little bit different.

In some senses I would argue that even though optically the index is at 19500, actually a lot of the market is already significantly trading at levels which are much lower than that. It is only these few growth stocks which have held up the index at a price level very different from what has happened to the rest of the market.

I really do not know what will cause the market to drop down to those trough valuations, but is that something one needs to keep at the back of your mind, I think it is certainly a risk that one needs to keep at the back of the mind. This will be the third year of single digit earnings growth. Right now, the forecast is still for about 12-13 percent earnings growth for FY14, but looking at the kind of revenue attraction and looking at the indications that companies are giving us, I am very hard-pressed to see how earnings growth will again clock in at anything better than single digit. So, three years in a row, we have had single digit earnings growth. Continuing to hold onto a PE trailing multiple of about 16.5-17 is getting more and more difficult.

Q: What do you do with IT? That is now becoming the most favoured hiding place. Even more than FMCG since the Hindustan Unilever's (HUL) price has started to crack. Can fundamentals justify any further expansion in valuations there?

A: If one looks at IT from a valuation perspective, the sector itself is not really trading at a huge premium to its typical historical multiples. We can get into a debate about those historical multiples and whether they are relevant, but the fact is that atleast relative to recent as well as long-term trading history, they are not expensive.

About two or three years ago we were talking about the fact that a lot of the Indian IT companies had actually lost their ability to compete and companies were rotating jobs back to the US etc. At the end of the day, when one looks at India and the fall in the currency, you ask yourself the question, which are the sectors in which we have companies which have proved to be globally competitive as exporters?

Then really in that sense from a stock market perspective there are only two sectors that come to mind, one is IT and the other is pharmaceuticals where Indian companies in general have proved to be capable of taking on the best in the world and growing their export business aggressively. So, if one wants to take a call that if there is one set of companies which can benefit from what has happened to the currency depreciation, partly in terms of margins, sharing some of those benefits with their end consumers and growing the overall volume of business, then these are the two sectors that really come to mind.

From that point of view, any company which can demonstrate in whichever sector it might be that it is capable of exporting its goods and services to the rest of the world, is certainly in a little bit of a sweet spot given what has happened to the currency right now and I think IT and pharma certainly fit the bill. So yes, that is an area that we feel comfortable about, particularly given the fact that valuations are not at a premium to long-term averages or for that matter even to recent averages.

First Published on Jul 30, 2013 09:50 am