Market overvalued despite fall; no signs of growth: Andrade

While most money managers are fretting about tepid earnings, Andrade feels the bigger problem lies elsewhere.

"The inflection point for this market will not come from earnings growth. It needs companies' balance sheets to start growing soon," says Andrade, adding that the industry is not yet at the bottom of capital spending.

Among sector picks, Andrade prefers non-banking finance companies (NBFCs) over public sector banks (PSBs).

Below is the edited transcript of Kenneth Andrade’s interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.

Latha: We have seen this continuous down tick for the past 7-8 days what is your sense are we looking reasonably valued at around 8,000 or do you think these markets can plum further depths?

A: Valuations are up about 10 percent from its high which traded somewhere around level of about 9,000 so it has not corrected massively. However, going into the rest of the year the focus continues to be on the part of the economy that can revive and contribute to the bottom lines. At least at the initial stages of the result season in to 2015 year end the growth doesn’t seem to be or the growth part of the market doesn’t seem to be very visible. So that is poking some part of a market at this point in time so valuations might tend to come off or stay where they are at this point in time but over a period of time we have to get growth back into corporate India.

Latha: Is this a silver lining, the three finance and non bank companies that announced numbers yesterday Mahindra & Mahindra Financial Services Limited (MMFSL), Larsen & Toubro Finance and State Bank of Mysore showed a dip in their non performing loans (NPLs) by a good one percentage point. Is there anything positive in that in terms of the stress at least declining?

A: For a lead indicator for stress declining you need to wait for the larger financial companies to come through. All the companies that you put into perspective there or these three companies have had a very rough first nine months and you probably writing back some of those provisions that have come back that they had provided for the first nine months.

So the real indicator would be still the larger financial institution as and when they declare their results.

Sonia: I was just going through your IDFC Premier Equity Fund which is your midcap and smallcap fund and it has given some fabulous returns in the year gone by of almost about 55 percent odd. What is the prognosis for the next one year is there still value in the midcap and the smallcap space or do you think the time has come now to take some profits off the table?

A: 2015 may be in 2016 and some part of 2017 I don’t think you will get too much of value in the market itself. So the focus on finding companies that are cheap and can deliver returns purely based that they are cheap and they move up may not be the right strategy looking into the next 2-3 years. Remember the sentiment for a country like India is fairly positive.

You have got money which is on the sidelines whether it is domestic investor or even on the foreigners waiting on the sidelines waiting to look for an opportunity to invest into the country. So the focus needs to move away from valuations, the focus needs to move on how companies will execute over the next 2-3 years. The opportunity is to find these kinds of companies that can execute well into the environment. So we don’t really think that the market will be cheap even if you get a correction from this level in 2015.

Latha: You have been repeatedly harping on that theme that who would be the first set of companies that are showing growth and that is where perhaps one should latch on to. You won’t talk stocks but tell us the sectors where you think you can expect that first round of improvement? What, home finance companies used to be the theme in the markets about 2 months back where would you look for the first signs of growth or are already seeing them like for instances the commercial vehicle guys?

A: Most of these sectors, industries are still being niche and not really large enough to contribute to the overall growth of the economy. However, if I had to put it between the investment economy and the consumer economy, leverage drives economic growth and currently the entire investment economy. The corporate balance sheets just do not support incremental leverage to grow. So that left to the consumer part of the economy and personal balance sheets are still not leveraged in the respect.

You have to map it down from mortgages down to profit & loss (P&Ls) of individual consumers. I am not sure about 2015 but that would be a very large setup into the next 3-4-5 years.2015 just might be the start of it all. So 2015, 2016 and some part of 2017 you might be getting some elements of correction that might take place in markets or in these companies given that macros are not conducive for headline growth numbers. That is where the opportunity will surface for most investors going forward.Sonia: Just going through your sectoral allocation in your funds manufacturing and engineering still forms your top holdings which is somewhere around 25 percent odd. But I notice that you have brought it down from where it was earlier. You did mention that growth has not picked up. Have you booked profits in the capital good space and how do you approach it now going ahead not juts the larger ones like L&T but even some of the smaller guys like the Crompton Greaves etc?

A: The portfolio construction is largely bottoms up and we do have an overall macro view of where the environment is. More specifically we don’t come across too many companies in the manufacturing/engineering space which can leverage their balance sheets to deliver the growth. If there are companies that are around the capital good segment they are fairly expensive given where they are historically traded in 2007 and 2008. So that is probably one element why we may not have going forward also a significant amount of allocation to that specific space, to the engineering/ capital goods space.

Latha: How are you approaching the finance space as a whole, at least sectorally what are the preference non bank, private bank, PSU bank?

A: We still go for the non banking finance companies. We like monoline businesses that are there. We are not cutting across the entire financial services sector and a fairly low exposure to public sector banks.

Latha: There has been some growth in the midcaps and the smallcaps over the past several months. You have a lot of actually smallcaps and midcaps in your various funds. Would you get wary or would you still hunt for gold there?

A: What is happening with that part of the market or rather all of corporate India and this is noticeable even when we still talk to them or we interact with these companies is the focus is still on the cost line. So, every company is still working on efficiencies of bringing down cost of manufacturing or cost of services or cost of delivery and hoping growth will come back. So, there is no defined. So, that is the equation with corporate India. Growth is not defined.

A lot of corporates are still waiting for that element of growth to come back within the economy so they can put capital to work. So, the big theme that is there with corporate India is balance sheets are, or the cost of manufacturing is coming down, investments are coming down and the profit and loss accounts are getting more and more efficient. The manufacturing practices are getting more efficient. So, that is the first leg of revival that we can see across companies. And that is good because the element of margin pick-ups come from there.

When growth comes back then you can see the real operating efficiencies of these businesses actually kick off. So, we are probably at the bottom end of the spectrum when it comes to looking at the financials of the smaller businesses on the ground. We really need to wait for that element of growth pick up. Then life will be much smoother for most of these companies.

Sonia: Talking about operational efficiencies, one of the stocks that you have in your equity opportunity fund is Coal India and over there we have seen the government try to ease some of the bottle-necks. The production for Coal India has been rising. Is this a good long-term story that you see? And apart from coal, what about power? There as well the government has been making some efforts.

A: What we tend to like as businesses, as companies which do not have too much of leverage and have some kind of monopolistic characteristics around them. The other elements that we tend to like is as long as the regulatory framework is clear, we do not mind putting money to work out there. So, this is one company that exists, one company amongst the many public sector businesses or the government owned companies that exist that falls into that regulatory framework which is fairly well defined and has got no real stress on an entire balance sheet. And obviously there has been a lot of money has gone into creating capacities at the other end or is used for business that exists. So, it is available at a fair valuation and I would say one of the companies that are trading at a cheap valuation for reasons of ownership or majority ownership. And we just have to wait till it shows that element of growth and you still get companies around which could look like absolute return companies aver a period of even one year.