Mkt to face reality check soon, +ve on pvt banks, IT: Invesco MF

Indian equity markets are trading at a 20 percent premium compared to historical averages and a reality check is in order in the form of first quarter earnings, says Vetri Subramaniam, CIO of Invesco Asset Management Company."There are lot of good businesses out there but you are not really getting them at mouth-watering valuation. We will just have to make do with that," he told CNBC-TV in an interview.Subramaniam, whose Rs 144 crore-asset Invesco India Growth Fund, has netted a compounded 12.48 percent, compared to 8.18 percent for the BSE 100, is overweight financials, IT and automobile stocks.In the interview, he explained his portfolio construction approach and why he is overweight the sectors he is.Below is the verbatim transcript of Vetri Subramaniam’s interview with Sonia Shenoy & Anuj Singhal on CNBC-TV18.Anuj: Do you think the market needs a bit of a reality check considering that we are now trading above median valuations or do you think liquidity could make a complete mockery of a valuations and the market could just keep climbing higher from here on?A: That is hard to say, on the short-term pretty much anything can happen based on the where the mood is swinging. However, we will have a reality check over the next month or two as the earnings come out. This time it is a slightly longer earning season. We will have a bit of check in terms of what the health of corporate India is, how earnings are progressing, what companies are saying about what they are experiencing on the ground?Valuations are not cheap they are at significant premium to the long-term average. When I last spoke to you guys, it was just a day after the Budget or the day of the Budget and at that time the markets were trading just inline with their long-term averages maybe a 2-3 percent premium.Today they are back up to a 20 percent plus premium. As investors you just face with the tough situation that when you look at companies there are lot of good businesses out there but you are not getting them at valuations which are mouth-watering we will just have to make do with that.Sonia: We just had a very enriching conversation with the management of IndusInd Bank and I noticed that it is one of your top holdings in your dynamic equity fund. What the way forward is for some of these banks that have a huge potential to move very closer to their larger peers? For IndusInd Bank case in point is HDFC Bank. Do you see a major re-rating underway for names like these?A: Cannot comment on individual names but banking sector is an interesting case in point right now. If you look at the overall credit growth, it is just about running in high single digits to low double digits. However, in the same environment we are finding some banking institutions which are growing credit in excess of 24 percent almost closer to 30 percent and some who are not able to grow credit at all because they are faced with their own internal challenges.So, this is a great environment for some of the banks who have got a strong balance sheet, high capital adequacy, not constrained by their doings in the past few years resulting in larger non-performing assets (NPAs). So, they are able to sort of scout for and grow aggressively in the current environment.Where competition on the asset side is still very limited, so that is a great environment for institutions who are able to grab this opportunity with two hands. They can grow much faster than the industry.Having said that in terms of valuations honestly it would be a little hard to see how these institutions could trade significantly higher valuations than where there are today. The bet would have to be that they can significantly gain on the asset side in terms of market share over the next few years.Remember that the entire public sector banks still account for about two-thirds of total credit in the systems and the private banks are still a very small share of aggregate credits. So, I think they have strengthened their liability franchise significantly over the last decade the private sector banks. Now there is an opportunity for them to gain market share on the asset side. What we would like to back these institutions with a great track record in terms of execution.Anuj: Just to take that point forward and I know you won’t talk stocks but you will get fair gist of what I am saying. In terms of your top holdings you have more towards IndusInd Bank, Kotak Mahindra Bank and HDFC Bank and less towards the likes of ICICI Bank, Axis Bank and a PSU banks. At current valuations do you think the laggards of the banking system may now start to run especially if the economy turns around?A: I don’t have a view in terms of what will run or not run as and when the market feels something about the economy. However, our thought process in this is fairly clear which is that as you come out of a slightly difficult situation for the economy, there are some areas where we have seen growth, there are some areas where there is still a little bit of gloom or some structural problem is still holding back the economy.However, our thought process is that which are the companies, which are likely to benefit and gain from growth and as it becomes more and more visible as it becomes more sustainable and perhaps moves into a higher growth trajectory. We think it is those institutions across the whole range of industries, which have already come through a very difficult environment, standing tall, having good balance sheet, strong cash flows. This is their opportunity to grab a larger share of the growth opportunity that lies ahead.Our thought process is to back those companies to get a disproportionate benefit of growth in the next few years rather than look at companies, which have significant balance sheet issues where we are not clear how they will resolve them. Most importantly where management attention is then focused on trying to clean up their internal issues rather than to execute in the market place. So, that is what our thought process is.Anuj: The other pocket that stands out is the oil stocks, quite a bit of exposure to Hindustan Petroleum Corporation Ltd (HPCL) in your funds. Do you get a sense that the oil marketing rally has still legs to go? These stocks have been beaten down for a decade but we have seen things grow for them now. Do you get confidence that may be some of these stocks could do well over the next few years?A: These have been long-term holdings for us again without talking about individual companies. What has been encouraging for us is that as we transition to a free market pricing regime we have seen the government give them flexibility. At some of point, there is scope for these companies and the industry as whole to try and increases its marketing margins. We haven’t seen any signs of that as yet but at this point of time we think the valuations look quite okay.These are eminently profitable businesses and there are in a sweet spot right now because even the refining business for many of them is doing quite well whereas the underlying attractiveness of these some companies was originally the marketing business. So, they are in a bit of a sweet spot right now and marketing continuing to remain quite eminently profitable, valuations not very excessive. So, it is an area that we are still quite invested in.Sonia: I keep going back to that conversation we had with Romesh Sobti a while back because he gave us a lot of interesting targets for the longer term. He also spoke about how the microfinance business will grow from Rs 3,000 crore to 9,000 crore over the just the next two to three years. What are your views on how this space is shaping up because within the non banking finance companies (NBFCs) space you do have exposure to some of the names like LIC Housing Finance etc but what about the newer listings, the Ujjivan Financial Services, Equitas Holdings, do you see a lot of scope to make money there in that pocket?A: NBFC space continues to be interesting whether it is housing finance, whether it is the auto finance business or for that matter the microfinance business. So, within that everybody has their own thought process on which they businesses they prefer.Our thought process in most of the NBFCs has been that some of these companies have quite strong balance sheets, good capital adequacy but cyclically they have suffered on account of high credit cost over the last few years.However, because their balance sheets are so solid we wanted to play an improvement in the credit cycle, we would rather do that through some of these NBFCs than do it through some of the banks where we think capital adequacy has been greatly comprised. So, that is where the attraction for some of these NBFCs comes to us. As far as microfinance is concerned we honestly don’t do too much in that space.Anuj: One space where we have seen clearly Brexit impact, while the market has moved on is IT. Again there is some fresh headwinds as well whether it is the visa bill or cross currency headwinds; do you get a sense that this is an underperforming sector for now or do you take comfort from the fact that in the past the companies have managed to get across these headwinds and have created wealth?A: If you look at it, structurally these are some of our most competitive companies. Obviously, it is a play on the large amount of work force that is available to them over here in India. They have managed to build fantastic frontend customer relationships and also domain knowledge. They are increasingly being able to leverage that quite well. I think one of the challenges in the IT industry is that they are throwing up a lot of cash but they haven’t been aggressive enough in terms of making acquisitions either to strengthen their domain competencies or in terms of acquiring new customer relationship.Some of these companies have de-rated over the last few years because they have been throwing up a lot of cash, but haven’t put it to use in terms of growing the business. This is just been sitting as financial investments on their books and perhaps they need to take a page or learn from the actions of what we are seeing in our Indian pharma companies who have been a lot more aggressive on the acquisition front.These companies have a wonderful business model, it is capable of sustaining high return on equity (ROE). However, the risk appetite will need to increase going ahead in terms of being willing to use the existing cash flow to create growth opportunities for themselves through the merger and acquisitions (M&A) route.So, valuations at this point of time over there are quite comforting for us. The whole sector is trading at a discount to the market and many of them are trading extremely cheap in the low teens. So, it is an area that we think still remains quite attractive based on valuations and on long-term track records.