Valuations reasonable at 16 PE; like auto, banks: Deutsche

He expects corporate earnings growth to accelerate this year, as various profitability indicators - sales, EBITDA, net profit growth - are at 10 -year lows. He says quarterly performance could be volatile, but for the year as a whole, the number will be robust. 

Further triggers for the markets include progress on reforms including the passage of GST Bill, rationalisation and simplification of tax laws, earnings growth for the March and subsequent quarters, inflation trajectory and monetary easing by the RBI, extent and distribution of monsoon, he adds.

Below is the edited transcript of Akash Singhania's interview with Moneycontrol.com

Q: How does India look right now compared to other emerging markets?

A: Indian markets have been an attractive investment destination buoyed by improving macro and recovery in growth on an absolute basis as well as on a relative basis compared to other emerging markets. India's macro situation has improved significantly in the last two years as the following indicators reveal:

1) There is strong political stability backed by a majority government, which facilitates passage of reforms. In the past year, we have seen multiple reforms including petrol and diesel price deregulation; increasing foreign direct investment limits in defense, insurance, railways and construction; amendment of mines and mineral auction procedures including coal block auctions.

2) GDP growth bottomed out in FY13 at 4.5 percent and since then growth has picked up and is expected to be at 7 percent levels this year. For the first time in many years, India’s growth this year could be higher than China’s growth.

3) Fiscal deficit and current account deficit has improved significantly from the levels we saw in 2013.

4) Wholesale price and consumer price inflation are at multi-year lows. 

5) Interest rates have fallen by 50 basis points so far in the period January-April 2015 and there is room for further cut during the course of the year.

6) Oil prices are significantly down from the levels we saw in the period January-March 2014 and India being a net importer of oil, benefits from decline in oil prices.

Valuations of Indian markets are reasonable at around 16 times one year forward earnings which are near to long-term average of our markets. From a fund flow perspective, Indian markets have seen more than 15 billion dollar inflows from foreign institutional investors in each of the last three calendar years. We remain sanguine on domestic growth prospects and believe that India will continue to remain an attractive destination for foreign investors.

Q: What is your outlook on the market from a 6-month and 12-month horizon?

A: Backed by an improving macro, cheap valuations and continuous inflows from foreign institutional investors, market performance in 2014 was robust after many years of consolidation. Expectations on returns need to be moderated going forward as part of it has been factored in current valuations which are now reasonable. Triggers for the markets include progress on reforms including the passage of GST Bill, rationalization and simplification of tax laws, earnings growth for the March and subsequent quarters, trajectory of inflation and monetary easing by the RBI, extent and distribution of monsoon.

The risks to the Indian markets are sharp rise in oil prices and volatility in global markets based on global events like Fed rate hike or global risk aversion. Near-term volatility based on news and events is inevitable and here to stay. However, investors should focus on the longer-term return potential of the market based on its fundamentals including economic macro, growth and earnings prospects. We remain positive on Indian macro and expect Indian equity markets to deliver double digit returns to investors in the medium to long term.

Q: Do you see the RBI cutting rates in June?

A: Given benign inflation and improving macros, we believe that we may see a further cut during the course of the year, timing of which will be more data dependent.

Q: How do you see corporate earnings broadly faring in FY16?

A: We expect corporate earnings growth to accelerate. Various profitability indicators of corporate performance stand at a 10-year low. Sales growth, EBITDA growth, EBITDA margins – all are near their 10 year lows. Corporate PAT to GDP again is near 10-year lows. We expect these to pick up with recovery in economic growth. Also, corporate earnings tend to grow faster when interest rates are cut and growth recovers. Quarterly earnings could be volatile but on an annualized basis corporate earnings are likely to grow in double digits for FY16 as well as the subsequent two to three years.

Q: Which are the pockets in the market where you see value right now?

A: From a medium to long-term perspective, we see value in financials, automobiles and selective industrials. These sectors will benefit from pick-up in demand, operating leverage and lower interest costs as well as oil prices. We think consumption and pharmaceutical sectors still have longer term secular demand drivers in place and are poised to do well in the long term.

Q: What is your strategy when it comes to playing the midcap space?

A: Mid and small cap stocks have greater dispersion and volatility in returns. A few parameters which need to be thoroughly analyzed are: business model including the industry environment, entry barriers and competitive landscape and company fundamentals in terms of its business and financial strength including return ratios, leverage and cash flows. Background of the promoter, his past track record, quality and delivery of top management team and corporate governance practices play an integral role in selecting mid and small cap companies. Valuations, ownership and liquidity should also be seen before making the final selection.

Our investment strategy is based on a fundamental approach to investing with quality and growth as its key drivers, particularly bottoms-up when selecting stocks in the mid cap and small cap space. Focus has been on investing in quality companies with robust business models and consistently achieving superior risk adjusted returns with lower volatility. Over time, we believe emphasis on quality is increasing and an argument for growth at relative value (GARV) is gaining over growth at reasonable price (GARP). It’s natural that quality does not come cheap. Hence, valuations should be looked at relatively with a different perspective.  For example, valuation of a quality stock should be relative to the valuation of the sector (and not the Nifty) and also relative to the premium / discount to Nifty which it has traded empirically rather than the Nifty itself. This comparative and relative valuation differentiates long-term winners from value-traps.

Q: How much cash are you sitting on in your equity funds?

A: We have cash holdings between 0-2 percent across different equity funds, at the end of April, 2015.

Q: Do you see a likely Fed rate hike later this year as a major cause of concern for India?

A: The Fed rate hike is expected in the second half of this calendar year. The Indian economy is now better placed to withstand the effects of a Fed hike as fiscal and current account deficits have improved substantially and the rupee has stabilised. The Indian economy is witnessing higher growth compared to many other emerging market economies and is a big beneficiary of falling crude prices. This is reflected in improving current account and a stable currency. There could be short-term volatility in global emerging markets but the Indian markets should be relatively less impacted.