Corporate profits, markets can double in next 4-5 years: Prateek Agrawal

Says, 'We are hopeful since minimum support prices for crops are up and public sector employees have started to get wage hikes'

Even as markets are hitting new highs, Prateek Agrawal, business head and chief investment officer at ASK Investment Managers, tells Vishal Chhabria that valuations are still at fair levels, and there could be further gains, aided by a revival in earnings growth. Edited excerpts:

Markets are hitting new highs, so are valuations. Does that worry you?

No. I believe that in the context of declining interest rates, valuations are fair, given that markets discount future cash flows into the present. A close to a two percentage point decline in interest rates over the past two years and the expectation that interest rates would remain low, has made 18-19 times one-year forward PE (price to earnings) as the new normal versus 16.5 times in the past. A strong long-period growth outlook, given the reforms and strength in the global economy, further aids valuations. Profit margins are now less than half the peak margins of over seven per cent in 2007-08 and should look up. 

How will margins improve?

As the capital expenditure cycle revives and investment into housing goes up over the next few years, we should expect an uptick in margins. It happened between 2002 and 2007, when margins moved from two-three per cent to seven per cent, led by buoyancy in the economy, a favourable global economic trend and rising commodity prices. We had a backdrop of similar reform and macroeconomic template then as now. The economy is coming out of a sluggish period and has the benefit of a pent-up demand. The government’s spend is high and has support of a record foreign direct investment.

So, chances of a margin increase itself driving earnings over next three-four years are high. If we go back to average margins, profits will increase 50-60 per cent. In the next three-four years, if corporate tax rates decline as promised by the government, profits could look up further. There is a very good chance of the organised sector doubling profits over next four-five years. And markets should logically reflect the same.

Earnings have disappointed in the last few years. What makes you confident?

Earnings should have improved last year itself, but got impacted by demonetisation. Last year’s festival season was good for businesses. But, after digesting demonetisation and the goods and services tax (GST), growth is coming back. This year’s festival season has gone reasonably well, the monsoon was decent, minimum support prices for crops are up and public sector employees have started to get wage hikes. Hence, we are hopeful. Quick numbers from sectors such as cars, two-wheelers, energy and cement sales point towards a recovery.

Markets have seen a lot of equity issuances. Will these impact the secondary market?

That thought keeps coming. But, in some ways it is good for the market. Good businesses offer new investment opportunities. If fundraising is done well and investors make money, it actually helps sentiment. The past tells us that if there are a few large issuances clubbed together, as it happened recently, in that brief period markets may take a step back as people use cash to put into a new offering. The difference between now and 2007-08 is that very high quality issuances have come to the market. In most cases, companies don’t need the money. It is an exit by a private equity firm. Earlier, companies had come rushing to raise money. So, it’s pretty healthy now.

Are you positive on public sector banks (PSBs) after recapitalisation?

You would really value a bank on price per adjusted (for bad loans) book. Now, because the government is putting a large sum, the price-to-book and price-to-adjusted book will converge. So, valuations should reflect the new reality. The big question is at what price PSBs will get the infusion. In the past, the government put in money at the then prevalent price. 

All said and done, there is a new lease of life. So, there has to be higher valuations. We are more positive than we were on this pack. We have taken some exposure, but are not going overboard. In terms of capabilities, we have not seen much change and that keeps us wary. Let’s see the progress. If they do it well, we’ll get more positive.

With the US economy, interest rate and dollar inching up, cheap money will reduce, and hurt markets like India?

Cheap money has reduced, the dollar has strengthened and hence money has flown out from all emerging markets into the US; more from India, less from others. But, India is the only large country witnessing interest rate declines. Hence, Indians are finding domestic markets very attractive. That is a new story. For several years, Indians were not buying and domestic markets were at the whims and fancies of foreign investors (FIIs). Now, Indians believe in their economy, making FIIs significantly less relevant than they were in the past in terms of ability to move markets. 

We interacted with many institutions abroad and their interest in India is very high. Industry is continuing to deliver good numbers in spite of whatever we have seen. PSBs have been promised capital. The whole template, block by block, has been put into place, creating a strong framework for a sustained three-four years kind of a good growth. Presently, the India story is one of the most promising ones globally.