Difficult to say when leverage problem will get over: Shilpa Kumar

Market is in a sweet spot, there's a reason for companies to issue equity, says ICICI Securities CEO

India's economy is going through structural change and this will, in the longer term, reflect positively in corporate earnings, says Shilpa Kumar, managing director and chief executive officer at ICICI Securities. In an interview to Samie Modak, she also says the high valuations suggest investors are giving more importance to the long term than the current fundamentals. Edited excerpts:

We have seen a sharp rally this year. What has driven it?

Structural changes enacted by the government and the increase in domestic liquidity. Both demonetisation and the goods and services tax (GST) will have far-reaching implications. Both will support the formal economy and benefit companies in the organised sector. The second factor, domestic liquidity, is a corollary to the first. We are seeing mutual funds and insurance companies getting good flows.

Is it a concern that the market rise is being led by valuation expansion?

Our proprietary valuation model suggests investors are putting much more valence on long-term factors than on current earnings. The two drivers will have to play out in the longer term but in the immediate term, earnings will be under pressure. The short-term news is not as positive as the long-term news. In fact, the reverse. Everything good in the long term is affecting earnings in the short term. Take demonetisation, a long-term good but short-term impacted. We just about got out of that and then there was GST. Again, very good for the long term but will impact earnings in the short term. Add structural problems like high corporate leverage and bad loans that banks are taking time to resolve.

Medium to long-term, our model says earnings will be supportive because, when these structural changes play out, it will help corporate activity and in earnings growth momentum. What we will also need is demand support for corporate investment and enthusiasm to really pick up. India is one country that can see both consumer demand and corporate investment. We need both.

Positive factors like the monsoon and pay commission implementation indicate demand should be supportive. Also, as interest rates come down, it will give corporates a bit more cash in hand. In the interim, Government spending will give the first-level impetus for investment spending. The overhang is coming out of infrastructure and large projects, where leverage is high. They are still trying to sort the problems. It is difficult to precisely say when the leverage problem will get over but one can certainly say it has bottomed out.

How soon do you expect earnings to play catch-up?

Our house is constructive on earnings growth. Over the next two years, we see double-digit earnings growth. Earning pick-up cannot be precisely timed, especially for sectors like banking. How quickly banks are able to resolve the bad loan issue will determine the BFSI (banking, financial services and insurance) impetus to growth.

The trends in terms of retail (small investor) flows? Are you seeing a high amount of interest?

We at ICICIdirect have a big retail franchise, covering pure equity and distribution of mutual funds (MFs). As interest rates are dipping, more and more households and retail customers are actually considering equity and MFs as an investment option. Equity is still under-owned in an Indian household. There is greater interest to move to financial savings. It is encouraging that investors are also realising that one can't time the market. You have to stay invested for long-term wealth creation. We saw that during demonetisation -- retail investors stayed invested and kept steadily investing. This gives us much more comfort than anything else.

Will that patience be tested if markets go into a big correction mode?

One can't expect investors to not respond through extreme cycle changes. What gives us comfort is that investors are not pulling out money at every market correction. This is supported by data that investors now, rather than timing the market, are investing regularly. They can of course keep changing their allocation between equity and debt as the fundamentals change.

Are you seeing increase in retail activity on the direct investing side as well?

Certainly, when the market is good, there is increase in activity. We have seen investor participation go up on ICICIdirect.com. There is a lot more customer participation directly and through exchange-traded funds. The increase in IPOs (initial public offers of equity) and good listing-day performance has also helped participation. We are seeing good participation in IPOs, MFs and direct equity.

Market regulator Sebi is reviewing the derivatives framework. There is a concern that uninformed retail investors are getting into this risky space. Your view?

Within retail, there are two types of investors. One is the long-term investment variety and the other is actually someone who wants to participate more dynamically. Our concern always is whether the risk an investor takes is commensurate with his financial profile. Sebi is trying to put up a good regulatory framework to protect investor interests.

ICICI Securities has a strong investment banking franchise. How does the deals pipeline look?

Going forward, we have a very healthy pipeline. The buoyancy in the market is supporting fund raising activity. This is helping the corporate sector to deleverage. It is also allowing promoters to get equity into their business. A lot of mid-sized firms, which had raised private money, are also having the discipline of giving exits to PEs (private equity entities) through the public market. Given the valuations, investors are also welcoming the issue of new equity. A lot of insurance companies have filed for IPOs. This is resulting in the creation of a whole new vertical in the listed space. Beside, there are high-quality names wanting to enter the market. So, the market is in a sweet spot-there is a reason for companies to issue equity and there is demand from investors for this fresh supply.

It is likely that deals worth over $5 billion (Rs 32,000 crore) could get bunched in the later part of the year. Will the market have problems in absorbing so much paper supply?

There are several large-sized issuances lined up. The government also has an aggressive disinvestment target for the year. Looking at the structural trend of more domestic money coming into the market, not to forget EPFO's (the employees provident fund body) increased allocation, the demand side will be supported. Also, foreign investors have not invested in a sustainable way so far. So, the FIIs (foreign institutional investors) should invest in a big way in some of the deals. This suggests the paper will be absorbed.