Earnings need to pick up for market rally to sustain: Harshad Patwardhan

Interview with Harshad Patwardhan, chief investment officer-equities at Edelweiss Asset Management

Earnings growth over the next two years for S&P BSE Sensex / Nifty50 universe is expected to be in the region of mid-to-high teens, based on consensus estimates, HARSHAD PATWARDHAN, chief investment officer for equities at Edelweiss Asset Management tells Puneet Wadhwa in an interview. Edited excerpts:

Are the markets fully valued at this stage? Can investors still dabble in equities given the sharp run-up seen thus far in calendar year 2017 (CY17)?

Indian equity market has seen a very strong start to the year 2017. Valuations on a 12-month forward basis are now at around 17.3x earnings, or about one standard deviation above the mean. Earnings growth trajectory needs to pick up going forward (which is our base case), for the current momentum to sustain. While we advise near-term caution due to the sharp recent rally; we retain our constructive view on Indian equities from a medium-to-long term perspective.

What are your estimates for corporate earrings for FY18 and FY19? Have you lowered estimates post demonetisation? If so, what is the reduction (bps) in estimates?

Based on consensus numbers, earnings growth over the next two years for S&P BSE Sensex / Nifty50 universe is expected to be in the region of mid-to-high teens. While this may appear high compared to last few years; it must be remembered that this growth comes on a very low base. There was virtually no earnings growth over the last three years, and in fact, EPS CAGR from FY08 to date is barely 5%.

The impact of demonetisation is less than initially feared and also appears to be transient compared to initial worries of a long lasting damage. In fact, the listed organised businesses seem to have gained at the expense of their smaller unorganised competitors.

Which sectors are you overweight and underweight on at the current juncture? Do you see a tilt in favour of consumption and banking sectors going ahead?

We are overweight on industrials, financials, consumer durables and cement while underweight on IT, FMCG and pharmaceuticals. We believe discretionary consumption will be a long duration theme as the government works on easing supply side constraints. We expect private sector banks and select non-banking finance companies (NBFCs) to continue to outperform overall industry growth due to structural advantages over public sector banks and superior execution.

What is the road ahead for information technology (IT) stocks? Are they a good contrarian play from a 12 – 24 month perspective?

Visa issue is just one of the factors that will have an impact on IT services business dynamics. It is hard to say how exactly it will play out but it is fair to say that Indian companies will have to reinvent their business models to an extent and the cost of doing business will go up. 

Automation is another big issue impacting the traditional business model of Indian IT services companies. Given all these issues it is likely that the organic earnings growth of many of these companies will be much slower than in the past. 

From stock price performance perspective, some of the recent developments about capital restructuring (in terms of returning cash to shareholders in the form of dividend/buy backs, etc.) might partially offset some of these negative developments. 

What are your views on the developments in the telecom sector, and the road ahead?

Telecom sector in recent times has seen dramatic developments in terms of huge new entrant disrupting the market, incumbents trying to defend their market share and the pressure leading to industry consolidation. While in the medium-to-long run, it is conceivable that a more consolidated industry will see improved profitability; intense competitive pressure will likely continue at least in the near-term.

Capital goods and consumer goods related stocks/indices have done well over the past few months. Is the tide turning?

We see capital goods related stocks doing well over the medium-term as underlying economic growth gradually picks up in pockets and spreads to other areas. While synchronous recovery is still some time away, select capital goods businesses leveraged to early recovery will do well. On the consumption side, businesses more leveraged to rural economy might do well as buying power recovers both due to more government focus on rural areas and better productivity. Consumer durables might prove to be a multi-year story.

What is an ideal portfolio mix that you suggest investors should have given the domestic and global headwinds? Can debt outperform equity in calendar year 2017 (CY17)?

We expect Indian equities to deliver better returns than fixed income assets and should form a core component of the investor portfolio. We also believe investors should allocate portion of their equity exposure to quality mid-cap portfolios (depending on ability to stomach higher volatility) which in our view will likely outperform the large-cap universe over the medium-term.