Indian equities are not cheap at these levels: UTI AMC's Vetri Subramaniam

The macros may be slightly more adverse as compared to a year ago, but they still remain in a comfort zone, says UTI AMC head

With the markets scaling to all-time highs, VETRI SUBRAMANIAM, group president and head of equity at UTI Asset Management Company, tells Puneet Wadhwa the road ahead for the markets depends on not only the economic growth trajectory but also valuations. Edited excerpts:

The market hit an all-time high last week. Will this buoyancy continue?

There are a lot of variables involved here. From a growth perspective, India still remains reasonably well placed. The macros may be slightly more adverse as compared to a year ago, but they still remain in a comfort zone. The headwind really comes from the fact that aggregate valuations in India are pricey, and they have remained so for a while now. This is a big challenge. The outlook for the market depends on not only the economic growth trajectory, but also valuations. Indian equities are not cheap at these levels.

For global investors, the attractiveness of Indian companies over the long-term remains and based on their past experience, investors are holding on. From what we hear, when investors look at comparative valuations across the globe, they are finding good value elsewhere and that is reflected in the flow data.

Are you concerned that the rise has been driven by a handful of stocks?

The general interpretation is that the market movement is healthier if there is a larger number of participating stocks. That said, there is nothing unusual about the divergence in market moves across sectors or stocks. This year, the mid-cap index is down over 14 per cent as compared to a 5-per cent rise in Nifty50. The divergence in these two is 20 per cent. It was a similar story last year as well with both the indices giving a positive return, albeit with a divergence of 20 per cent.

How do you see the Indian markets performing in comparison to their global peers over the next few months, especially in the emerging markets?

There are a lot of variables involved here. From a growth perspective, India still remains reasonable well placed. The macros may be slightly more adverse as compared to where they were a year ago, but they still remain in comfort zone. The headwind really comes from the fact that aggregate valuations in India are pricey and they have remained so for a while now. This actually is a big challenge. 

The outlook for the market not only depends on the economic growth trajectory but also valuations. Indian equities are not cheap at these levels. The attractiveness of Indian companies is there and investors are holding on to these stocks, but no one is excited about increasing flows into India right now. From what we hear, when investors look at comparative valuations across the globe, they find good value elsewhere.

What are your earnings estimates for FY19 and FY20? 

If one looks at a broader universe, the (growth) expectations are still in single digits. Bloomberg consensus estimates for FY19 projects 23–24 per cent earnings per share (EPS) growth for the Nifty50 index. That, per se, is a very healthy number. However, we have seen in the recent past that the growth forecasts are higher at the beginning of the year and then the earnings don’t come through. 

Even if we presume that this forecast comes true, one must realise that a big chunk of this growth is because the base year numbers of several companies were depressed in 2017–18 (FY18). As a result, the normalisation of their profits in FY19 results in a strong growth number. The forecast normalisation of earnings in four-five very big companies accounts for almost 50 per cent of the incremental profits of the Nifty50 index in FY19. In a nutshell, we expect a good year, but the 23 per cent growth number is overstated due to the weak base. 

What are the risks to these estimates?

From a risk perspective to earnings in general, there are a few things to keep in mind. First, raw material prices, in general, are moving higher. In the last few years, we have had a situation where gross margins have been continuously expanding for corporate India (non-financials). This is unlikely to repeat as raw material prices are trending up. Therefore, gross margin expansion as a source of profit growth looks unlikely. If anything, this upward pressure will create a downward pressure on earnings. The support to earnings will have to come from volume growth and operating leverage. Even if gross margin compresses, revenue growth combined with operating leverage can still give reasonable profit growth. Interest costs too have moved up. This could potentially create a bit of a down-draft for earnings. That said, one needs to be careful how earnings are interpreted, as the aggregate earnings are getting affected by bank losses and credit cost in P&L may remain elevated this year as well.

Over next one year, which is a bigger risk — earnings growth not coming through or the political landscape?

Over the last 25 years, we have been through multiple elections and there has always been election-related volatility. The overall trajectory for Indian markets has stayed upward over a long-term across different political regimes. Eventually, it is the earnings that matter. Equity markets are slaves to earnings. If one analyses the performance of companies and markets over 20 years, politics does create volatility. The defining factor has been the structural factors that have driven the growth of the nation and corporate earnings.

IMF has cut India’s growth projection for 2018 – 19 by 10 basis points (bps) to 7.3 per cent. Are markets factoring this in at the current levels?

Some of the concerns highlighted include inflation, high oil prices etc. Certainly, these factors have a dampening effect but the underlying momentum in the economy remains strong. The economy seems to be reasonably in good shape and I don’t think there is significant change in the economic growth trajectory. What is more relevant to observe is the volume growth and when do we start to see some traction on investments in the private sector, which still at this point in time has not shown a significant pick up.

How are you interpreting the key economic indicators?

If one looks at high frequency indicators such as retail sales, credit growth etc., are showing some momentum, but one needs to be careful here as the base numbers were depressed post demonetisation and pre implementation of goods and services tax (GST) bill. Broadly, the indicators are in good health. To the extent these growth indicators are pointing upwards, we are seeing pressure on inflation (on account of crude oil). The currency, too, has been falling (in line with most emerging market currencies), there has been some deterioration in the current account deficit (CAD) as well. Some macros are showing signs of pressure from where they were a year ago, but to the extent that they have moved in a direction which is not surprising given that growth has picked up, there are no red flags at this point in time.

What’s your view on pharma, information technology (IT) and consumption related sectors?

At UTI, we run a multiplicity of funds and one may find the sectoral positioning very different across them. In the UTI Value Opportunities Fund that I manage, we have an overweight position on IT for a while, but it has been so for over a year now. At that time, the valuations were very attractive. Now that the valuations have moved up, we still think there are some signs of growth in this sector. We still are overweight on IT. 

We are slightly overweight on the pharma sector where fundamentally business models (both in IT and pharma) are robust. They have gone through growth and capital deployment issues but at these valuations we find reasonable level of comfort in both. As far as consumption is concerned, the valuations of select stocks is high. In the UTI Value Opportunities Fund, we have stayed away from areas like staples where we are underweight, but more in the consumer discretionary space, especially autos, we have an overweight positioning. That’s our positioning for participating in consumption-led growth in the economy.

Are the trade wars fears overdone?

The trade war is a completely unknown factor at this juncture. There has been some escalation in tensions and the equity markets have reacted to some extent, but not dramatically. If the trade wars really tart to escalate, the pain will spread from the foreign exchange markets to equities. At this point, everyone is being a bit sanguine and positioning and expect that the parties involved will reach a solution acceptable to all sides. An escalating trade war is in nobody’s interest. It cannot be good for growth and markets.