Market returns will be interplay of profit growth, PE ratio: Rana B Gupta

'As bad loan resolution and recapitalisation programme progresses, we might see banks providing heavily for provisions,' Rana B Gupta

Global markets corrected last week after US President Donald Trump proposed to raise tariffs. RANA B GUPTA, managing director, India Equities at Manulife Asset Management (Singapore), in a conversation with Puneet Wadhwa said one needs to monitor whether this situation escalates to more protectionist measures and retaliation from trading partners. India, he feels, remains a unique, bottom-up story. Edited excerpts: 

What is your interpretation of the hike in import tariffs by Trump?

First order impact of the hike in tariffs on steel and aluminium will be low. While tariffs could be a negative supply shock that increases price and lowers growth (in the US), spending on these items only account for one per cent of US gross domestic product and two per cent of global trade. However, the US economic policy, which focused more on growth initiatives like cutting regulation and taxes, now resorting to protectionist measures could open the doors to retaliation. There should be less of a direct impact on India. US accounts for two per cent of India’s steel exports. One needs to monitor whether this situation escalates to more protectionist measures and retaliation from trading partners.

Where do you see the markets by the end of December 2018?

Market returns will be interplay of profit growth and where price to earnings (PE) ratio settles. While Indian equities can sustain a higher-than-average PE ratio during times of earnings growth, the global situation needs to be monitored and how oil prices play out. There are important elections in the next 12-15 months, which can add to volatility.
 

Though we do not comment on specific market levels, one highlight worth mentioning is that growth has picked up. It is visible in auto sales, cement dispatches, etc. This should be reflected in earnings growth, too. The normalised operating profit for the Nifty grew at 15 per cent year-on-year for both, September and December 2017 quarters. We expect operating profits to continue to grow in mid-teens.

Is it advisable to stay away from mid- and small-caps over next 12 months?

There are opportunities in organised retail, consumer durables, white goods, domestic pharma, logistics, staffing services, and real estate. All these sectors are also beneficiaries of a substantial value transfer from the unorganised sector due to ongoing formalisation of the economy.

What are your expectations from the upcoming earnings season?
 

We think normalised earnings growth will be in mid-teens. Over the next 12 months, consumer companies, including autos, are likely to report good volume growth; after Q4 FY18, private banks’ slippages are likely to come down; and there should be a good margin performance from information technology companies. But, we are cautious on the provisioning requirement for banks and execution of orders by construction companies. Earnings from energy and metal companies will depend on how global growth plays out.
 

We need to watch out the impact of not only Trump tariffs, but also from central bankers shrinking their balance sheets, China cutting fiscal deficit and enduring outcome from elections in Italy and upcoming elections for House in the US.

How are foreign investors  like you viewing India?

India is a quite unique, bottom-up story. An important thing we would watch out for is the resolution of non-performing loans and recapitalisation of banks. Progress on certain steel and cement assets have been encouraging. We expect this process to play out before the end of 2018. After that banks should be in a position to grow credit. The key concern will be around higher trade deficit led by crude prices. Deficit due to gold and electronics imports have also grown. India does not seem to have an answer to this by either increasing exports or doing import substitution.

What are your sector preferences?

We like consumer stocks, particularly from organised retail, durables, white goods, and select food companies. We also like banks with good low-cost deposit franchise and exposure to either small and medium enterprises, top corporate houses or a judicious combination of both. Among some of the bottom-up picks, domestic pharma, logistics, staffing services, and real estate look good. Some of these are big beneficiaries of government’s reforms leading to formalisation. We remain cautious on the infrastructure and construction sectors.

Has the fraud in the Indian banking system shaken foreign investors?

The recent scam is a distraction for sure. This can tighten credit availability in certain sectors, too. But, we do not think this will have a long-term impact. As bad loan resolution and recapitalisation programme progresses, we might see banks providing heavily for provisions. However, addition to stressed assets should significantly drop after Q4 FY18, and credit cost should decline in FY20. We like large private sector lenders and top tier state-owned banks. Good quality retail banks have continued to do well. They remain core structural bets.