More stable guide for valuation can be the P/B ratio: UTI MF's Kulkarni

Kulkarni tells Jash Kriplani that stimulus support and fiscal policy response of governments are making investors look beyond the Covid-19 pandemic

While economic uncertainty persists, the domestic equity markets are holding onto the gains seen since March lows. Swati Kulkarni, fund manager, UTI Mutual Fund, tells Jash Kriplani that stimulus support and fiscal policy response of governments are making investors look beyond the Covid-19 pandemic. Edited excerpts:

How do you see the current valuations?

Given the wide divergence over the past few years between estimates and actual reported earnings, it’d be better to see valuations from a 12-month trailing basis. On the price-to-earnings matrix, valuations for the leading equity indices are at the upper end of the fair value zone (i.e., around one standard deviation above the last 10-year average). However, this was also impacted by the depressed earnings seen in the June quarter, which may be the worst-affected quarter for many businesses because of the nationwide lockdown. As uncertainties are likely to continue and affect earnings, a more stable valuation guide can be the price-to-book ratio. For the Nifty50, the trailing price-to-book multiple is at 2.5x, which is lower than the last 10-year average of 2.7x.

What is driving the market rally and do you see it sustaining?

Over $7 trillion worth of support measures globally may be driving the rally. Investors are drawing comfort from the extended support through monetary and fiscal measures across the globe and are willing to look beyond the pandemic. It is always difficult to predict the market movements in the short-term, given the expected market volatility.  

Which sectors you are positive on, and which sectors are avoidable?

We are positive on pharmaceuticals, IT, and telecom. We are underweight on the media, oil and gas, financials, hospitality and construction sectors. As long-term investors, we focus on evaluating businesses for their ability to sustain challenging times and invest for future growth at higher return on capital employed (RoCE). 

How do you see corporate earnings play out?

Earnings decline is expected in FY21 as businesses limp back to normalcy with intermittent lockdowns and partial opening up of the economy, in a scenario where the infection is still spreading.

How are mid- and small-caps looking at current juncture? Do you see opportunities?

Small-caps have remained relatively volatile, while the valuation differential between mid-caps and large-caps has since normalised. Across market cap, some companies generate consistent cash flows and high return on capital. We see opportunities in such companies, as well as in companies where there can be improvement in the profile of return ratios. These opportunities are more bottom up, rather than sector or market cap-specific.

As someone managing an MNC fund, do you see MNCs in a position to take advantage of disruptions with their cash-rich balance sheets?

Most MNCs focus on their core operations and avoid capital allocation to non-core areas. Typically, they deepen their presence with quality offering supported by strong branding. They are more likely to consolidate their market position with the help of strong financials and gain market share from weak players.

Are valuations attractive within the MNC space?

We prefer investing in MNCs with strong entry barriers. Such companies possess durable competitive advantages that often lead to long runway for growth. Relative valuations should be seen in the context of quality of the businesses, cash-flow generation, high return ratios, and zero debt on books, as against the same parameters for non-MNC broad market indices. While MNCs are trading at relatively premium valuations, their return on equity (RoE) and RoCE are significantly higher. The near-term valuations for MNCs are at the higher-end of their historical range.