Valuations turning favourable for Indian stocks: Manulife's Rana B Gupta

The outlook for the rest of FY19 is 'cautiously optimistic'

With the election season approaching, Singapore-based Rana B Gupta, Managing Director (India equities) of Manulife Asset Management, which has around $393 billion in assets under management globally, tells Puneet Wadhwa that Indian markets will respond more to global and local factors, beyond the outcome of Assembly elections. Edited excerpts:

What is your interpretation of how the markets have played out over the past few weeks? What is the road ahead for the remaining part of financial year 2018-19 (FY19)?

During the first five months of financial year 2018 – 19 (FY19), Indian equities outperformed. However, in the last two months some negative developments both globally and locally came together. Firstly, the oil prices went up, secondly, US dollar and rates firmed up, thirdly, US - China trade relations further deteriorated impacting EM s. Locally, India was negatively impacted by rising trade deficit due to higher crude prices, GST revenues missed estimates raising spectre of fiscal slippage and default by an infra financing non-bank finance companies (NBFCs) led to disruption in whole sale money market. Period of extreme stress could be behind us as oil prices have cooled off, trade deficit came down, GST revenues picked up and last but not the least, it appears that disruption in wholesale money market has been contained.

Outlook for rest of FY19 is cautiously optimistic. Optimistic because, we see some certain sectors being beneficiary of long term trend of formalisation (due to reforms in indirect taxation), financialisation (higher financial savings) and fiscal stability. Cautious because of near-term headwinds. Globally, prospects of lower global liquidity due to central bankers' shrinking their balance sheets and higher US rates are still ahead of us. 

Locally, we are looking at slowdown in aggregate credit growth as NBFCs will have to reduce growth to repair their balance sheet. Investors also will have to live with volatility around state election results. Last but not the least, earnings growth picture have been mixed due to margins coming under pressure. Although we expect earnings growth to remain healthy but further downgrades from consensus estimates likely.  

How does India look within the emerging markets (EMs)? Will you describe India as a ‘buy on dips’ market?

India's share of export to GDP (gross domestic product) is one of the lowest among EMs. Therefore, ongoing trade dispute should not directly impact Indian equities much. If it further escalates, there could be impact on sentiment, business confidence, future capex regionally. In such a scenario, indirect impact on India is possible. Higher oil price and shrinking global liquidity are negatives. India's relative preference among EM would depend on trajectory of trade dispute, oil prices and US rates.

We think it makes sense to look at Indian equities when valuations are in your favour in an uncertain world. Over last 10 years, average PER (pre-earnings ratio) for Indian equites have been 15x. When equities are trading at their average valuation, we would think valuation is beginning to be in favour. This framework can be applied to sectors, companies as well. Moreover, in this kind of environment, we think, it will be prudent to look at companies with good cash flows and reducing financial leverage.

How are you, as a foreign investor, viewing the recent developments?

The recent fall has made valuations reasonable. That said, we like sectors with underlying positive trends available at a reasonable valuation. We see opportunity in large retail deposit funded private banks. Firstly, such banks can gain loan market share as NBFC s will have to bring down their growth rates, Secondly, margins can expand due to higher lending rates. Thirdly, for private banks with exposure to corporate assets – credit cost can sharply fall in following years. It appears in this sector, drivers of better earnings, better growth, margins, lower credit costs is coming together and valuation is in line to lower than average. We also like non-life insurance due to low penetration and higher rates environment, which would help profitable growth.

On the other hand, we are cautious on NBFC s with the exception of short term consumer finance. We think even well-established NBFCs in asset financing, mortgage etc. will see moderation of growth and margin pressure. Relatively new NBFC s with exposure to whole sale assets could face significant challenges. Outside financial space, we think areas where NBFC's supplied much of incremental credit like 2 wheelers, tractors, commercial vehicles, Micro/ small enterprises could slow down due to lack of adequate and timely credit availability.

Are you using this fall to add stocks to your portfolio?

We see the recent correction as an opportunity in certain segments through our bottom up view. We like, electrical consumer durables. This segment should continue to see strong demand as a result of ongoing electrification. There is opportunity in mid-cap healthcare, where companies have more exposure to branded generics markets in India and other EMs. Last but not the least, consumer companies in personal care space with margin resilience either due to falling input prices or receding competitive pressures are also worth a look.

Foreign institutional investor (FII) flows have thinned over the past few months. Do you see a pick-up anytime soon? 

FII flows have reversed from entire EMs. In case of EM Asia, as per data, FII's selling in trailing twelve months as a percentage of market-cap is now equal to selling we have seen in early 2016 and in late 2011, early 2012. Based on that, we think worst of selling may be over.

Whether FII flows pick up and pace of the same will depend on trajectory of US rates. If the US Federal Reserve hikes another two – three times and then signals pause, it will be a beneficial backdrop for flows. Among local factors, now that currency has stabilised and we have seen some improvement in macro data, flows could come back if such improvements are sustained. For Indian equities, continued domestic flow will be more important than FII flows.

Do you think, the next wave of selling can come in post an adverse state election outcome?

Results of upcoming state elections are most transient and its impact over-estimated. That is not to say that markets will not react negatively in case market perceives outcome to be adverse. We do not expect such negative reaction to last more than few days or weeks. We think markets will respond more to the global and local factors beyond the state election outcome, which will add more volatility for sure, but, it will not change course of the market.

A bigger challenge is to deal with the potential slowdown in both policy and corporate decision making, and rise of political rhetoric as the country heads in to general elections in April – May 2019. There are some worries on outcome of general elections, too. In spite of political rhetoric, successive governments have by and large showed continuity in policy making.

What does this then mean for is the outlook for corporate earnings over the next few quarters?

In the September 2018 results season (Q2FY19), we have seen reasonable top-line growth but there has been a pressure on margins. Going forward, we expect similar trend to play out as input cost and rates rise. Certain credit sensitive sectors can also see muted top line growth, e.g. auto, due to slowdown in total credit growth as NBFC s slow down growth to manage their balance sheet. On the other hand, we see strong earnings growth for private banks.