We remain constructive on mid-and small-caps: Taher Badshah of Invesco MF

We think mid-and small-caps are best bought during periods of soft valuations, market uncertainty and investor indifference instead of in euphoria, says Badshah

Brent crude oil prices hit $75 a barrel mark for the first time in 2019 on fears of tighter sanctions on Iran. TAHER BADSHAH, chief investment officer for equities at Invesco Mutual Fund tells Puneet Wadhwa despite the oil price rise, the Reserve Bank of India (RBI) would still have room to cut rates given current inflation and growth dynamics, and that should allow financial leverage-led earnings growth for the corporate sector. Edited excerpts:

Brent oil prices hit $75 a barrel mark for the first time in 2019. Are the markets factoring the possibility of a higher fiscal deficit due to this?

Oil prices have seen volatility within this band of $50-85 on more than one occasion in the last few years and has generally been driven by geopolitics. The current demand – supply balance and availability of alternates will act as an automatic mechanism to contain oil prices within a narrow band.  That said, with fuel price deregulation over time, impact of higher oil prices has been increasingly passed on to the consumer instead of it being absorbed by the fiscal.

How do you think the Reserve Bank of India (RBI) will respond to this development?

Overall headline inflation may continue to remain moderate for longer even with individual sub-components like food inflation going up in the near future. The RBI would still have room to cut rates given current inflation and growth dynamics, and that should allow financial leverage-led earnings growth for the corporate sector.

Have the markets run up too fast, too soon?

While there has been 11 per cent rally in the Nifty50 and a near 10 – 15 per cent rally in the mid-and small-cap indices in the last two months, India has been among the weakest performing markets globally.  Large-cap valuations at 35 per cent premium to the long-term average remain a challenge. However, valuations of mid-and small-caps have corrected and on an adjusted price-to-earnings (PE) basis now trade at a 25 per cent discount versus the long term average of 14 per cent discount and thus appears more reasonable.

Can the mid-and small-caps outperform their large-cap peers in calendar year 2019 (CY19)?

We continue to maintain our constructive view of the past six months on mid-and small-caps given continuing attractiveness of valuations in this space. We think mid-and small-caps are best bought during periods of soft valuations, market uncertainty and investor indifference instead of in euphoria.

Are you using the election-related volatility to add to your position?

Our investment approach has been virtually uninfluenced by events such as elections that are entirely out of our control. Over the past six months, markets have seen considerable volatility and anxiety related to matters such as growth slowdown in certain sectors, liquidity concerns, RBI policy, challenges around the non-bank finance companies (NBFC) sector etc, which at one level did provide opportunities to buy some good quality businesses at attractive valuations. Our focus has continued to primarily be bottom-up driven in identifying ideas that are either growth at reasonable price or sheer valuation driven opportunities where a stock is cheap relative to intrinsic value of its business.

What are your earnings estimates for March 2018 (Q4FY19) quarter and financial year 2019 – 20 (FY20)?

The Q4FY19 earnings outcome is pretty much expected to be on similar lines as what one saw in Q3FY19, with corporate and retails banks driving bulk of the expected growth in earnings for the Nifty. Global cyclicals, the driver of earnings over the past few quarters, is likely to decelerate sharply. We will also likely witness slower growth in NBFCs. Some consumer discretionary segments, such as autos, would see de-growth. Technology would post healthy year-on-year growth backed by deal wins and a favourable currency whereas capital goods and healthcare would manage low-teens growth helped by a low base.

Which sectors are you avoiding at the current juncture?

We see few pockets of strength and recovery in the infra/industrials space but not wide enough to be substantively upbeat on the sector. Also, we have been very selective on fast moving consumer goods (FMCG) segment due to valuation challenges, which could lead to long periods of time correction in many of these. In pharma too, changing business dynamics in exports, which could cap return on investment (ROI) and continuing regulatory challenges keeps our enthusiasm subdued. Our exposure in this sector thus revolves more around companies with a higher domestic component and low downside risk on their overseas investments.

March 2018 quarter results of information technology sector (IT) have been a mixed bag. What’s your view on this sector?

While there have been variations in operating profitability of IT companies who have reported thus far for Q4FY19, trends in revenue growth, deal pipeline and incremental deal wins across most of them seem to suggest fair visibility of growth for the next three – four quarters. The sector seems to be well-balanced on the growth-valuation matrix with midcap IT relatively more attractive versus large-caps on a relative scale.

Are auto and aviation sectors a good contrarian bets from 12-month perspective?

Pockets of value are emerging within certain sub-segments of autos though headline auto sales would likely take a couple of more quarters to return to growth. Aviation is undergoing consolidation, but business volatility led by uncertainty of oil prices, and its related impact on fares and air traffic may continue to remain pronounced.