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Anand Shah, chief investment officer with BNP Paribas Mutual Fund, tells Chandan Kishore Kant the country has entered a phase where stock picking based on strong earnings growth forecasts has more importance than before. Valuations are not cheap any more, as the markets had rallied a little ahead of the fundamentals. Edited excerpts:
The March quarter's corporate earnings have been less than anticipated. Have stock prices rallied beyond the fundamentals?
The quarter's earnings are broadly five per cent below the consensus expectations for Nifty companies so far. However, the results are more or less in line with our expectations. We were expecting an earnings disappointment, due to lower crude oil and commodity prices, weak rural consumption and unfavourable currency movement. Stock prices have rallied in expectations of an improving macro environment, which will only play out after a few quarters. Thus, we can say the market had rallied a little ahead of the fundamentals.
What's your investment strategy, given the current corrections?
We continue to focus on companies with strong earnings growth potential, while remaining sector-agnostic. We identify companies based on our valuation framework. The management’s competence and corporate governance are additional hygiene factors. We have entered a phase where stock picking based on strong earnings growth has become more important than earlier, as the markets have rallied sharply over the past 18 months and valuations are not cheap any more.
What challenges do you foresee, which could have a potentially negative impact on our markets?
In the past two years, India's macroeconomic parameters have benefited from the fall in crude oil prices and prudent fiscal and monetary policies. The policies adopted by the central bank and the government are intended to structurally revive the economy, rather than resorting to the easier path of kick-starting by way of monetary easing or high government spending. At the current juncture of rising bond yields globally, a sharp increase in crude oil prices and global slowdown remain the key risk for markets.
Is the consumption theme losing steam?
We believe this theme has a long way to go in India. With rising per capita income, on the back of favourable demographics, there will be an explosion of the middle class over the next two decades. However, the segments of the market that will benefit in the next two decades will differ from the past two.
While consumer goods, pharmaceuticals and two-wheeler manufacturers grew exponentially in the past and will grow at a slower pace in future, we believe the big growth will emerge in newer segments like entertainment, telecom, online businesses and, maybe, airlines and tourism. Thus, despite the near-term headwinds of a slowing in the rural economy and high valuations, we believe consumption will continue to be a long-term winner, albeit in different sectors.
Does the banking sector appear better?
Asset quality issues, especially on infrastructure, metals & mining spaces, are not sorted yet. Poor asset quality has resulted because of a sharp fall in commodity prices, ambitious assumptions on availability of natural resources, and global and domestic economic slowdown. The government can solve asset quality issues related to natural resources. For the rest, we need to wait for a turn in the business cycle, locally and globally. We continue to prefer those private sector banks which are more focused towards retail lending and, thus, have a superior asset quality.
The rural economy is under stress. In this backdrop, what sectors would you like to avoid?
Companies whose sales are dependent on the agricultural economy or sectors which were benefiting from rising rural consumption over the past few years need to be assessed carefully for any eventuality of a poor monsoon. Companies in sectors like two-wheelers, consumer goods, cement and value-added agricultural inputs are vulnerable.
Are you still bullish on cement and telecom?
We continue to be positive on telecom, based on our analysis of the secular consolidation process. We believe the outcome of spectrum auctions, while costly, should act as a catalyst to accelerate the industry’s consolidation, while removing the overhang of spectrum renewal that was concerning the market. More, these players should benefit from the exponential growth in data demand.
On the cement sector, there are near-term headwinds in terms of rural slowdown and a delay in uptick in infrastructure investment, while stock prices have rallied. So, we have booked some profits and reduced some exposure; however, we remain overweight on cement.
Is our market turning stock specific once again or there is still room for sectoral plays?
As far as our philosophy is concerned we are looking for both. We are continuously looking to identify where sectors have overall improving fundamentals on the back of growth or lower competitive intensity. However when it comes to identifying individual companies in those sectors with improving fundamentals, or otherwise, we have a very strong framework to identify winners in each sectors. Thus for us it is never, either one, but always both.
Having said that, as we stand, at current valuations, there are very few sectors where we overall see secular growth opportunities at reasonable price, barring private sector banking and telecom sector. Hence sectoral plays will be lesser going ahead, and portfolios will turn more stock specific.
What's the outlook for Information Technology (IT) sector?
The IT sector is running on a treadmill and their services are getting commoditized over time (it’s happening at faster pace today). For sector to revive, they will have to reengineer themselves and innovate rapidly and till than they will have to continue to depend on volume growth and depreciating currency to sustain growth. Near term outlook of IT sector, on the back of cross currency headwinds and budget constraints in traditional IT services business, the IT companies will witness slower earning growth. We remain underweight on this sector.
