Anoop Bhaskar, Head-Equity, UTI Mutual Fund gives his perspective on the valuations of Indian markets.
On June quarter earnings
The first quarter numbers have neither been very encouraging nor discouraging.
While we don’t collate numbers for the entire market, from what I gather, the profit growth is in high single digits and the revenue growth is about 18 per cent. This has come off from the 20- odd per cent in the earlier quarters. But profits are a little difficult to correlate (with last year) as a change in rules in accounting for forex losses was made in December last year. So they don’t give the correct picture of what the profit growth could be at the PAT (profits after tax) level. Among the large caps, the results are better than what was expected. Mid- and small-caps have been struggling a bit on profitability.
Valuations
They are very skewed because investors are willing to pile on to stocks that have stability in earnings while they are shunning stocks where weak operating numbers have made the stocks even more ‘value’ than what they were earlier on.
For example, Punjab National Bank now trades at about 0.7 times price to book value. HDFC bank trades at 3.8 times price to book. The last three quarters numbers of HDFC bank have been in line with market expectations whereas PNB disappointed with lumpiness in NPAs (Non- Performing Assets).
So it can’t be a market where in the same economy, a private sector bank trades at over 3 times and a PSB, at less than one time. So that’s where markets tend to distort and the pendulum moves to the extreme at a point in time. Right now investors are seeking safety.
So HDFC Bank, IndusInd Bank, Kotak Mahindra Bank, and even Yes Bank to some extent, all trade at a premium to middle-of-the-rung private sector banks such as ICICI Bank and Axis Bank, and also at a significant premium to PSBs.
The situation was exactly the opposite, a year-and-a-half ago. So these cycles occur. We’ll try and play them smartly and try to benefit from them.
The valuation of the Nifty and mid-cap index was the widest about two years ago. But by the last 3-4 months of 2010, they had narrowed significantly. Now they have again widened.
The small-cap story is a lot different.
There is a general eschewing of smaller companies in the market last two years and their valuations continue to trade at levels that were there in March 09.
The gap between the Nifty and the small cap today is as wide as it was between January and March ‘09.
On the midcap front, some part of that gap has got covered. Now there is no significant valuation gap that you can play.
If you were to play companies with Rs 10,000–22,000 crore market capitalisation as midcap, that segment of the market is priced as well as the large caps.
Only at a market capitalisation of below Rs 6,000-7,000 crore will you get opportunities.
This segment gets mostly covered under small caps. But the risk also is quite high.
The economic cycle is at a stage where these kind of companies will have a tough time over the next one or two quarters.
So if you buy anything in that segment, you will have to have a fairly longer holding period.
On FMCG and pharmaceutical stocks
It is a question of balancing between companies that have had stable earnings but high valuations and trying to increase the beta in your portfolio by having companies where the valuations are quite compelling but the earnings could be at risk.
Ideally if one is looking at value as the only parameter, then buy PSBs.
But it has got more complex issues. They might have one or two quarters more of weak earnings.
May be investors will feel confident to buy those companies only when a certain set of ground realities are seen.
So, for example, if the RBI is able to cut interest rates or before that the government brings in diesel price hike or inflation stabilises, you will find that PSBs will get re-rated at that point of time.
But we are not very clear when that trigger will play out. Till then, being overweight n stable companies with earnings that will not spook the markets in the near term is the way out to play the portfolio.
Over a period of time, reduce those companies, and add on to companies that have higher beta.
So you could buy infrastructure, PSBs or companies in metals or auto segment.
On the return on equity (ROEs) of companies in the last 3-4 years
That’s a concern. Drop in ROEs will eventually lead to a drop in PE multiples that the markets can command.
That will, in turn, lead to lower returns for equity investors.
One reason I think is profitability has got impacted by companies trying to focus more on sales growth rather than improving margins. This is because they have been worried about the demand coming off if they were to increase prices.
Only during downturns in the economic cycle will companies tend to protect margins and give up growth. That stage has not come yet.
Either the rupee has to appreciate or the demand has to increase significantly for ROEs to improve. It will not happen in the next one or two quarters.
Anoop manages the UTI Equity, UTI Opportunities and UTI Master Value funds.
