The Indian market looks expensive at current levels, according to Sanjeev Prasad , senior executive director and co-head of Kotak Institutional Equities. In a telephone interview, Prasad said the best of India’s macroeconomic scenario was behind us, but earnings could see a significant improvement going ahead, due to a very low base for sectors like banking and commodities.
How do you view the Indian market at this point of time, with benchmark indices at two-year highs? Do you think there is froth building up, or is there value in the market?
It is not a cheap market. If we get 5-6% returns from here for the rest of 2017 for the frontline indices, we should be happy. The mid-cap and small-cap space, however, is very expensive. We may find one or two names here and there, but largely, they are pricey.
Most parts of the market are quite fully valued. In some cases such as consumer staple and discretionary sectors, they are even discounting fiscal year 2019 earnings. There is value only in parts of the market.
There is value in a few sectors such as corporate banks and IT service companies, assuming potential positive developments in those sectors. For example, the corporate-focused banking sector could see a re-rating if there is some resolution on the NPL (non-performing loans) problem. Similarly, IT stocks are inexpensive given the market’s concerns regarding immigration and taxation issues in the US. If these issues play out with limited impact for the IT companies, the sector could see a re-rating.
What is your take on the pharmaceutical sector at this point of time?
There is some value selectively in stocks such as Cipla Ltd, Aurobindo Pharma Ltd... Aurobindo is cheap at 13 times FY19 P/E (price-to-earnings ratio). Cipla is also at 16.5 times FY19 earnings. Even Lupin is not looking too bad at 17.5 times FY19 earnings.
The issue with this sector at large is that there is a fair amount of uncertainty on the pricing environment in the US. The uncertain pricing environment stems not so much from regulatory-led pricing challenges as market-led pricing challenges.
In many of the generic products or segments where these companies operate, they have started to see a lot more competition. Clearly, profitability which had been very high on these molecules has and will start coming down. At the same time, because of the US FDA-related issues, these companies have not been able to introduce new molecules in their ANDA (abbreviated new drug application) pipelines in the US market. The current portfolio has started to see price erosion, and introduction of new products has got delayed at the same time.
When do we see a significant recovery in corporate earnings?
The funny thing about India’s earnings is that when we look at the top 50-100 large cap names, a disproportionately high share comes from global sectors such as IT and pharma, global commodity sectors and regulated sectors such as power utilities. So, irrespective of level of activity in the domestic economy, the earnings numbers can move in a different fashion. That has exactly what has happened over the last two-three years.
Since early 2015, we have seen a very big improvement in India’s macroeconomic parameters—Inflation came down significantly and current account deficit has also declined sharply. However, earnings growth between FY14 and FY16 has been flat, if you look at Nifty-50 companies. One of the reasons for this was the collapse of global commodity prices – oil and metals, which hurt the earnings of upstream oil companies and metal producers. Also, we saw a slowdown in earnings for IT companies, and we also had company-specific USFDA issues affecting the profits of the pharma companies.
Lastly, while banking should have done better with the economy improving, we had the problems of bad loans in the banking sector, which relates to the rapid expansion in wholesale credit in the last economic cycle. That is the dichotomy of India’s economy and earnings.
Going forward, I do not see much of improvement in India’s macroeconomic parameters from where we are. Inflation has bottomed out, and will go higher from here to about 4-5%. If you look at interest rates, they have bottomed out too. Current account deficit may gradually widen, but may still be manageable.
However, we could potentially see a big jump in earnings numbers and the reason for that is the very low base for sectors such as the banking and commodities. We expect credit costs for the banks to decline from 2HFY18, which will result in higher profits of the corporate banks. Also, the improvement in global commodity prices and implementation of anti-dumping duties on steel will lead to a sharp increase in the profits of the upstream oil & gas companies and the metals sector in FY18.
What is your take on GDP numbers that came out last week?
The issue is that the proxies that are used to make these estimates are largely from the formal sectors. It is not very clear how much of the impact on the informal sectors is captured in this data. So, it is possible that once more data points come out, we will a have more informed view on the third-quarter GDP data and we may even see some downward revision to the current numbers. However, it appears that the impact of demonetisation is not as high as was originally feared by the market.
In recent times, we have seen the Tata–Mistry spat and some issues also spiking up at Infosys Ltd between founders and the management. What impact do you think such instances can have on the reputation of Indian companies?
I would not want to comment on specific companies, but I think as a general fact, there may be challenges when there is a generational change in a way. Most of the Indian companies have founder-promoters or very long-serving professional managers who play a huge role in building the company and more importantly, the culture of the firm. The firm gets largely identified with the founder-promoter or with the professional manager, and these individuals typically have a very dominant influence on their companies. Some of the companies have put in a proper succession plan while some others have been somewhat lagging on this aspect.
I would think a proper succession plan under which the successor is identified early enough and works with the incumbent for a longish period will address the issue of any discontinuity and discord. Finally, the boards of companies have to play a far bigger role in ensuring a smooth transition of power.
How viable is it to run the telecom business in India?
I think the telecom business model has changed dramatically in that companies will have to offer much higher data capacity to the customers, which can meet all the telecom requirements of the customer. Companies will have to work out the ARPUs (average revenue per user) that can financially support a much higher capacity usage by customers. The traditional model of pricing every service individually to the customer is dead.
What Reliance Jio is trying to do is to up the game in terms of offering a lot of capacity to customers at a competitive ARPU, which makes sense to it based on its business plan and strategy. There is a paradigm shift that is happening in the telecom sector in that it will entail much higher investment by the companies in data capacity.