S Krishnakumar, chief investment officer – equity at Sundaram Mutual Fund, believes that Indian manufacturing sector is poised for massive growth due to government reforms and increasing labour costs in China.
There seems to be a disconnect between the markets and the economy. How are you navigating your portfolio at this juncture?
While there could be perceptions of disconnect between markets and the economy, one should not forget that in most times the markets lead the economy given that they discount the future. Even today, we believe the markets are looking beyond the dip in the economy in FY 2021, as we already seem to be normalising on growth recovery and expect an uptick in January 2021 or April 2021 quarter.
The macro positives of good forex reserves, low external debt to GDP, abundant liquidity, dropping rates, stable currency supported by better geopolitical considerations and an eye on reforms are also macro positives in addition to a global risk in trade favouring emerging markets.
When do you see earnings growth coming through?
Earnings excluding those of financials will see a recovery by the fourth quarter of FY21. Financials will have to be looked at from the kind of provisions necessitated by the restructuring exercise and stabilisation of financials which we can have a better handle by end of the year. However, the big risk to our banking sector seems to be out of the way with the Reserve Bank of India’s restructuring window and the significant equity capital raised by banks to tide over. Overall, we expect a significant growth in earnings into FY 2022-23.
Some are of the view that markets would favour mid and small caps over large caps in the near term. What is your view?
The bear markets started manifesting during 2017 end when the broader markets peaked off with valuations turning euphoric with strong growth built into forward earnings. Growth started slowing down from the middle of 2018. This was due to slackening global growth impacted by trade war noises, local issues of non-banking financial company (NBFC) crisis of liquidity, higher rates. Thus, the growth premiums came off across mid and small caps. Even within large caps that were generally holding up, it was getting more polarised with investors preferring only those select growth stocks. The final capitulation in markets in March and subsequent stabilisation has created a scenario of reasonable valuations in mid and small caps. The PE multiples bottomed out at long term averages while price to book multiples are still 30% below the average. Considering the V-shaped recovery in high-frequency indicators, one can be quite positive on broader markets.
This time the markets have recovered swiftly. The index started going up because it was supported by a few stocks. You will have polarised rally when there is a scarcity of growth. Even established businesses like Bajaj Finance and HDFC Bank could not grow in the first quarter. When growth is disrupted, the high premium multiples enjoyed by a few stocks are corrected. Small and mid-cap stocks correct more sharply and thus the PE multiples look very attractive. This time, the PE multiples didn’t fall below 10. From 24 times in 2017, they fell to 14 times one-year forward basis now. They came down to long term average and improved slightly. Compared to Nifty, the mid and small caps are 15% undervalued currently. Earlier in 2017, small and mid-caps were trading at a premium of 20% to large cap index. So small and mid-caps are currently attractive compared to their own history and in comparison to Nifty.
Within financial services, asset management and insurance firms have been relatively less impacted by the lockdown. Do you think events like the one we are witnessing right now will further push demand for insurance?
India has one of the fastest-growing millionaire population. There a lot of startups and millennials who have done well. If 10,000 people are graduating every year from college and they take a risk to start a business around 10-20% would be successful. The valuation of their business increases astronomically. After selling their business these entrepreneurs would need wealth managers to manage their money. The next generation is very conscious of saving and investing. They want to put money in equity, especially through systematic investment plans. We will see a lot of new investors coming to the market through mutual funds.
People are now conscious and aware about securing their life and health insurance. Catastrophes and events like pandemics reinforce the need to have adequate insurance for cars, homes, health and life. So insurance and wealth management is a big area of secular growth given the low penetration rates and the rising count of millionaires and high net worth individuals in India.
There is a lot of optimism and hope on the revival of the manufacturing theme. What makes Indian manufacturing space so competitive?
India missed the manufacturing revolution and jumped into services space like software and business process outsourcing.
The world’s dependency on China could reduce as the wage cost has started increasing in China. China is hiking the salaries of its workers to boost domestic consumption. China is no longer as competitive as they were earlier. India has now become competitive on a dollar basis. We have made substantial progress on power also. We have built a capacity of 1 lakh megawatt of power over the last decade. The cost of power is coming down. We have a fairly good coal output. We are building capabilities in solar power. The dedicated freight corridor would help fast track the delivery of goods and cut down costs by 30-40%. Labour reforms are underway. The government has a large land bank for companies to open factories in India. These measures will help exporters as well as domestic-oriented companies. Government’s scheme of production linked incentive is focused on sectors like electronic manufacturing. We will start assembling mobile phones and related accessories in India. This will cut down the import cost. The government is addressing the current account deficit problem by encouraging domestic manufacturing. The announcements made in the Budget 2020 will help the economy over the next three years.
When do you think value stocks will come into the limelight?
Value stocks do well ahead of the commencement of an economic expansion phase. They are much beaten down and initial re-rating happens as the first flush of growth is seen. The firm belief is that value stocks come back into the limelight when the growth inflection happens and then over the next phase of real expansion growth stocks take over.
