Betting on 3 sectors that offer a good blend of growth and value: Sahil Kapoor

There has been a reversal in the market in last eight-nine days. What is the sense that you get there?
Two-three things. First, sometime last month, we reached average valuations. Nifty and Bank Nifty and most of the frontline indices started trading at their 15-year average valuations. We did not go to the cheap category but certainly pockets of the market went below average valuations which is a good thing. For example, on a price to book basis, Bank Nifty started trading below two times which is historically a good support area, where if you invest consistently, you will make a lot of returns over time.

Most indices, not only in India, but globally have reached some sort of average valuations. The froth that we saw in 2020-21 seems to have worked off largely because of rising interest rates and the sentiment that has got hit.

The second important point is if you look across the market breadth, globally a number of mid and smallcap indices are now trading at valuations lower than largecaps; in fact, some of them have been trading below their long-term averages approaching the cheap category. So I guess we are in some kind of area where it makes sense to be a little more optimistic in terms of your equity allocations and consistently try and add to good companies and good funds over time.

In terms of expectation, in terms of downgrades that has happened. What is the quantitative data on recent FIIs selling? How are things moving? Also, how do you think the EPS downgrades or upgrades are panning out for the whole market?
In terms of FPI flows, we have seen a very large outflow this year bordering about $35 billion out of India in CY22 which is a very large number and when you square it up with what has happened in other emerging markets, we are largely a function of lot of passive outflows.

So, as per the data that we track, in the last one year, emerging markets have seen an outflow of between $220 to 240 billion and India has got its own fair share of that outflow. Our MSCI weightage has been close to about 12-12.5% and that is where we have also been seeing the outflows. Recently, in the last two-three weeks, we have seen that EM outflows are stemming and some amount of sanity is coming back.

China is reopening and trying to give some amount of stimulus to boost up its economy. It is quite possible that emerging market outflows, of which a very large proportion is our own outflows, are reversing or tapering to some extent. My guess is that the second half of 2022 may not be as bad as the first half. If I may venture a guess, it is quite possible that in the second half, we may have limited outflows or maybe no outflows.

The second important point in terms of valuations and earnings growth is that the Street was expecting growth of about 17-18% in earnings in FY23 and it is quite clear with the actions that have happened in last one month that part of growth which was coming from oil and gas and metals, is going to get dialled down. Now the market expects between 12% and 14% growth. I think we are at the lower end between 12-12.5%. That looks achievable because the other part of the market which is domestic local consumption plus banking and financial services, is coming back at a faster pace. If you balance these two out, FY23 and ahead, one could expect growth of 12% plus, bordering about 14% for the next two-three years.

Let us talk about sectors. We have seen that growth stocks have done well. Value has started to outperform towards the second half. But now we are seeing a correction across both value and growth. How should one approach this market?
We exercise two very basic principles. First, we do not want to overpay and second, we want to buy good companies. Across the horizon, whether you look at growth or value stocks, when markets are out of whack, they are sentimentally back and offer opportunities in all these buckets. I think there is opportunity in most of the buckets.

For example, you spoke about growth stocks and particularly Nasdaq. If you look at a part of Nasdaq and eliminate the non-techie names, in the broader market, there is trading at close to 20-21 times forward earnings and when we look at the last 15 years, most of these large companies have seen their profits multiply between 17 to 18 times.

So if we are getting that kind of growth at 20-21 times multiple, given that we do not know what will happen in the next six months, it makes sense to start allocating to these kinds of companies over time.

Similarly, when one looks at parts of the Indian market, sectors like auto or banking and financial services and even auto ancillary, there is a lot of opportunity available when one goes bottoms up. There are companies sitting on good strong fundamental balance sheets and possibly their earnings are also increasing at a faster clip than what most people expected 6 to 12 months ago. This is the idea one should look forward to, buy companies which offer good value right now in both the buckets and look for earnings which will rebound in the next two to three years.

With this sort of an unprecedented hike coming in from various governments to ban a lot of products in terms of exports to curb inflation or for food security, how are markets trying to price all this?
Data is telling us something which is a little different from what the market is expecting right now. A lot of people are still very fearful about inflation but at the margin, the data has started to turn. There are two, three very important points; first is a very large source of inflationary pressure over the last one and a half years has been commodity prices. Lets put them in three buckets – industrial metals, agri and oil & gas.

Industrial metals and agri commodities have already fallen between 25-40%. In terms of oil and gas, there has not been a sizable correction which is more regional in nature. There is a possibility that if we see a correction in agri commodity side, inflation will very well act negatively on the headline inflation numbers.

Second, when one looks at core demand, many governments across the world – be it the US or other western countries, along with their central banks – are trying for a slowdown. They are doing it because they know that the current level of supply is not too strong for the current level of demand. So a structured demand slowdown is happening and that is visible in many numbers.

Once that is achieved in the next two, three months, it is quite possible that we will see inflation data dialling down. The inflation numbers will be at 40-year high this month is what the consensus estimates show, but in the next three to six months, we could possibly see a dial down of inflation and inflation expectation.

So, there is going to be a change in sentiment in the next six months and users of commodities is now becoming a theme. A lot of people are thinking about companies which will benefit from them. We have been focussing on that theme for the last three to six months and this theme is going to gain a lot of currency over the next one or two years. That is how I look at it.

Let us just talk about the larger picture. A lot of stocks have corrected, especially some of the heavily FII owned stocks, even in the midcap space have corrected as much as 30%, 40%, 50%. What would be your approach in terms of valuations and growth outlook?
We have been largely sticking to domestic names and one of the sectors where we feel there is a lot of opportunity is banking.

The growth in the banking sector is almost higher than the 10-year rolling average that we had. So since the global financial crisis, we have not crossed banking credit growth going above the 10-year rolling average. Right now the 10-year rolling average is at about 9.9, let us say 10% and our YoY growth is now at about 13%. If we are able to do a teen kind of credit growth, it is a good number.

Secondly, the GNPA ratios have fallen. In bad years, they used to be 10-12% and now they are bordering 5% and may be in the next one and a half-two years they will border 3.5% or lower. So, very clean balance sheets, good growth in corporate loans. Retail loans give a very clear indication that this is a sector where fundamental things have improved.

When one looks at the prices in the last three-four years, nothing major has happened. A lot of sector churn has happened but the sector as a whole has not gained a lot. So, it offers good value. If you do good bottoms up there are great opportunities to be explored in the banking space and similarly in the NBFC space.

The other sector which looks juicy is auto and auto ancillary, most of the segments that you look at whether it is two wheelers or when you look at passenger vehicles or tractors, I think there is a lot of juice left in terms of the overall consumption cycle. Our private final consumption expenditure exceeded that of pre-Covid level just a quarter away so the whole kicker from private consumption is still ahead of us.

Most of these companies are sitting on good balance sheets. They have cash on their balance sheet and if growth comes, they will be able to capitalise a lot more. Plus, in the last five years, stocks have not done exceedingly well. The auto index made a lifetime high yesterday or close to that level. There is still a possibility of good upside in the auto sector as it offers a good mix of growth and valuations.

The third which I think still sits on very strong valuations is the pharma space or healthcare space as a whole. Nifty pharma as an index is trading at about 2.2. If you remove one or two companies, at 2.5% free cash flow yields, it is at a very juicy level and valuations are also very attractive. The only piece missing is the earnings growth, which most likely will translate from next year onwards. These are the few sectors which offer a good blend of growth and value.