ET OnlineThe Largecap/midcap PE ratio is at a 30% discount to its long-term average, indicating that largecaps provide an attractive entry point, says Harish Sharma, Head - Brokerage and Wealth Management (HNI & Mass Affluent), Edelweiss Financial Services, in an exclusive interview with Kshitij Anand of EconomicTimes.com.
ET.Com: Do you think largecaps present a buying opportunity at current levels? Suggest any top five stocks in which investors can park their funds?
Harish Sharma: Sensex has corrected by 10% from its peak. It is currently trading at 13x one-year price/earnings ratio, which is lower than its long-term average of 15x and at the all-time peak of 24x.
The largecap/midcap PE ratio is at a 30% discount to its long-term average, indicating that currently, largecaps provide an attractive entry point. Some of our top picks in the largecap space are:
ICICI Bank:
ICICI is India's second largest bank and largest private bank with total assets of about Rs 6.5 trillion as of FY15. It will be the biggest beneficiary of buoyant economic outlook, pick-up in corporate credit, continued retail credit growth, given its extensive reach and client relationships. Its P/BV is reasonable compared to those of Axis, HDFC & Kotak Bank.
Larsen & Toubro:
L&T has a dominant presence across verticals of roads, power, commercial and residential real estate, railway, water and defense etc. With economy picking up and government spending gaining momentum, there is huge order potential for L&T. The company also has an international presence. A thrust on international business over the past few years has seen overseas earnings growing significantly.
Maruti Suzuki India Ltd:
MSIL is India's largest passenger vehicle manufacturer with more than 40% market share. The India passenger vehicle sales are expected to grow from 3 million units per year to over 10 million units per year by FY20-21 (19% CAGR), and we believe that Maruti will be a major beneficiary of this trend. The stock has tripled in the last 3 years and we believe that there is significant upside potential.
Sun Pharmaceuticals Ltd:
Sun Pharmaceuticals (SUNP) emerges the numero uno in India with 9.2% market share post Ranbaxy acquisition. Its acquisition of GSK's opiates business in Australia places it in an extremely favourable situation as well.
Infosys Ltd:
Infosys is the second largest IT services company in India with 910 active clients spread across 50 countries with an employee force of 176,187. Infosys has started investments in newer technologies and training employees in these newer areas. These investments will bear fruit in the near term and provide a boost to the stock.
ET.Com: Despite sharp pullbacks, Indian market always manages to find heavy supply at higher levels. The consensus call is that there are problems; there are structural problems, cyclical problems which are weighing on India. How do you see the India story amid Greek woes and uncertainty around US Fed rate hike?
Harish Sharma: In CY2014, Sensex rose by 30% - highest in the past five years, indeed a good performance. Key drivers were a) Decisive central government b) Expectation of changing fundamentals in the economy, and c) A central bank governor with high global repute provided confidence to the markets. Also, inflationary pressures eased largely due to fall in crude, and our external volatility reduced, resulting in sentiment boost.
In the past few months, markets have corrected by up to 10%. Stock market expectations perhaps were running ahead of fundamentals and were pricing in big-bang reforms. Although the central bank cut rates thrice, it was accompanied by hawkish statements - indicating limited room for further rate cuts. Further, we faced one of the worst quarters of corporate earnings after 2008 crisis and IMD's initial forecast of lower-than-normal monsoon also affected the near-term sentiment.
A few international factors also added to the fall in the Indian indices These included lack of consensus between Greece and its creditors on the release of the bailout package and uncertainty regarding the timing of US fed rate hike. Also, the global bond sell-off has resulted in US and German yields increasing by about 30 bps in the last 6 months. Combination of all these domestic and international factors is providing some temporary pain in the markets.
Our long-term growth story remains intact. For the next few years, India is expected to experience a goldilocks situation where we will have high growth and low inflation. The government is also taking proactive steps towards ensuring longer-term growth. These include reforms in the energy sector, empowering the states and reducing the leakages in the subsidy transfer process.
Further, corporate earnings are at a low of 4.3% of GDP, lowest levels since FY 2003-4 and against the peak of 7.1% reached in FY08. Hence, with the government measures and fiscal spending on infrastructure percolating into the economy, we will see corporate earnings rise. We are looking at high growth rates over the next 3-5 years and believe that the temporary pain in markets will subside as the long-term growth story takes centrestage.
ET.Com: India versus China, where are you on this good old comparison? Why is Chinese equity market drawing so much attention? Should investors in India be worried if there is further flight of capital?
Harish Sharma: When you look at numbers, the Chinese markets now appear overheated. Volatility has crossed its previous June, 2012 peak. The Shenzhen stock market, a small-cap dominated exchange, has more than doubled. The Shanghai stock market, China's large state-owned enterprise driven exchange, is up almost 60 per cent this year, and increased by 1.5 times over the last 1 year. This explosive rally in Chinese shares is a mix of several factors.
Chinese government is trying to facilitate a shift of the economy from investment-oriented to a consumption-driven one. They have facilitated investing in stock markets and creation of wealth effect for the citizens of China.
The PBOC, The Chinese central bank, has also cut interest rates and reserve ratios twice this year.
The government has been making repeated reassurances through its state-run media in case of any stock market rout. The government-backed regulator removed a 17-year-old ban restricting participants from owning more than one trading account in April and increased the limit to 20.
Also, margin funding has increased dramatically to 8% of free-float market capitalisation. This wave of equity cheerleading has led to opening of more than 30 million new accounts since January, which is more than combined account openings of the last three years.
The Chinese Premier Li Keqiang announced the Shanghai-Hong Kong Stock Connect programme in April 2014 that allowed foreign fund managers access to yuan-denominated A-share stocks. This triggered a surge in number of hedge funds entering the Chinese largecap dominated Shanghai stock markets from Hong Kong.
These hedge funds have been reporting double-digit returns ever since. Global benchmark Index creators like MSCI have been aggressively planning to include Shanghai and eventually Shenzhen stocks into its indices which has fuelled the rally further.
In fact, as we speak, in the last one week, Shanghai composite has corrected by 10%. After MSCI announced that it would wait for further reforms before adding Shanghai stocks to its Emerging markets index, Shanghai stocks have corrected, removing frothy valuations. The recent correction was led by cement stocks and select banking stock which declined more than 20% in the last few trading sessions.
But, fundamentally India is in a much better position as compared to China in several aspects. India is the largest democracy with comparatively mature financial market. India's 'common law' system and open government policies also provide confidence to domestic and outside investors.
India is at its inflection point, with growth showing signs of picking up, the government taking continuous measures and spending fiscal funds to provide a thrust to infrastructure and boost manufacturing. India is one of the preferred investment destinations across emerging markets. The long- term growth story of India remains intact, hence the risk of significant losses for a prolonged period remains limited.
ET.Com: FIIs that were the backbone of Indian markets in calendar 2014 are slowly taking profits off the table. They have already pulled out over Rs 4,700 crore from the Indian capital markets in the first two weeks of the month? Do you see the trend continuing? What are the factors which will make them stay?
Harish Sharma: In FY 15, India experienced record high FII flows. We saw equity inflows of USD 18.1 bn and debt of USD 27.4 bn, hence leading to net total FII flows of USD 45.5 bn against the previous high of USD 30 bn in FY11.
This number was 5 times higher than the total of about USD 9 bn in FY14. Although in May, 2015 and first two weeks of June, we saw some outflow, this number is small when we look at the larger picture. The outflow can partially be attributed to some redistribution of allocated capital that EM and Asia pacific funds could be doing.
Since they have been largely overweight on India throughout 2014, there could be a slight reduction in their India allocation. There were few worries on the retrospective MAT issue as well.
However, the government has been rectifying that and taking measures to ensure that FIIs face a stable tax regime. Global liquidity remains ample, as Japan, Europe & UK continue their monetary easing programme and with India being in a sweet spot, global funds are likely to flow into the Indian markets. Further, domestic institutional investors are more than compensating for the current FII outflows. After 5 years of net redemptions, DIIs have pumped in about Rs 1,9000 cr YTD in FY16.
ET.Com: Do you have a Sensex/Nifty target in mind for December 2015 or a 12-month target? Could you tell us what sectors investors should look at over over 6-12 months?
Harish Sharma: We think corporate earnings have bottomed out, growth is showing signs of pick up and inflation is at very comfortable levels. These, coupled with the government spending on infrastructure and speedy clearances of projects, has set the stage for growth in the Indian economy. Based on this recovery, estimated Sensex EPS for FY17 at 2010 and assigning a P/E multiple of 16x, we believe the Sensex should range between 32000 and 33000 levels by March, 2016.
In terms of sectors, we like the Private banks. In the infrastructure space, selective and large players with their diversified segment presence provide an excellent opportunity to ride the Indian infrastructure story.
With the government's thrust towards 'Make in India', auto and auto component sector are also preferred. Our stock-pick philosophy includes analysing the company's opportunity size, moat around the business, growth potential, earning visibility, corporate governance, cash flows and return ratios.
Hence, even for investors, our advice is that before investing in a stock, one should follow the top- down approach of research and must understand the industry dynamics and company's presence and capabilities. Most importantly, management's competence and credibility need to be assessed rigorously.
ET.Com: Gold has come under pressure amid uncertainty around US Federal Reserve rate hike. What is your call on the yellow metal? Should investors book profits or buy on declines? What is your year-end target for Gold?
Harish Sharma: Gold generally works as a good investment avenue when there is global risk aversion (like the 2008 financial crisis) or when inflation is very high (like in India in the last 5-6 years). Hence, only in specific periods, like 1976-1980 and 2001-2012 does gold offer higher returns and outperforms other asset classes. But, if we compare long-term average performance, equity offers much better return than gold. Over 1996-2014, in USD term, Sensex offered 500% return as compared to 200% return from gold.
After reaching the highs of Rs 32,700 in August, 2013, gold prices have been at the low end as positive flow of US macroeconomic numbers and pressure on global commodity prices are forcing down the gold prices globally. Going forward, with the low inflation across the globe, and lower physical demand requirements from India and China, gold prices are expected to drift lower in the short run. There could be a possible 7-10% downside in gold prices from the current levels.
The government's ambitious gold monetisation scheme is to mobilise gold held by households and institutions in the country. This would create a pool of gold that is available to the gems and jewellery sector. We believe that a successful implementation of this scheme can increase the gold supply and may lead to lower prices.
ET.Com: Do you think largecaps present a buying opportunity at current levels? Suggest any top five stocks in which investors can park their funds?
Harish Sharma: Sensex has corrected by 10% from its peak. It is currently trading at 13x one-year price/earnings ratio, which is lower than its long-term average of 15x and at the all-time peak of 24x.
The largecap/midcap PE ratio is at a 30% discount to its long-term average, indicating that currently, largecaps provide an attractive entry point. Some of our top picks in the largecap space are:
ICICI Bank:
ICICI is India's second largest bank and largest private bank with total assets of about Rs 6.5 trillion as of FY15. It will be the biggest beneficiary of buoyant economic outlook, pick-up in corporate credit, continued retail credit growth, given its extensive reach and client relationships. Its P/BV is reasonable compared to those of Axis, HDFC & Kotak Bank.
Larsen & Toubro:
L&T has a dominant presence across verticals of roads, power, commercial and residential real estate, railway, water and defense etc. With economy picking up and government spending gaining momentum, there is huge order potential for L&T. The company also has an international presence. A thrust on international business over the past few years has seen overseas earnings growing significantly.
Maruti Suzuki India Ltd:
MSIL is India's largest passenger vehicle manufacturer with more than 40% market share. The India passenger vehicle sales are expected to grow from 3 million units per year to over 10 million units per year by FY20-21 (19% CAGR), and we believe that Maruti will be a major beneficiary of this trend. The stock has tripled in the last 3 years and we believe that there is significant upside potential.
Sun Pharmaceuticals Ltd:
Sun Pharmaceuticals (SUNP) emerges the numero uno in India with 9.2% market share post Ranbaxy acquisition. Its acquisition of GSK's opiates business in Australia places it in an extremely favourable situation as well.
Infosys Ltd:
Infosys is the second largest IT services company in India with 910 active clients spread across 50 countries with an employee force of 176,187. Infosys has started investments in newer technologies and training employees in these newer areas. These investments will bear fruit in the near term and provide a boost to the stock.
ET.Com: Despite sharp pullbacks, Indian market always manages to find heavy supply at higher levels. The consensus call is that there are problems; there are structural problems, cyclical problems which are weighing on India. How do you see the India story amid Greek woes and uncertainty around US Fed rate hike?
Harish Sharma: In CY2014, Sensex rose by 30% - highest in the past five years, indeed a good performance. Key drivers were a) Decisive central government b) Expectation of changing fundamentals in the economy, and c) A central bank governor with high global repute provided confidence to the markets. Also, inflationary pressures eased largely due to fall in crude, and our external volatility reduced, resulting in sentiment boost.
In the past few months, markets have corrected by up to 10%. Stock market expectations perhaps were running ahead of fundamentals and were pricing in big-bang reforms. Although the central bank cut rates thrice, it was accompanied by hawkish statements - indicating limited room for further rate cuts. Further, we faced one of the worst quarters of corporate earnings after 2008 crisis and IMD's initial forecast of lower-than-normal monsoon also affected the near-term sentiment.
A few international factors also added to the fall in the Indian indices These included lack of consensus between Greece and its creditors on the release of the bailout package and uncertainty regarding the timing of US fed rate hike. Also, the global bond sell-off has resulted in US and German yields increasing by about 30 bps in the last 6 months. Combination of all these domestic and international factors is providing some temporary pain in the markets.
Our long-term growth story remains intact. For the next few years, India is expected to experience a goldilocks situation where we will have high growth and low inflation. The government is also taking proactive steps towards ensuring longer-term growth. These include reforms in the energy sector, empowering the states and reducing the leakages in the subsidy transfer process.
Further, corporate earnings are at a low of 4.3% of GDP, lowest levels since FY 2003-4 and against the peak of 7.1% reached in FY08. Hence, with the government measures and fiscal spending on infrastructure percolating into the economy, we will see corporate earnings rise. We are looking at high growth rates over the next 3-5 years and believe that the temporary pain in markets will subside as the long-term growth story takes centrestage.
ET.Com: India versus China, where are you on this good old comparison? Why is Chinese equity market drawing so much attention? Should investors in India be worried if there is further flight of capital?
Harish Sharma: When you look at numbers, the Chinese markets now appear overheated. Volatility has crossed its previous June, 2012 peak. The Shenzhen stock market, a small-cap dominated exchange, has more than doubled. The Shanghai stock market, China's large state-owned enterprise driven exchange, is up almost 60 per cent this year, and increased by 1.5 times over the last 1 year. This explosive rally in Chinese shares is a mix of several factors.
Chinese government is trying to facilitate a shift of the economy from investment-oriented to a consumption-driven one. They have facilitated investing in stock markets and creation of wealth effect for the citizens of China.
The PBOC, The Chinese central bank, has also cut interest rates and reserve ratios twice this year.
The government has been making repeated reassurances through its state-run media in case of any stock market rout. The government-backed regulator removed a 17-year-old ban restricting participants from owning more than one trading account in April and increased the limit to 20.
Also, margin funding has increased dramatically to 8% of free-float market capitalisation. This wave of equity cheerleading has led to opening of more than 30 million new accounts since January, which is more than combined account openings of the last three years.
The Chinese Premier Li Keqiang announced the Shanghai-Hong Kong Stock Connect programme in April 2014 that allowed foreign fund managers access to yuan-denominated A-share stocks. This triggered a surge in number of hedge funds entering the Chinese largecap dominated Shanghai stock markets from Hong Kong.
These hedge funds have been reporting double-digit returns ever since. Global benchmark Index creators like MSCI have been aggressively planning to include Shanghai and eventually Shenzhen stocks into its indices which has fuelled the rally further.
In fact, as we speak, in the last one week, Shanghai composite has corrected by 10%. After MSCI announced that it would wait for further reforms before adding Shanghai stocks to its Emerging markets index, Shanghai stocks have corrected, removing frothy valuations. The recent correction was led by cement stocks and select banking stock which declined more than 20% in the last few trading sessions.
But, fundamentally India is in a much better position as compared to China in several aspects. India is the largest democracy with comparatively mature financial market. India's 'common law' system and open government policies also provide confidence to domestic and outside investors.
India is at its inflection point, with growth showing signs of picking up, the government taking continuous measures and spending fiscal funds to provide a thrust to infrastructure and boost manufacturing. India is one of the preferred investment destinations across emerging markets. The long- term growth story of India remains intact, hence the risk of significant losses for a prolonged period remains limited.
ET.Com: FIIs that were the backbone of Indian markets in calendar 2014 are slowly taking profits off the table. They have already pulled out over Rs 4,700 crore from the Indian capital markets in the first two weeks of the month? Do you see the trend continuing? What are the factors which will make them stay?
Harish Sharma: In FY 15, India experienced record high FII flows. We saw equity inflows of USD 18.1 bn and debt of USD 27.4 bn, hence leading to net total FII flows of USD 45.5 bn against the previous high of USD 30 bn in FY11.
This number was 5 times higher than the total of about USD 9 bn in FY14. Although in May, 2015 and first two weeks of June, we saw some outflow, this number is small when we look at the larger picture. The outflow can partially be attributed to some redistribution of allocated capital that EM and Asia pacific funds could be doing.
Since they have been largely overweight on India throughout 2014, there could be a slight reduction in their India allocation. There were few worries on the retrospective MAT issue as well.
However, the government has been rectifying that and taking measures to ensure that FIIs face a stable tax regime. Global liquidity remains ample, as Japan, Europe & UK continue their monetary easing programme and with India being in a sweet spot, global funds are likely to flow into the Indian markets. Further, domestic institutional investors are more than compensating for the current FII outflows. After 5 years of net redemptions, DIIs have pumped in about Rs 1,9000 cr YTD in FY16.
ET.Com: Do you have a Sensex/Nifty target in mind for December 2015 or a 12-month target? Could you tell us what sectors investors should look at over over 6-12 months?
Harish Sharma: We think corporate earnings have bottomed out, growth is showing signs of pick up and inflation is at very comfortable levels. These, coupled with the government spending on infrastructure and speedy clearances of projects, has set the stage for growth in the Indian economy. Based on this recovery, estimated Sensex EPS for FY17 at 2010 and assigning a P/E multiple of 16x, we believe the Sensex should range between 32000 and 33000 levels by March, 2016.
In terms of sectors, we like the Private banks. In the infrastructure space, selective and large players with their diversified segment presence provide an excellent opportunity to ride the Indian infrastructure story.
With the government's thrust towards 'Make in India', auto and auto component sector are also preferred. Our stock-pick philosophy includes analysing the company's opportunity size, moat around the business, growth potential, earning visibility, corporate governance, cash flows and return ratios.
Hence, even for investors, our advice is that before investing in a stock, one should follow the top- down approach of research and must understand the industry dynamics and company's presence and capabilities. Most importantly, management's competence and credibility need to be assessed rigorously.
ET.Com: Gold has come under pressure amid uncertainty around US Federal Reserve rate hike. What is your call on the yellow metal? Should investors book profits or buy on declines? What is your year-end target for Gold?
Harish Sharma: Gold generally works as a good investment avenue when there is global risk aversion (like the 2008 financial crisis) or when inflation is very high (like in India in the last 5-6 years). Hence, only in specific periods, like 1976-1980 and 2001-2012 does gold offer higher returns and outperforms other asset classes. But, if we compare long-term average performance, equity offers much better return than gold. Over 1996-2014, in USD term, Sensex offered 500% return as compared to 200% return from gold.
After reaching the highs of Rs 32,700 in August, 2013, gold prices have been at the low end as positive flow of US macroeconomic numbers and pressure on global commodity prices are forcing down the gold prices globally. Going forward, with the low inflation across the globe, and lower physical demand requirements from India and China, gold prices are expected to drift lower in the short run. There could be a possible 7-10% downside in gold prices from the current levels.
The government's ambitious gold monetisation scheme is to mobilise gold held by households and institutions in the country. This would create a pool of gold that is available to the gems and jewellery sector. We believe that a successful implementation of this scheme can increase the gold supply and may lead to lower prices.
( Originally published on Jun 22, 2015 )
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