ET NowRavi Muthukrishnan of ICICI Securities says India is far better placed than other emerging markets as many factors have become positive for India. In an interview with ET Now, he said, three major factors can affect all emerging markets, crude oil prices and Fed rate hike and a slowdown in China. All three are bad for countries like Brazil and Russia, but for India, at least two of the three factors would be positive. Excerpts:-
ET Now: At a time when the stock market is struggling with the earnings momentum and global headwinds, what explains the underlying interest in the smallcap and midcap indices? On a one-year basis, three-year basis and YTD basis, the smallcap and the midcap indices massively outperformed the benchmark indices.
Ravi Muthukrishnan: If you look at the midcaps in particular, they have done remarkably well since September last year. In fact, their outperformance against the largecaps is about 13 per cent so far this year. In terms of valuations, they are one standard deviation about their historical averages. If you look at the largecaps versus midcaps, the premium that the largecaps demand over the midcaps is roughly about 2 per cent on a medium-term basis and about 7 per cent on an average basis. That number seems to have come down dramatically. So going forward and looking at the earning season this year, the midcaps have not really done well. We have seen a lot of downgrades in the midcap space compared with the largecaps, where the upgrades have been far more than that in the midcaps. If you look at all of this in totality, I see scope for outperformance by the largecaps over midcaps going forward.
ET Now: So what sense do you get about the overall market? Would you say the worst is behind us in terms of earnings uncertainty on the Fed which is going to get over soon or do you think the market could witness another shakeoff once the Fed hikes rates in December?
Ravi Muthukrishnan: Let me put it very systemically. Look at what happened in the last couple of days. The government came out with a slew of reforms. For example, it came out with reforms of the subsidy regime, it increased FDI limits, it reformed the roads sector, came out with a subsidy-sharing formula and, most importantly, it came out with a cess for the Swachh Bharat programme, which showed it is very much against populist measures.
The second is, relative to other emerging markets, India is much better off. The simple reason is that commodity prices are low. Three major factors can affect all emerging markets, crude oil prices and Fed rate hike and a slowdown in China. All three are bad for countries like Brazil and Russia, but for India, at least two of the three factors would be positive. As such, we are far better placed than other emerging markets.
Third, FII flows have been bad in November, but DIIs have done extremely well, November has been slightly subdued because of the festive season. The earnings season has been bad, but a low base should drive earnings growth going forward.
So we are very positive about the earnings moving up in the next half of
FY16. Net-net if you look at all these factors, India is on a good wicket now. We have a target of 8,900 for Nifty50 based on FY17 earnings with the standard deviation multiple of 0.5 against the average of 14.8 for India. So 8,900 is our target and we are quite optimistic that a lot of positive things will come in the market. About the negative triggers for all of this, one is, of course, the GST itself. But I guess with all the problems that the government has been having with the opposition, something should emerge in this winter session.
Two, all of us are worried about the Fed rate hike, but more than the Fed hike, we are quite concerned about the rate hikes that can happen beyond that, because I believe the Fed rate hike has already been discounted in stock price. The third factor is about the earnings season turning much worse than what it is today, which I believe is little less of a concern because of the low base. The fourth, of course, is the budget itself. Should the government try to focus more on populist measures than on development measures, the market will not like it too much. But going by the current trends of what they did with the Swachh Bharat cess, less of populism is on the cards.
ET Now: Keeping those factors in mind, I guess you have taken all of those into account when you looked at which sectors and which stocks form a part of your recommendations. Let us start off with what has probably been the weakest one in the last six to nine months, and that is the pharma pack. Sun Pharma is down 33 per cent from its high and is under a lot of pressure. Why would you be recommending a Sun Pharma?
Ravi Muthukrishnan: We are equal weight on pharma as a sector, but among them we like Sun Pharma for two reasons; they have 400 approvals which have come in the US, and some more are in the pipeline. Taro and Ranbaxy businesses and many other business subsidiaries should be doing very well in the US. Gleevec is one of the products that will come into the market in February and, more important than all of this is the fact that their India business is doing well as is their prescription business.
They have a fantastic sales force, they are the best in this country. The integration benefits would be at least $300 million. So net-net, all of it places this company in a better position than many others. Yes, I have been reading some news about Taro investing some money in one of the wind mills, which is a small blip in the overall business proposition. But the company came out with the announcement that there is more towards tax savings. But net-net, if you look at the benefits and look at the positives against one negative, Sun Pharma should do very well post integration.
ET Now: The fall in the stock from the recent high is not a joke and great companies do not fall 40-50 per cent. Is the core business of Sun Pharma, which is the US business, coming under pressure because of USFDA problems, because of price erosion? I am actually worried about the core aspect rather than it investing in a wind power business or somewhere else for tax-saving purposes?
Ravi Muthukrishnan: Yes. But looking at the number of approvals they have got and the number of approvals that are in the pipeline and the way the company is performing, the Ranbaxy business is also contributing to that success in the US. There is less concern there… most of the problems are over, the stock should move upward from now.
ET Now: It is interesting to see that you have got L&T in your list irrespective of the kind of horrific management commentary that we saw in the quarter gone by. I am assuming L&T is going to be a long-haul bet, right?
Ravi Muthukrishnan: Exactly. That is precisely the reason. We have not put that as a short-term call. We have taken a six-month view on that stock. It is the strongest largecap company to be ideally positioned for the type of positives which are going to happen in the infrastructure space, well positioned to take advantage of the capital. This will happen very quickly. It has got the best management play and the strongest balance sheet. It has a huge experience behind it and, of course, we project that its earnings are going to grow at 18 per cent CAGR moving forward. The order book looks healthy and growing execution skills are great. For me, I have to pick one stock to capitalise on the infrastructure development or the capital revival in the economy, and for me the best bet is L&T.
ET Now: I would like to explore your thoughts on what is happening to the value end of the market, because markets are currently giving disproportionate premium to some of these quality stocks, starting from a Nestle to a 3M to a Pidilite, which you track. What are your thoughts there?
Ravi Muthukrishnan: One of the things I would still bet on is quality stocks. I have to play it safe in this market and I would rather bet on quality stocks. As it is a question of premium, the high or low premium should be looked at from a relative standpoint. For example, if you take most of these companies, their ROEs could be more than 50 per cent. So when you have such high ROEs, the spreads being very large, I do not see why they should not demand a premium. But will it move further from here on? Maybe yes, because if you think you have to take shelter in quality, these are the best stocks to look at.
ET Now: I guess Sun Pharma would be forming a part of your list of recommendations, because it is probably a value pick now because of the correction that has happened. The other interesting one is Maruti, which by any yardstick is not a value idea but is probably a growth idea?
Ravi Muthukrishnan: It is a growth idea and I still think the growth potential is very high for this company. I will tell you why is it so. One reason is, they have products across segments now. For example, from the entry level to the highend level. Now two things can happen because of the Seventh Pay Commission. With lots of money in the hands of these government employees, you would expect some of them to go for entry-level cars and some of them to trade. So if that is what is to happen, then you will have virtually all segments having huge demand from government employees going forward. Either way this is the best play in the domestic space, like I said before, because of the product portfolio they have and the wide distribution network they have. As of today, their valuations are still below their long-term averages. So growth looks good. Valuation is decently good enough because of the fact that it is lower than the long-term average. Their margins are improving and their quarterly results were good. So Maruti is still a good domestic play for me in the auto space.
ET Now: At the current level, that is the key question about Maruti. The ride has been phenomenal in last one year-and-a-half. For fresh entrants who have completely missed out on the Maruti story, do you still think it could be a good entry point?
Ravi Muthukrishnan: If I were to really play the auto theme in India and I want to look at stocks in the four-wheeler space, and I need to choose between Tata Motors and Maruti, I would still bet on Maruti for now.
ET Now: The other question that I had was with regard to the frenzy that we are seeing in some of the beaten down pockets, which may or may not necessarily hold water. For example, we have seen a big rally in sugar. Of course there has been a correction after that as well. But a sudden spurt in sugar because of a lot of talk about how global prices may move up. We have not quite seen that happening in the base metal companies as of now. Maybe that could happen because valuations seem interesting and, maybe, PSU banks as well wherein most of the large banks are trading sub-book as well. Do you find any merit in any of these three or some other beaten-down pockets currently?
Ravi Muthukrishnan: I will not be able to comment on sugar, because we do not cover that sector. In any case where there is a lot of regulatory pressure, I would want to stay away from that sector. PSU banks, if I were to look at it very closely, the NPA issues are still there. They do not have strong balance sheets and I am not really sure how they will live up to the challenges should they surface in the future.
To me, if I were to look at banks, I would prefer private banks because of the fact that their tier-1 capital is very strong. They have the power to withstand any sort of challenges that can come there way. Most of them have a retail focus. I think for banks the biggest driver should be their retail exposure, which unfortunately is pretty less in case of PSU players compared with the private banks. As for metals, I would want to wait because you never know how commodity prices will shape up despite the fact that valuations are very exciting. I would still want to stay away for some time with PSU banks, except for one or two in that space.
ET Now: Tell me what is your preference when it comes to the midcap segment of the market, because now it seems GST is going to be finalized, or at least a consensus is going to reach within the political parties on GST sooner than later. Logistics, we all have seen how they have been flying around; auto ancillaries have made great money for investors in the past. Suddenly, we are seeing a spurt in textiles, sugar as well as jute companies. Do you have anything that is looking interesting from this list?
Ravi Muthukrishnan: Yes. I would look at some of the midcap companies in the road space, in the logistics space. I cannot name stocks because I have not taken any approval for that. But I definitely like some of the stocks in the road space. I definitely like some of the stocks in the rail space, the coach space and logistics. We are excited about one or two stocks there. But in other sectors you talked about, sugar, as I said before we do not cover that sector. So I have no views on that sector.
ET Now: Would you have views on aviation now with the largest of the players actually listing and listing with a bang, so to speak? That sort of has rerated the entire sector. We have seen the moves on Jet or for that matter SpiceJet, which has seen a phenomenal run from 11 bucks or so on the stock?
Ravi Muthukrishnan: Yes. It is all because of the aviation fuel. So long as that lasts, the sector should do well. It has been on the business model as well. I think IndiGo really opened the eyes for investors in terms of their business model. But we do not cover that sector, so we do not cover IndiGo as well. So I may not be able to comment on that.
ET Now: Based on the thoughts that you expressed at the start of the interaction about what you believe the index could do or the market behaviour could be over the next 20 to 24 months and based on the ideas that you have given now, would it be fair to assume that if you were to play the market over the next 12-24 months, you would be basing your portfolio more on the largecaps, and midcaps would form a part but probably a smaller part of your current stock selection process?
Ravi Muthukrishnan: Definitely. See I would prefer largecaps for now. But I would not shun midcaps. I would like quality midcaps. Among the midcaps, though I do not expect that asset class to outperform, but I definitely see outperformance in some pockets in the midcap space, especially the quality names.
ET Now: At a time when the stock market is struggling with the earnings momentum and global headwinds, what explains the underlying interest in the smallcap and midcap indices? On a one-year basis, three-year basis and YTD basis, the smallcap and the midcap indices massively outperformed the benchmark indices.
Ravi Muthukrishnan: If you look at the midcaps in particular, they have done remarkably well since September last year. In fact, their outperformance against the largecaps is about 13 per cent so far this year. In terms of valuations, they are one standard deviation about their historical averages. If you look at the largecaps versus midcaps, the premium that the largecaps demand over the midcaps is roughly about 2 per cent on a medium-term basis and about 7 per cent on an average basis. That number seems to have come down dramatically. So going forward and looking at the earning season this year, the midcaps have not really done well. We have seen a lot of downgrades in the midcap space compared with the largecaps, where the upgrades have been far more than that in the midcaps. If you look at all of this in totality, I see scope for outperformance by the largecaps over midcaps going forward.
ET Now: So what sense do you get about the overall market? Would you say the worst is behind us in terms of earnings uncertainty on the Fed which is going to get over soon or do you think the market could witness another shakeoff once the Fed hikes rates in December?
Ravi Muthukrishnan: Let me put it very systemically. Look at what happened in the last couple of days. The government came out with a slew of reforms. For example, it came out with reforms of the subsidy regime, it increased FDI limits, it reformed the roads sector, came out with a subsidy-sharing formula and, most importantly, it came out with a cess for the Swachh Bharat programme, which showed it is very much against populist measures.
The second is, relative to other emerging markets, India is much better off. The simple reason is that commodity prices are low. Three major factors can affect all emerging markets, crude oil prices and Fed rate hike and a slowdown in China. All three are bad for countries like Brazil and Russia, but for India, at least two of the three factors would be positive. As such, we are far better placed than other emerging markets.
Third, FII flows have been bad in November, but DIIs have done extremely well, November has been slightly subdued because of the festive season. The earnings season has been bad, but a low base should drive earnings growth going forward.
So we are very positive about the earnings moving up in the next half of
FY16. Net-net if you look at all these factors, India is on a good wicket now. We have a target of 8,900 for Nifty50 based on FY17 earnings with the standard deviation multiple of 0.5 against the average of 14.8 for India. So 8,900 is our target and we are quite optimistic that a lot of positive things will come in the market. About the negative triggers for all of this, one is, of course, the GST itself. But I guess with all the problems that the government has been having with the opposition, something should emerge in this winter session.
Two, all of us are worried about the Fed rate hike, but more than the Fed hike, we are quite concerned about the rate hikes that can happen beyond that, because I believe the Fed rate hike has already been discounted in stock price. The third factor is about the earnings season turning much worse than what it is today, which I believe is little less of a concern because of the low base. The fourth, of course, is the budget itself. Should the government try to focus more on populist measures than on development measures, the market will not like it too much. But going by the current trends of what they did with the Swachh Bharat cess, less of populism is on the cards.
Ravi Muthukrishnan: We are equal weight on pharma as a sector, but among them we like Sun Pharma for two reasons; they have 400 approvals which have come in the US, and some more are in the pipeline. Taro and Ranbaxy businesses and many other business subsidiaries should be doing very well in the US. Gleevec is one of the products that will come into the market in February and, more important than all of this is the fact that their India business is doing well as is their prescription business.
They have a fantastic sales force, they are the best in this country. The integration benefits would be at least $300 million. So net-net, all of it places this company in a better position than many others. Yes, I have been reading some news about Taro investing some money in one of the wind mills, which is a small blip in the overall business proposition. But the company came out with the announcement that there is more towards tax savings. But net-net, if you look at the benefits and look at the positives against one negative, Sun Pharma should do very well post integration.
ET Now: The fall in the stock from the recent high is not a joke and great companies do not fall 40-50 per cent. Is the core business of Sun Pharma, which is the US business, coming under pressure because of USFDA problems, because of price erosion? I am actually worried about the core aspect rather than it investing in a wind power business or somewhere else for tax-saving purposes?
Ravi Muthukrishnan: Yes. But looking at the number of approvals they have got and the number of approvals that are in the pipeline and the way the company is performing, the Ranbaxy business is also contributing to that success in the US. There is less concern there… most of the problems are over, the stock should move upward from now.
ET Now: It is interesting to see that you have got L&T in your list irrespective of the kind of horrific management commentary that we saw in the quarter gone by. I am assuming L&T is going to be a long-haul bet, right?
Ravi Muthukrishnan: Exactly. That is precisely the reason. We have not put that as a short-term call. We have taken a six-month view on that stock. It is the strongest largecap company to be ideally positioned for the type of positives which are going to happen in the infrastructure space, well positioned to take advantage of the capital. This will happen very quickly. It has got the best management play and the strongest balance sheet. It has a huge experience behind it and, of course, we project that its earnings are going to grow at 18 per cent CAGR moving forward. The order book looks healthy and growing execution skills are great. For me, I have to pick one stock to capitalise on the infrastructure development or the capital revival in the economy, and for me the best bet is L&T.
ET Now: I would like to explore your thoughts on what is happening to the value end of the market, because markets are currently giving disproportionate premium to some of these quality stocks, starting from a Nestle to a 3M to a Pidilite, which you track. What are your thoughts there?
Ravi Muthukrishnan: One of the things I would still bet on is quality stocks. I have to play it safe in this market and I would rather bet on quality stocks. As it is a question of premium, the high or low premium should be looked at from a relative standpoint. For example, if you take most of these companies, their ROEs could be more than 50 per cent. So when you have such high ROEs, the spreads being very large, I do not see why they should not demand a premium. But will it move further from here on? Maybe yes, because if you think you have to take shelter in quality, these are the best stocks to look at.
Ravi Muthukrishnan: It is a growth idea and I still think the growth potential is very high for this company. I will tell you why is it so. One reason is, they have products across segments now. For example, from the entry level to the highend level. Now two things can happen because of the Seventh Pay Commission. With lots of money in the hands of these government employees, you would expect some of them to go for entry-level cars and some of them to trade. So if that is what is to happen, then you will have virtually all segments having huge demand from government employees going forward. Either way this is the best play in the domestic space, like I said before, because of the product portfolio they have and the wide distribution network they have. As of today, their valuations are still below their long-term averages. So growth looks good. Valuation is decently good enough because of the fact that it is lower than the long-term average. Their margins are improving and their quarterly results were good. So Maruti is still a good domestic play for me in the auto space.
ET Now: At the current level, that is the key question about Maruti. The ride has been phenomenal in last one year-and-a-half. For fresh entrants who have completely missed out on the Maruti story, do you still think it could be a good entry point?
Ravi Muthukrishnan: If I were to really play the auto theme in India and I want to look at stocks in the four-wheeler space, and I need to choose between Tata Motors and Maruti, I would still bet on Maruti for now.
ET Now: The other question that I had was with regard to the frenzy that we are seeing in some of the beaten down pockets, which may or may not necessarily hold water. For example, we have seen a big rally in sugar. Of course there has been a correction after that as well. But a sudden spurt in sugar because of a lot of talk about how global prices may move up. We have not quite seen that happening in the base metal companies as of now. Maybe that could happen because valuations seem interesting and, maybe, PSU banks as well wherein most of the large banks are trading sub-book as well. Do you find any merit in any of these three or some other beaten-down pockets currently?
Ravi Muthukrishnan: I will not be able to comment on sugar, because we do not cover that sector. In any case where there is a lot of regulatory pressure, I would want to stay away from that sector. PSU banks, if I were to look at it very closely, the NPA issues are still there. They do not have strong balance sheets and I am not really sure how they will live up to the challenges should they surface in the future.
To me, if I were to look at banks, I would prefer private banks because of the fact that their tier-1 capital is very strong. They have the power to withstand any sort of challenges that can come there way. Most of them have a retail focus. I think for banks the biggest driver should be their retail exposure, which unfortunately is pretty less in case of PSU players compared with the private banks. As for metals, I would want to wait because you never know how commodity prices will shape up despite the fact that valuations are very exciting. I would still want to stay away for some time with PSU banks, except for one or two in that space.
Ravi Muthukrishnan: Yes. I would look at some of the midcap companies in the road space, in the logistics space. I cannot name stocks because I have not taken any approval for that. But I definitely like some of the stocks in the road space. I definitely like some of the stocks in the rail space, the coach space and logistics. We are excited about one or two stocks there. But in other sectors you talked about, sugar, as I said before we do not cover that sector. So I have no views on that sector.
ET Now: Would you have views on aviation now with the largest of the players actually listing and listing with a bang, so to speak? That sort of has rerated the entire sector. We have seen the moves on Jet or for that matter SpiceJet, which has seen a phenomenal run from 11 bucks or so on the stock?
Ravi Muthukrishnan: Yes. It is all because of the aviation fuel. So long as that lasts, the sector should do well. It has been on the business model as well. I think IndiGo really opened the eyes for investors in terms of their business model. But we do not cover that sector, so we do not cover IndiGo as well. So I may not be able to comment on that.
ET Now: Based on the thoughts that you expressed at the start of the interaction about what you believe the index could do or the market behaviour could be over the next 20 to 24 months and based on the ideas that you have given now, would it be fair to assume that if you were to play the market over the next 12-24 months, you would be basing your portfolio more on the largecaps, and midcaps would form a part but probably a smaller part of your current stock selection process?
Ravi Muthukrishnan: Definitely. See I would prefer largecaps for now. But I would not shun midcaps. I would like quality midcaps. Among the midcaps, though I do not expect that asset class to outperform, but I definitely see outperformance in some pockets in the midcap space, especially the quality names.
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