Since we have elections in the first half, markets could be range-bound but in the latter half, it could deliver decent returns, Mahesh Patil, Co-CIO, ABSL MF, tells ET Now.
Edited excerpts:
Whether he is bullish on 2019
2019 is going to be a year where you would see some improvement in the macro front. We have already seen that happen in the last two months and the bottom-up story will continue to play out. We have seen earnings growth start to pick up in the last two quarters. That momentum should continue into CY19 and you should see fairly strong earnings growth coming in again from a lower base. The banking sector has got strong growth and the consumer sector and other sectors like infrastructure and construction should see a good recovery getting into the next calendar year.
Looking at where the valuations are currently and some of the macro headwinds on the global front, I would say 2019 would be a year where one should be positive but expect moderate returns because A) we are starting the year with not very attractive valuations. The PE multiples for the market are probably 10% higher than the long-term average but earnings growth has not kept pace.
Long-term average multiples would be around 16 times PE multiple. Since we have elections in the first half, markets could be range-bound but in the latter half, it could deliver decent returns. Expectations should be more moderate going forward.
Not really. What we are expecting is that irrespective of whoever comes to power, the reforms should continue going forward. We do not see any impact on that.
Even with the coalition?
Yes. We have seen that earlier also. Whatever momentum you have in the economy and the corporate recovery, that should not get impacted by any kind of government and we do not see any reversal of the reforms already undertaken. Obviously, if there is some instability on the political side and that could be a temporary phenomenon, the PE multiples could get impacted and that is what we are already factoring in. We are expecting that some kind of derating of multiples could happen. We have seen that earlier also in the past elections that whenever the results have not been in line with expectations, markets have reacted initially, but in the subsequent months, have regained those points, depending on the underlying fundamentals.
That should play out and post elections, three-six months down the line, the fundamentals will really catch up with the markets and that is what will drive the market going forward.
While the PE multiples look higher than the long-term average, I would like to emphasise that the earnings are still depressed. Compared to the long-term average, the overall ROE for the Nifty or profit as a percent of sales, are almost at a seven-year, eight-year low. On lower depressed earnings, the market is still comfortable paying a higher PE multiple. Over a longer term, the PE multiple could normalise, but in the near term, as the earnings trajectory growth, as it tries to really come out from a depressed numbers, the growth numbers could be slightly better than even the long-term average. That is what we are expecting.
Even after the downgrade, after these quarterly numbers, the earnings growth for FY20 is upwards of 20%.
On making a case for 20-20 odd percent growth in FY20
When we break down the growth component in Nifty, the banking and financial services sector has got around 35% weightage. Their growth will be fairly strong again. It probably can be called as a base effect especially as the growth in top three or four corporate banks would be the key drivers for growth.
So if you remove the corporate banks or the banking sector, then the growth will be around 14% or so, which is a more realistic moderate number that one is expecting. Across the board, as you move forward, we are seeing some momentum coming back into the capital goods sector.
The capital goods companies are starting to show increase in terms of order book. Post elections, you will see momentum start to pick up in the order build up but more important, execution before the election normally tends to pick up. That should drive better growth.
Consumer staples have been fairly good and despite the increase in inflationary pressures, they should be able to maintain their margins and the push by the government on the rural sides should drive consumption fairly strong. We expect strong numbers coming in from the consumer pack to drive the earnings and then all the other sectors will contribute more or less in the low teens.
On SEBI decision to allow MFs to segregate distressed and illiquid assets
It is a good move and which is something which the industry has been asking for it because it takes care of certain defaults on the existing book during times of crisis . We can keep those assets aside in a separate account and that helps in terms of getting back new investors.
On what happens in IL&FS case
All the existing investors in the fund will be given proportionate units in that separate account. So any new investors after that who comes in, will have a portfolio which is cleansed from those toxic assets.
As and when recovery happens in that because that portfolio will mark to market down, it does not mean that there will be losses on that. They will have a normal regulation process which it will go through and whatever recovery happens in that portfolio, will be paid back to the existing investors who were there prior to the demerger of that asset.
On accountability of fund managers if assets go bad
There is no question about that. The accountability remains the same. The impact on the existing investors remains the same. It is only to ensure that new investors who are coming in are not concerned by the underlying assets.
We have seen earlier that when these kind of cases happen, there is a pressure of redemptions and no new investors come in because they are worried about some part of the portfolio which they do not want to have because of the concerns on the asset quality. The impact on NAV remains the same.
So, I do not think it really dilutes the whole process in terms of fund managers taking risk. Again, it will only be done in extreme situations. I do not think we are worried that it will lead to fund managers taking additional risk or diluting the whole process of due diligence. That is not going to happen.
Whether Indian market is mature enough for commodity derivatives
It is still too early. One has to really look into it and see how one can really come out with products around that and look at the depth in that market. Some of the commodity derivatives are pretty liquid but it is not across the board. We will have to work out and sit down and see how we can look at that opportunity and come out with products which give a decent look at the risk return and the volatility in that segment.
The structure is important because every one month you have to roll these products. So, one has to look at the risk also. We cannot take longer term view there. It is too but clearly but the mutual fund industry will look into it and come out with some products down the line.
How do you see the banking system change?
We have seen the overall stress on the banking system which went through the NPA cycle having peaked out and that would start to reflect on the P&L and lower provisioning going forward. That is already underway.
Second. With all the challenges in the NBFC sector, we have seen the banking sector trying to gain market share and so the credit growth has been fairly strong. The credit growth number has been around 14-15%. That should help the growth for the banking sector.
There will be some improvement on the margin front because some pricing power is coming back to the banking sector. The corporate bond spreads have gone up and for the banks the borrowing cost is not too much on the liability side. So, there should be some margin improvement.
With the bond yields having eased off significantly, we have seen a 70 bps decline over there with some gains on the investment book, especially for the PSU banks which could come in pretty handy at this point in time, when they are struggling in terms of profitability.
All these factors would lead to an improved outlook for the banks. For the PCA banks, we do not know exactly how much relaxation would be there but if the government is able to introduce the capital infusion which they have talked about in the budget, that should be good.
But PSU banks will also have challenges because the market will be worried about farm loan waivers. That could weigh down the PSU banking sector but by and large, it should see some relief in terms of an improvement in margins and the fresh slippages ratio can come down and that would provide some relief on the loan loss provisioning. It should be good for most of the banks to report strong earnings coming from a very low base, especially for the corporate banks.
Big election bet in 2019 as a theme
One would not like to bet anything on the elections because we do not know the outcome. Rather we would look at themes which could play out irrespective of the elections and that is the best way to play because betting on election outcome is not something which we would like to do.
The broader themes would be a) the banking and financial services sector. They are steady I think we should see an improvement over there.
b) The consumer discretionary sector has seen a setback in the last two quarters because of certain concerns about and consumer confidence got impacted. The tight liquidity situation hurt in terms of availability of credit to that sector. Those things will normalise and the whole implementation of GST also has not been as great and post election, you will see a more rigorous implementation of that.
The shift from unorganised to organised which we were expecting to happen. did not happen to that extent and that should benefit the consumer discretionary space going forward.
C) Capital goods sector as we are seeing capacity utilisation levels move up in this sector. People are not still doing capex because they want to wait for the election outcome before committing any large capex. That should gain traction post the elections. These are the two three sectors which one can look at positively again irrespective of the election outcome I would say.
On justifying paying 50 and 60 times PE for 12-13% growth in FMCG basket
The consumer staples within that are looking fairly expensive on the PE multiples and there the returns could probably moderate down. We are not really so much overweight on the consumer staples. It is more of the consumer discretionary or the consumer durables and other retailing companies which are also expensive but there the growth rates could surprise positively going forward. There is earnings stability in consumer staples. Growth is fairly healthy and rural growth has been fairly steady. There are concerns about other sectors, but as the broader market starts to do better, some of these stocks could relatively underperform.
It is a question about absolute performance. The stocks could give absolute returns but can they give pretty large returns? Probably not.
Do you have to play for outperformance or just performance now?
The headline market returns would be more moderate looking at the overall macro concerns. It should be more of a bottom up and companies and our view is that with steady growth and the returns not being very high, we are not really targeting companies which can give you exaggerated returns or multi baggers. It is more a protection on the downside and a steady return.
At present, there are a lot of challenges both globally and domestically. So wherever there is earnings visibility, steady earnings growth and moderate returns, that is where one should focus on. There are stocks and sectors which are pretty depressed in terms of valuations. One can even look at those when some stability and confidence comes back in the market,You could probably get potentially oversized returns because valuations are depressed. If you are able to get a PE rerating, that is where you will make the multi returns. But one should not really expect that over the next six months.
Edited excerpts:
Whether he is bullish on 2019
2019 is going to be a year where you would see some improvement in the macro front. We have already seen that happen in the last two months and the bottom-up story will continue to play out. We have seen earnings growth start to pick up in the last two quarters. That momentum should continue into CY19 and you should see fairly strong earnings growth coming in again from a lower base. The banking sector has got strong growth and the consumer sector and other sectors like infrastructure and construction should see a good recovery getting into the next calendar year.
Looking at where the valuations are currently and some of the macro headwinds on the global front, I would say 2019 would be a year where one should be positive but expect moderate returns because A) we are starting the year with not very attractive valuations. The PE multiples for the market are probably 10% higher than the long-term average but earnings growth has not kept pace.
Long-term average multiples would be around 16 times PE multiple. Since we have elections in the first half, markets could be range-bound but in the latter half, it could deliver decent returns. Expectations should be more moderate going forward.
On whether expecting a clear mandate in 2019
Not really. What we are expecting is that irrespective of whoever comes to power, the reforms should continue going forward. We do not see any impact on that.
Even with the coalition?
Yes. We have seen that earlier also. Whatever momentum you have in the economy and the corporate recovery, that should not get impacted by any kind of government and we do not see any reversal of the reforms already undertaken. Obviously, if there is some instability on the political side and that could be a temporary phenomenon, the PE multiples could get impacted and that is what we are already factoring in. We are expecting that some kind of derating of multiples could happen. We have seen that earlier also in the past elections that whenever the results have not been in line with expectations, markets have reacted initially, but in the subsequent months, have regained those points, depending on the underlying fundamentals.
That should play out and post elections, three-six months down the line, the fundamentals will really catch up with the markets and that is what will drive the market going forward.
On whether to buy big or just nibble in run-up to election
While the PE multiples look higher than the long-term average, I would like to emphasise that the earnings are still depressed. Compared to the long-term average, the overall ROE for the Nifty or profit as a percent of sales, are almost at a seven-year, eight-year low. On lower depressed earnings, the market is still comfortable paying a higher PE multiple. Over a longer term, the PE multiple could normalise, but in the near term, as the earnings trajectory growth, as it tries to really come out from a depressed numbers, the growth numbers could be slightly better than even the long-term average. That is what we are expecting.
Even after the downgrade, after these quarterly numbers, the earnings growth for FY20 is upwards of 20%.
On making a case for 20-20 odd percent growth in FY20
When we break down the growth component in Nifty, the banking and financial services sector has got around 35% weightage. Their growth will be fairly strong again. It probably can be called as a base effect especially as the growth in top three or four corporate banks would be the key drivers for growth.
So if you remove the corporate banks or the banking sector, then the growth will be around 14% or so, which is a more realistic moderate number that one is expecting. Across the board, as you move forward, we are seeing some momentum coming back into the capital goods sector.
The capital goods companies are starting to show increase in terms of order book. Post elections, you will see momentum start to pick up in the order build up but more important, execution before the election normally tends to pick up. That should drive better growth.
Consumer staples have been fairly good and despite the increase in inflationary pressures, they should be able to maintain their margins and the push by the government on the rural sides should drive consumption fairly strong. We expect strong numbers coming in from the consumer pack to drive the earnings and then all the other sectors will contribute more or less in the low teens.
On SEBI decision to allow MFs to segregate distressed and illiquid assets
It is a good move and which is something which the industry has been asking for it because it takes care of certain defaults on the existing book during times of crisis . We can keep those assets aside in a separate account and that helps in terms of getting back new investors.
On what happens in IL&FS case
All the existing investors in the fund will be given proportionate units in that separate account. So any new investors after that who comes in, will have a portfolio which is cleansed from those toxic assets.
As and when recovery happens in that because that portfolio will mark to market down, it does not mean that there will be losses on that. They will have a normal regulation process which it will go through and whatever recovery happens in that portfolio, will be paid back to the existing investors who were there prior to the demerger of that asset.
On accountability of fund managers if assets go bad
There is no question about that. The accountability remains the same. The impact on the existing investors remains the same. It is only to ensure that new investors who are coming in are not concerned by the underlying assets.
We have seen earlier that when these kind of cases happen, there is a pressure of redemptions and no new investors come in because they are worried about some part of the portfolio which they do not want to have because of the concerns on the asset quality. The impact on NAV remains the same.
So, I do not think it really dilutes the whole process in terms of fund managers taking risk. Again, it will only be done in extreme situations. I do not think we are worried that it will lead to fund managers taking additional risk or diluting the whole process of due diligence. That is not going to happen.
Whether Indian market is mature enough for commodity derivatives
It is still too early. One has to really look into it and see how one can really come out with products around that and look at the depth in that market. Some of the commodity derivatives are pretty liquid but it is not across the board. We will have to work out and sit down and see how we can look at that opportunity and come out with products which give a decent look at the risk return and the volatility in that segment.
The structure is important because every one month you have to roll these products. So, one has to look at the risk also. We cannot take longer term view there. It is too but clearly but the mutual fund industry will look into it and come out with some products down the line.
How do you see the banking system change?
We have seen the overall stress on the banking system which went through the NPA cycle having peaked out and that would start to reflect on the P&L and lower provisioning going forward. That is already underway.
Second. With all the challenges in the NBFC sector, we have seen the banking sector trying to gain market share and so the credit growth has been fairly strong. The credit growth number has been around 14-15%. That should help the growth for the banking sector.
There will be some improvement on the margin front because some pricing power is coming back to the banking sector. The corporate bond spreads have gone up and for the banks the borrowing cost is not too much on the liability side. So, there should be some margin improvement.
With the bond yields having eased off significantly, we have seen a 70 bps decline over there with some gains on the investment book, especially for the PSU banks which could come in pretty handy at this point in time, when they are struggling in terms of profitability.
All these factors would lead to an improved outlook for the banks. For the PCA banks, we do not know exactly how much relaxation would be there but if the government is able to introduce the capital infusion which they have talked about in the budget, that should be good.
But PSU banks will also have challenges because the market will be worried about farm loan waivers. That could weigh down the PSU banking sector but by and large, it should see some relief in terms of an improvement in margins and the fresh slippages ratio can come down and that would provide some relief on the loan loss provisioning. It should be good for most of the banks to report strong earnings coming from a very low base, especially for the corporate banks.
Big election bet in 2019 as a theme
One would not like to bet anything on the elections because we do not know the outcome. Rather we would look at themes which could play out irrespective of the elections and that is the best way to play because betting on election outcome is not something which we would like to do.
The broader themes would be a) the banking and financial services sector. They are steady I think we should see an improvement over there.
b) The consumer discretionary sector has seen a setback in the last two quarters because of certain concerns about and consumer confidence got impacted. The tight liquidity situation hurt in terms of availability of credit to that sector. Those things will normalise and the whole implementation of GST also has not been as great and post election, you will see a more rigorous implementation of that.
The shift from unorganised to organised which we were expecting to happen. did not happen to that extent and that should benefit the consumer discretionary space going forward.
C) Capital goods sector as we are seeing capacity utilisation levels move up in this sector. People are not still doing capex because they want to wait for the election outcome before committing any large capex. That should gain traction post the elections. These are the two three sectors which one can look at positively again irrespective of the election outcome I would say.
On justifying paying 50 and 60 times PE for 12-13% growth in FMCG basket
The consumer staples within that are looking fairly expensive on the PE multiples and there the returns could probably moderate down. We are not really so much overweight on the consumer staples. It is more of the consumer discretionary or the consumer durables and other retailing companies which are also expensive but there the growth rates could surprise positively going forward. There is earnings stability in consumer staples. Growth is fairly healthy and rural growth has been fairly steady. There are concerns about other sectors, but as the broader market starts to do better, some of these stocks could relatively underperform.
It is a question about absolute performance. The stocks could give absolute returns but can they give pretty large returns? Probably not.
Do you have to play for outperformance or just performance now?
The headline market returns would be more moderate looking at the overall macro concerns. It should be more of a bottom up and companies and our view is that with steady growth and the returns not being very high, we are not really targeting companies which can give you exaggerated returns or multi baggers. It is more a protection on the downside and a steady return.
At present, there are a lot of challenges both globally and domestically. So wherever there is earnings visibility, steady earnings growth and moderate returns, that is where one should focus on. There are stocks and sectors which are pretty depressed in terms of valuations. One can even look at those when some stability and confidence comes back in the market,You could probably get potentially oversized returns because valuations are depressed. If you are able to get a PE rerating, that is where you will make the multi returns. But one should not really expect that over the next six months.
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