Unlike Argentina against Saudi, India must perform, not run on its reputation: Nilesh Shah

“In some sense, we are like the Argentina against the Saudi Arabia match where with players like Lionel Messi, there were expectations that Argentina would dominate and win the match. Markets are discounting most of the positives and hence it is important that we deliver and we do not run on reputation and rather, we run on actual performance,” says Nilesh Shah, MD, Kotak AMC

The market veteran also said Kotak is looking to accumulate IT stocks on a bottom up basis over next 3-6 months. Edited excerpts

At the current juncture, looking at where we are, where inflation concerns are getting doused and where markets are reconciling to the fact that commodity prices are down and global markets are looking much more stable, are we in for a good patch for the next couple of months?
The market has discounted most of the positives which you have mentioned – India growth ahead of global growth, commodity prices including oil softening, inflation coming under control in India from Jan 2023 onwards and globally also central banks slowing down their rate hikes and more capital flows into India.

In some sense, we are like Argentina against the Saudi Arabia match where with players like Lionel Messi, there were expectations that Argentina would dominate and win the match. Markets are discounting most of the positives and hence it is important that we deliver and we do not run on reputation and rather, we run on actual performance.

What is the definition of actual performance? From a stock market standpoint, will it be the macro? Will it be the earnings growth? Will it be the trajectory of how banks are moving?
It is very surprising that in the September 2022 quarterly result for Nifty 500 companies, EBITDA margins have actually come down sharply. They are lower than even June ‘20 quarter.

Now because sales are higher than June 20 quarter, absolute EBITDA as well as absolute net profit after tax is higher than June 20 quarter but the EBITDA percentage reduction does show that companies do not have pricing power or they have not been able to pass on the raw material cost increases to the consumers.

Clearly we need EBITDA margin to expand or sales value to expand at a much faster pace. Maybe September 2022 quarter was bearish, December 2022 thanks to the festival season could see an uptick in EBITDA margin. At the end of the day, the market will be looking forward to profitability and earnings.

Undoubtedly, our governance as well as commitment to green both will be counted and that will give us a premium to other emerging markets. But the biggest driver for return from here onwards will be earnings growth.

Is that the reason that there is a lot of thrust towards the FMCG/consumer space? Is there an optimism when it comes to earnings revival within FMCG?
In FMCG, apart from earnings growth, there is also a realisation that these are the stocks where there is no issuance. It is easy to get out of some of those FMCG stocks but very very difficult to get in. Over the last year or so, people have realised that and hence the sellers are reluctant. They are happy to absorb one or two quarters of underperformance because the long- term story remains always better.

My feeling is that it is the lack of selling which has ensured that the FMCG stocks continue to trade at a higher valuation. Apart from that, there is a long-term growth story that eventually India will move towards lower middle income country and middle income country, boosting consumption.

Given that IT has seen quite a bit of interest of late, do you think that with valuations turning a lot more compelling for the IT sector, this is a space for investors to park their money?
Definitely. This is the time to start accumulating IT stocks. They have some headwinds still coming in terms of demand uncertainty. However, some of the pressure in terms of salaries and wages costs has started reducing substantially. Valuations have corrected quite significantly and more importantly, these have the cleanest of balance sheets with one of the best governance. As Nasdaq bottoms out and starts moving up, there will be a rub-off effect on Indian IT companies so we will be looking to accumulate IT stocks on a bottom up basis over next three to six months.

As we go towards the year end and the new year, some zing seems to be missing. How do you anticipate the year ending for India and next year do you think India is going to stay an outperformer given all the kind of noise we have started to hear from China?
Next year will be a fight between flows and fundamentals. India’s weight in emerging markets has moved from about 8% to 16% and that will probably go up higher as HDFC Bank enters into MSCI emerging markets. It can go even further higher if Korea gets upgraded from an emerging market to the developed market.

There is also a trend where many investors are looking for MSCI emerging market ex China indices. If that trend picks up, there could be more flows to India. The domestic institutional investor flows also continue. Clearly on one side, we believe next year FPI as well as domestic institutional investors will be net buyers in the market.

On the other hand, there is the earnings growth trajectory. We are at a stage in valuation where we trade at a marginal premium to long-term averages. However, we trade at a substantial premium to other emerging markets. It is not that our valuation has expanded by much but their valuations have corrected significantly.

If our earnings growth delivers better than my peer group, then those premiums can be justified and then fundamentals and flow ensure that India is an outperformer. However, if September 2022 quarterly result strength continues where earnings growth is muted, then there will be a fight between fundamentals and flows and India may not be an outperformer.

It would suffice to say earnings growth next year will determine whether India is an outperformer, market performer or underperformer.