Valuations in India have reached a point where there is hardly any margin for error left particularly in sectors where one would love to invest, said Manishi Raychaudhuri, Asia-Pacific Equity Strategist, BNP Paribas. He also said that it was too early to draw a conclusion that foreign investors had turned bullish on India as a reversal of trends had happened across all emerging markets. Excerpts:
How are India’s valuations vis a vis the other Asian markets?
Till late November, India’s valuation premium relative to Asian peers was looking set to converge to its long-term average. But over the last couple of months, India’s outperformance has expanded the valuation gap again. Currently, I think on both price-earnings and price to book, India is around 50% more expensive than the regional average.
What does it mean in terms of foreign flows?
If this buoyancy in the American markets continues for a while, India would be as much a beneficiary as its emerging market peers. Having said this, I think for foreign investors to get enthused incrementally about India, we need slightly cheaper valuations. We also need some clarity on earnings environment. In India, we are still seeing consensus earnings declining. Even after the recent declines and recent earnings estimate cuts, overall the earnings estimates seem slightly overstated. So, I think once the earnings estimates settle down to more achievable levels and once the market gets cheaper again, that will be the trigger for FII players to pick up.
U.S. President Trump’s policies are being keenly watched. Are there sectors other than IT that may be impacted by U.S. policies?
India has 2-3 significant exporting sectors. IT is the most obvious one. Apart from that, we also have pharmaceuticals or the generic drugs segment. And there we have seen increasing vigilance from the Food & Drug Administration in the U.S. So obviously some of these exporting sectors — IT, pharmaceuticals, maybe even some of the textile and garment exporters — they will have to watch out for some of these potential trade restrictions that might come up.
Different views have come in on demonetisation. Your perspective?
Honestly, the impact of demonetisation in numerical terms is impossible to estimate at this point, simply because this type of an experiment has not been tried anywhere historically. We can only guess the impact from visible statistics. If you look at the earnings that have come up from the organised sector, Indian companies in the Oct.-Dec. quarter..., have not really been that bad. I think that the impact of demonetisation on profit earnings, on GDP growth, it will possibly be a 2-3 quarter phenomenon. There may be some sectors which will have spillover effect into the April-June quarter. Post-demonetisation, BNP Paribas’ economics group has reduced India’s GDP growth estimate for FY17 by about 80 bps.
What is your target for the Sensex in 2017?
By the end of 2017, we have a published Sensex target of 30,300. That means about 5% - 6% upside from here, which would imply that the market has possibly moved up too sharply, too soon. It’s moved up 10% in a matter of two months. That is why in the short term we are a little cautious about the way the market could behave. A correction could provide investors a better entry opportunity. Over the long term, however, we remain overweight on India in our Asian Model Portfolio.
Which sectors are you bullish on?
The sectors we are positive we divided into four silos. The first are the so-called consumption rebound beneficiaries. There, we look at both consumer staples selectively and the consumer discretionary sector in particular. The auto sector, particularly those companies which cater to rural and semi-urban consumption recovery, appears interesting to us. The second silo contains the potential investment recovery beneficiaries but here we are very selective because many of the industrial companies or the building material companies, which are the principal candidates, are also highly leveraged.
The third are the private sector banks, particularly those focussed on retail lending and not so much on corporate lending. Finally, despite headwinds from potential H-1B visa restrictions, we haven’t turned negative on IT services. They are cash generators and we expect the recent spate of buy-backs to continue.
And, sectors you would stay away from?
The first would be hard commodities, particularly metals and mining. The second, though it has had a sharp rally on the back of merger news recently, is telecom. We also are very cautious of highly leveraged companies in materials, industrials, and in property.
Corporate governance has been a hot topic of late.
I think investors in general are paying much greater degree of attention to corporate governance now than they ever used to. The extent of investor activism is rising all across Asia. They are clearly questioning the management a lot more. We have seen the emergence of proxy advisory firms to aid that process. All this is likely to lead to a much better governance landscape for companies in Asia. Within Asia, we believe Indian corporate governance standards would possibly fall in the top quartile. It’s relatively easy to find large frontline companies in India with reasonably good governance and disclosure standards than in most other Asian markets. This ease of stock selection, apart from higher return ratios, makes India attractive to secondary market investors, in our opinion.
