Mid-cap valuations are still higher than their 10-year average, further decline is still possible
In current volatile market, we are evaluating companies and sectors that are demonstrating higher growth than the market with a focus on management quality and corporate governance practices, says Shibani Kurian, Sr. Vice President and Head of Equity Research, Kotak Mahindra Asset Management Company.
In an interview with Moneycontrol’s Hiral Thanawala, Kurian talks about the pain in mid-cap stocks and valuations, impact of rising oil prices on equity market, stock selection strategy, new emerging sectors to watch out for and much more. Following are edited excerpts of the interaction:
What is your outlook on the stock market in medium term?
Our view is that markets will remain volatile as long as there is a tussle between macro and micro parameters. On the macro front, two things worry us the most; one is the Current Account Deficit (CAD) and given that oil prices are on their way up we expect CAD to be in the range of 2.7-2.8 percent of GDP this year. With CAD moving up, funding the deficit becomes a challenge. The second concern that we have is on the banking sector. On ground, today, 11 public sector banks (PSBs) are under RBIs prompt corrective action which means that they can’t lend. Also, PSBs have become extremely risk averse and they want to largely lend to AAA corporates. With signs of demand picking up, it is possible that a situation of credit squeeze in the economy can actually accentuate especially if no structural solution is found to address the issues of PSBs and adequate capital is provided to these banks.
On micro front, from our assessment of the situation on the ground and what we are seeing in terms of high frequency data, there are clear signs of improvement in demand. It means that consumption demand is still strong and therefore overall growth is likely to pick up. However, as global macro worries remain such as rising oil prices, trade war between countries, rising US bond yield and the Dollar being strong we could see some flight of capital from emerging markets to developed markets.
What will be the impact on market if oil prices continue to rise?
Rising oil prices is clearly a risk from a domestic macro perspective. It will have different impact across parameters. First impact is on CAD and we believe that at prevailing prices, CAD this year would be in the range of 2.7-2.8 percent of GDP. Further, higher oil prices would also have direct and indirect impact on inflation. While, oil component is not as high in the CPI basket as much as in WPI but still there will be an impact in terms of inflation and would form a factor that RBI takes into account while formulating monetary policy. Thirdly in terms of fiscal deficit, government has budgeted subsidies at a significantly lower oil price. So now, if oil stabilizes at the current level then government has to rework its subsidy assumptions and that could put some pressure on fiscal deficit. That pressure can be offset if tax collections are better than expected and GST collections picks up from hereon.
What is your assessment of current mid-cap valuations?
Midcaps have already seen a huge correction this year. However, mid-cap valuations are still higher than their 10-year average and remain at a premium to large-cap valuations. This gives us a sense that there could be further pain in the mid-cap space. From here on, it is possible that the downside is not as acute as what we have seen in the last few months but some further decline on the mid-cap side is still possible.
What is your stock selection strategy in the portfolio?
Our investment philosophy is growth at a reasonable price. We follow a model where emphasis is on three parameters i.e. corporate governance, capital allocation policies and the company’s balance sheet with a focus on return ratios. Second, we also look at high growth companies with scalable business models and also those companies, which are gaining market share in the industry that they operate in. So, high growth and high quality is the focus.
Which sectors are looking attractive for long-term investment?
One sector where we believe growth has been strong is domestic consumption. Now, here, we mean not just FMCG and consumer durables but we have looked at consumption as a wider basket. This includes segments such as automobiles for instance (passenger vehicles, tractors and two-wheeler manufacturers) and retail private sector banks which are finding an opportunity to grow and gain market share.
Any sector which you are cautious about and are staying away?
Telecom is one sector which we are staying away from. We have already seen consolidation in this sector and we have three large players fighting for market share. Despite the consolidation, pricing power is not coming back and we don’t see profitability improving in the near term. Metals is another sector wherein there is cyclicality and volatility among the stocks. US dollar strength is also impacting metal prices and the sector has several global linkages, the outlook for which are uncertain at this juncture.
What are the emerging sectors to watch out for long-term investment?
There are new entrants in financial services space which could change the dynamics of the sector over the medium term. These include small finance banks, payment banks and niche NBFCs which are promising. These companies however need to demonstrate that their business models really work.
General insurance as a space is also a new segment in the listed markets and is an interesting space. There were a few listings in the past year. Since these listings and on the back of the proposed consolidation of some of the PSUs players, a lot of rationality in pricing has emerged. It means profitability of the sector is improving. At present, overall sector is registering losses at the underwriting level but as the pricing starts to move up and people are not irrational in terms of competition then underwriting profitability and return on equity will also trend upwards.
