“We have been underweight on lending financials for 6-9 months. Banks are struggling to maintain high ROEs. Core profitability is hurt by pricing pressure across most segments,” says Aditya Sood, Fund Manager at InCred Asset Management.

In an interview with ETMarkets, Sood said: “Capital levels are now much higher. Banks feel compelled to hold CET1 at >15%, under pressure from regulators and rating agencies” Edited excerpts:

Nifty has run into some turbulence ahead of the Interim Budget 2024. What is weighing on D-Street or is it just profit taking?
Aditya Sood: On the domestic front the leading economic indicators point to a 7% plus GDP growth, inflation being in RBI’s targeted range, the fiscal deficit and the current account deficits are under control, the domestic flows are resilient at USD 22.3 bn in CY23 backed by monthly SIP flow of USD 2bn, FII flows bounced back during the year.

FIIs turned buyers with inflows of USD21.2b in CY23 vs. outflows of USD17b in CY22. The Nifty-50 delivered a 30% earnings growth in 1HFY24.

The leading economic indicators (GST collections, auto monthly numbers, power demand, PMI data, et al.) indicate that earnings momentum will continue to remain intact in 2HFY24.

Corrections are a part of any bull market and are healthy for the long-term trend of the market. Having performed so strongly in recent years, India’s equity market may take a breather for a period.

Do you think Indian markets are trading at a large premium compared to historic averages and peers? But in the past, we have seen markets sustain rally even though they might be overvalued.
Aditya Sood: India has traded at higher valuation levels than other emerging markets for years and its current valuations are high again, following the recent outperformance.However, over more than 20 years, the MSCI India Index has outperformed the MSCI EM Index by 2.3% annualised despite these high valuations.India’s premium relative to other emerging markets is a function of the superior profitability profile of Indian companies and superior ROE profile vis-à-vis emerging market peers.

We believe that India’s market premium is supported by powerful demographic trends, increasing urbanisation and rising wealth, export growth, geopolitical tailwinds, and an enabling policy regime.

These factors are coalescing at a time when the corporate deleveraging cycle of the last few years is coming to an end and as India enters a new upcycle in corporate profitability.

What are your expectations from Interim Budget 2024?
Aditya Sood: As in FY24 the main aim of the government was to tread the fine line between populism – considering it is an election year, growth – in a slowing growth environment globally and staying the course on fiscal prudence, the government has till now managed it well.

As a result of strong domestic demand and higher-than-expected economic growth, the tax collections were buoyant, providing the government with much-needed cushion.

An area wherein one can expect some announcements would be disinvestment because the government only has achieved ~17% of the target till November.

On the capex front, the budget will put an emphasis on spending for development while also providing a foundation for advancing the industrial and infrastructure sectors.

However, the rate of growth in the capex spending will be at a slower pace, compared to what was seen in post-covid years.

As the upcoming budget will be an interim one, we do not expect any major announcement, although we believe Railways and the roadways to see major capex expansion in FY25.

If someone is planning to put in money at current levels – do you think risk-to-reward is favourable? What is the kind of time horizon that one should look at if someone is putting in fresh money?
Aditya Sood: In the new year 2024, several tough questions confront investors. At a portfolio level, should investors look to take profits or wait for a correction to deploy incremental capital and increase the equity exposure, will the geopolitical crises escalate and how it impact the markets?

We would recommend a staggered deployment approach for investors in the current environment. One should have a 3–5-year horizon while allocating incremental capital in this market.

The opportunity set has narrowed after a good year of returns still there are pockets of opportunities in stocks on a bottom-up basis. Our portfolio-building approach has been agnostic to market capitalisation and sectors.

Which sectors are you overweight on for the year 2024?
Aditya Sood: We have a positive stance on discretionary consumption which is driven by rising consumer discretionary spending as it gains share in total consumption, as per-capita GDP has crossed the important US$2,000 mark.

The number of households earning more than USD 3500 has the potential to grow 5-fold over the next decade. People upgrading from the bottom of the pyramid makes us constructive on low unit consumption in India, we expect a recovery in rural demand.

Are there any sectors on which you think one should go underweight on or book profits?
Aditya Sood: We have been underweight on lending financials for 6-9 months. Banks are struggling to maintain high ROEs. Core profitability is hurt by pricing pressure across most segments.

There are very few pockets of high-ROA lending left, especially for banks trying to control exposure to unsecured retail. Risk aversion in wholesale has reduced ROEs in that segment to subsistence levels.

Moreover, capital levels are now much higher. Banks feel compelled to hold CET1 at >15%, under pressure from regulators and rating agencies.

Our underweight stance is also predicated on the belief that the best asset quality is past and credit cost should mean revert.

Are there any sectors where structural stories are continuing and why?
Aditya Sood: The zero COVID policy in China has created an opportunity for India to emerge as a preferred destination in global manufacturing. India is better placed than most countries on the geopolitical stability front.

The PLI programme has incentivised large-scale investments by corporates, and infrastructure augmentation through the dedicated freight corridor and the NHAI corridors would improve the logistics competitiveness, all these measures have led to companies to shift the supply chain incrementally to India.

India is also going to be a large market for most of the companies that are manufacturing in India. Over the next decade, we expect the manufacturing share in India’s GDP would grow.

We have seen more SME IPOs hitting D-Street so far in 2024 compared to mainboard ones – what could be the possible reason for this? Do you see more SMEs coming on to D-St as an encouraging sign?
Aditya Sood: 2023 was a stellar year for SME IPOs. In CY23 162 companies have gone public. These signs are encouraging especially in an economy like India which has one of the largest listed universe of companies.

SMEs are an important part of the economy and drive economic participation in both urban and rural areas and accounting for ~36% of manufacturing output.

SMEs would require ongoing legislative support to expand credit availability via non-banking and banking channels, India’s SME sector would benefit from this avenue of financing.

Fundraising would be a function of the buoyancy of the underlying equity market and investor sentiment.

We have seen a swift move in railway stocks in the past few weeks. What is driving the rally?
Aditya Sood: The performance of railway stocks has been buoyed by the robust order inflow in FY23, and growth was seen across the board spectrum by Indian Railways.

Large ticket orders include Vande Bharat orders along with the ordering of 73,000 wagons by Indian Railways. We expect railways to post revenue CAGR of 15% over FY23-26E.

We believe that with a growing order book, a healthy order pipeline and strong government focus on building its railway infrastructure, there can be an upside to revenue growth assumptions.

However one needs to be mindful of valuations in these stocks wherein there is a mismatch between narrative and numbers.

How should one look at the small & midcap stocks? There are mixed views in terms of valuations.
Aditya Sood: Market valuations are reasonable at more than 0.5x the historic mean, many large cap companies have underperformed the Index returns over the past 2 years.

Small and Midcap valuations are ruling above the Nifty, a trend we believe can persist, though SMID index valuations are unreliable due to granularity and lack of reliable forecasts on many companies and also gets skewed by loss making companies.

SMIDs should continue to outperform, with better earnings growth and momentum in return ratios. We expect SMID earnings growth to exceed the Nifty and drive outperformance.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)

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