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Ramanathan also says: “While we like India-related stories in consumption, infra and PSUs, the value of safety, value of margin is more in the lower value stocks per se at this juncture.”
I was just looking at some data points on how the valuation differential between midcaps and largecaps is widening. On the one hand, in the largecaps, the valuations as well as earning expectations are low. But in the mid and smallcap universe, valuations are at a premium – 10-year high with expectation of earnings growth going forward. Either undervalued largecaps or the overvalued midcaps will start moving. Which side will move first in your view?
Satish Ramanathan: I think the largecap has kind of cooled off a little earlier than the midcap and smallcaps. It has got to do with the flow of money because the flow of money is predominantly from the local markets. We have domestic retail and DIIs investing, whereas FIIs are either selling or keeping quiet. So, either way, they typically focus on the largecap and consequently the mid and smallcaps continue to outperform.
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Now, valuations for midcaps and smallcaps are at 20-25% premium to largecap peers. This is likely to continue if the structure of the market remains the way it is. For the gap to converge, it either requires some change in sentiment or it has to be induced by external flows from FIIs.
Also the second point I want to understand is banks. Liquidity is tight right now. RBI believes it is seasonal. Some are expecting some moves in the near term but cannot say when. Till liquidity is eased out, the deposit growth will lag the credit growth. Does it mean for a quarter or two, the banking universe NIMs could remain under pressure because they will have to give higher rates to attract more capital and more liquidity as deposits?
Satish Ramanathan: Yes, to some extent, the fight for capital will continue because domestic savings has come down and banks typically tap domestic savers such as corporates and retail to lend onward. The retail savings rate has come down to some extent and corporate capex has also revived. So, corporate incremental savings would come down into the future. It is our assumption that deposit rates will continue to remain on an upward trajectory for some time.
I also want to understand where do you see margin of safety coming in the market? Where are you nibbling in right now? Where does risk reward appear quite comfortable to you?
Satish Ramanathan: The healthcare and pharma names have gone through a long-term structural adjustment and seem to be coming out of that. Valuations are reasonable, cash flows are good. So, pharma is one area we are looking at.
The IT sector also gives a decent risk reward because the growth is not factored in, valuations are reasonable. While we like India-related stories in consumption, infra and PSUs, the value of safety, value of margin is more in the lower value stocks per se at this juncture.Where are you trimming your positions or churning out of where you think valuations do not justify the earnings?
Satish Ramanathan: Some of the infra names where execution may be a challenge is where we are probably trimming or reallocating some of the profits to names which are a little more defensive.I want to come back to the PSUs once again. Yesterday, Prime Minister Modi made a big pitch. In fact, talking about how efficiencies and profitability outlook of PSUs have increased a whole lot and improved a whole lot over the past few years. But how much of the good news is already in the price in your view, especially defence and railways?
Satish Ramanathan: In the case of defence, we need to watch how they execute because ramping up ship building or aircraft manufacturing takes time. It does not happen overnight. And the markets have anticipated fast execution and there could be disappointments along the way. So, we are a little cautious on that side where execution could be a challenge. In the case of infra as well, we see that execution could remain a challenge. It is not that all the bottlenecks have been cleared. The pace of execution has improved, no doubt, but it is still something which we need to watch and confirm.
Which of the earnings caught your attention this time around out of the earnings season which came out? Any sectors or , where the revenue growth is there? The large observation was yes, profit growth is there, but revenue growth has been slightly on the weaker side?
Satish Ramanathan: The revenue growth has been a little weak because of two reasons. One is that the volume growth has itself come down a little bit. The second is that some of the companies have passed on the benefits of lower commodity prices. As a result, the revenue growth appears muted while the EBITDA growth has remained fairly strong.
We need to look at the underlying reasons for each of these categories where revenue growth is flattish and understand why it is so. In general, we think there is a slight recovery on the agri side and a recovery on the consumption from rural India. We think that two-wheelers would be an area where the cost benefit is favourable and we also see some benefit coming in from some of the IT names as well, where the risk reward is favourable.
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