Monthly markets podcast India July 2021

Narayan Shroff (NS): Hello & welcome everyone to our monthly podcast for Barclays Private Clients India. I am Narayan Shroff, part of the India Investments team and I will be your host for this podcast.

In the next few minutes, I will share with you our broad economic and market outlook and our investment strategy, followed by a short interview with our guest, Sunil Singhania, one of the top names in Indian equity markets and the Founder of Abakkus Asset Manager LLP.

Sunil will share with us his views on the Indian equity markets from the current vantage point.

The unprecedented monetary and fiscal support, high liquidity and low interest rates have supported the financial market performance in India. However, the constrained economic environment through the Covid waves, ensuing lockdowns and the general risk aversion through this period led to more of a K-shaped recovery.

Parts of the market trade at rich valuations while others struggled through the pandemic.

With a sharp economic recovery in sight in the second half of the year, a broader bounce in each asset class may occur. Also, while inflationary pressures are building up, in a structurally lower rates environment, investors may need to take more risks to earn long-term “real” returns.

The Reserve Bank of India may be channelling liquidity and targeting stable interest rates across the curve that is also conducive to more sustainable domestic growth. That said, financial markets are likely to remain on a tightrope, depending on inflation data and inflationary expectations.

In the near term, the market and policymakers seem to be aligned that inflation is likely to be transient and addressable through counterbalancing factors such as unemployment, stabilizing pent-up demand and supply-side catch-ups.

With the recovery and run-up in Indian equities over the last year or so, it may be time to review asset allocation and rebalance as required. Also, within this allocation, it may be worth considering increasing the risk allocations in each asset class using a “core/satellite” strategy, with the satellite portion representing higher risk strategies.

To mitigate the potential volatility in satellite portfolios, especially from any risk-off triggers globally or domestic headwinds, would suggest staggering allocations over coming months and maintaining appropriate portfolio diversification.

Active management remains key for core portfolios, due to high valuations and the low margin for errors when pricing in “longer” projections. For satellite portfolios, the same holds with a large bottom-up universe to select from and a market that may keep rotating across sectors and themes.

In Indian debt, would continue to suggest keeping core portfolios invested in high-grade corporate bonds of up to 5-year maturities, through a mix of actively managed and roll-down strategies. The still steep rates curve seems to offer enough carry to compensate for any residual duration risk in roll-downs.

We reiterate that the RBI would support the bond markets through its policy stance, liquidity measures and rates stability across the yield curves. With the inflation prints and higher bond supply in the market, however, portfolio volatility may remain elevated.

With the broader economic recovery, it may be worth building a satellite fixed income portfolio across mid-yield, high-yield and structured credits.

Our preference in the non-AAA segment remains towards credit and/or perception upgrade candidates and in sectors standing to profit from government policies and economic revival, including infrastructure and select nonbanking financial companies with a focus on housing finance and those lending to small and medium enterprises.

Residential real estate-backed debt, by marrying higher yields with appreciating collateral values, looks well positioned. Once again, selection, diversification and monitoring remains key.

The different growth profile of the largest economies, especially in recent quarters, highlights the importance of global equity exposure for Indian investors. Our preference here continues to be for US equities and Asian emerging markets, besides the opportunities that are expected to prosper from the new normal across the technology spectrum.

In Indian equities, would continue to suggest sticking to quality businesses and a resilience bias in the core portfolio. It includes companies that may thrive using their pricing power and adding to their market share, even if their margins were to come under input price pressures.

Satellite equity portfolios might comprise of small and midcap portfolios and cyclicals (including the pandemic-led late-cyclical sectors like auto, retail, leisure, travel and tourism).

We expect the Capex cycle to kick in faster than some forecast due to formalization of the economy. While this process had started post the demonetization in 2016, GST implementation in 2017 and IL&FS-triggered credit crisis in 2018-19, the pandemic seems to be accelerating it further.

The weaker and vulnerable businesses are giving way to more “organized” ones. This has led to a faster Capex cycle as these organized players need to scale up supplies quickly. The capacity lying idle with the vulnerable companies may not be fully picked up by their stronger peers, who would rather create fresh capacity on their “cleaner” books.

To discuss more on the Indian equity markets, we have our guest, Sunil Singhania with us. Sunil is one of the most successful equity investment managers in India. Under his leadership, Reliance Mutual Fund ran one of the most successful equity investment management franchise.

In 2018, he founded Abakkus Asset Manager LLP that focuses on investing in companies with sustainable businesses and high RoEs.

NS: Hi, Sunil. Thanks for joining us today. Let me start by asking you the most important question in equity markets. What is your reading on corporate earnings growth?  I mean what will fuel the growth?  Consumer demand, corporate spending, government spending or exports?

Sunil Singhania (SS): Thank you, Narayan, for having me. So if you actually see in the recent past growth was led by consumption. Going ahead we feel it will be a combination of all the factors you mentioned. For the last few years, government policy actions led to disruptions like the GST, which is the General Sales Tax, and the demonetisation. Post the pandemic, the government policy action has shifted towards focusing on economic recovery and growth.

Along with the consumption and infrastructure spends, the PLI, which is the Production-Linked Incentive Scheme, and focus on manufacturing, the China+1 strategy which is now very clear all over the world, and divestments will all be supportive of growth.

Once the concerns relating to COVID-19 starts to ebb, you will see the pent up consumer demand back as people start to focus on enjoying life, coming back normalcy and this will lead to a period of uncertainty going away as well as spending due to the pent up savings coming back.

NS: Sunil, how do you see the P&Ls emerging across sectors?  I mean volume growth versus price growth in the top lines, input price rise and the impact on margins, then you have the capex drag or any other drag on the near term profitability?

SS: So, if you see, the demand has been very strong and it is likely to be strong. On top of that, in last few years there has been supply side constraints and particularly during the pandemic also there have been constraints on supply.

Add to this, you also have a scenario where inefficient plants and polluting plants have gone out of production. There will definitely be some pressure on inflation, but our view is that this will be transitionary in nature and as the supply side comes back when economies open, inflation will also start to, may taper off. I think with input rising costs, there might be some drag on near time margins, but I think eventually, the strong demand will take care of that.

NS: Sunil, with the recovery in sight and increasing profitability do you see the corporates using these accruals to deleverage their balance sheets or reinvest in growth?

SS: It will all depend on where you stand. For some corporates where the leverage is high it would make sense for them to first deleverage and that would also enable them to have a better balance sheet and also reduce cost of borrowing. For some corporates and sectors where there is capacity constraint, a combination of a good balance sheet as well as a demand led expansion might be an obvious choice.

I think overall we feel that there would be the capex which will come back and particularly on the private side. Demand repayments would be there but the current utilisation rates for most of the industries are high and as the demand picks up, it would merit capacity increase to be the order of the day.

Also, a lot of cyclicals like metals have seen a sharp jump in profitability over the past year and so and the outlook on the prices also seems to be pretty strong. I think these sectors would be significantly deleveraged and they would all prepare themselves for the next phase of expansion.

NS: Yeah, thanks Sunil. Sunil, from your long experience in medium equity markets what are the trends and opportunities that excite you in your bottom up stock picking, especially in the context of medium and small-cap companies?

Do you see leadership and resilience in these businesses through all the pains they have seen through the demonetisation, GST rollout, IL&FS-triggered credit crisis and now the COVID-19 crisis? Also, what are the opportunities that would benefit from the new normal and the IPO market activities?

SS: So, the last few years have been very eventful. A lot of disruptions that you mentioned, whether it was demonetisation or the GST was supposed to lead to a shift from the unorganised to organised. That shift was a little bit slow, but I think COVID in a short period of time has fast tracked the shift from the unorganised to organised.

Digital is clearly a theme, as has been the case all over the world, and I think in this environment digital as a theme has only again got reinforced.  The way we work, the way we study, the way we entertain ourselves, the way we shop has completely changed and digital is at the forefront of every business.

Manufacturing and the China+1 strategy is also a theme which is gaining acceptance from the industry and the government policies are also supportive.  Even in India, you have antidumping duties and protection duties on a wide range of products. The Production-Linked Incentive Scheme is also a boon to promote Indian manufacturing and I think that would again be a key theme.

For India, IT and pharma have always been great sectors because these are sectors where India has global competencies and therefore we continue to find opportunities there. From a bottom up perspective, the good thing is India is a country of very diverse nature, a lot of listed companies, and in our style of investing we don’t shy away from taking some tactical positions even in cyclicals like metals, sugar and chemical companies. So, it’s exciting times ahead.

NS: Finally, the clichéd question. What about timing the investments currently?  Price to earnings ratio, price to book ratio, EV/EBITDA, discounting rates...I mean how much forward should one look?

SS: So now a very interesting question. Obviously in bear markets we start to look at trailing multiples and in bull markets we start to look at four years, five years ahead. Frankly from our perspective, going beyond 12 to 24 months ahead is very difficult because, the predictability of earnings clearly, clearly drops.

Our view is that at the current levels, because of the strong earnings growth we have seen and which is likely even in the current financial year ’22, the markets are trading at somewhere just over 19 times FY23 which is around, 10 to 15% premium to its long term average.

But given where the interest rate environment is it is very logical that P/E multiples all over the world would have inched up a little bit. You know, but from our side we are a little bit conservative and for us entry valuations while investing are as important as growth.

Another interesting aspect of the market particularly over the last six - eight months has been in the change in the stocks and sectors that have been outperforming. Unlike, the last three - four years where it was predominantly a very narrow rally, now the broader markets have started to significantly outperform with the mid- and small-cap indices doing much better.

The reason has also been the fact that there was massive underperformance from 2017 to 2020. The broader markets, particularly the smaller companies, grew faster in the last 12 to 18 months and because there was this deep discount in valuations, I think all this has led to a period where they have significantly outperformed.

Institutional investors were also not very kind to them in terms of investing. There was general apathy and there was hardly or zero holdings in these stocks and that has also led to a much sharper rally in this segment.

I think going ahead our view would be that the earnings growth looking strong as we approach the next couple of years, markets would continue to see a broad based kind of rally and I think in that kind of an environment a slight premium to the long term average as far as the P/E multiples is concerned is quite justified.

NS: Thank you again, Sunil, for joining us today.

SS: Thank you, Narayan, and thanks Barclays for having me for this podcast.

NS: With this we come to an end of our podcast. Thank you for listening to us. Stay safe and healthy and happy investing.