‘Select mid-caps in IT, cement and pharma are attractive’

Stock market has been heading lower on concerns of domestic economic slowdown and general investor apathy. We asked Venugopal Manghat, Co-Head of Equities, L&T Investment Management about his views on the economy and expected earnings of listed companies.

Excerpts from the interview:

Do you think that GDP growth rate will increase from here? If yes, which sectors should we bet on? Are capital goods stocks a good bet?

The Indian economy saw an almost decade-low growth with the third quarter GDP growing at 4.5 per cent. The most resilient part of the economy, services, grew at a historically low pace of 6.1 per cent, possibly led by tightening of government expenditure.

My view is that GDP growth could be in the process of bottoming out and FY’14 would be an improvement over FY’13 at about 5.5-6 per cent growth.

The drivers of this marginal recovery could be many including a continuation of reform initiatives adopted in the recent past, a more facilitating policy environment which would entail removal of bottlenecks that have slowed down investments etc.

As there are a number of state elections this year, there could be an uptick in government expenditure as well. Commodity prices are correcting, given a weak global demand scenario, and interest rates are on a slow downward trajectory — both of which are good for our economy.

Finally, agricultural output also should improve this year if we get a reasonable monsoon, given the low base of last year.

It is early to pinpoint sectors that would drive an upswing and lead the market, as we are likely to see only a limited recovery.

It would be better to take a bottom up stock view and build a portfolio rather than a top down, sectoral stance. The capital goods sector is a beneficiary of industrial activity and would require a revival of the capex cycle to do well.

Over the last couple of months there were some early signs of bottoming out of industrial production. But the recent core industries growth data for February of -2.5 per cent does not look promising even though it is on a high base.

Given the sharp correction in mid-cap stocks since the beginning of this calendar, have any stocks or sectors become attractively valued?

Yes, mid- and small-cap stocks have seen significant correction. This reflects poor risk appetite, lack of investor interest in markets as also the fact that a challenging macro environment impacts the growth and profitability of these companies significantly.

Many companies are also stuck because of balance-sheet issues. As the scenario mentioned above is not likely to change dramatically on a sustained basis very soon, one needs to be more careful at this stage.

Mid-cap stocks as a class generally tend to do well in a strong growth environment which is not the case currently.

Having said that, I do believe that there are a number of good quality companies in the lower market cap range which are run well, which are in good businesses that have potential to grow, at reasonable valuations and investors would do well to identify these and remain patiently invested for the longer term.

It is extremely stock-specific, but there are sectors like IT, cement, pharmaceuticals, and so on, where selectively mid caps are attractively valued.

Which sector is expected to post surprises in their its for the March quarter?

Overall, the March quarter results may be a disappointment. Sectors such as cement, metals, automobiles, capital goods etc have seen a slowdown, probably worse than expected.

Even though there are adverse cross-currency movements for the software sector, our belief is that this sector would deliver reasonably good results and the commentary could be positive.

Private sector banks and pharmaceutical companies also could show relatively better growth. Public sector banks could see low growth, margin pressure and continuation of asset quality issues, though some banks could have a quarter on quarter improvement.

What is the corporate earnings growth that you are projecting for FY-14? What is Sensex EPS likely to be for FY-14?

I believe that there could be disappointment on FY-13 growth and further downgrades to earnings estimates for FY-14 after the fourth quarter results. Consensus expectation on FY-14 earnings growth will need to be moderated.

Corporate earnings growth in FY-14 in my view would move in line with GDP and IIP growth trends which are subdued, but expected to improve this year. Considering the current trends globally and a weak but recovering Indian economy in FY-14, Sensex earnings growth could be 7-10 per cent over FY-13.

Is the structural uptrend in gold complete?

Since August/September 2011, gold price has lost its momentum for various reasons. An improving US economy and a strong US dollar seem to be working against gold as also other factors like weak demand trends in China, and so on.

Going forward, lower gold imports into India is possible due to the increase in import duty and could be an additional factor impacting gold demand. A strong global equity market towards the end of last calendar year also seems to have taken away some of the flows from Gold ETFs, which was earlier considered a safe haven investment class.

While the US economy does appear to be on a recovery path, reversal of the QE programme in the US will take a while to materialise.

Also, the European scenario is not getting better with Cyprus getting into a distress situation and potentially more such crises to come.

Considering these factors, my view would be that even though gold has certainly lost its earlier momentum, it is too early to say that the uptrend is over.

What is your view on policy rates?

While at this point, it is a tough choice between controlling inflation and stimulating growth for the RBI, two things could turn positive.

First, inflation is expected to cool (even if for a few months) further, given benign commodity prices, food inflation coming down with the rabi crop hitting the market and the base effect kicking in.

Second, some of the initiatives taken by the government like curbing gold imports, increasing diesel prices and thereby bringing down the demand for oil, fiscal austerity measures, and so on, would help reduce the deficits with a lag.

Given this scenario, my view is that the repo rate may be reduced by 50 basis points more during the financial year.

What do you think will be the trigger to bring retail investors back to stock market?

It is clear that over the last few years investors have been negative on equity investments and one of the reasons could be poor returns from equities as an asset class in this period and the high returns offered by competing asset classes like real estate and gold.

I think these investors will come back to equities once they see the trend reversing. The biggest trigger in my view is therefore the visibility of higher returns. As returns from deposits, real estate and gold corrects, investors will look for alternative investment avenues.

If over the next few months interest rates go down, the economy picks up steam and there is an improvement in earnings growth, markets could deliver and that would be a trigger for retail investors.

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