‘We are underweight on companies with high leverage'

Ms Swati Kulkarni , Vice-President and Fund Manager for UTI Mutual Fund, says that rising interest rates and policy issues have slowed the investment cycle, even as the big picture doesn't look too gloomy.

Excerpts from an interview:

Downgrades to Sensex earnings estimates have been a concern for the markets for some time now. Do you see further downgrades happening now, with the rate increases? What does that spell for markets?

The downgrade concerns are mainly coming from the margin pressure due to high raw material prices, wage inflation and top-line concerns arising from limited pricing power in a phase of slowing economic growth. Commodity prices have softened a bit from the peak levels.

If the commodity correction persists due to slowing global growth, Indian companies will experience margin and earnings expansion.

Earnings downgrades in select sectors may not be very worrying for the equity market as valuations are attractive for markets as a whole. They are also below historical average multiples.

The market appears to be much more concerned about growth than value today. So many stocks and sectors available at low price-earnings multiples (PEs) are declining even further. Do you agree?

From a relative perspective, among the global equities, India has always remained a growth market.

The valuation premium over the developed market is justified with relatively higher expected growth.

Having said that, there could be certain stocks and sectors at any given point of time that may remain at lower valuations on account of certain concerns on earnings visibility or uncertain competitive scenario or simply because of excessive pessimism.

If we find that the concerns are priced in to a large extent, there could be an opportunity to gain from these value picks.

Is the premium the market is paying for consumption stocks justified? Much of the recent move in the markets has been driven by the consumption theme, with infra stocks completely out of favour. Do you see this trend reversing?

The preference for consumer stocks is clearly coming out of the strong demand visibility for the coming few years, backed by the rising income levels in urban and rural areas and demographic advantage — 50 per cent of the population in the working class for the next 20 years.

The premium valuation may sustain till we see initial signs of a pick-up in the investment cycle.

For that we may have to look for evidence that the rate hikes are done with and also increased activity in infrastructure ordering.

Will an erratic monsoon cloud the prospects on earnings?

Cumulative monsoon till date is only 3-4 per cent below normal. The risk is reducing as the monsoon advances.

Hypothetically, if we see a poor monsoon from here on, it may adversely affect consumer demand and worsen the inflation fears.

Recent macro indicators all signal a slowdown in the manufacturing side of the economy. What is triggering this slowdown? Is corporate India running up against capacity constraints?

The Index of Industrial Production has been very volatile in the past. There is a high base effect of last year coupled with the effect of monetary tightening.

Projects are being put on hold in certain sectors for clarity on policies, environmental clearances and fuel linkages.

Rising interest rates are another important factor in postponing of investment decisions. I hope that the slowdown does not result in worsening the supply-side issues, with their adverse structural impact on inflation in the system.

The Reserve Bank of India has been more aggressive than expected in hiking interest rates. How do you see companies coping with debt and interest costs?

Companies that are highly leveraged get affected on account of rising borrowing costs and also due to the limited ability to restructure capital in a not so benign capital market.

Added to these, the order intake is slowing, clients are postponing deliveries — choking off the cash flows for these companies.

We avoid or stay underweight on such companies in a rising interest scenario.

Many managers have been betting on mid-cap outperformance for quite some time now, but it somehow doesn't play out at all. Why and when do you see a catch up in mid-cap valuations?

Investors need to pick good companies which have the ability to withstand a challenging business environment especially during times of macro headwinds. One has to be stock specific here.

The mid-cap companies with competitive positioning, pricing power, product strength and financial strengths continue to outperform relatively, despite the tough environment.

For example, our own mid-cap dominant funds such as UTI Master Value Fund and UTI Mid-Cap Fund have posted 6 per cent and 10 per cent returns respectively in the last six months, when large-cap indices such as the BSE Sensex and S&P CNX Nifty have struggled to post positive returns.

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