Markets have factored in a lot of negatives

In a growth environment, a price earnings multiple of 25 times may be normal, whereas in the absence of growth even a nine PE can look expensive.

“If you have a long-term view for investment, then contrarian bets can be taken now. Otherwise staying neutral or staying out of the market for the next two quarters may be a safe move,” says Mr Vikas Khemani, President and Head — Wholesale Capital Markets, Edelweiss Financial Services, in an interview to the Business Line. Excerpts:

What are the key takeaways from the current results season?

There is no doubt that we have seen fairly depressed earnings. There are cost pressures and margins are compressing. Interest costs too, are clearly going up and taking a further toll on profitability.

There are a couple of things here. Locally the fuel prices have gone up and that has put pressure on both the primary cost and derived cost. Secondly, operating profits are also hurt when fixed costs remain and revenue growth is not as expected.

This is true of capital goods or construction companies where fixed costs are incurred but revenues have not come in as they should. So, quite a few businesses such as capital goods, steel or cement are witnessing negative operating leverage. The FMCG and IT sector have been exceptions. In IT, this may have happened but for strong revenue growth aided by the rupee depreciation.

Also a lot of companies that have foreign borrowings have taken a hit as a result of the mark-to-market losses. Hedging too is difficult with the kind of currency moves we have had. Also companies do not hedge their imports to that extent. These have also taken a toll.

The results and management meet also indicate that quite a few companies may go for debt restructuring.

What would be the sectors to bet now?

The markets are expected to remain volatile over the next couple of quarters. So you need to take a call on your investment perspective. If you have a long-term view then contrarian bets such as capital goods or infrastructure can be taken. Otherwise staying neutral or staying out of the market for the next two quarters may be a safe move.

We have been talking of disappointing earnings. Have some sectors shown improvement?

Export-oriented manufacturing sectors such as chemicals and intermediates have done fairly well. This is because there has not been any significant capacity addition in these sectors and secondly they have benefited from the falling rupee.

What is your sense of forward valuations?

We have to look at it from the point of a subdued growth environment. A lot of negatives have also already played out. SBI's results were recently out, Moody's downgraded Indian banks and oil prices are up. But markets have hardly reacted.

That suggests that people have factored in a lot of negatives in the market. So my sense is that markets are likely to stay in a range — not too much downside or much upside.

Only when the growth environment picks up, which may be two quarters down the line, after interest rates start coming down, will markets see some improvement. Putting a valuation will be contextual only when seen with the growth. In a growth environment a price earnings multiple of 25 times may be normal, whereas in the absence of growth even a nine PE can look expensive.

You said markets have factored in a lot of negatives. But do you think they may yet react to developments in the Euro zone?

I think globally, most of the negatives are there in the public domain. Tomorrow if a Greece default happens, my sense is that reaction may not be too severe because people have been expecting it for long.

However, any other unexpected event may have more of an impact. But, my sense is that they should be able to find some solutions for the current problems. So markets should probably start looking up by next year.

Locally, we have market experts call the current slowdown a cyclical one rather than structural. If so, do you see a revival soon?

Much would depend on the government policies. Even a cyclical slowdown can be a prolonged one in the absence of counter-cyclical policies by the government. This means that in a heated environment, the government goes for tightening measures and in the absence of a growth environment, it would push spending.

Currently, we have a situation of policy paralysis. If we had had strong policies to counter the current situation early on, then this could have been one of the best times for India. Better fiscal or inflation management for instance, could have seen strong inflows into India given the situation elsewhere. So, in the absence of such measures, a cyclical downturn may become slightly elongated or even risk becoming a structural downturn.

We have seen renewed interest in small-caps by FIIs. Do they not perceive risk there?

Quite a few private equity players have been buying into small-cap companies. Their investment perspective is usually three to five years.

So if the company is good — even if the current market environment has taken a toll on them — private equity players are best placed to take advantage of the situation.

What is your reaction to the government asking some of the cash-rich PSUs to go for share buyback?

It is not a good move for the simple reason you are depleting the resources of the company. Obviously, there are business reasons for these companies to hold cash. And they may at best be distributed as dividends. If the government wants to enjoy the resources, then there are ways to take the company private.

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