Value rotation remains key; financials in 3-5-year good asset cycle: Mukul Kochhar

What is your hypothesis of the market because it appears that the opinion is equally split; some part of the market is saying markets are very expensive, others are saying falls will be shallower because of the superior quality of earnings and economy. Which side of the argument are you on and how are you analysing the markets right now?
It is undeniable that India is an expensive market. Just to give you an idea, for the last 10-15 years, we have always traded in line with the US market. Both the US and India are the most expensive markets in the world. Today, we are at a 15-20% premium even to the US market and that should give us an idea how expensive in multiple terms the Indian market is.

Having said that, we are the fastest growing major economy. There is a major reconfiguration of the economy taking place. Manufacturing is picking up. There is reconfiguration of supply chains of energy supply chains’ investments in new energy, which is creating a lot of opportunities. India is a very interesting place to be in, even though headline indices are expensive. These are driven by a few stocks as we work with investors. We are finding enough opportunities to be invested in the country for the long term and make reasonable returns.

First of all, let us take stock of what is driving the economy right now. What are the internals of the economy looking like? Stuff like capacity utilisation levels, capex etc. Are there green shoots in the economy? What are the signs you are reading in this direction?
This is actually one of the most important debates we are having with investors. The investment cycle is probably one of the most volatile and a factor that moves the needles towards higher or lower growth. In that, India is looking fairly good. If you look at the base, we all know that government investment has been picking up and the government has been spending more on capital expenditure than revenue expenditure and the intent is there for everyone to see.

On the private capex side, we do a lot of analysis. We drilled deep down the numbers. If we look at BSE 500 capex, we were roughly at 3.5% early on in 2011 or so at 3.6% of GDP. This is now down to roughly 2%. So the base is very low in terms of private capex. Secondly, are we seeing green shoots? Yes, of course, we are. We have a proprietary database of ordering in the economy or private ordering in the economy and we see definite pick up there.

In fact, the last two quarters have seen record ordering in the economy which means going forward, capex should improve on a very low base. The debate then shifts to how strong this recovery is going to be and for that, capacity utilisation becomes the point of discussion.

I would like to extend the discussion a little bit. We measure capacity utilisation in traditional sectors which have existed in India – energy, cement and metals and then we say that capacity utilisation has still not peaked and therefore the capex cycle will be modest. What is really happening is new sectors are emerging. Manufacturing in India is emerging and that requires a decent amount of capex. We see a pick up in manufacturing economies and companies.

A very big part of the capex story in India is going to be once again reconfiguration of the energy supply chains rather than new energy. Now remember these businesses did not exist in India and so as we build the new energy base in India,we suspect that the capex cycle is going to take people by surprise. It is going to be stronger than what people are thinking of a very low base.

So how is the positioning of big players in the market right now? Last couple of months saw big selling by FIIs which seemed to have ebbed in November. What are they enquiring about, what sectors are you recommending? Also, what are the concerns and what keeps them in the market right now?
We are seeing a distinct change in the level of involvement of FII investors in the country. Historically, India was always a country of interest. It is one of the best performing markets globally for the last 5, 10, 15 years. Having said that, the depth to which the FII investors would go to was very limited. This has changed. India has become a major focus.

Just to give you an instance, some of the large foreign investors in India would have one or two member teams looking at the country. Now they have four or five. So the focus on India has improved and that has allowed the foreign investors to look at a broader array of stocks and therefore we see increasing participation in the midcap space, which was not there before.

Price discovery is going to be better going forward. A lot of stories will emerge even from levels where the market has gone and give multibagger returns just because the price is going to be better because of overall more interest from investors.

What are your big sectoral overweights right now which you are recommending to your key clients and also the valuation?
Broadly speaking, Nifty is expensive. So, in parts, we have broadly been talking about rotation into value stocks. It is called value rotation for a couple of years. We continue to propose that. Within the largecap stocks also, we are proposing sectors where valuation is reasonable and where there is good earnings visibility. So automobiles is one sector that we are quite bullish on. Within automobiles, two-wheelers specifically and within four-wheelers also, we have preference for some stocks.

We are overweight on financials. Within financials, we see a long-term, 3-5-year story of a good asset quality cycle. We are recommending people to get into places where stocks have remained cheap and we expect asset quality to stay good for multiple years and not just a single year cycle.

We do not expect that the cycle will be short lived and therefore some of these cheaper stocks which historically have had asset quality problems will outperform going forward. We are positive selectively on pharma names. IT is a big counter consensus call while the street is negative. We find value opportunities in a few stocks, midcaps and a couple of largecap stocks we are recommending. Overall, we are neutral on the sector.

Our big underweight is FMCG. When people look at expensive stocks, this is the first sector that comes to light. In light of the fact, we also believe that long-term global interest rates will be higher in the coming decade, which is the 2020s. We expect steady de-rating of the FMCG stocks. These stocks by the way are not very high growth ones. We think they will struggle to justify the multiples that they trade at. We are also underweight in metals.

In the broader market,be it engineering, capital goods, infrastructure or even financials, there is a distinct change in the kind of numbers which some of these companies are reporting. We are also seeing some change in the way large investors are behaving towards this pocket. Are you getting interesting enquiries from funds for the broader market?
This is specifically for industrial manufacturing…?

No. I am saying that in midcap banks, smaller banks, smaller engineering, smaller infra, we can see a lot of institutional activity. Are your clients interested in broader markets?
100% right. Nifty is undeniably expensive and returns will be difficult to come by. So stock selection will be key and we are looking for higher growth. Stories are trading at reasonable multiples and for that, one has to get into broader markets. Within largecaps also, there are opportunities available in some government names and autos.

In broader markets, higher growth will be available and the manufacturing sector is going to see higher growth due to the very low base. There. So, there is more interest in the broader economies across sectors