- Private banks or PSBs: The better bet?
- More room for upside left in small-caps?
- Prospects of pre-election rally strong?
Tamanna Inamdar in conversation with #ICICISecurities' Vinod Karki on 'Talking Point'.
- More room for upside left in small-caps?
- Prospects of pre-election rally strong?
Tamanna Inamdar in conversation with #ICICISecurities' Vinod Karki on 'Talking Point'.
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TVTranscript
00:00 (upbeat music)
00:02 - Welcome, you're watching Talking Point.
00:13 I'm Tamannaah and Amdar.
00:15 We're at a very interesting time in the Indian markets.
00:18 We're making new highs every day,
00:21 technically as per the numbers,
00:24 but are we seeing that same frenzy confidence
00:28 to sustain that level of growth?
00:30 A couple of factors there need to be very clear
00:33 to turn the tide.
00:34 Questions that we're trying to address today
00:36 with our guest on the show.
00:38 Does the growth potential in the broader markets
00:42 and small and mid cap companies continue
00:44 despite the kind of run up in valuations?
00:47 What about the role of FBIs?
00:50 FBIs have been selling at least
00:52 for the first couple of months of 2024.
00:54 When does that pivot turn?
00:57 Is it going to be after Fed cuts rate?
01:00 Is there going to be a wait for China to improve?
01:04 Or are we going to wait for the election season
01:07 to end at least in India?
01:09 We're gonna talk a bit about IT companies
01:11 and financials as well.
01:13 So an interesting chat lined up
01:14 and to answer some of these questions today
01:16 is Vinod Karki, Senior VP of Equity Research,
01:19 ICICI Securities.
01:21 Vinod, hi, welcome to Talking Point
01:23 and great to have you on the show.
01:25 Let's begin by getting your take on where we are.
01:28 So we've ended a fairly successful Q3 season,
01:32 one would say, though there are divergent views on that.
01:35 I'd like to know what you think.
01:36 What in your view is the next big trigger?
01:39 - Thanks, Kamandha.
01:41 So yeah, if you just see where we are.
01:45 So if you just roll back where we started the year,
01:47 we were close to this level,
01:49 21,800 on the Nifty, I guess,
01:52 we're in around December, Jan.
01:55 And we are around 22.
01:58 So it's just a couple of percentage points here and there.
02:01 But you have to look at the market in two contexts.
02:05 One is the valuation and the other is the growth.
02:08 So there is no denying that on valuations,
02:12 things are expensive,
02:13 but all equally important is that there is no denying that
02:17 after a long time, we're seeing the profit cycle
02:22 continue to grow at a sustained pace.
02:25 So if you just see the overall profitability in the system,
02:29 corporate system, we were in effort 23,
02:32 we were at around 4.3% of GDP.
02:35 And on a 12-month basis after this Q3 results,
02:38 we are at 4.9.
02:39 So all said and done,
02:42 the corporate profits are growing at a rate
02:45 faster than nominal GDP.
02:46 There's no question about that.
02:47 And if I look at any forecast of P&I season,
02:52 like Nifty and the other smaller mid-cap indices,
02:57 it's anywhere between close to around 20% or,
03:01 that's the focus I'm getting from 20 to 25 perspective.
03:06 While we know that the nominal GDP
03:07 will be growing at 10, 12% kind of thing.
03:09 So this faster than nominal GDP expansion
03:13 of profit cycle is continuing.
03:15 But as we know, the valuations are at the higher end,
03:19 which typically happens when growth is at a faster clip.
03:24 So that's how we are currently right now,
03:27 that growth is quite robust,
03:31 but valuations are not leaving much
03:34 on the table right now for investors.
03:36 - I want to speak specifically about growth,
03:41 and then we'll come to valuations,
03:43 because you have a very strong and fair and clear point
03:46 that valuations are not leaving much on the table.
03:48 But when you're talking about earnings,
03:50 and your report on Q3 says that,
03:53 as far as small caps are concerned,
03:55 the maximum upside impact to GDP left within small caps
03:59 is at 0.7% versus cycle peak of 1.2%.
04:02 I want to get your sense on whether some of these earnings
04:07 really stood the test of valuations,
04:09 because the run-up and anticipation
04:11 when it came to the actual numbers in corporate earnings,
04:14 did you see spots of disappointment there?
04:18 - I think, Lynx, when I see the beats and misses,
04:20 it was even Steven kind of thing.
04:22 There was some misses in mid-cap,
04:25 but small caps were reasonably good,
04:26 large cap was reasonably good.
04:28 But what I made a point over there is,
04:32 if you're to believe in a cyclical recovery in the economy
04:35 driven by the investment rate,
04:37 epic cycle, real estate cycle,
04:38 which typically benefits these smaller companies a lot,
04:42 because they get a good amount of ordering
04:45 in terms of these capital intensive sectors.
04:48 We have seen that the previous profit cycle,
04:50 which peaked out in 2008,
04:53 at a peak of around 6% to 7% of GDP.
04:57 If I see where we are right now,
04:59 and where the maximum, what I should say,
05:02 if you're to believe in a cycle
05:04 that things peak out at a certain point in time,
05:06 the maximum upside left is still in small cap,
05:10 because they have been affected a lot
05:14 over the last several years,
05:15 several crisis have been there,
05:17 and they are coming out of this bad situation.
05:21 And in terms of where they are and where they can go,
05:25 there is a lot of steam left in terms of,
05:28 purely on a cyclical basis where capital sector,
05:33 I mean, the whole epic cycle, real estate cycle is picking up
05:36 which typically tends to benefit the smaller companies.
05:41 So yeah, so I think the growth is there.
05:43 It shows up in the estimates also,
05:45 when I look at the nifty mid cap or the small cap estimates,
05:50 I mean, the growth is in 20s,
05:55 as compared to 17, 18% estimated growth for the nifty 50.
05:58 So there is this element of higher growth,
06:01 I mean, on trailing basis, as well on expectation basis.
06:06 And on a cyclical basis, it seems that there is steam left
06:09 in terms of earnings growth for this space.
06:11 - Earnings growth, yes.
06:12 But then let's come to the second part
06:13 of what you said in terms of valuations,
06:16 and how much of that value is actually left on the table.
06:20 So I was having a conversation yesterday
06:22 and there was an interesting quote that came up
06:24 to describe the markets right now,
06:26 which is, it's a bit like you come late to the party
06:28 and the best food and drink is over.
06:30 And then you're sort of rifling through the leftovers
06:33 to see what you can find.
06:35 Do you get that sense or are there enough spots
06:39 of fairly valued companies still there?
06:42 Or you just have to now live with the current valuations
06:45 and expect earnings to catch up?
06:47 - I think it's of the latter,
06:50 that you have to live with these higher valuations.
06:52 Because when I look at my framework of relative valuation
06:57 of small and mid caps over large caps,
06:59 it is at a most unattractive zone
07:03 from a cyclical perspective.
07:05 So there is no margin of safety in small cap, mid cap,
07:08 there is no question about that.
07:11 They are in fact clearly trading above large caps.
07:16 But as I said, if you see past instances
07:20 where these such situations happened,
07:21 the such situation happened
07:23 after the first Modi election victory in 2014.
07:27 And mid cap, small cap indices went up
07:30 within a matter of few months, 70, 80%.
07:32 I mean, that's not a much stops.
07:35 And they became expensive compared to large cap.
07:37 And what we saw is that after 2018 was when,
07:42 I mean, after four years that bubble bust.
07:43 So these higher valuations can remain longer,
07:48 several years in fact,
07:51 if the growth continues to support it.
07:55 So that's the point.
07:56 I mean, in fact, this time around the growth
07:58 is more supportive than it was earlier.
08:00 Because earlier in 2014 to '18,
08:02 I don't think there was investment boom
08:04 or a real estate cycle boom in fact was fading.
08:07 But this time it's rising.
08:09 So that's something on their side.
08:11 But there's no margin of safety
08:13 where you can have very high alpha from this space.
08:18 But you can't say they're going to collapse.
08:21 They may tag along, do kind of nifty,
08:25 the large cap kind of returns.
08:27 That's possible.
08:28 - Yeah, so I mean, anyone who has been waiting
08:32 for that correction for the last many months
08:34 is I suppose still waiting.
08:36 You mentioned the real estate cycle turn
08:39 and you've said it a couple of times.
08:40 So I must ask you, Vinod,
08:43 do you think that there are still fairly valued companies
08:47 in that space which have not run ahead of expectations?
08:50 Because if you look at broadly, the earnings were fine.
08:53 But in some cases, there were some disappointments
08:56 in terms of scale of execution,
08:57 in terms of cost of inputs.
09:00 These are things that real estate players
09:02 are also struggling with.
09:04 Anything that you like or an outlook you have
09:06 on this space in the listed category?
09:09 - Yes, so real estate cycle for sure is,
09:14 we just entered, I think, the second year into the cycle.
09:17 So typically, they can last five to six years
09:20 or even higher, depending on the structural strength.
09:23 But the stocks, I think, are mostly,
09:27 if I look at our coverage in the US,
09:28 are mostly price to perfection.
09:30 I don't think there's a huge upside there,
09:32 any big upside left.
09:34 But the way to play real estate is, I think,
09:38 to the supporting companies.
09:42 For example, if you look at banks,
09:45 which will be lending to the real estate mortgage cycle.
09:49 So if you're saying that there's gonna be
09:52 a real estate cycle, obviously,
09:55 mortgage lending will be a good sector.
09:58 And you have a lot of financial companies there
10:01 and large companies, which are at very reasonable valuation.
10:04 So, and building material companies,
10:07 where there have been, some of them at least
10:10 are in our coverage notes are reasonably valued.
10:12 So I think you have to play more indirectly
10:17 in the real estate cycle through lenders
10:19 and the guys who build out these real estate projects,
10:24 which are available at reasonable valuations.
10:27 - Vinod, came to know your view on private banks as well.
10:31 Definitely one space left out,
10:33 definitely in the large cap space.
10:36 And I think one highly,
10:38 there were two or three headlines from the results season.
10:40 It was IT companies didn't do as badly as was expected.
10:44 And private banks did worse than was expected.
10:46 HDFC Bank being on top of that heap.
10:48 Now you're seeing a bit of a sentiment turnaround.
10:52 Would it be fair to say that the next leg of the rally
10:55 is coming from private banks and the large ones at that?
10:59 - From a cycle perspective,
11:01 I'm extremely confident of the banking sector as such,
11:03 especially large caps and in that,
11:06 relatively the private banks,
11:08 if you see their long-term valuation,
11:09 they are at reasonable valuation.
11:11 So from a cycle perspective, when I say cycle,
11:13 if you look at the NPA cycle,
11:14 we're still bottoming out on the NPA cycle.
11:16 You're not yet from the bottom.
11:18 RBI says in FY24, we'll be forming a bottom
11:20 of the NPA cycle.
11:22 Whereas the CAPEX cycle is just about picking up.
11:25 So in the previous cycle, if you see between 2003 to 2008,
11:29 it was largely the corporate lending cycle,
11:32 the real leveraging in the corporate sector,
11:33 which led to huge gains in growth for banks.
11:38 So that's yet not picked up.
11:41 We are sub double-digit growth in that space
11:44 while retail is what is driving whatever growth there.
11:47 So I think the combination of where we are in the cycle,
11:51 both on valuation and growth trajectory and NPA cycle,
11:54 I'm extremely confident on banking as such,
11:58 especially in some of these quality large cap banks.
12:03 I think that's a good space to be.
12:06 I mean, if you see the rest of the market-
12:09 - Private or public?
12:10 - Public, private, both.
12:11 Both, both.
12:12 - Okay.
12:13 Okay.
12:14 Because PSBs are the ones in favor,
12:16 not so much as private banks,
12:18 but you're saying both are coming.
12:19 - Yeah, so both, both, both.
12:21 I mean, I would prefer the larger banks
12:25 because we can expect that they have the wherewithal
12:30 to really absorb the growth in a big cycle.
12:36 And wherever there has been,
12:41 they have shown the ability to underwrite in a prudent way
12:46 because the biggest risk with banks
12:49 is the underwriting issue, basically.
12:53 Can they keep NPAs limited when the cycle turns?
12:58 Because growth anyways will come,
13:00 the credit growth will come up.
13:03 We have seen in the past cycle
13:04 that when the credit growth really picked up
13:06 due to the re-leveraging cycle,
13:08 credit growth was almost two times of nominal GDP.
13:12 So one cannot say that this will not happen again.
13:16 There may be a time over the next two, three, four years
13:19 where credit growth might be much higher than nominal GDP,
13:23 given the way the economy is progressing
13:25 and we're getting GDP upgrades.
13:28 There is no way a country can expand investments
13:31 and cap-ex and overall productivity
13:34 without getting bank credit to participate.
13:38 So that's going to happen for sure.
13:41 - Vinod, it would be a miss
13:43 if we didn't talk about the possibility
13:45 of a pre-election rally.
13:46 Now, the question over here gets a little complicated
13:49 because a continuity of the same government
13:53 has been priced in.
13:54 You saw that big bump up late last year.
13:57 Do you think that this has in a sense become a non-event
14:00 or are you expecting a bit of a pre-election rally
14:03 like we have been seeing consistently over the last,
14:05 I would say five or six general elections
14:08 three months before the event?
14:12 - I think we are already in that mode
14:14 where the market is getting excited
14:17 that we're going to have a clean mandate, a clear mandate.
14:20 So that rally is already progressing in my view
14:24 because if I just wind back six months ago
14:28 or something like around that time,
14:29 there was some uncertainty about mandate
14:32 being a little weaker and all,
14:33 but that was, I think now behind us
14:38 and people are quite confident
14:41 that there's going to be clear mandate
14:43 and political reforms are going to continue.
14:45 So I think we are already in that kind of,
14:49 that's why the market I think is hitting all time highs
14:52 currently at this speed.
14:53 That's already playing out.
14:55 I don't think there's any huge surprise on that front.
15:00 Surprise in the sense that that hasn't played out,
15:05 that the market is taking dominance over.
15:09 That's already underway as we speak.
15:12 What can surprise is basically that it's not as clear
15:17 as it was thought to be when it actually comes out.
15:20 That could be what you should say, a risk.
15:24 But enough nowadays, nothing could suggest
15:27 that that's going to happen.
15:28 So I think there could be some excitement post-election
15:37 if it really comes through,
15:40 but then after that, that will no longer be a trigger.
15:44 So after that, it's got to be what the budget,
15:49 final budget will be and what is talked about
15:54 in terms of development plan and overall spending
15:58 and how revenues are picking up.
16:00 All those fundamentals will take over beyond this.
16:03 - Okay, so you're saying we're already
16:06 in a pre-election rally.
16:08 That's what's leading to this excitement.
16:11 - Yes.
16:12 - And broadly we say, okay,
16:13 because policy continuity, et cetera.
16:15 But if I were to ask you specifically,
16:19 why as an investor, someone who tracks the market,
16:22 you think that this will be good for the Indian economy
16:25 and for investments?
16:26 Where do you see policy continuity actually make an impact
16:31 in terms of valuations improving?
16:34 - Yeah, so if you look at the interim,
16:36 which I thought was just, I mean,
16:39 it should ideally be just a statement, nothing more,
16:43 but it unveiled one of the,
16:45 which I think was undermined.
16:47 People are talking much about it,
16:48 but I think it is very important to note
16:51 that the interim budget talked about what is called
16:53 as adding the Anushatham innovation as the term
16:58 into the overall development plan of India long-term,
17:04 which is extremely positive in my view,
17:07 because when I look at global economies
17:10 where the spend on innovation R&D,
17:13 global R&D spend is more than 2% or China,
17:19 we were at similar position in China
17:22 at the start of the century at 0.7%.
17:25 GDP, we have just maintained it around GDP at currently 0.7.
17:30 But there was a lot of emphasis in the interim budget,
17:33 which is a statement laid out in a corpus
17:35 of 1 trillion rupees for zero interest rate loans
17:40 towards R&D spend.
17:42 I think this is extremely positive in my view.
17:45 It's going to improve productivity in the economy
17:49 going forward, and it is timed so well
17:51 because what we have seen historically
17:53 is that R&D spend anyway increases
17:55 when the CAPEX cycle picks up in the economy,
17:59 which we have seen in the past also.
18:00 So we're seeing this CAPEX cycle pick up
18:03 in the economy, private investments happening.
18:05 And if there is a policy measure towards,
18:08 really pushing R&D spend,
18:14 that's going to enhance productivity in the economy.
18:16 And that's going to be very structured in my view
18:18 from a long-term perspective, and I'm very positive
18:20 about that.
18:21 - Let me come to the PSU rally.
18:25 And you have largely been bullish on PSU companies.
18:30 Now we tend to bracket it in one basket,
18:33 but the fact is that there are many, many
18:35 different kinds of businesses.
18:37 You have PSUs in the energy space,
18:39 in railways, banks, et cetera.
18:42 Do you think that the overall change in sentiment
18:45 after I think decades, that PSU companies
18:49 can also be profitable, they can also bring value,
18:52 will sustain, A, and which of these baskets
18:56 really look like they will have more to give?
18:59 - So this PSU versus private thing is more to do
19:03 with how, where the demand in the economy
19:06 and cycles are playing out.
19:07 See, if all this positivity about PSUs
19:10 would never have happened, if the PSUs
19:12 would not have delivered on growth,
19:14 there are a lot of book rising and the profits rising.
19:17 And we have seen this story play out.
19:18 Only thing is people have forgotten completely
19:20 that between 2003, 2008, where the section
19:24 of the economy was that the investment rate
19:27 Kepik cycle and the companies would grow
19:30 by balance sheet expansion,
19:31 they were the darlings of the market.
19:34 So when the Kepik cycle expands,
19:40 you have balance sheet driven companies really do well
19:43 because demand for capital intensive sectors rises.
19:47 And PSUs are typically in these spaces
19:49 and they did really well because the profit,
19:51 the growth, the balance sheet expansion,
19:53 everything was expanding.
19:54 And they did really well during that time.
19:58 Post 2012, till about 21 pre-COVID,
20:03 there was this phase of, you know,
20:05 that the investment rate, the overall real estate cycle,
20:09 everything fell and the Kepik cycle fell,
20:11 corporate Kepik fell.
20:13 And so that's the time when these companies
20:18 just did not pick up.
20:20 But I mean, apart from the cycle,
20:22 we are also seeing that the emphasis,
20:24 the focus of the government towards defense spending,
20:27 defense indigenous manufacturing in India,
20:30 these are the new initiatives and policy measures
20:34 which have also helped the overall manufacturing Kepiks
20:38 theme, which is helping these companies anyways.
20:41 So I think this is a phase of,
20:46 as long as the Kepik cycle continues,
20:49 PSUs in my view, such balance sheet driven companies,
20:54 be it PSUs or private will continue to do well.
20:59 The gap between PSUs and private will always remain
21:01 in my view in terms of valuations
21:03 because of the perception that investors typically have.
21:08 And these perceptions don't change.
21:10 I mean, they didn't change in the earlier cycle,
21:13 but what matters is growth coming in this sector or not.
21:18 So it's clearly coming.
21:19 We've seen order go from these companies really picked up.
21:22 - Okay, so growth is coming.
21:24 The PSU and private sort of perception lag will continue.
21:27 But as we round up this conversation,
21:30 then I ask you to look forward.
21:32 What are the sectors and spaces that you're seeing
21:36 with the biggest pop coming ahead,
21:38 at least in the next six to 12 months?
21:40 - So there are two things to answer this.
21:48 One is there will be continued momentum in some of the
21:51 sectors, so where the growth will be good,
21:53 but there will also be some, for example, banks,
21:57 they're getting, what you should say,
21:59 some kind of re-rating is happening.
22:02 So it's a combination of these two, I think,
22:05 will be where I would bet my money,
22:07 basically where the valuations are getting re-rated.
22:12 People are recognizing that these valuations are cheap
22:16 and the fundamentals are improving.
22:18 So as I talked about financials and large banks,
22:21 and on the momentum side,
22:25 in the sense where growth, not momentum, stock momentum,
22:28 I'm talking about growth momentum,
22:30 where order book is improving and all,
22:33 and demand is robust.
22:35 I think a mix of industrials, the capex cycle companies,
22:40 and some of the discretionary consumption categories
22:44 like premium products, autos, and things like that.
22:48 I think that these are two spaces I'll be bullish on,
22:52 three spaces rather, financials, large financials, banks,
22:54 industrial capex driven companies,
22:58 and pockets of discretionary consumption.
23:01 - Discretionary consumption is the buzzword indeed.
23:03 Thank you so much, Vinod, for speaking with us.
23:06 Vinod Karkia of ICICI Securities there
23:09 on how he sees markets panning out.
23:12 (upbeat music)
23:15 (dramatic music)