R Sukumar, managing director and chief investment officer of Franklin Asian Equities, Franklin Templeton believes that Indian equities are close to trough valuations, and therefore could give better returns than debt in 2012. However, he does believe the slowdown in earnings and growth is likely to continue for a few more quarters.
“Earnings are likely to bottom out towards the second half of FY12,” he said, adding that the high fiscal deficit is going to continue to be an overhang.
Sukumar further adds that the market has to brace itself for lower foreign institutional inflows. “Due to adverse headwinds as far as fund flows are concerned, we could see low FII flow as compared to the average we have seeing over last three-four years,” he explained.
Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.
Q: After a pretty poor 2011, is this year going to be another tough one or do you expect a better year for equities?
A: In terms of economic growth and corporate earnings growth, it will be a tough year. But as far as equity markets are concerned, I think the expectations have already been reset. So to that extent, if the economy starts seeing some pickup in the second half, then the market prospects can be better this year compared to last year.
Q: Would you go as far as to say that we may be close to a bottom for the market or is that difficult to say just yet?
A: Yes, it’s always difficult to say what the bottom is because it's made in a very brief period when extreme panic sets in. But I think we are close to trough valuations. There can be improvement in return on equity from the trough level in the next cycle and the market is not pricing that in. There can be better earnings growth in 2013 and 2014 compared to 2012.
So those are some of the positives we can look forward to once the economy and the companies consolidate and fresh investment phase starts accelerating the economic growth and corporate revenue growth.
Q: By which quarter do you think we may begin to see the trough in terms of earnings performance?
A: I think it will be Q3 or Q4 of 2012 because we are still seeing deceleration in sectors. The margin pressures continue for large sections of companies, so I am not very optimistic that in this or the next quarter we will see recovery in earnings.
Q: When you speak to your overseas peers, what do you hear in terms of fund flow interest into this market and how do you think 2012 will be on the fund parameter?
A: At this point of time, I don’t think there is a lot of demand for Indian equities. We have to remember that a lot of money that came into India came in through India dedicated funds. While some of them might be seeing inflows, as a category India funds is not a hard category. We are not seeing major inflows into this category, and in fact it is shrinking a bit.
So there are headwinds as far as fund flows are concerned. We have to brace ourselves for low FII inflows compared to the average we have seeing over last three-four years.
Q: People are very worried about the deficit picture and the fact that it may not improve. Do you expect any silver lining to emerge over the next 3-6 months from the Indian macro front?
A: Deficit is going to be a concern for sometime. I don’t see any magic formula to cut down the deficit immediately. We have to make some hard decisions, but hard decisions are obviously not forthcoming considering the political situation.
So if the deficit is going to continue at a higher level, then we have to brace ourselves for a lower net savings rate in economy and so per se the investment rate is also probably going to be lower. So the potential GDP growth, even when we see a recovery, probably is not going to be as high as we saw in last cycle; that seems to be the most probable scenario now.
Q: By when do you start taking bets on the infrastructure front? We have seen a reasonable PMI December number, so when do you start seeing the first signs of recovery in the investment cycle?
A: I think its going to be some time in second half of 2012. But as far as investment and infrastructure sector is concerned, I think the more basic issue is the range in quality of companies that are available for investment, the way they manage their businesses, the risk, treatment of minority shareholders, etc. So people have to think many times before they touch many of the counter.
So the choices available in the sector are very low and if the mindset of the company is not about delivering good return on capital to minority shareholders, then minority shareholders have to think whether they need to invest in that sector at all.
Q: Could you be more specific of what you are talking about? Do you mean large investments which have stretched their balance sheet?
A: Yes, they have stretched the balance sheet, asset structure related issues, related party transactions etc and so lot of value for the minority shareholders has been depleted. It’s not a cyclical issue, it’s a structural issue and we need to see improvement in management style, policy framework and corporate governance.
Q: The linchpin event for the market seems to be when the Reserve Bank will start to cut rates. By when do you think in this calendar year the market should expect to see a steady trend on that and just by extension of that what would you do with the banks now?
A: We believe that there is going to be little bit of margin compression. As we have said several times in some of the recent shows, we expect the public sector banks to be more affected compared to the better managed private sector banks. So we would be wary of investment and public sector banks.
We would like to invest in good quality private sector banks at reasonable valuations. We think they have good long-term growth potential and the profitability levels are satisfactory. So that’s our view on investments in banks.
Will the defensive names lag in the next rally? Read on to find out..
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