India’s economic engine seems to have survived the second wave of the covid-19 pandemic. Business balance sheets are strong and rural demand is back, leaving inflation as the primary macro challenge, said Nitin Sharma, Director Research and India Site Head, Fidelity International, in an interview with Kshitij Bhargava of Financial Express Online. He added that the IT, Consumer, Healthcare, Materials and Auto sector are expected to report robust operating and financial performance. Nitin Sharma further talks about the upcoming internet IPOs and guides investors on what to look for before investing in new-age companies.
What are the key risks and catalysts for markets at this juncture?
The fundamental catalyst at this stage for the markets is the economic path beyond the current pandemic, which is also the single most significant risk factor at the same time. While markets are taking comfort in the shorter duration of the second wave and gradually rising vaccination rate, uncertainty persists on the possibility of a subsequent wave.
On the fundamentals front, the economic engine seems to have survived the second wave hit. Banks and non-bank lenders have taken some hits but, the system’s ability to fund the economic activity revival is largely intact. RBI remains committed to supporting growth while the government is taking several steps for kicking off a structural growth cycle. Business balance sheets are generally in good shape and ready to fund future growth beyond the pandemic. The primary macro challenge is climbing inflation. Central banks seem to have taken it more of a transient supply-shock impact now and haven’t advanced any QE withdrawal, but they will be forced into a balancing act if wages begin to climb consistently. Markets such as India with a higher valuation will generally be more susceptible to resultant rising benchmark yields, and this will impact FII flows as well, which will be stronger for India than for most other emerging markets. India has seen ~ $34 billion FII inflows over the last 12 months as against outflows for Indonesia, Thailand, Malaysia, South Korea and Taiwan.
What sectors do you think are the most attractive right now?
India offers some great structural plays across multiple sectors, so a stock-specific approach always works better here. Expect robust operating and financial performance from IT, Consumer, Healthcare, Materials and Autos. Banks and NBFCs, too, should bounce back after absorbing the impact of the second wave, but performance will be more lender specific. The challenge is that most good names in these sectors are already discounting the expected positive cycle and are trading at expensive valuations, generally well beyond one standard deviation of 10-year averages. On that front, sectors such as Oil and Gas, Metals and Pharma offer a better prospect.
We are gearing up for some big-name IPOs now; we’ve just seen Zomato; What do you think should be looked at when investing in similar companies that are yet to turn profitable?
A vibrant venture and private equity investing landscape in India over the last several years is set to see some high-quality, established businesses coming up with IPOs in the coming period, which is a very positive development overall for the markets. However, investors do need to be extra careful while analysing such companies. First and foremost, they will need a relatively longer investment time horizon as the underlying operating model itself may not have stabilised for some of these businesses. One expects a long structural growth path for these names, so it is essential to understand each segment’s total addressable market and competitive scenario. A favourable emerging industry structure, say, driven by a consolidation of players, is extremely important for sustainable profits to kick in. Management quality is always a critical factor in analysing a business and is even more so for these businesses, both for the long-term ambitions and the ability to transition from a growth mindset to one focussed on generating profits from a scaled enterprise. Coming up with a fair valuation for such IPOs can be tricky as you need to base it on long term expectations, making the valuation models very sensitive. Beyond that, the usual balance sheet strength, operating leverage and cash flow generation potential are always important.
We are into the earnings seasons now, what are your expectations considering the second wave and resultant lockdowns in the previous quarter?
While being severe, the second wave impacted economic activity for a shorter duration compared to the first wave. This has led to the earing expectations for the financial years 2022 and 2023 largely holding through the pandemic induced disruption of the last quarter. The earnings for Autos, Consumer discretionary and Industrials sectors will show an impact of the lockdowns, as also the numbers for Financials where both incremental credit growth and collections were impacted. On the other hand, commodity prices will support the Energy and Materials sectors. Strong demand and delivery resilience will continue to lead to a positive revenue performance for the IT sector.
How are domestic markets placed in terms of valuations when compared to global peers?
MSCI India is trading at ~20 P/E based on 2022 earnings versus ~15 for Asia ex-Japan, but then India has always traded at a premium to most emerging market peers. This was historically supported by superior real Return on Equity (RoE) for India. However, this relative RoE advantage for India has diminished over the last few years resulting in the Indian markets looking expensive versus their peers as well as their own history. India’s 2022 earnings growth is also in line with most other emerging economies, leading to markets such as China and Indonesia appearing cheaper based on near-term earnings metrics. One must keep in mind, though, that India offers some excellent, scaled-up businesses with strong moats and a long growth runway, so the valuation premium will likely persist.
The interview was originally published in Financial Express in July 2021.
The opinions expressed are author's own. Fidelity International is not responsible for the author's opinions.