earnings growth: Earnings growth to remain quite strong in auto, cement & pharma sector: Harsha Upadhyaya

“However, on the largecap side, the valuations are not so expensive. It is just about 5% or 6% higher than the historical averages. So, if you want to construct a portfolio, having a little bit of tilt towards largecaps is a better way to manage risk,” says Harsha Upadhyaya, CIO-Equity, Kotak AMC.

Let us start with the view in the market. Everybody is of the view that you need to be cautious. FIIs are selling, global geopolitical concerns are there, but none of the major indices are a distance away from the recent highs. The smallcap index is 1% away from its all-time high. The midcap index is 2 and Nifty is off by about 1%. So, if there is nervousness in the market and if there are concerns around valuations, then why are markets ignoring it? Why is price action so strong?
Clearly, valuations continue to be at elevated levels. Your question is pertinent that why is market not showing that nervousness. But if you look at how markets reacted a couple of weeks back when disclosures were announced on the mutual fund categories like smallcap and midcap, even without any fundamental negative we did see smallcap and midcaps correcting in double digits whereas Nifty was down only about 2% or 3% at that point of time. So, that clearly shows that there is nervousness in the market. It is just that the liquidity has also been quite strong at this point of time. So, to an extent, that is getting nullified at this point of time. However, given the current state of valuations, one needs to be cautious, that is what we believe.

However, on the largecap side, the valuations are not so expensive. It is just about 5% or 6% higher than the historical averages. So, if you want to construct a portfolio, having a little bit of tilt towards largecaps is a better way to manage risk.

So, what is your portfolio strategy right now?
For us, we generally do not keep too much of cash in our portfolio. So, most of our portfolios are fully invested. Cash is hardly about 1% to 2% just to manage liquidity. And if you look at our portfolios, our portfolios have been tilted towards domestic businesses and even within domestic we have been looking at more cyclical themes rather than consumption-oriented themes as consumption trends continue to be weak. There is no pocket where there is too much value in the market at this point of time.

However, it is to be evaluated on a relative basis and on a relative basis we do find more value in largecaps as compared to mid and small. So, wherever the mandate allows, we have tilted a little bit towards largecaps in recent times.

So, within the pool of cyclicals, what sectors find highest allocation?
Clearly, there are a couple of sectors which are likely to exhibit better earnings growth compared to the market average earnings growth even going forward, that has been the case for financial year 2024.

But we do see a couple of these sectors continuing that trend even into financial year 2025, probably into financial year 2026 as well.

So, auto, auto components, cement, these are some of the names that we like. We also like industrials. There has been a very-very strong order inflows that have been seen across the sector. We do believe that at some point of time, the execution will also pick up and margin should remain quite strong given that the commodity cycle is still benign.

We also look at pharma. Pharma should also show reasonably strong earnings growth, better than market average earnings growth. So, these are some pockets where we think earnings growth will continue to remain quite strong.
And hence, even though the valuations may be a little higher than comfortable levels in some cases, that may continue as long as earnings growth continues in this trajectory.

Speaking of earnings growth, give us a sense as to where is it that you are expecting there to be a positive surprise on the upside and where is it that you believe that the disappointments will continue when it comes to earnings?
This quarter is unlikely to be a very big quarter either in terms of positive surprises or negatives. In fact, this is one of the slowest earnings growth that you will see if you look at the last couple of quarters.

So, this quarter we will see probably about 6% to 7% earnings growth on a year-on-year basis for Nifty basket.
However, for the full year, financial year 2024, you will see still upwards of 20% earnings growth. Thanks to somewhat unfavourable base of last year, last quarter, we are unlikely to see big numbers in this earnings season.

So, we may not see too many companies delivering very-very strong results or very-very muted set of numbers.
But within that overall view, we also find IT services, for example, will remain muted.

Even going forward, I think the volume momentum continues to be weak. The margins have not been great. There have been several verticals which are still showing a decline or very-very slow growth. So, this will continue to lag the overall market average earnings growth.

Banking and financial services though could be more or less in line with market average earnings growth; however, there are near-term headwinds in terms of how credit growth is going to pick up given that the deposit growth has been difficult for most banks.

While on a valuation basis maybe this sector looks better than some of the other sectors, but in the very near term it is unlikely that it will outperform.

So, it has been a very-very lacklustre kind of an earnings season when you compare it to previous few quarters, I would say.

Why are banks not chipping in? If the economy is doing well, if credit growth is decent, inflation fears are behind us, banks are massively underperforming. Why is that?
One to begin with, I think before this entire bull run started they were one of the leaders of the market and their valuations were at very-very high levels compared to their own historical valuation levels and suddenly we have seen this segment delivering earnings growth which is lower than the market earnings growth which has not happened for many years and at the same time we have had many of the other cyclical themes which were not showing any earnings growth, suddenly coming back and delivering better than market earnings growth.

So, suddenly, the incremental money has definitely moved towards some of these cyclical and manufacturing sectors where there is a reasonable degree of confidence on the earnings growth moving forward.

However, as I said, while the near-term headwinds still continue for banking and financials, we do believe that if at all there is any segment where valuations are around the COVID levels or pre-COVID levels, then the largecap banking names are the only ones to really look at.

So, in case there is volatility in the market, probably this sector will outperform. However, if market continues to move up, then probably it may not outperform, that is our view at this point of time.

Let us look at the importance of election and the importance of budget. From market standpoint, election is more like a no-show. But what about budget?
Budget definitely will be focused on more because this is the third term, if at all the consensus expectations come true, then that will be a kind of a focus from the government in terms of how to accelerate the growth and how to build on the platform that has been built in the last 10 years, etc.

I think all eyes will be in terms of what kind of an impetus will be there on infrastructure growth, what kind of an impetus will be on manufacturing growth, and how jobs will be created in the country because ultimately that is going to drive consumption growth as well.

All of these factors will be focused. And our sense is if the same government were to come back, some of the policies that we have seen in the past 10 years will only get accelerated and to that extent it should be positive for most domestic-focused businesses.

You earlier talked about maintaining a tilt towards largecaps as opposed to what the broader market has been doing. Do you believe it is still overheated because, we were just calculating irrespective of that March shake-off that we got within the mid and smallcaps specifically, we are again back to just about a percent, two odd percent away from the all-time peak.
Definitely. The valuations have been more or less similar. If you just forget those couple of weeks of downside volatility that we saw, market is back to earlier levels.

Midcaps are still trading at a valuation which is almost like 20-25% premium to their historical averages. When I talk about historical averages in case of midcaps, I am talking only from, let us say, in 2017 or 2018 when the recategorisation happened and there is a clear sense in terms of how money has moved into these segments.
So, even on the basis of those elevated valuations, we are already higher by 20-25%.

There is no room for earnings disappointments here. And if you look at smallcaps, the case is even more elevated in terms of valuations. It is almost like 45% premium to long-term averages. So, that is where we believe that earnings delivery is going to be very-very crucial for smallcaps and midcaps.

If there is any disappointment, then market may not have the room to really take those disappointments. However, in case of largecaps, while valuations are higher, they are not so high. With some shallow correction or some sideways market for the next couple of months those valuations can get adjusted to historical averages, so that is where our comfort is more on largecaps at this point.