Correction may not be deep or extended: Kotak Institutional Equities CEO

In a Q&A, Pratik Gupta, CEO & Co-Head, says despite several near-term headwinds, India offers relatively stronger long-term growth and returns prospects

Markets like Brazil and France have done well despite the worsening Covid-19 situation, thanks to global liquidity, says Pratik Gupta, chief executive officer & co-head, Kotak Institutional Equities. In an interview, Gupta tells Samie Modak & Ashley Coutinho that despite several near-term headwinds, India offers relatively stronger long-term growth and returns prospects. Edited excerpts:

The Covid-19 crisis is weighing on the market. How much worse can it get?

The markets are already pricing in this spike in cases and also of more states imposing Maharashtra-style restrictions. In addition, there is hope that vaccination will be ramped up, which will reduce risks. There is also a lot of global liquidity sloshing around and many local investors missed the earlier rally – many want to buy on dips. Other markets like Brazil (5,000+ daily deaths) and France (one-month lockdown) have rallied despite the negative news. Hence, any correction in India is also unlikely to be deep or long lasting. The risk to this view is if the situation results in a nationwide lockdown, but that appears unlikely.

 The earnings growth estimates for FY22 and FY23 are steep. Will a fresh lockdown lead to downgrades?

We were expecting Nifty earnings growth of 27 per cent and 18 per cent in FY22 and FY23, respectively, before the second wave. Now, there’ll be some cuts to our estimates. In particular, sectors like hotels, airlines, multiplexes, retail malls will be significantly impacted — but these sectors don’t have much weight in the Nifty. However, earnings growth in FY22 and FY23 should still be relatively strong on a year-on-year (YoY) basis – this will be driven mainly by banks (lower credit costs), autos and telecom (low-base effect due to losses at some companies in FY21) as well as metals (strong commodity prices).

The rupee has been weakening against the dollar. Will this act as a headwind?

Over the next few months, the US dollar is expected to do relatively better because of the strong economic recovery there and higher bond yields. So, that is indeed a headwind for some momentum-oriented foreign portfolio investor (FPI) inflows. However, the rupee has already lost about 3 per cent against the dollar over the previous fortnight. It could weaken only gradually for the rest of 2021, given India’s strong forex reserves (at $580 billion) and the expected long-term weakening trend in the dollar. More importantly, India’s corporate earnings growth prospects are still quite strong, which is attracting foreign investors.

Last year, India got more than its fair share of FPI flows? Will that continue?

Most emerging market investors remain overweight on India given our relatively stronger long-term growth and return on equity (RoE) prospects. India remains an attractive domestic consumption growth story, and with prospects of more business-friendly measures (such as the PLI scheme, labour reforms). Also, the recent underperformance versus many Asian peers, we should see strong FPI inflows into equities again this year. The key risk to this view is that of a sharp increase in US bond yields.

 What kind of returns should investors expect?

Over the next few months, one should expect single-digit returns at the index level – it will be difficult for the overall market to get re-rated significantly higher from current levels in a rising interest rate environment – because the Nifty is already trading at a relatively high price-to-earnings multiple of about 22 times FY22 and 19 times FY23. However, the long-term returns from equities should still be in double-digits given the strong 20 per cent earnings CAGR over the next 2 years. This would still be better than fixed income returns.

 Which sectors do you like?

We recommend looking beyond the next few months, which may be impacted by short-term lockdowns and overall EM weakness. From a one-year plus perspective, we like some leading private banks and NBFCs with strong balance sheets and ability to gain market share as the economic recovery plays out later in 2021. We also like global-recovery plays like IT services (mainly tier-1 vendors) and metals (steel and aluminium) given strong global demand. We also like some mid-caps in capital goods, real estate, and specialty chemicals — sectors likely to grow well in the next 2-3 years.

Banking and IT stocks are trading at a premium to their historical valuations. What’s the outlook there?

A. For both banks and IT services, earnings growth and RoE prospects are much better for the next few years. Hence, the premiums are justified. Banks are effectively leveraged plays on economic growth, and with India’s GDP expected to grow at 10 per cent in FY22, they should do well as the focus shifts from asset quality to loan growth. We continue to prefer private banks (versus public sector banks) that have raised capital, have a strong liability franchise and where credit costs will decline in FY22. In IT services, while the overall demand environment is expected to stay strong, our preference remains for tier-1 vendors as we are worried about a war for talent and believe larger companies are better positioned in such an environment.

Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd