Current valuation should not deter one from investment: Vikas Khemani

An interview of the President & Chief Executive Officer, Edelweiss Securities

Vikas Khemani, president and chief executive officer at Edelweiss Securities, chats with Hamsini Karthik on a series of topics. He remains optimistic on the Indian markets and believes earnings growth will be driven by domestic-oriented stories. Edited excerpts: 

There’s been a lot of expectation around shift in business from the unorganised sector into the organised one after goods and services tax (GST) implementation. Are your clients witnessing this?

Any structural change takes time. The shift from unorganised to organised is an impending reality. However, this will be a long process. Many catalysts will play a role but each takes time to kick-in. The GST impact will be felt only a few quarters down the line; it is still in a very early stage. The sectors which are slated to be large beneficiaries of this shift are those with a fragmented market, where the organised sector accounts for a small portion of the overall size and those where standardisation and accuracy are either essential or highly desirable. 

A clear example is the jewellery sector. Strong growth was witnessed in the results of leading players in this space, testimony to the same. Building materials (tiles, paints) are also likely to be large beneficiaries of the ongoing shift. On the services side, diagnostics and health care would be big beneficiaries. The organised sector accounts for around 10 per cent (health care) and 15 per cent (diagnostics). As focus on preventive medication, incidence of lifestyle diseases and penetration of health insurance all rise, the organised players could leverage their brand and reliability.

While the transition is playing out, it did take a toll on the June quarter results. We’ve had more than five consecutive quarters of earnings downgrade.

In the past three to four years, there have been many structural reforms and issues on the global growth front, which have delayed the earnings recovery cycle. However, most of this is now behind and we have in place a much more productive economy. Hence, in the ensuing years, I expect strong earnings recovery.

Yet, how long should investors be okay with the current valuations, which aren’t cheap by any means?

The Indian markets have done well this year, which obviously creates the feeling of stretched valuations. However, if you look at the structural set-up of markets (falling interest rates, growth, low inflation, young population, huge domestic markets), no other emerging market of meaningful size offers this at this point, which will justify the valuation. On a standalone historic basis, when you compare, you need to see this with reference to prevailing interest rates. In a low interest rate environment, equity valuation will always be higher than historic ones. I do believe India is a multi-year wealth creation story and the current valuation should not deter one from investment.

Which sectors offer reasonable growth potential?

In the 2003-08 cycle, earnings growth was higher in sectors more exposed to global growth – metals, oil, information technology, etc. In this cycle, I expect earnings growth to be driven by more domestic-oriented stories. Companies in financials, consumer discretionary, cement, construction, chemicals and fertilisers, and affordable housing should witness strong growth. A bottom-up approach is always better for stock picking.

Mid-caps have been more vulnerable in recent times vis-à-vis large-caps. Should one use this chance to book profits on these stocks?

While it is true that mid-caps have rallied a lot and are expensive compared to large-caps, it is not broad-based. There are a few places where there is perhaps overexuberance. To paint all mid-cap companies with a broad brush of being expensive is potentially misleading. In fact, there are a lot of companies in this space where growth prospects are good and the story is exciting.

Steps taken of late by the markets regulator and stock exchanges might force investors to take a cautious stance on these names, particularly for small-caps.

I don’t think this move should, by any chance, reduce the appeal of mid-caps and small-caps. If anything, in the long run, this move is in investor interest. Yes, some of the oversight in the process could have been avoided, which is more an accident than a pattern.