Market fairly valued, volatility to continue: ASK Investment managers

In a Q&A, Prateek Agrawal, who is also the firm's CIO, says given the strength in overall earnings as seen in FY24 EPS outlook, the direction of the market is likely to be positive

At the current juncture, the market is valued fairly and the world is embarking on liquidity tightening measures in the face of high inflation, says Prateek Agrawal, Business Head & Chief Investment Officer, ASK Investment Managers. In an interview with Ashley Coutinho, he says volatility should be expected to remain higher than usual. Edited excerpts:

What is your equity outlook for the coming months? What are the key triggers to watch out for?

Over the last two years, markets were bouncing back from lows; there was valuation comfort and there was a support of strong earnings growth. Easy liquidity scenario helped. This has reduced volatility dramatically. At the current juncture, the market is valued fairly and the world is embarking on liquidity tightening measures in the face of high inflation. Hence, volatility should be expected to remain higher than usual.

Given the strength in overall earnings, with FY24 earnings per share (EPS) for Nifty expected to be near 1,000, versus approximately 715 in FY22, it is expected that the direction of the market would be positive. Overall, one should expect market compounding to be a tad lower than earnings compounding, going forward. Key triggers to watch for are factors that impact inflation. Covid-19 related disruptions in China is one cause of supply chain issues and high inflation. Another of course, is the Russia-Ukraine situation which is causing oil prices to be high. Any normalcy in these would help the cause of equities and vice-versa.

What is your take on valuations?

It is expected that valuations are sustainable while volatility would be high. If we take a 18.5 times multiple to the 1,000 EPS for Nifty for FY24, we do arrive at a ballpark figure of around 18,500 for Nifty which leaves a fair amount of upside, while a tad lower than the earnings compounding that we hope to see over this period.

It is expected that there are high chances of the index EPS numbers to be attained. This is because the large profit pools in the country such as IT and lending institutions are seeing good business tailwinds. The third large profit pool is commodities where the outlook is better than before. The swing in the third profit pool would be matched by opposite swings in users of commodities such as autos, cement, consumers, etc.

One of the beliefs is that investors should look at changes in index composition over time. Index has seen shares of higher valued consumer, NBFC, life insurance, and retail businesses expand sharply over time and a corresponding decline in weight of lower valued commodities and PSU banks. Over time from FY93 till FY22, the move in the market has been in line with the move in the earnings of the index. It is on this count that the index levels are sustainable, while on a shorter-term timeframe markets can be volatile.

How much of a pain point will the surge in crude oil prices be for India?

Crude is our single largest import. One dollar increase in the price of crude increases the imports by around $1.3 billion. We have seen an over $30 increase in the price of crude and this means an over $40 billion impact to a $3 trillion economy, a 1.3 per cent shave off.

Higher crude prices are also resulting in higher inflation. Central bank tightening to curb inflation would be through higher interest rates and lower surplus liquidity which could also impact growth negatively over a period of time.

What is your view on mid and small-cap stocks?

We are positive about this space. If we look at major themes at present such as China +1 (chemicals, textiles and APIs), PLI benefits (electronics), move away from unorganised towards organised (diagnostic chains, footwear, modern retail, etc), make in India particularly defense, most of the beneficiaries where the positive impact is large are in the mid-cap space. This should help this space. In terms of stock performance, periods of high volatility are usually bad for mid-caps and this is something that has to be kept in mind. Focus on quality is hence of paramount importance. Businesses which are free cash flow generating and can grow well deep into the future are better positioned.

How will the LIC IPO impact the market? What is your take on new-age companies hitting the market?

A large IPO takes out liquidity for a period of time and that causes negative volatility. However, a large IPO also brings in several new investors into the market. If the large IPO is successful and the investors make money, it can have a positive impact on the market.

Every period throws up new businesses. We have to stick to time tested methods of valuing any business. While businesses in flavour have changed over the course of time, valuation methodologies such as DCF have proved to be more enduring. It is believed new age businesses do serve a great purpose and are needed. In most cases though, a cash-flow based valuation methodology fails to throw up value and may actually present downside and one needs to be very careful and be very selective. We are invested in few new age tech businesses where valuations do meet our methodology.

What are your estimates for FY23 corporate earnings growth? Will capex pick up this year?

Our estimates for FY23 earnings growth is between 17-20 per cent. Yes, capex is picking up. It is the first time after the 2003 to 2008 period that we are seeing all three engines of capex, the government capex, the household capex (home buying) and corporate capex (aided by PLI schemes) all beginning to grow. It is expected that over time these trends would strengthen. Higher commodity profitability should help companies repair balance sheets quicker and embark on new capex, a trend we are already seeing in steel and aluminium companies. Higher energy demand is seeing a bump up in capex in the field. In fact, one can expect some coal-based facilities to also come up even as the renewable space scales up.

Which sectors are you betting on?

We are investors who focus on businesses that offer a combination of high quality and high long period growth. Lenders in the private sector focussed on retail, Speciality chemicals and API manufacturers who are benefiting from China +1, electronic manufacturing benefiting from PLI have been our focus. Beneficiaries of unorganised to organised move is another space that we believe can offer long period growth and grocery and jewellery retail and diagnostic chains are part of portfolios.

It is believed that users of commodities with pricing power are facing a tough time currently. However, they have corrected in price and this juncture does present a contra trade that would benefit when commodities decline in prices. The period of wait may become longer as the global uncertainties that we have discussed above may take longer to sort out. Commodities are a very risky part of the market and current profitability has a low chance of sustaining.