We don't see a lot of upside in equities from current levels: Venkataraman

As the government unveils a series of policy-related measures to stem the economic fallout of the Covid-19 pandemic, R VENKATARAMAN, managing director, IIFL Securities, tells Puneet Wadhwa that though the benchmark indices are significantly lower from the peak, they continue to price in a fairly optimistic scenario. Edited excerpts:

Your interpretation of the stimulus measures announced by the government? Is that what the markets and industry were expecting?

While we await full details and the implementation of the announcements, some of the policy steps to improve funding access to non-banking financial companies (NBFCs) are positive. However, equity funding plans could face challenges on valuations, participation from other financial institutions, etc. The fully guaranteed loans to small and medium enterprises (SMEs) are also good. That said, more steps will be needed to revive growth. The announcement of amendment of the Essential Commodities Act will likely remove a major hurdle for farmers and the food supply chain. The whole agri-supply industry and retail chains will see a news business scenario. However, we need to wait and watch how the implementation unfolds.

Can we see lower levels on the Sensex and Nifty once companies start unveiling financial performance over the next couple of quarters?

Although the benchmark indices are significantly lower from their peaks, they continue to price in a fairly optimistic scenario. The Nifty is trading near its long-term average on 12-month forward price-to-earnings (PE), but the consensus estimates imply around 10 per cent year-on-year growth in the Nifty’s earnings per share (EPS), which is quite unrealistic. Hence, we do not see a lot of upside in equities from the current levels. That said, the sector leadership in equities is also shifting, and sectors like pharma, telecom and insurance should do well. The Q1FY21 earnings may not surprise investors as companies are generally expected to report extremely weak numbers; the duration of the slowdown may surprise the markets as they seem optimistic on the recovery.

Are retail investors feeling left out after the rally from March 2020 lows?

The equity collections of mutual funds (MFs) are a good pointer to retail sentiment and the data suggests a continuing preference to equities. The systematic investment plan (SIP) flows have seen a modest dip in April and suggest that households continue to prefer equities. Households may prefer savings over consumption after the income shock faced by them because of the lockdown. Some of these savings could be allocated to mutual funds.

What has been the impact on the retail and institutional broking business of IIFL?

The institutional broking business has been more or less in line with pre-Covid-19 trends. Volatility drives up volumes, but they will likely taper-off once volatility subsides. On the retail front, we have experienced increased participation in direct equity by investors, as well. There have been many queries for asset allocation and wealth preservation strategies. Many are first-time investors from the younger generation, who have entered the markets after a significant fall in March.

What has been your market strategy since the March lows?

We remain overweight on pharma, telecom, and insurance; we maintain an underweight stance on cyclical sectors like industrials, and metals & mining. Pharma will continue delivering upside over the next two-three years. We prefer Cadila, Dr. Reddy's and Aurobindo Pharma, as they have the best product fit to take advantage of the circumstances, besides their valuations are also not too rich. That said, the broader market is likely to continue to remain unpredictable for some time.

What about the financial sector?

Non-performing assets (NPA) should rise for both banks and NBFCs as unemployment has jumped to record levels and small businesses may not enough funds to survive the lockdown. The three-month loan moratorium announced by the Reserve Bank of India (RBI) should help to an extent. However, it will not be able to prevent a spike in non-performing loans. However, the economic stimulus could potentially trigger a large cash infusion into the economy. With the right conditions, the special liquidity scheme and the partial credit guarantee scheme (PCGS) could address the cash flow issues that NBFCs and SMEs/MSMEs are currently facing. However, more measures may be required to improve investor confidence in the sector.

Do you expect the pace of earnings downgrades to pick up over the next couple of quarters?

We expect corporate earnings to decline in the financial year 2020-21 (FY21), given the expectation of a contraction in gross domestic product (GDP). The downgrades momentum could continue through the year, as the extent of damage to the economy due to the Covid-19 pandemic becomes clearer. As per a stress-case scenario done by IIFL Institutional Equities about a month ago, we broadly assume GDP growth of 3.5 per cent in FY21, and 4.5 per cent in FY22, reflecting a prolonged impact of the virus and the lockdown on the economy.