K N Sivasubramanian, chief investment officer, Franklin Equity - India, Franklin Templeton Investments, believes the markets have enough depth to absorb the $2-billion worth of stake sales required to meet the June deadline for minimum public shareholding. Institutional flows however, remain a key factor in determining how things will pan out, he said. In an interview with Sachin P Mampatta and Sneha Padiyath, he discussed why pharma companies won't be hit too hard in the long term by the new drug price control policy, the impact of rupee depreciation on the IT sector and the outlook on earnings. Edited excerpts:
How does the new drug price control policy affect your outlook for pharma sector?
At a broad level, the policy should lead to price cuts for many leading firms. The impact varies based on current price premiums, NLEM (National List of Essential Medicines) coverage and overseas revenue component. Such cuts will weigh on short-term margins, but there is no material change in the long-term outlook. Many Indian pharma companies have, over time, moved away from the traditional domestic focus and simple generics-led business to invest in new growth segments and move up the value chain. This, alongside the rise in healthcare spending in India, offer companies good opportunities for expansion.
There is $2 billion worth of stake sales, which have to happen by the first week of June. How major an overhang could this be on the market?
We don't expect these divestments to have an impact on the broader market, given the current buoyancy in foreign institutional investor (FII) flows and the depth of the Indian markets.
Do you see room for further correction? Are you sitting on cash?
The positive global sentiment, interest rate cuts and strong FII flows have helped Indian markets rally strongly over the last month or so. Whilst this has happened with no material change in economic fundamentals, we believe the macro environment is likely to become positive over the coming quarters. A return to high growth rates, however, will be possible only over the medium term. Given the strong long-term growth fundamentals, at current valuations of 14-15x one-year forward earnings expectations, the markets provide a good entry point for long-term investors. We are bottom-up investors who do not take any cash calls. Our holding period tends to long, but any sharp corrections can lead to attractive valuations emerging on a relative basis. We will use such declines to increase exposure to quality companies available at good prices.
What could depreciation in the rupee mean for export-oriented sectors such as IT?
The impact of currency depreciation varies across different sectors. While it benefits export-oriented sectors such as IT, it tends to push up the cost of imports. A weaker rupee partially offsets gains from the decline in global oil/commodity prices. It also undermines the return potential of foreign investments into Indian assets. The rupee's decline could add to export competitiveness and help narrow the gap. The near-term direction will continue to be influenced by global events and domestic policy /macro data, but we don't envisage significant deterioration in currency value from current levels.
How would you rate the current earnings season?
At this stage, we believe that markets are fairly valued and unlike the start of 2012, earnings growth expectations are closer to reality. Earnings for corporate India as a whole have lagged nominal GDP (gross domestic product) growth over the past few years and this is expected to change in the coming year.
The fall in global commodity prices and easing borrowing costs should have a positive impact over the near term. The medium-term outlook depends on the evolving macro situation, both in India and overseas.
Earnings dispersion is expected to remain high across sectors and hence believe investors are better off adopting a bottom-up, fundamental research focus - quality of management/balance sheet will be important.
Is there a threat of further earnings downgrade?
It is important to note that the recent policy changes though positive, their impact on growth is likely to be visible only in the medium term. Meanwhile, investment activity remains weak and concrete steps need to be taken to speed up investment project clearances. Also, there is an urgent need for credible progress on fiscal consolidation and encouraging long term savings in the country. Any progress on these fronts could further help boost confidence in the India growth story. At this stage, we believe the likelihood of earnings quality deterioration is low.
