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Earnings key to market gains even if macro improves: Vetri

The big challenge for the market is that even though the macro situation will continue to improve, further upside in share prices will depend on the growth in corporate earnings, says Vetri Subramanium, Chief Investment Officer, Religare Invesco Mutual Fund.

In an interview to CNBC-TV18, he says valuations are no longer cheap even if they may not be absurdly expensive. So there is unlikely to be a further expansion in price to earning (PE)multiple, and market performance will be related to earnings growth.

Putting this in perspective, Subramanium said last year’s 30 percent rally in benchmark indices was driven two-thirds by PE expansion and one-third by earnings growth.

He says the feedback from the industry is that sentiment has definitely improved in the last few months but on ground activity is yet to pick up.

Subramanium is hope of capacity utilisation improving in the coming quarters, but says that for now the underlying growth trends are weak.

The consensus estimate for earnings growth in FY16 is 17 percent, but Subramanium cautions that is possible only if there is a decent revenue growth, which in turn will allow companies to reap the benefits of operating leverage and increase margins. For the December quarter, he expects corporate earnings to be in the low single digits.

On the positive side, he says there is a clear disinflationary trend, and even if banks are yet to reduce interest rates, the cost of funds for corporates has already reduced by 50-75 basis points over the last few months. He expects the RBI to cut benchmark rates by 5-75 basis points during the course of this calendar, and sees it benefitting interest rate senstive cyclicals in a big way.

He is cautious on industrial stocks like capital goods and infrastructure as he does not see the investment cycle picking up in a hurry. He is positive on consumer discretionary stocks like auto, white goods and retail, as he feels the valuations are still reasonable.

Below is the transcript of Vetri Subramaniam’s interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.

Latha: Your note on the market, we put behind such a good year. Will 2015 turnout to be at least as good or almost as good?

A: Once you had a good year like 2014 was, it is a bit difficult to expect to build on that or repeat it easily. The key challenge for the economy or rather for the market is that even though the economy, we think will gradually start to improve and perhaps do better by the time we get to the end of the year, from a market point of view valuations are no longer in the cheap territory, they are not absurdly rich but to expect that you see further PE multiple expansions from these levels immediately is a bit hard to see and therefore the market’s performance is going to be related a lot more to underlying earnings growth.

The earnings forecast for FY16, if you look at the consensus numbers, is about 17 percent odd but even over there one reason why that percentage number is 17 percent, is that the actual FY15 earnings has seen some cuts but there will be some acceleration, there are low levels of capacity utilisation across a large number of industries, so I would tend to think that whatever outcomes that you see this year for the market, will be more closely related to earnings growth rather than PE multiple change, which is very different from last year because if you look at last year’s 30 percent move in the market, 2/3rd of that came from a change in the PE multiple and only 1/3rd came from earnings growth.

Sonia: There are lots of big global events that are lined up this week, the European Central Bank (ECB) policy, the Greek elections and in this fortnight there is Federal Open Market Committee (FOMC) meeting as well. What would top your list in terms of key triggers for this market and which way do you think it could take the market?

A: I do not have a crystal ball and if you look at the history of what has happened over the last few years, it is impossible to foretell what might happen and what the outcomes will be with some of these large macro events. Surely that is something that we should worry about but we are at a point where what we are more happy doing is taking a call on the companies that we own and as long as we believe that these companies are well placed to benefit from a recovery and growth in India and that’s the way we are happy to position our portfolio and there is no real way to insulate yourself from some of the large risks that you mentioned, will these eventually have an impact on economic growth in India, will it affect our financial market. Certainly there are linkages and I cannot wish them away but it is very hard to build them into your underlying portfolio construction and therefore, at some level we tend not to focus too much on these things when we are trying to manage a portfolio for the long-term.  

Latha: Let me come back to the domestic theme that you have raised, earnings growth. Are you confident of that 17 percent earnings growth, we have not seen so much by way of growth in the macros as well the last Mahindra and Mahindra Financial Services Ltd (MMFSL) number seems to indicate some very deep stress in the market?

A: It certainly is a big challenge. If you look at what companies are saying even as they start talking to us during the course of this earning season, everybody is continuing to repeat the same message which is that sentiment has improved but activity has not improved as yet very significantly. That is also visible in the numbers that you are seeing in terms of corporate earnings growth or even in the forecast for corporate earnings growth, the estimate is that for the December quarter, corporate earnings growth was just about in the very low single digit range. So, underlying growth trends are still very weak and honestly, when you talk about that, 16-17 percent consensus earnings growth for the market in 2016, the underlying premise is that there will be some pick up in revenue growth and only based on that pick up in revenue growth are you likely to see the benefit of operating leverage for a lot of companies, which are currently operating at lower levels of capacity utilisation. If the topline growth is going to be in the low single digit, then you may not get that expansion in margins and the increase in profitability ahead of growth in revenues. So I think that is very important that we see that number, these are still early days, it is a very nascent recovery honestly at this point of time. So you have to be little careful in terms of where you want to lay those positions down.

Latha: Will the rate scenario or the rate cycle help. How much are you expecting by way of rate cuts and how would you play that?

A: If you look at the consensus, it is about 50-75 bps over the course of the year. We are comfortable with that. The fact that it was cut last week was a surprise but the way we look at portfolios, it doesn’t matter because it doesn’t change our forecast for what we think over the rest of the year but this is very hard business in terms of getting that exact number right.

However, what we have more focused on is that there are disinflationary trends which are visible; the growth pick up is still very nascent, so in a way that is a good thing from an inflation outlook point of view because producers do not have pricing power at this point of time. Therefore, from our point of view we are quite happy that there will be some downward movement in rates over the course of the year but the important thing to keep in mind is that a lot of companies that we talked to, are already telling us that over the last two-three quarters they have already seen 50-75 bps drop in some of their borrowing cost because they have been going to the market and raising money rather than to the banks. So in terms of visibility of lower borrowing cost – that will be visible perhaps even in this March quarter and the market will monitor what the Reserve Bank of India (RBI) does but the general trajectory is down and that will create tailwind for interest rate cyclical.

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