Alok Agarwal, Head-Quant & Fund Managers, Alchemy Capital, says India is much more expensive than the world, but currently India’s premium to the world stands at around 13% on a one-year forward PE basis and this is the lowest number we have seen in the last four years. We need to get a higher premium because of double-digit nominal GDP growth, double-digit corporate earnings growth, and the double-digit ROEs are likely to continue for a longer period of time. And hence, the risk-reward has improved significantly.
What are you making of the market construct given the fact that we have seen a sharp downtick in the market? Now, no doubt, we are seeing a recovery. But we did see a sharper sell-off come in markets. Do you think now India is poised to be a value buy given the fact that we have seen that correction that was warranted?
Alok Agarwal: Yes, we saw quite a bit of correction in the last two months. While the headline indices fell around 10-11% from the peak, broader market sell-off at an individual stock level was quite severe. More than half of Nifty 500 stocks fell more than 25% from their peak. We had all the reasons as well. We saw FII selling at around $15 billion in the last two months on the back of slowing corporate earnings growth, slight signs of even the economy slowing down with the GST collection slow, the bank credit at a slower rate. So, there were a number of reasons. There was a higher valuation. There was selling. And we saw a correction. But now the risk-reward stands quite favourable. It is quite interesting to note. In fact, you also mentioned that India is a value buy. Definitely, India is much more expensive than the world, but currently India’s premium to the world stands at around 13% on a one-year forward PE basis and this is the lowest number we have seen in the last four years. On a relative basis, our premium is lower and it is quite justified why we need to get a higher premium because of double-digit nominal GDP growth, double-digit corporate earnings growth, and the double-digit ROEs likely to continue for a longer period of time. And hence, the risk-reward definitely has improved significantly.
The risk-reward has definitely improved, as you are mentioning, but given that we have seen a sharp fall, a lot of sectors, a lot of stocks have become quite attractive, must have become at least quite attractive. Which are those pockets or sectors that are the right value buys at this juncture?
Alok Agarwal: In India, the structural theme has been consumer discretionary. So, we all have been knowing that the demographics have been in India’s favour, be it the younger population or the rising per capita income and we are seeing pockets of such things, successes, and growth in consumer discretionary segment, so that segment is a very wide segment, right from the autos to the retail to various food items.
Everything comes under that, but that is the segment that is on a naturally growing structural growth basis. Apart from that, the current cycle in the economy is more capex driven and hence, the capex related plays, the industrial and cyclical related plays are the ones that are having a higher revenue and growth visibility. These stocks have had more than disproportionate corrections in the last three-four months. So, higher visibility multiplied by the correction that we saw recently, make it very attractive to rebuild positions in them.
What is your take on the banking space actually because this is one space, which everyone has been hoping and waiting for to make a good comeback to lead the markets higher. But banks have been beaten down quite a bit. What is your take? When will they revive?
Alok Agarwal: Let me put banking or lenders and classify them into two parts. Let us first look at the top private banks or the leaders out there. So, if we look at the banking credit growth, right now that stands, the last number was around 12% growth which is the lowest in about two, two-and-a-half years. We have been seeing that because of the lower deposit growth numbers, the credit growth numbers came down all the way from 18-20% to about 12%, so that is where the headline growth numbers have got a little arrested,
Then, comes the next important point in the income statements, which is the net interest margin. The net interest margins for most banks are being protected. But going forward, as the mobilisation of deposits gets a little difficult in order to ensure that their growth numbers continue, there could be some let up in the margins and the key question would be around what is the credit cost, that has been fantastic in the last two years.
In case there is any increase in the credit costs, that could be some question marks on the profit growth as such. Plus, at the same time, we are seeing that the higher profit areas of personal loans have been growing at a lower pace, as guided by the regulator. But if I look at the overall lending segment, in the previous cycle, the last decade between the global financial crisis till about COVID, was a period where there was consumption-driven growth in the economy and hence all the value chain players in and around consumption did very well.
A lot of the private lenders in terms of lenders to consumers did extremely well. This cycle is more to do with a capex driven growth and in case that is likely to continue, the value chain in and around capex and the lenders of these capex are the ones that are likely to be in a better position of showing growth and improvements and hence that is the reason we are seeing a dichotomy in that a lot of these banks are trading at valuations that was much cheaper, some of them have been reporting great earnings, but have not really seen that kind of returns.
They have been over-owned but it is about the visibility of much higher growth that will drive them. There are certain question marks right now, but top-notch quality.
Trent is one of the top holdings in your PMS strategy, but you must surely be happy given that there has been a stellar rally in the share prices. But aren’t you worried now about the valuations being quite stretched for Trent or are you of the view that given the expansion plans and given the diversification into lab-grown diamond and beauty, these premium valuations would sustain going forward?
Alok Agarwal: Well, you partly answered that question. In the consumer discretionary space, especially the retail space, while the opportunity has been huge, there has been no debate around that, but to our surprise and to the surprise of all the market participants, there have not been too many successful players out there.
What certain companies have done is that they have executed their strategies so well and executed in a manner that was really liked by the consumers and the shareholders alike, making growth come by without committing too much of capex at a much higher ROEs and the execution rates being faster. Once you achieve that success in a particular line of business, say clothing, etc, and want to replicate it in some other areas like lab-grown diamonds or some other grocery segments as well, then the whole area of growth opens up.
The key point is whether there is growth in the overall segment or a huge opportunity size? The answer is yes. And do you have a very good executor out there? So, as long as that is there, the higher growth visibility for a longer period of time can sustain higher valuations.
What is your view on the IT plays? Is now the time to relook at this because they have seen a fair bit of fervour in these counters already?
Alok Agarwal: Yes, we saw a lot of fervour in this sector in the last few months. The IT index trades at around 29 times on a one-year forward basis and in the next two years, earnings growth on a consensus basis has been projected around 13-14%, which turns out into a PEG ratio of more than 2x, which is actually more expensive than the market.
Given the election results in the US, there have been expectations of a tax rate cut in the US which could lead to more IT spending by the companies out there and hence, the top line for IT companies may improve. We are yet to see that improvement in the guidance by the companies themselves. We would wait for that.
Some of these are great quality companies but have been lagging because of lack of growth. But if we come down from the larger names towards the larger midcap names, some of those companies, especially in the ER&D space, are having a higher visibility of growth. That is the way we divide the sector in two parts, those which are having difficulty in growing at a faster pace, where we are underweight and those which are growing at a much faster pace and gaining more market share within the IT space where we are positive.
