5 stocks make up 50% earnings in largecaps

Reliance, HDFC Twins, ICICI Bank and Bharti will contribute more than 50% of the earnings in the large cap space, says Ashutosh Bhargava, Fund Manager, Head, Equity Research. A nervousness has gripped the market right now. Some cracks are probably emerging in the US markets. The commentary from Raghuram Rajan on the economy is worrying and pandemic is just not getting under control. Where exactly are the global and Indian economies right now?There is a debate going on whether the markets and macro are disconnected because I do not think the kind of runup we have seen since March I or anyone else would have imagined considering that we are facing the biggest contraction in global economy in the last seven to eight years. There is a disconnect between the Indian economy and rest of the world as well. Global economy is actually doing better than what people were expecting three-four months ago, the reason being their policy makers have provided both fiscal and monetary stimuli and in terms of the Covid measures, the lockdowns were less stringent compared to India, wherein we had a more stringent lockdown. Obviously, the extent to which both the Government of India and the RBI has provided the stimulus on a relative basis is much lower, versus that in certain developed markets like the US and Europe. Within the global economy, manufacturing is recovering faster and services are more impacted because of Covid. The two largest economies, the US and China, are doing better than expected. China is actually growing and likely to have a positive growth this year. If you look at US data, the biggest surprise has come from there, particularly on the labour market and manufacturing side. That is doing well and it is supporting some part of our economy and some part of our market. But as far as the domestic economy is concerned, we are observing a gradual recovery as we are relaxing the lockdown. So, month after month, there is some improvement but as compared to the rest of the world it is relatively slow. Let us talk about the market valuations. One of the fastest re-bounce was seen in India as well as globally. How are you analysing the valuation picture versus real earnings potential out of the top 200-300 companies in India? Are you feeling comfortable at the valuations?There are two-three things. Macro will take time to recover. Next year, again we will have 15% kind of nominal GDP growth. The base will be supportive but I want to highlight that what we are observing is that micro is looking better than macro and the different sectors and a lot of non-financial old economy sectors because of comparative intensity being lower, micros are definitely looking better. Even in the June quarter earnings, EBITDA was almost flat for non-financial Sector and so there is a lot of cost control, lot of efficiency the corporates are looking at. Earnings are going to be better than nominal GDP growth. However, what the market is pricing in is for largecaps. Next year for BSE 100 there is around 39% earnings growth expectation versus flat growth for this year. For BSE 200, FY23 profits are likely to double versus FY20 and so in three years, profits are likely to double. You have to look at it in the context of the fact that in the last six years, there is almost zero earnings growth. So, the market is a bit optimistic, pricing in very, very strong recovery and some kind of vaccine solution as well. The valuation on a two-year basis, may not look very high but on a 12-18 month basis, we have never seen valuations like this in the Indian or the global market. We are trading at 22 times or above from a 12-month perspective with an 19.5 times on FY22 basis and again after discounting 40% earnings growth, there is hardly anything left in terms of valuations rerating. But the market is pricing in a lot wherein I do not think there could be a meaningful earnings surprise on the positive side. It is a tricky situation that if you allow time, the market will start looking more reasonable but a lot of good things are being priced in. There are cracks emerging in the big strong pillars of the US market which is tech and Indian market has been very correlated with Dow over the longer term. If there is a case building for topping out or sideways or a meaningful correction in the US markets, where would India hide in such a situation when earnings are not very handy and things remain uncertain? Some kind of consolidation is not only expected to some extent but it is actually healthy also, like the way we have seen the runup in Nasdaq and even in some pockets in our market. The valuations went through the roof and people started talking about bubble and all that. If the market consolidates more in terms of time and less in terms of price, we should welcome it because we do not want a situation where the market can run up very sharply and then the investors have to face a prolonged period of disappointment as far as returns are concerned. I think some consolidation is good. What is happening in the US to my mind, is that tech has done well but the rest of the market; old economy, financials or even small caps have underperformed. There is this debate about value versus growth, tech versus the rest of the market and you start to see some rotation in the US market and this correction looks like more than a deep cut in the market. You will see some rotation happening to the small caps and financials in the US and the same thing should be expected in India. We have seen some rotation already happening in favour of value for the last two, three months but given the setup and the valuation differential, value on a relative basis may keep doing better and as I said, there is no case for a runaway rally. But I do not think one should expect a very deep kind of a cut also. So this rotation will be a bigger story, micro will be a bigger story, bottom up will be a bigger story while the market will do its own things. I am not too perturbed with consolidation, it is good. What are the things which you are excited about? Where do meaningful opportunities for emerging profit pools exist on a 2-3 year, five year kind of view? If you look at overall large cap space, five stocks are going to contribute more than 50% earnings. Reliance, HDFC Twins, ICICI Bank, Bharti I think these five stocks will contribute more than 50% of the earnings in the large cap space. But from a thematic perspective, micro is looking better and across sectors. There has been massive consolidation in financials in the last two years, since we had our own version of the shadow banking crisis. Due to Covid, these large companies, companies with strong liability franchises and with decent capital adequacy and some of these large banks have actually raised capital. This sector will generate a very large profit pool because pricing power is returning to the large players. One can expect margin expansion in the near term. So asset quality worries aside, there is a large profit pool available with financials. Telecom is another sector where profits would be very large. Other sectors where I am excited is due to the narrative on Atmanirbhar Bharat and the Make in India. Last six years, it was more of a slogan but in the last one to two months, with really commendable announcements from the Government of India, week after week, we are seeing announcements coming for APIs, for electronic manufacturing and for defence. These are the new emerging areas wherein you will see a lot of opportunity coming and the company’s profitability would be much higher on a three-five year basis versus the rest of the market. So financials, telecom and in defensives, pharma and chemicals have big potential. Part of this whole import substitution theme with supply chain moving away from China story falls into pharma and chemicals as well. These are three-four themes wherein from profitability perspective, you will see bigger headlines and some kind of upside surprise as well. How much of recovery is priced in your view? What are some of the key risks investors should bear in mind in their overall hypothesis of this recovery?A lot of it is priced in. The only sector where it is not priced in is financials. Someone has to taken a contra view. That sector has materially underperformed. People still do not have financials. I think markets have to go up. Financials which are performing better in profitability, can only take the market higher. Other than financial, a lot of sector are pricing on a FY22, FY23 basis. Even in the broader market, you will find that at an aggregate level, a lot of things are priced in. But as I said, I do not think this market is a top-down market. The way to look at this market is that it is a bottom-up market. There are pockets of opportunity across market caps. So you will find good risk reward and within sectors, you will have a lot of winners while the sector may not do much. The focus should be on bottom-up. While there will be a lot of talks about US elections and other factors which are more top down, our focus internally is more bottom up. We are finding a lot of good risk reward opportunities from a 2-3-year perspective. As far as risk is concerned, there is definitely a risk in the form of the US election. It can go either way. There will be some nervousness there. Oil remains a risk. While we are in a kind of sweet spot at this point of time, we cannot expect that oil prices will go up to $60-65 and the India profitability story will not be affected. The last point is the market still expects more from the government and the RBI that reform momentum will continue and some stimulus around the festive season will come. There is very little scope for disappointment from the policy maker side. These are two-three things that we are looking at very closely. Market is probably being relatively complacent but we cannot take where the market is priced to perfection. We cannot ignore these two-three risks in the short to medium term.

from Economic Times https://bit.ly/2ZgIvkG
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