1. Firms with good operating leverage to drive markets: Swati Kulkarni, UTI Mutual Fund

Firms with good operating leverage to drive markets: Swati Kulkarni, UTI Mutual Fund

The stocks of automakers, consumer discretionary sectors and industrial manufacturers are expected to perform better...

By: | Published: December 4, 2014 2:45 AM

The stocks of automakers, consumer discretionary sectors and industrial manufacturers are expected to perform better over next two-three years as they have a good operating leverage benefit, feels Swati Kulkarni, the executive vice-president at UTI Mutual Fund. speaking to Mithun Dasgupta, Kulkarni says the government’s “Make in India” initiative can help the country substitute engineering goods, industrial and auto component imports as a strong local demand would facilitate vendor development and would be cost effective on account of its scale. Excerpts:
How do you see equity valuations in the stock markets?

Equity valuations for the large-cap indices like Sensex and Nifty in terms of the trailing 12-month price earnings (PE) multiple are at 19.8 and 19.2 times, respectively. BSE small cap index is at 33 times and BSE mid-cap index is at 23.8 times in terms of trailing 12 month price earning multiples (Source: Bloomberg, as of November 27). Thus, the large-cap stocks are at relatively attractively valuation.  In the mid and small-cap space, the growth expectations are running high. At 15 times FY16, valuation for S&P BSE Sensex is in the mid range of its historic PE band and we expect the earning upgrade cycle from the second half of FY16, on the assumption of strong economic recovery and margin expansion benefits due to operating leverage.

Do you see valuations rising over the next two-three years?
Historically, earning upgrades have led to a further PE expansion. Sensex’s earnings grew 7% CAGR from FY08-13. The earning growth estimate for next three years is 17-18%. Even without factoring in any PE expansion, there is an opportunity for returns on equity investment in line with the earnings CAGR, provided investors have at least three years investment horizon.

Which stocks do you think would gain the most?
Sector wise, companies with good operating leverage would be the drivers over next two-three years. Auto, consumer discretionary and stocks in industrial manufacturing or auto ancillary can see a better growth in profits over and above the sales growth.

How do you see the government’s “Make in India” initiative, which aims to make the country a manufacturing hub?
It is a welcome step as the government wants to attract investment, which in turn would kickstart the investment cycle, create jobs and increase contribution from the manufacturing sector in the overall growth. To address the challenges of the country’s demographic profile, these efforts will be helpful, but they must be supported by speedy approvals, stable and predictable policy. India has a skilled English-speaking manpower available at a lower cost, which will help create a strong local demand and may improve cost competitiveness and open export opportunities in medium term.

Do you expect the initiative to help India reduce its dependency on imports and reduce the current account deficit — a matter of concern for long?
Reducing import dependence is a long-term objective. I don’t think import substitution can be achieved in near term as our major imports are crude (accounts for more than 50% of our trade deficit), gold and electronic goods. That would need investment in Exploration and Production (E&P) activities. In fact, we cannot rule out a pick-up in imports of machinery even as we promote manufacturing activity in India. Therefore, I think it would be too early to expect that imports will go down. Over five to 10 years, we could see a meaningful reduction in imports if we attract investments in E&P and coal mining. Import substitution can happen in engineering goods, industrial and auto components as strong local demand would facilitate vendor development and cost efficiency due to scale.

How do you see the rupee’s movement in short and medium-term?
Rupee would remain range bound between 61 and 63 in the short term. The sharp depreciation of rupee against US dollar of over 25% in the past three years is unlikely to repeat. Macro situation has improved with a better current account deficit (under 2% of GDP by FY15) and strong capital flows. Of course, the volatility is given, particularly when the US Fed acts on the expected tightening of interest rates somewhere in the second half of 2015 and the arbitragers liquidate their rupee investments and convert it in US dollar on the expected reduction in interest rate differential.  Over medium-term, the rupee movement will be guided by the macro developments and inflation and interest rate differential.

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