"Over medium term, corp earnings could improve"

Quality businesses that generate cash flows consistently and earn higher return on capital employed than the cost of capital, will exhibit earnings resilience, Swati Kulkarni, EVP and Fund Manager – Equity, UTI AMC tells ET Wealth.Do you feel the market is taking a breather after the sharp run up or do you expect a deeper selloff?Market movement in the short-term is hard to predict and does not have material significance in long-term wealth creation. The markets will remain volatile given the uncertainties around the impact of the pandemic on the economy, consumer and borrower behaviour, income and job losses, MSME stress and the pace of recovery.Are index valuations giving a distorted picture given that the run-up has been powered only by a few stocks?Index valuations at any given point will be influenced by the valuations of a few heavyweight stocks in the index. In the past one year, NSE Nifty 50 Index declined by 2.5%, whereas the top five contributors with 31% weight generated 10.5% return. The re-rating of these stocks pushed the index and its valuation higher. The valuation of the index is useful in getting a broad sense of the current status versus the historical range. Stock selection depends on the stock-specific fundamental attributes and relative valuation of the stock.Are you surprised by the earnings resilience in certain pockets? Which are the segments affected more than anticipated?The peculiarity of this pandemic is that there is no play book to draw learnings from. Businesses, policymakers, lenders and investors are all treading cautiously. A few leveraged businesses have raised capital and cash conversion is the mantra. The pandemic has reiterated that the timing and nature of the risk is unpredictable, and we cannot eliminate the risk but can manage it. The quality businesses that generate cash flows consistently and earn higher return on capital employed than the cost of capital, exhibit earnings resilience. We prefer to predominantly invest in such businesses.We observed that companies with supply chain efficiencies, scattered production facilities did relatively better in the initial lockdown period. While we expected IT to handle the supply side well by enabling work from home quickly for most service lines barring a few like BPO and testing operations, the new deal win growth momentum in the sector was a positive surprise. Pharma showed resilience with advanced demand from patients stocking up their regular medicines and opportunities in pharma intermediate sales for certain companies. Agriculture-related businesses like tractor, fertilisers and agrochem remained resilient as the disruption did not hit rural India initially and monsoon was normal.The continuing high rate of infection and intermittent lockdowns are pushing further the recovery in sectors like aviation, hotels, restaurants, real estate.How do you expect broader corporate earnings trajectory to pan out?It is obvious that corporate earnings for this financial year will decline from the levels reached last year. Businesses have controlled fixed costs and discretionary costs. We believe part of the cost reduction can be structural as corporates continue to allow work from home, use virtual means to connect, reduce travel expenses, resort to digital advertising etc. This will lead to margin improvement and lift earnings trajectory.Over the medium term, corporate earnings are likely to improve as the policies announced in the area of agriculture, labour and manufacturing could lead to higher productivity and economic growth. The government may boost infrastructure development by leveraging the corpus of NIIF, thereby creating more jobs and the much-desired multiplier effect on the economy. The pandemic has necessitated global companies to consider “China Plus One” to de-risk sourcing strategies. With improving infrastructure, production linked incentives and competitive tax regime, manufacturing and exports from India could improve.Do you see larger businesses capturing higher market share or profit pool?Rather than size, the businesses having strong competitive franchise are more likely to capture higher market share. With pricing power or cost advantage, such businesses have consistent cash flow generation, well managed capital structure and strong return ratio, which give them financial muscle to handle the challenging phase and capture growth opportunities.How will the large-cap fund rediscover outperformance relative to index?Over the last 3-5 years across large, multi and large and midcap categories, the retail plans of the funds have struggled to beat the benchmark TRIs. This can be attributed to the underweight stance in the funds on a few large outperforming stocks in the index. Over the past year, the percentage of funds outperforming the benchmark in all three categories has increased. With broad based growth, the divergence in performance may not be as stark as in recent past. At times, market underestimates the long growth runway or the cyclical recovery in the businesses, thus creating mispricing opportunities. We believe the investment process will help us spot such opportunities time to time and allow us to create outperformance over the long term.What should investors expect from the equity market in coming years?The point to point returns due to pandemic are moderate at 3.9% for 3 years and 8.1% for 5 years holding period; the average rolling return is 11%. Typically, risk free rate plus the equity risk premium should be the expected return from the broad market indices. With 10 year G-sec rate of 6% and equity risk premium of 5-6% one may expect equity market return of 11-12% on an average.

from Economic Times https://ift.tt/34pQlKj