Mid & Smallcap companies by nature tend to fall more in a market correction, in the longer term, companies from this space that have healthy earnings growth and cash flow generation could continue to outperform.
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Investment in the mid and small caps with a long time horizon, higher risk appetite and selection of the companies with the ability to deliver sustainably higher earnings could be rewarding, Karthikraj Lakshmanan, Senior Fund Manager-Equities, BNP Paribas Mutual Fund, said in an exclusive interview with Moneycontrol’s Kshitij Anand.
Q) Mid & Smallcap stocks have taken a beating in the last 2-3 months. Both S&P BSE Smallcap index and Midcap index are down on a year-to-date basis. What should investors do with stocks which have already corrected in double digits and is impacting portfolio performance?
A) Mid & Smallcap companies have significantly outperformed largecaps in the last four years partly helped by very healthy domestic flows and improvement in fundamentals.
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The valuations of the mid & small cap companies had moved ahead of their largecap peers in many cases. With FII outflows, long-term capital gains tax announcement in the budget and some funds realigning their portfolios post reclassification of schemes by SEBI, we have seen a correction in Mid & Smallcap stocks.
While Mid & Smallcap companies by nature tend to fall more in a market correction, in the longer term, companies from this space that have healthy earnings growth and cash flow generation could continue to outperform.
Q) Moving from stocks, most of the funds based on the small & midcap theme is bleeding. What are you suggesting your clients – hold them and continue SIP, add more money on dips or book profits, if any?
A) As mentioned previously, mid & small cap space has higher volatility and risks compared to largecaps. In the long-term, few of the companies that have delivered consistent earnings growth tend to migrate to the largecap space, more true in case of emerging economy like India.
Investment in the mid & small caps with a long time horizon, higher risk appetite, and selection of the companies with the ability to deliver sustainably higher earnings could be rewarding.
Q) Twenty-one public sector banks (PSBs) have incurred losses totaling Rs 25,775 crore due to banking frauds in the financial year 2017-18, a Right to Information reply. Do you think it will be a wise decision to catch this falling knife?
A) PSU banks have had issues with asset quality, capital, asset mix, lower fee businesses and continuity of top management. The government has infused capital and some of them have raised equity from the markets helping them to improve the balance sheet and make higher provisions against the NPAs.
With the RBI’s withdrawal of restructuring schemes, a large part of the unrecognized bad assets seem to have been recognized in March quarter of FY18. Going forward, the slippages could peak in next 1-2 quarters while resolution/recovery/write-offs may take longer.
While the government and the Central Bank have been taking various measures to address the issues faced by the public sector banks, the full resolution still seems to be some time away.
We believe there are selectively very few banks within the space which have sufficient capital for growth even after accounting for provisions and have potential to get back to reasonable return ratios in the next 2-3 years.
On the other hand, some of the private banks which have healthy profitability, retail-focused asset mix, stable managements and good return ratios have opportunity to further accelerate market share gains as many of the PSU banks are under Prompt Corrective action list of RBI, restricting them from growing and even others primarily focused on addressing the asset quality situation.
Q) Most of the results for the quarter ended March are out. How do you rate the performance of India Inc. in Q4? Also, your top 5 stocks to buy post earnings season and why?
A) Q4FY18 results were a mixed bag with Nifty 50 profits declining on a year on year basis led by higher slippages and provisioning in corporate banks and some one-offs in other companies.
The number of companies beating estimates was lower than the misses. While there could be some further downgrades for FY19 and FY20 EPS estimates as they are very high at ~19-20% levels, still the overall growth is likely to pick up from FY18 growth rates helped by a recovery in consumption, depreciating rupee helping exporters and increasing profitability of commodity players who have seen prices moving up.
While private sector investments might be still some time away, consumption seems to be picking up, especially in rural areas. While higher Crude Oil prices, rising Inflation, interest rates, worsening CAD and Foreign Investor flows are Macro negative, the pick-up in Nominal sales growth led by inflation, government spending, expected near normal monsoons and formal sector gaining share in some areas post GST are some of the positives likely to help individual companies/specific sectors.
We believe B2C businesses in Financials and Consumer, rural-focused companies, select exporters and some commodity companies benefitting from better pricing and demand environment are likely to have better earnings growth.
Q) What is your call on Crude Oil, and where is it headed by December 2018? Do you think high crude oil prices will make Aviation, OMC, tyre stocks slightly unfavorable?
A) Crude Oil prices have significantly risen and more than doubled from the Lows of 2016. Local Currency depreciation in CY18 has further added to the woes. Higher fuel prices clearly is negative for aviation as that is the largest cost item and the end consumer prices are sensitive though there has been a structural growth in passengers air traffic in last few years.
While OMCs have been passing on the cost inflation thus far, any absorption of the same could impact profitability. Higher crude prices could lead to higher crude linked raw material prices for tyre companies with some lag, which could be negative for profitability.
Q) What is your call on Sensex/Nifty by end of December 2018?
A) In the Long-term, stock and index performance is linked to the earnings growth with some lead/lag. While valuations have rerated in last few years leaving little room for further increase in multiples especially in light of rising interest rates, earnings growth is likely to pick up going forward in next couple of years which could determine performance of the markets.
Q) Flows into mutual funds have slowed. Is domestic inflow story coming to an end?
A) In the last few years, domestic flows have picked up with FY18 touching an all-time high. Monthly SIP flows have crossed a billion-dollar run rate.
While there has been some slowdown in the recent past, especially in March, led by some redemption, flows tend to be volatile and cyclical depending on various factors. These include recent returns in equities, the attractiveness of alternative asset classes and overall market sentiments.
However, in our view, there is a secular underlying trend led to an increase in financial savings by households and better awareness of equities as a long-term investment asset. Equity exposure of average household is still low.