valuation: Looking for attractive valuation plus strong fundamentals? Financials is the answer, says Ramesh Mantri

Ramesh Mantri, CIO, WhiteOak Capital AMC, says when we look at combined fundamentals and valuation, there are some sectors where fundamentals are very strong, but valuation is very high like industrials, capex related and then smaller industry segments like defence, electronics and manufacturing. The fundamental corporate earnings have been good but the valuation is high. The space where valuations are attractive and fundamentals still remain very strong is financials, particularly banks and you cannot have an economy growing at 7% per annum and financials not growing.

In the sharp rally which the market has seen in the last 15 days, your portfolio must have done very well. How are you toggling between valuations and earnings growth within your portfolio right now?
Ramesh Mantri: Of course, markets have rallied now because there were concerns earlier on election outcomes, I think those concerns are receding. Markets love political stability and the expectation is to have a lot of political stability this time. In terms of earnings growth, this quarter has been a mixed bag for markets because one of the reasons we can see clearly is government spending has been weaker and that flows through the economy and expecting that post the next week election outcomes you will start seeing the flowing through the economy, the government spending coming back and of course the RBI dividend which has been a huge dividend will lead to increased spending by the government. So, earnings have been a mixed bag. Valuations in smallcaps are pretty challenging. Smallcaps as a basket are trading significantly above long-term valuations and we have started to see some risk and governance issues starting to emerge in the smallcap space and more in the SME space. Midcaps are slightly overvalued. And coming to largecaps that is where the clear… but midcap earnings have been very good that is an important perspective to have that midcap earnings have been good.

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Coming to largecaps, that is clearly where the value lies in the market. So, today as we speak normally, the risk is that largecaps tend to be most expensive and smallcaps cheaper. Now the risk pyramid is inverted and the highest value lies in the largecap part of the market. Coming to broader sectors, we look at sectors in terms of valuation but it is important to look at fundamentals. When we look at combined fundamentals and valuation, there are some sectors where fundamentals are very strong, but valuation is very high, for example, in industrials, capex related and then smaller industry segments like defence, electronics, manufacturing. The fundamental corporate earnings generally have been good but the valuation ask is high. The space where valuations are attractive and fundamentals still remain very strong is financials, particularly banks and you cannot have an economy growing at 7% per annum and financials not growing.I want to ask you about one part of the financial which you have represented in your portfolio is the insurance name, some of the insurance names which you have, this is also a part of the portfolio in the financial side, but has not done very well, do you think valuations and earnings, all of them bottomed out over there and from here on one or two years things look better?
Ramesh Mantri: One, of course, valuations in insurance have corrected quite a lot and the other one big reason, of course, is that there is a concern that certain adverse regulatory moves will happen in insurance. While one of the talked about things that is going on in the market is commissions and insurance can move that and it will be disruptive for the sector in the short term just like the mutual fund industry moved a few years ago from up front to trade, but actually longer term actually that makes the industry a lot more sustainable.

I think the big story of under penetration in insurance remains very large, apart from investment products, there is a real need for life insurance, health insurance, in fact the need for life and health insurance is more important than even investments, so it is a far more critical need than even investment. So, this industry clearly has a relevance, penetration level is very low and the tax regime is now becoming more levelized so everybody has to compete on merit which will create short-term challenges for insurance industry, but long-term actually is very good for them because they will have to start thinking of what is a real customer value proposition they have to go to the customer for their products, but this is going to be true for the industry over a long period.

You have some of the midcap IT names, high growth companies servicing very high growth niche right now. Are valuations becoming a bit of an issue there or are you comfortable holding them even at current levels?
Ramesh Mantri: The whole IT sector has had growth challenges last year because of slowdown and normally in a slowdown the history is that largecaps do better on growth and midcaps do worse and smallcaps get killed. But if you see the last few years cycle, actually smallcaps and midcap IT on growth have outperformed largecaps.

The reason is that today’s smallcaps and midcaps in IT services are very different from the earlier decades. Today many of these companies are run by CEOs who have been part of large companies themselves. Instead of trying to be everything for the customer which are largecap IT companies, these companies have figured out their niche and are willing to compete in that space with the largest companies and number three, many times their CEOs tend to be based in the US close to clients so they are better positioned to give comfort to clients. So, many of those small and midcap IT services companies are outgrowing largecaps. They are very unique, and in that context we will look at that. Within that, there is a very interesting story in IT services now that is playing out in India. Normally, when we talk of IT services, we only talk about people selling to the western world, but now because of this tech adoption in India and also the regulatory actions that have been taken on banking space, we think there is clearly a large capex cycle in IT in banking sector and we in our portfolio own a number of names which are focused on the Indian market tech for financial services and we have seen already tech problems with number of banks in India. So, the Indian market is now becoming relevant for tech companies.

One last word I want to understand from you is which part of the market do you think is completely unloved and ignored right now and is pricing in all the negative which may actually start reversing with say next six months to one year time frame.
Ramesh Mantri: That is a very simple answer that is simply BFSI, private banks, the fundamentals are good and yet they have become the meme stocks. People forget some of these private banks have great track records over 25 years and just because they have not done well for couple of years that does not mean you can write them off and these are solid institutions and you cannot have an economy growing at 7% and banks not participating in them.

So, clearly that is really the ignored part of the market, valuations are below long-term averages, fundamentals are very strong, so this is clearly where you can create a lot of alpha. I am very confident over longer periods we will create a lot of alpha in this space.

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