ETMarkets Smart Talk- We expect IT and pharma to do well amid attractive valuations: Kedar Kadam

In an interview with ETMarkets, Kadam said: “We like Capital goods, Cement, Speciality chemicals, Auto ancillaries and select large banks & consumer names. Instead of the sector, we prefer to take stock-specific bets across the broader market” Edited excerpts:
Market are climbing new peak every day with Sensex at 66000 while Nifty50 is above 19500 levels – is the market running ahead of fundamentals?
Well, if we look at the headline indices the picture warrants caution, though in our view there are still pockets of opportunities in select sectors and stocks.

Domestically, the broader equity markets essentially traded sideways during the monetary tightening cycle. This allowed earnings growth to catch up with valuations.

As a result, India is not as expensive as it was both in absolute terms and relative to the region. On a Bloomberg consensus estimates the benchmark Nifty50 is currently trading at 12-m forward PE of 20x, near 5-year and long-term averages.

We expect India’s economic growth to track above its long-term trend and stay ahead of its major peers in 2023. Supportive government policies, a sustained revival in services, and a pick-up in private capex are tailwinds for growth.

In our view, CPI inflation is likely to trend lower in 2023, to track within the RBI’s medium-term target range of 2%-6% given the high base effect, easing commodity prices, and the lagged impact of monetary policy tightening.

Therefore, the current valuations look comfortable at headline indices though what worries us is the growing risks to earnings & rich valuations in select sectors & stocks.We expect the earnings growth momentum to sustain in H1FY24 while expecting moderation in H2’ CY24 on account of slowing demand conditions amid (1) global slowdown, (2) domestic demand weighed down by the lagged impact of the RBI MPC’s rate hike cycle and (3) risks of uneven rainfall weighing on the rural sector. (4) elevated financing costs.

Given this backdrop, we see growing risk to earnings in H2’CY24 & limited room for further valuation multiple expansions.

Many call this a global rally as most of the global markets have done much better so far in 2023 and India is just catching up now. What is fueling optimism?
Yes, this is a global rally, nothing seems to be able to derail global equity markets this year as they shrug off cracks in the banking sector, last-minute US debt ceiling agreements, weak economic momentum seen in developed markets in Q2’CY23 as well as the surprisingly hawkish Fed policy meeting.

Investors are betting on stocks because they believe the US can escape a recession, and companies can withstand the pressure of higher rates.
In the US forward-looking recession indicators such as the inverted yield curve, tighter bank lending standards, weak manufacturing activity, and depressed consumer confidence readings are all flashing warning signs.

Meanwhile, measures of real economic activity such as job growth and household spending are only gradually moderating. Most of the other major economies are also slowing and at risk from aggressive central bank tightening.

The US economy has proven resilient to the Fed’s hikes, with growth and employment both holding up in recent months. The investors are putting more weight on economic data while ignoring interest rate hikes; the momentum and FOMO can drive stocks higher but the buying rage warrants extreme caution amid likely earnings downgrade in H2’CY23 and rich valuations.

The Nifty rallied ~11% during the April-June quarter and was the 4th best-performing index after Brazil (+15.9%), Japan (14.2%), and Russia (14.1%).

We expect India to remain among the best-performing markets given resilient macros and robust earnings growth trajectory.

Which sectors are likely to lead the next leg of the rally in markets?
We expect yesterday’s underperformers to be winners of tomorrow, i.e. IT and Pharma. The valuations are very attractive from a long-term investment perspective despite short-term risks to earnings.

Besides these defensive bets, we like Capital goods, Cement, Speciality chemicals, Auto ancillaries and select large banks & consumer names. Instead of the sector, we prefer to take stock-specific bets across the broader market.

What do you make of the numbers delivered by big thicket IT companies in Q1?
Well, the results were weak on the expected lines, and we could see another couple of quarters where earnings, especially top-line growth, could come under pressure on account of global macro headwinds.

The new deals win trend across sectors through showing moderation the companies are seating on a healthy order book. The management commentaries, though sound cautious, remain optimistic about the long-term demand outlook.

In our view, the underperformance of the IT sector over the last 12 months largely factors the prevailing macro-overhang and valuation multiples indicate limited downside risk.

Any sector(s) that you think are overvalued and investors can look at going underweight on/reduce exposure?
Well, themes like defence, manufacturing, and infra have a robust potential to grow though many of the names in these sectors really warrant caution. The tide has lifted all the boats, so one should be selective.

Secondly, within the BFSI space, though valuations are reasonable we see growing risks to earnings coming from compression in NIM, receding deposit inflow, and high competition. We prefer to remain with select top names here.

What is your take on the recent IPOs which have hit D-St in June and July? Most of them are not big-ticket names but still attracted a lot of interest. How should one approach the companies in 2023?
True, generally when the broader market sentiments are upbeat, IPOs, in general, attract a lot of interest. This time it was no different, the surprising element was the listing premium and further rally on top of that.

For a corporate, an IPO enables it to raise substantial amounts of capital, which it can use to finance new capex, retire debts, and fuel growth.

Therefore, for an IPO investor or secondary market investor, it is very much essential to assess the quality of the company and trading valuation multiples.

What is your take on HDFC Bank-HDFC merger? On paper it looks rosy but do you think there will be internal challenges? Do you see a similar consolidation in the industry?
Well after the long haul HDFC Bank-HDFC merger is done now and the crucial phase of integrating the twin giants begins.

We could see challenges in terms of

1) Integrating the large branch networks and creating a viable strategy for their smooth and long-term functioning,
2) employee-related churn and cross-product training,
3) Addressing the technological challenges faced by the bank over the last few years.

Yes, we expect further consolidation in the Indian BFSI space given the presence of too many players and possible synergies to be generated out of consolidation.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)