"We believe the Union Budget is an event that lays the foundation for reforms and measures which benefit the underlying economy over the long term. We believe companies create wealth, not markets (including such macro events). So our focus may not be on the event itself, but on scouting ideas which are beneficiaries of reforms and measures."
THOUGHTS ON BUDGET
The budget, in a nutshell, has not taken any shortcuts from the structural initiatives path that this Government has chosen. While it has lowered the revenue growth expectations in line with the slower growth in the economy, it has kept its focus on maintaining fiscal discipline within their permissible limits. The capex initiatives from the Government side are focused more towards the development of affordable housing and basic infrastructure areas (road, rail, water, electricity, gas and healthcare) that are channelized towards improving the ‘ease of living’ for a greater section of the population. Further, there is renewed thrust towards energy conservation, water management & promoting the adoption of electric vehicles, which essentially are steps towards a cleaner environment. To fund these initiatives, the Government has tapped areas such as improving taxation on energy and gold (customs duty for gold and excise duties on petrol & diesel have all been hiked), increased surcharge on creamy layer of the economic pyramid (individuals with an income in excess of Rs. 20 million, the surcharge has been hiked by 3% and 7% for different slabs), formalization of the economy through improved compliance under GST and accessing international capital markets. FIIs will be allowed to sell/transfer investments in debt securities of Infrastructure Debt Funds and NBFCs within the specified lock in period. In order to make India a more attractive FDI destination, the government is expected to look to further liberalize investment in aviation, media and insurance sectors. Local sourcing norms for single brand retail may also be eased. This chosen path will ensure a slow but more steady and structural improvement in growth levels for the economy and one that we believe provides continuity.
Data source: Budget 2019-2020 Documents (https://www.indiabudget.gov.in).
KEY CHALLENGES FOR THE ECONOMY
The challenges before the economy is the slowdown in growth rates brought about by the weakness in the NBFC space – given they helped in bringing speed to providing credit in the market. While some structural measures are being taken to address this situation through market oriented regulations, the resolution is likely to take some time given the ongoing regulatory changes. This, coupled with the slowdown in global growth rates and the deceleration in consumption in domestic markets are key challenges for the capacity utilisations in various segments of the economy. Revival of investment cycle in this current context maybe a little more delayed. However, there are pockets of the economy where capacity utilisations are running high and one can expect some momentum in these specific sectors.
THOUGHTS ON VALUATIONS
We expected macro events, globally and domestically, to dominate the equity markets in the first half of the year, but we believe the second half of the year being largely driven by earnings delivery. In this context, we see a reasonable year for equities amidst the volatility. Stock selection is likely to be crucial and can make a large difference to equity portfolios. Expect earnings to accelerate from FY19 levels even assuming for earnings downgrade (even budgeting for earnings downward revisions) as consensus estimates budget for over 20% earnings growth from FY19 to FY20 for Nifty 50.
We see valuation premium likely to hold up in the coming 12-24 months, due to return of earnings growth (to above longer term average levels) from the subdued levels that were seen in the last few years as well as strong SIP led domestic flows besides India continuing to be a structural high growth large market for foreign investors in a global environment of low growth, volatile cycles and low interest rates. Though the high frequency macroeconomic indicators we track are signalling sluggishness in growth, we believe benign inflation, easing interest rates, policy continuity and economic reforms bode well for investment and consumption revival.
Forecast of near normal monsoon by Indian Meteorology Department should provide solace to rural India which is currently under stress. While the rural wages are steady around 5% but good monsoons should help boost the consumption and the rural economy at large. While cyclical consumption remains sluggish (auto and ancillary), we are positive on business-to-consumer (B2C) companies such as retail banks, insurance, multiplexes, paints, retailing, cement and select consumer staples. Lower interest rates and improved policymaking should give a much-needed spur to investment.
Data source: Bloomberg
CURRENT SECTOR POSITIONING
We are positive on financials and select pockets of consumption. Private banks within financials have gradually been gaining market share from PSU banks over the last two decades which is a structural trend likely to continue going forward as well. We believe private banks are equipped with adequate capital and better access to the markets for additional capital if need be besides stable management, focus on retail business and fee income leading to better return ratios. We believe the banking space has potential for high growth even from next 3-5 year perspective due to lower credit costs for corporate banks and higher retail growth for all as long as the retail credit cycle continues to be on a good wicket as it has been in last many years. While private banks valuations have moved up, they are not too expensive from the past average basis considering the strong growth potential in next few years. We also like insurance within financials, as the sector may deliver good growth in the medium term with the potential to improve profitability by increasing the proportion of higher profitable but under-penetrated term insurance business. Insurance companies have gone through valuations correction as well in the last couple of years due to capital market weakness thus making the valuations reasonable.
Further there are pockets of Consumption like organised retail, paints, packaged foods, movie exhibition (multiplex) and aviation which continue to clock good volume growth despite overall consumption slowdown. While this segment is expensive, the higher and sustainable growth visibility provides opportunity to pick companies. Other than these, there are few select industrial companies with healthy balance sheet and execution/technological capabilities which could benefit from gradual pick up in India’s private sector capex.
IMPORTANCE OF STOCK SELECTION IN CURRENT MARKET SCENARIO
We have seen since the beginning of 2018 that the Indian markets performance has been starkly skewed with a handful of companies accounting for most of the market price performance across capitalisations. Mid and small cap companies have gone through a deep correction after many years of outperformance. Going forward, we believe there are few companies from few sectors across market capitalization which can deliver superior sustainable earnings growth. Hence stock selection becomes paramount. We continue to be positive on Indian equities from a medium to long term perspective (over 3-5 years horizon).
OUR INVESTMENT PHILOSOPHY
As a philosophy we believe that “companies create wealth and not markets” and thus the focus is on identifying businesses which can grow earnings at a faster rate for significantly long periods of time. Towards the same we have an in-house Business – Management - Valuation (BMV) framework, an elaborate process which helps us in identifying those companies (that could possibly grow earnings at faster than market growth rates, for significantly long period of time.)
For any company to make it to our portfolios it has to pass through each of the BMV filters. Firstly, business should have profitability growth structurally and/or cyclically far higher than markets. Also each business we invest in should also have sustainable competitive advantage (Moat) for it to sustain the superior earnings growth rate. And lastly, we also closely look at sector dynamics, where we would like to invest into sectors which are consolidating rather than fragmenting. Once a company passes through the business filter, then we move to management where we look for leadership in two aspects, one is competency and other is corporate governance. Once we are satisfied with the same, we then move to valuation and look for margin of safety by buying the company at a discount to its intrinsic value.
Thus, while investing we focus on all aspects of company viz. quality of business, sustainability of growth, governance and price being paid for the company. To us, all aspects are important and non-negotiable.
The sector(s) mentioned in this document do not constitute any recommendation of the same and BNP Paribas Mutual Fund may or may not have any future position in these sector(s).
The material contained herein has been obtained from publicly available information, internally developed data and other sources believed to be reliable, but BNP Paribas Asset Management India Private Limited (BNPPAMIPL) makes no representation that it is accurate or complete. BNPPAMIPL has no obligation to tell the recipient when opinions or information given herein change. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. This information is meant for general reading purpose only and is not meant to serve as a professional guide for the readers. Except for the historical information contained herein, statements in this publication, which contain words or phrases such as 'will', 'would', etc., and similar expressions or variations of such expressions may constitute 'forward-looking statements'. These forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those suggested by the forward-looking statements. BNPPAMIPL undertakes no obligation to update forward-looking statements to reflect events or circumstances after the date thereof. The words like believe/belief are independent perception of the Fund Manager and do not construe as opinion or advise. This information is not intended to be an offer to sell or a solicitation for the purchase or sale of any financial product or instrument. The information should not be construed as an investment advice and investors are requested to consult their investment advisor and arrive at an informed investment decision before making any investments. The Trustee, Asset Management Company, Mutual Fund, their directors, officers or their employees shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages arising out of the information contained in this document.
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