‘Domestic consumption theme is a good bet’

Sivasubramanian KN, CIO - Franklin Equity (India) at Franklin Templeton Investments, believes most companies will feel the
pain of rising headwinds in the near term. However, he is not unduly concerned on the margins front, given corporate India’s past profitability record. Speaking to DNA, Sivasubramanian said the well-managed companies, with pricing power and strong market share, would continue to do better than the broader markets, despite high valuations. Excerpts:

What do you make out of the fourth quarter earnings so far?
Corporate India’s latest earnings numbers have been a mixed bag, with topline growth remaining healthy, but margins coming under pressure owing to rising input costs. While consumer-oriented industries continue to hold up quite well, the capital goods segment has witnessed limited improvement in order books due to the slowdown in underlying investment activity. Headwinds such as rising inflation and interest rate will have an impact on Corporate India over the next year or so.

Would the Reserve Bank of India’s recent rate hike affect corporate investment plans?
Private investment has been lacklustre in recent quarters and the rate hikes might result in a capex slowdown. However, the rate hike needs to be seen in the context of rising demand-led pressure that has been pushing up non-food inflation and the global spike in commodity prices. The hike in interest rates is intended to cool down aggregate demand so that the economy can grow in a sustainable manner. In general, corporates plan for the long term and tend to look through the short-term cyclical policy measures.

Considering the macro headwinds, do you see any large earning downgrades?
We can expect some moderation in the earnings growth expectations in the light of prevailing macro-economic situation and expected monetary tightening. We expect earnings growth expectations to decline in the range of 2-5% from the current levels. Interest rate sensitive sectors such as banks, auto, capital goods and infrastructure could be prone to moderation of expectations.

So which are the companies that may survive these near term headwinds?
We believe that this period will pose challenges to companies without sustainable business models and those companies with the ability to sustain growth without external funding should attract investment flows. In addition to the macro environment, the heightened focus on corporate governance could lead to a valuation premium for well-managed companies.

Overall, we are not unduly concerned on the margin front over the long term- Corporate India has a reasonably good profitability track record and companies with strong market positions and pricing power are expected to fare better than broad markets, reiterating a case for bottom-up stock picking.

Which sectors are you bullish on right now, from near- to medium-term perspective?
Broadly, we maintain a positive stance on the domestic demand story and believe that sectors that can piggyback on the domestic consumption and investment themes are good opportunities from a medium- to long-term perspective. They will take advantage of the structural transition underway in India, with growing income levels, increased urbanisation and rise in infrastructure/ capex spending by the government and Corporate India.

The banking sector has witnessed sharp declines in recent months, owing to monetary tightening concerns. And we see the recent declines as a buying opportunity into some of the strong players, given that India remains under-served in terms of financial services and increasing income levels have led to increased demand for the same.

The recent regulatory uncertainty and graft probes have led to value in some of the top-tier telecoms stock, but we expect a consolidation in the industry with new entrants facing losses exiting and increased medium-to long-term traction for 3G services being introduced.

What do you make out of FII flows so far?
The outflows from Indian equity markets in late 2010 and early part of 2011 were due to a broader trend of rotation out of emerging markets (EMs) in favour of developed markets. It was driven by optimism about the growth recovery gaining traction in the developed markets as well as inflation worries in EMs. Over the short term, we may see fluctuations based on liquidity trends and risk appetite, but these would be flows from investors with a short horizon.

From a medium- to long-term perspective India will remain an attractive investment destination as the structural advantages far outweigh short-term cyclical headwinds. For long-term investors, there is increased confidence about the economy and we feel that global investors will continue to buy selectively irrespective of the levels. The underlying trend is likely to remain positive, unless there are any major risk events unfolding.

What are the triggers you see which may cause the markets to resume its uptrend?
Despite the short-term concerns, India remains an attractive growth story over the medium term. Well-balanced growth model alongside the lack of excesses, high savings rate and a large young population will lead to strong economic growth. The government will eventually push through further structural reforms that address infrastructure and skill gaps - the reform process does have support from majority of the political parties. Such positive developments would be crucial for medium to long-term direction.

Which sectors are you avoiding in near term?
We have very little exposure to the real estate sector on account of the lack of transparency and limited earnings visibility. Having said that, we are mainly bottom-up investors and our investment decisions are driven mainly by individual company fundamentals and its growth drivers, along side relative valuations.