Indian equity mkt well-positioned for continued growth in FY25: UTI AMC

Karthikraj Lakshmanan, Fund Manager - Equity, UTI AMC, believes the Indian equity market has strong fundamentals and is well-positioned for continued growth in FY25, backed by broad-based growth across sectors. He sees India's macro-stability as an advantage compared to other large economies facing inflation or growth challenges. While valuations are on the higher side, he believes India offers a compelling opportunity due to its growth prospects. In an interview with Bizz Buzz, Lakshmanan shares his insights on key factors driving inflows, his investment strategy, and the outlook for specific sectors

How does FY25 look up for the Indian equity market? What are the key factors that will drive inflows?

At the outset, let me clarify that we believe it is very difficult to predict flows, even more so in a short period of time as they are dependent on multiple factors and sentiment. Having said that in the long term, flows lead or lag fundamentals and it may be pertinent to evaluate that.

Last four years post-Covid down year of FY21, we have seen healthy double-digit earnings growth CAGR and that has reflected in the market returns as well. The consensus expectations are for continuation of this trend going into FY25 as well. Earnings growth this time around is broad-based with both cyclical as well as structural compounders delivering earnings growth. The magnitude as of now is higher on the investments side of the economy while the consumption side is mixed and little slower. Higher GDP growth led broad-based earnings growth is a big positive especially at a time when most large economies are facing challenges on high inflation and/or growth challenges. India could continue to be amongst the fastest growing economies amongst the large ones in the current financial year as well. Our economy’s macro-stability in terms of forex reserves, current account balance, fiscal deficit, government debt situation, inflation, etc, fares far better than our own past positioning us for a better outcome in case of any global slowdown.

The only major issue is that valuations are expensive compared to history and versus other economies as well. While India can provide a far more balanced high growth low volatility investment opportunity for the global investors, it does come at a higher price currently. However, within this, we find that small-caps and mid-caps are more expensive compared to their own average while large-caps are relatively better (using trailing P/BV metric).

How do you view the risk-reward profiles of IT, private banks and auto sectors?

We are positive on all three sectors. India has been successfully gaining market share in services exports over last two decades thanks to a significant contribution from the IT services sector and it does seem to have more legs from current situation as well. We have increased our exposure to information technology in 2023 as valuations have meaningfully corrected in last couple of years through time correction and absolute stock price correction. Valuations look attractive on free cashflow basis when compared with many other sectors. Companies in the sector have demonstrated good corporate governance, high cash flow generation and have been distributing significant proportion of the same to shareholders through buybacks and dividends. While last few quarters growth has been muted for the sector, deal momentum has been good and long-term digital transformation journey of clients provides growth visibility. At current valuations, the implied growth numbers are in single digit dollar revenue growth which seems quite achievable. While next few quarters may still be muted, the long-term growth visibility provides steady and stable compounding opportunity.

Private Banks are another area where we have been structurally positive. This is one sector where the valuations are still reasonable and lower than the five and 10 year averages at a time when asset quality issues are the least, capital adequacy is very healthy and growth prospects continue to be reasonably high though lower than their own history simply due to higher base. However, the sector’s growth could still be higher than most others from a medium to long term perspective. Private Banks have been a story of growing faster than the industry and the industry itself growing faster than the nominal GDP. We believe this may continue well into the next decade as well. While growth is slightly lower and return ratios are lower due to lesser leverage, the positive side is that most of the large private banks may not require equity capital raise for a long time for organic growth needs.

Auto sector, being cyclical and coming out of a bad phase of 2019 to 2022, did well in terms of business last year and the same reflected in stock price performance. While the long-term penetration led growth story is something which is intact, the low hanging fruits of cheaper valuations and higher growth from favourable base are done with. Hence, one may need to be selective going forward.

Can you explain your investment strategy focusing on long-term value, diversification, and risk management?

At UTI, the investment process we follow is called score-alpha in which all our universe companies are rated on two parameters of return on capital employed and operating cash flow generated in preceding five completed years. They are ranked based on these two parameters into a three-by-three matrix (R1, R2 & R3 and C1, C2 & C3). Each fund has a well-articulated strategy and positioning from pure quality and growth, blend to pure value depending on which some funds may have higher RoCE/OCF companies while others may have a blend and so on. Each fund sticks to the strategy irrespective of the market sentiment as we believe over the long term, consistency in strategy helps to generate better returns.

From risk management and diversification perspective, besides the regulatory limits, internally we do have guardrails in terms of number of stocks, liquidity, concentration, sector and stock weight limits, R1/C1 limits, etc. this ensures overall system level control while the fund manager runs the portfolio as per their style and pre-articulated strategy.

What earnings growth do you expect from large caps in the next few years, considering recent trends and market conditions?

If we take Nifty 50 as a representation of large caps, the market expectations are for double digit earnings growth in FY25 (11 per cent) after three strong years of earnings growth. This compares very well to the mid-single digit earnings growth witnessed for most of the 2010-20 decade when cyclicals were struggling. As we discussed above, the earnings are more broad-based now. If we assume that India delivers 6-7 per cent real GDP growth and inflation is around 4-5 per cent, then we are looking at double digit nominal GDP growth. The large companies clearly have the potential to grow the earnings in line or slightly better than nominal GDP growth.

Will the outcome of the upcoming general election significantly alter India's narrative for global investors?

Going by the last few instances, we have seen that markets tend to be volatile closer to the general elections. However, eventually in a few months post elections it is back to focus on earnings growth and fundamentals. The key from India’s perspective is the continuity of reform measures and macro-stability seen in last few years as there is less room for error from a valuation perspective.

On the long term narrative, India is fifth largest economy growing rapidly ahead of others, is a young nation likely to benefit from the favourable demographics leading to rising per capita income levels, is on its way to grow its renewable energy sources aggressively in the next decade, focused on improving manufacturing share in GDP, has been growing services exports at a healthy pace and the stock market offers very good mix of private, public and MNC companies across sectors.