Over the next 3 years, earnings may grow 15-20%: Manish Gunwani

The S&P BSE Sensex hit an all-time high today. Is this rally sustainable and how are we in terms of valuations?
On a valuation basis, we are trading at 17-18x one year forward price to earnings (PE) ratio. Looking at this from a historical perspective, it is slightly higher in terms of long-term averages. However, one must keep two things in mind. One, the earnings cycle for the past 7-8 years has been weak and many industry segments, especially in the case of corporate banks, earnings are fine. Over the next couple of years, even if earnings recovery is not strong, you can get decent earnings cycle because it will be reversion to mean for a lot of industries. The second thing happening globally is that S&P is at an all-time high, though globally economy has been weak. Central banks have been aggressive in keeping interest rates low. Cost of equity is lower and it looks like that high valuations are sustaining across the globe.

What kind of earnings growth should one expect in the next two-three years? What returns could investors expect on their equity investments?
In a 3-year block between FY19 and Fy 22-end, we believe earnings could grow between 15-20% CAGR. Given that the PE multiples are slightly high now, investors should expect returns to be less than earnings growth.

What sectors or themes are you betting on in the coming years?
There are three themes we are betting on. First, there is an economic recovery theme which we expect should benefit corporate banks, industrials and cement. The second theme is consolidation, where we believe the bigger players will get bigger because of the shift from unorganised segment to organised and due to weaker players getting out. Sectors like real estate, hospitals and hotels will benefit from this. The third theme is moving of manufacturing from China to India. High labour cost in China, environment compliance and trade wars with the US could lead to manufacturing coming to India. This will benefit industries like chemicals, pharma, contract research and manufacturing and electronic manufacturing.

The government move on selling strategic stakes in PSUs has attracted investors to this set of beaten-down stocks. Your views?

We like large PSU banks and also have decent positions in PSU stocks in some of our schemes. Investors are yet to make money in mid- and small-cap stocks over the past 18-20 months. The S&P BSE 150 Midcap index is down about 25% since January 2018 while the S&P BSE 250 Smallcap Index lost more than 50% in the same period. Should investors add money here? Definitely. We think that over a medium-to-long-term perspective at today’s starting point, mid- and small-cap indices will outperform large- cap indices. We are recommending multicap funds and midcap funds. Having said that, valuation distress is not as stark as 2009 or 2013. While we prefer midcaps over large-caps, the margin of safety which was there as in 2009 or 2013 where investors made super strong returns is not there yet.

After the IL&FS crisis broke out, several companies in the NBFC space have been badly hit. Are we out of the woods there?

The happenings in the NBFC space have had a big role to play in the slowdown. As a percentage of the banking system, they were about 25-30% but as a percentage of incremental credit they had reached a higher number. When a brake came on their disbursement, it played a significant role in the slowdown. The good part is more or less, we have crossed the bottom.