midcaps: Midcaps will outperform largecaps over 2-3 years: Kashyap Pujara, Axis Capital

The dominance of private sector banks or the large public sector banks is definitely a very strong competitive advantage which is not going to be displaced any time soon given the issues NBFCs are facing, says Kashyap Pujara, Head of Research at Axis Capital in an interaction with ET NOW. Edited excerpts:


ET Now: What is the way forward for equities this year given the slowdown in the economy, global weakness and the overall sentiment not looking that great?


Kashyap Pujara: Markets are close to 17-18 times one year forward earnings which is slightly above mean, as far as valuations are concerned. The current demand slowdown is still well entrenched and in the interim, economy is going to take a U-shape form of recovery; we are not going to quickly recover in the next quarter or so. The U-shape recovery will be on the back that the fiscal firepower by the government has been spent in the form of a corporate tax rate cut which will not give us an immediate demand boost. But with corporates actually saving on those tax rates, the investments will scale up and potentially over a one to two-year horizon the GDP growth will be higher. Progressively, GDP print will be better quarter by quarter and in Q4 GDP will be far higher than where we are now and likewise for the year ahead.

I think markets, which are to an extent buoyant at the current point, are sensing that there is going to be a recovery up ahead and people are taking cognisance of that and making investments based on viewpoint of one to three years.

ET Now: Private versus public banks — what trends are you observing? What do you expect in terms of market share changes over the next year?


Kashyap Pujara: In the banking space, the key trend that would play out is dominance. The dominance of private sector banks or the large public sector banks is definitely a very strong competitive advantage which is not going to be displaced any time soon given the issues NBFCs are facing.

A large amount of public sector banks would require capital, they will be getting into provisioning mode or to that extent integration mode, and thus, there will be a natural market share shift from the public to the private banks.

The large banks in the private space and the largest PSU bank in the country will only get bigger over time and size advantage will just get magnified.

One other key trend that we are seeing apart from dominance of these large names is also convergence. Historically, we have seen banks having retail-oriented side separate from the corporate lending oriented side, but what we are now seeing increasingly is that the large corporate lenders’ business models are becoming very similar to the large retail-led lenders’ and this convergence will only magnify.

In fact, if one were to look at the incremental lending by banks, most of them have a converged business model already. It is just a question of time before the valuations converge. You might have large retail oriented lending banks having a much higher valuation premium and that valuation premium will likely shrink over time and some of the large corporate lenders will converge.

ET Now: What are some of the factors that make midcap look more attractive in the current market scenario?


Kashyap Pujara: What we are seeing as a trend is that not only have midcap valuations have become extremely supportive but also we have seen participation of institutions on midcaps go down by 600 bps. It is going to be a U-shaped recovery for the midcaps. They tend to do well when GDP growth surprises and we will see GDP recovery going forward. As the recovery gets a bit broad-based, we will definitely see midcaps outperforming the largecaps over the next two to three years.

As far as the segments of the market are concerned, sectorally we prefer banks especially the prominent names given the dominance that is playing out there. In other segments, it is interesting to see companies in the pharma space at the current point in time because you are seeing a situation where many good companies, good businesses are basically are going through a bad patch and over a three to four-year period there is an opportunity to be made there.

As the economy recovers we will see opportunities in engineering, cap goods, infrastructure also playing out because the entire market is polarised towards B2C consumer driven names with free cash flowbut the valuation premiums in that space are at a point where I cannot make a case of a high IRR if one invests into some of those names. It would make sense to look at cap goods, engineering, select utilities, pharma spaces.

ET Now: What are your thoughts on the corporate tax cut led rally?


Kashyap Pujara: If you look at the current quarterly results, the way they have panned out is very much in front of us and in many cases we have seen top line to be lower than expectations but margin tailwinds have still played out and obviously the corporate tax rate benefit has come in as a welcome surprise. And that is permanent in nature. It is driving operating cash flows and free cash flows and the missing element of the last cycle which is price-led growth. High inflation in my view can get compensated with this tax cut which can actually be a replacement to the price-led growth.

This is definitely a very strong tailwind because markets are actually slave to earnings and return on equity. This corporate tax rate cut to a large extent has boosted both, the outlook on corporate profitability and the outlook on return on equity. The market rally that we saw in the recent past post the corporate tax rate cut is not unfounded and is a well called for rally.