The scope for positive surprises in earnings growth next year is limited. 2009 was the year of beta. 2010 will depend on alpha generation, which is never easy.
PANKAJ TIBREWAL, FUND MANAGER, PRINCIPAL MUTUAL FUND
What did the top performing equity fund for the year, Principal Emerging Bluechip Fund, do to manage its stunning 156 per cent return over the past year? Well, it got off the starting block when pessimism was at its extreme, bought the most beaten down sectors and took brave calls on highly leveraged companies, explains Mr Pankaj Tibrewal, Fund Manager, Principal Mutual Fund.Excerpts from an interview:
Principal Emerging Bluechip Fund is the top performing equity fund for the year. What are the sector and stock choices that powered these returns?
If you go back to when we launched the fund, the time was just right from an investment perspective, but quite bad, from a market perspective. Stock selection has played a vital role in the fund's returns of about 146 per cent for a year.
One factor which helped us was the mandate the fund had, of investing up to 30 per cent of its portfolio in large-cap stocks in the initial months. As our view was that large-caps would lead any rally, we fully used this leeway in the initial months. By March 2009, however, pessimism was at an extreme and we took the call that the market was oversold. If you ask me today whether we expected the market to double from those levels, the honest answer is ‘No'.
From a fund management perspective however, this has been one of the most difficult years to manage money. In January, you had the Satyam scam, in March there was extreme pessimism about global recession and in May the uncertainty of elections… Yet the returns that you today see for this calendar year came mainly from the first half, where the market view was so uncertain. To retain the conviction to buy at that point in time and to remain fully invested in the fund, was no easy task.
On sector choices, we took a few early calls to invest in sectors that were hit the hardest. One of these choices was metal stocks.
The other call that we took was unearthing quality companies with high leverage that had been severely punished. We took the view if the capital market were to revive again, companies with reasonable management, good businesses and business models could de-leverage quickly and would be re-rated. Those stocks have today become the darlings of the market!
During the height of the crisis you will remember that even technology stocks were beaten down as doubts were cast on the outsourcing model. So, wherever we bet on stocks or sectors during a phase of extreme pessimism, it worked out well.
What is your take on mid-cap stock valuations? Mid-cap indices are today trading at a PE multiple of about 19 times. Does that offer sufficient margin of comfort to invest in mid-cap stocks?
My view is that the upside in large-cap stocks is limited from here on. Most stocks in the BSE Sensex index are today discounting 2011 earnings, with the market factoring in an earnings growth of 20 per cent for that year. If you break down those earnings, you will find that they are coming mainly from energy, financials and metals, which are expected to contribute 75 per cent of the earnings growth.
Now there are a lot of ifs and buts to that growth. One problem is with the commodity cycle, where you do not know the shape of things to come. That makes me believe that the scope for positive surprises in earnings growth next year is limited. Yes, liquidity can drive markets for extended periods of time. But the call on liquidity is always a tough one.
There are however, many sectors where there is a clear valuation discrepancy between large and mid-cap stocks. The trend of mid-cap stocks outperforming is already evident.
If you look at the second half of this calendar year the index has moved only by 13-14 per cent but there are stocks that have moved 45-50 per cent. I think there are a good number of mid-cap stocks which would give you great returns over the next 6-12 months.
What is your view on the market for 2010?
I feel the market may not fall drastically. But near-term consolidation cannot be ruled out. If that happens it will be a stock pickers market.
If you look back at the previous bull run, you will find that 2002 and 2004 were the only years when the market moved less than 25 per cent. In both these years, the markets consolidated in a narrow range. When that happens, you always have to work a little harder to dig out stocks with a superior earnings story.
2010, I believe will be that kind of a market. The broader market will be range-bound with volatility picking up from time to time. 2009 was the year of beta, 2010 will depend on alpha generation, which is never easy.
What is your sense of earnings performance from Indian companies in recent quarters. While profits are improving, the topline for companies seems sluggish. Is that a worry?
It is. My sense is that, going forward into 2011, the bulk of the raw material cost savings and operating leverage may have played out for companies. The trend of earnings surprises from companies may end by December quarter this year. Earnings, from there on, will depend only on two factors — lower leverage, which can reduce interest costs, and topline growth.
The latter can, after all, only come from price or volumes. It will take time for pricing power to come back to producers, given that the global environment remains quite weak. In that scenario, you really need to focus on volume growth.
The theme we are looking at is: Which sectors can deliver volume growth in FY11, assuming prices stay flat or decline? Companies and sectors that show good volume growth may be the ones to enjoy premium valuations going ahead.
How big a risk do rising interest rates pose to the earnings outlook?
If you go back in history, there is usually a 12-15 month lag between changes in interest rates and the earnings response to it. In recent months, a good number of companies have been able to raise equity to repay debt. Our calculations show that even if you factor in equity dilution and weigh that against interest rate savings for companies, they may be able to deliver earnings growth. Capital raising is a blessing in disguise for highly leveraged companies. So which are the sectors you are bullish on at this juncture?
They would be consumption related sectors-FMCG, retail, financial services, where volume growth would not be a challenge. In the infrastructure space, we see potential in companies which own assets such as power plants, airports and ports, though valuations are not exactly cheap. In the downturn, we saw that companies that only work on a cash contract basis were hit harder as their margins were squeezed both by interest rates and raw material costs. Companies that own assets may see a dip in revenues during a slowdown, but they can always come back quickly once a recovery begins. They also face fewer risks from interest rates or raw material prices.
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