Prefer staggered investment approach; expect early double-digits earning growth in FY26: Karthikraj Lakshmanan
ETMarkets.com
Synopsis
Karthikraj Lakshmanan of UTI AMC projects single-digit earnings growth for FY25 and early double digits for FY26. He suggests focusing on large cap stocks, particularly in financials, IT, and consumer durables. Mid and small cap stocks are considered expensive, and investors are advised to have realistic expectations for the forthcoming years.
By ET Now
Karthikraj Lakshmanan, Senior V-P & Fund Manager, Equity, UTI AMC, says expecting single-digit earnings growth for FY25, which ends in March 2025. For FY26, the earnings growth is projected to be in the early double digits, not the high teens we have seen before. In terms of sectors with reasonable valuations, financials stand out. Private banks have been increasing their market share over the last 20 to 25 years and are expected to keep doing so with strong return ratios. Additionally, UTI AMC has favoured the IT sector for the past two years. The third sector they have focused on is consumer discretionary, but they are also interested in FMCG if valuations drop further.
Karthikraj Lakshmanan: Yes, we do not really work with a target for a year. But the broader picture – the macros are clearly good. Whether it is the GDP, which is higher than the long-term average of more than 6%, or the fiscal deficit which is on a glide path. The current account deficit is under control. The inflation is well under control. So, most of the macro parameters are doing well and there is not much of a concern there.
The issue has more been on the market valuations itself. Post COVID, we have had very stellar earnings growth as far as mid and smallcaps are concerned and even in the case of largecaps which came on the back of the operating margins improving. While the revenue growth has broadly been in that 9-10% mark, the operating margins have improved and that has led to better earnings growth, which has given a fillip to the markets.
The valuation excesses in the market have been taken out partially with the corrections that we have seen in the last four odd months. But still, we believe that the mid and smallcaps continue to be in the expensive zone, while the largecaps may be in the fair zone after this correction.
Largecap is the place to be and that is the consensus call coming in from all the fund managers. But within that, in which pockets do you see an opportunity with valuations turning a bit more reasonable? Financials has been the consensus call. Apart from that, any other sector that you wish to flag off?
Karthikraj Lakshmanan: You have called out the most consensus one – financials – because this is one sector where the private banks have been continuously gaining market share over the last two, two-and-a-half decades and they are likely to continue to do so going forward as well with good return ratios. At this point in time, the asset quality is not so much of a problem and this is one sector where the valuation whether you take five years or ten years, the valuations today are probably equal or lower than the average and to that extent you have the valuation comfort. We have a steady market share gain story and the valuations are attractive, so that still remains one of our key holdings.
Other than that, IT is where we have been overweight for the last two years. It has played out well in the last year or so. The thought process there has been that the relative valuations were quite attractive. While the growth is more measured, the corporate governance and the cash flows being returned to the shareholders were something which were ticking the boxes for us and to that extent, we have been overweight there.
While the valuation is no more as attractive as they were probably a year back, still most of the larger themes continue to be positive and the fact that the outlook for the businesses is improving with the US economy doing well is something which could bode well for the IT sector. So, to that extent. We continue to be positive there. Other than that, consumer durables and retail is one place, especially the latter where we are positive. There is an unorganised to organised story being played out. There are quite a few companies in each sub-segment. They are doing very well and gaining market share and doing it with good return ratios, that is one space where we have been positive and we continue to be positive.
You mentioned three sectors, of course, the financials, you are also overweight on IT, and you mentioned the retail part. I was coming to you about the consumption part, which has been largely ignored till now. There is some sort of a valuation comfort there, also the big fillip that came in posted the budget by the FM. Do you see the consumption pack, as far as the premium is concerned, picking up now whether it is hotels, airlines, and so on?
Karthikraj Lakshmanan: Yes, clearly within consumption, we have preferred the discretionary part and to that extent, maybe retail and durables qualify there. We have some exposure to airlines as well and we have been positive on autos as a segment. These are the segments where we believe the growth is good and the valuations are reasonable.
FMCG is one space where the cash flows are good, the visibility is quite good, and corporate governance is good. But the issue has been that the growth is lower compared to the valuations that they have had. They have gone through some time correction in the last three-four years, but still they are not cheap enough. But incrementally, this is one sector where we would want to look at if the valuations correct further because most other ingredients are in place, it is just that the valuations for the kind of growth that they offer were not attractive.
What is your strategy for 2025, because a lot has changed since the start of this particular year, and everyone has become very stock specific? Should one go ahead and make investments now or make a gradual investment and try to make a portfolio out of it?
Karthikraj Lakshmanan: Largecaps still seem in the fair value zone while mid and smallcaps even after the correction are in the expensive zone, so that is one area that we are seeing relatively within the equity portfolio, maybe largecap is a space to look at. And probably, each individual’s investing horizon could be very different so you cannot have a blanket answer, but probably from a near-term perspective considering the current situation, it is better to kind of have a staggered investment approach.
Like I said, maybe the excesses have been taken out in some pockets. There are quite a few companies which would have come down by 30% to 40% from the peak in the last few months but still there are pockets of excesses. The clear trajectory that we need to look at is, in the last four-five years if the earnings growth was high teens to 20% or even higher for mid and smallcaps, that now comes down to more realistic mid-teens kind of numbers and there could be even downside risk in the near term to some of that if the operating margins that were going up start to kind of reverse.
So, we are looking at a single-digit earnings growth in FY25, which is March ‘25; we are almost there. But even in FY26, as of now, it is mid-teens kind of earnings growth which could have some downside risk. So, the investors might be better off having reasonable expectations from the asset class compared to what they would have seen in the last three-four years because the earnings growth trajectory is likely to be more around the early double digits rather than the high teens that we have seen in the past.
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Two very bullish brokerage notes came out yesterday. One was by Morgan Stanley and the other one was by Citi. Morgan Stanley says that the risk-reward sentiment is now in favour of India. There are a couple of triggers that investors are not really looking at whether it is the stimulus by the rate cuts by RBI or through the Budget that came out this time. Also, FIIs have oversold and they might make a comeback. Citi also maintains that we might touch 26,000 by the end of December, that is a 13% potential upside. Do you see this as being too ambitious or overly optimistic given the global macros and the looming threat of reciprocal tariffs?Karthikraj Lakshmanan: Yes, we do not really work with a target for a year. But the broader picture – the macros are clearly good. Whether it is the GDP, which is higher than the long-term average of more than 6%, or the fiscal deficit which is on a glide path. The current account deficit is under control. The inflation is well under control. So, most of the macro parameters are doing well and there is not much of a concern there.
The issue has more been on the market valuations itself. Post COVID, we have had very stellar earnings growth as far as mid and smallcaps are concerned and even in the case of largecaps which came on the back of the operating margins improving. While the revenue growth has broadly been in that 9-10% mark, the operating margins have improved and that has led to better earnings growth, which has given a fillip to the markets.
The valuation excesses in the market have been taken out partially with the corrections that we have seen in the last four odd months. But still, we believe that the mid and smallcaps continue to be in the expensive zone, while the largecaps may be in the fair zone after this correction.
Largecap is the place to be and that is the consensus call coming in from all the fund managers. But within that, in which pockets do you see an opportunity with valuations turning a bit more reasonable? Financials has been the consensus call. Apart from that, any other sector that you wish to flag off?
Karthikraj Lakshmanan: You have called out the most consensus one – financials – because this is one sector where the private banks have been continuously gaining market share over the last two, two-and-a-half decades and they are likely to continue to do so going forward as well with good return ratios. At this point in time, the asset quality is not so much of a problem and this is one sector where the valuation whether you take five years or ten years, the valuations today are probably equal or lower than the average and to that extent you have the valuation comfort. We have a steady market share gain story and the valuations are attractive, so that still remains one of our key holdings.
Other than that, IT is where we have been overweight for the last two years. It has played out well in the last year or so. The thought process there has been that the relative valuations were quite attractive. While the growth is more measured, the corporate governance and the cash flows being returned to the shareholders were something which were ticking the boxes for us and to that extent, we have been overweight there.
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While the valuation is no more as attractive as they were probably a year back, still most of the larger themes continue to be positive and the fact that the outlook for the businesses is improving with the US economy doing well is something which could bode well for the IT sector. So, to that extent. We continue to be positive there. Other than that, consumer durables and retail is one place, especially the latter where we are positive. There is an unorganised to organised story being played out. There are quite a few companies in each sub-segment. They are doing very well and gaining market share and doing it with good return ratios, that is one space where we have been positive and we continue to be positive.
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You mentioned three sectors, of course, the financials, you are also overweight on IT, and you mentioned the retail part. I was coming to you about the consumption part, which has been largely ignored till now. There is some sort of a valuation comfort there, also the big fillip that came in posted the budget by the FM. Do you see the consumption pack, as far as the premium is concerned, picking up now whether it is hotels, airlines, and so on?
Karthikraj Lakshmanan: Yes, clearly within consumption, we have preferred the discretionary part and to that extent, maybe retail and durables qualify there. We have some exposure to airlines as well and we have been positive on autos as a segment. These are the segments where we believe the growth is good and the valuations are reasonable.
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FMCG is one space where the cash flows are good, the visibility is quite good, and corporate governance is good. But the issue has been that the growth is lower compared to the valuations that they have had. They have gone through some time correction in the last three-four years, but still they are not cheap enough. But incrementally, this is one sector where we would want to look at if the valuations correct further because most other ingredients are in place, it is just that the valuations for the kind of growth that they offer were not attractive.
What is your strategy for 2025, because a lot has changed since the start of this particular year, and everyone has become very stock specific? Should one go ahead and make investments now or make a gradual investment and try to make a portfolio out of it?
Karthikraj Lakshmanan: Largecaps still seem in the fair value zone while mid and smallcaps even after the correction are in the expensive zone, so that is one area that we are seeing relatively within the equity portfolio, maybe largecap is a space to look at. And probably, each individual’s investing horizon could be very different so you cannot have a blanket answer, but probably from a near-term perspective considering the current situation, it is better to kind of have a staggered investment approach.
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Like I said, maybe the excesses have been taken out in some pockets. There are quite a few companies which would have come down by 30% to 40% from the peak in the last few months but still there are pockets of excesses. The clear trajectory that we need to look at is, in the last four-five years if the earnings growth was high teens to 20% or even higher for mid and smallcaps, that now comes down to more realistic mid-teens kind of numbers and there could be even downside risk in the near term to some of that if the operating margins that were going up start to kind of reverse.
So, we are looking at a single-digit earnings growth in FY25, which is March ‘25; we are almost there. But even in FY26, as of now, it is mid-teens kind of earnings growth which could have some downside risk. So, the investors might be better off having reasonable expectations from the asset class compared to what they would have seen in the last three-four years because the earnings growth trajectory is likely to be more around the early double digits rather than the high teens that we have seen in the past.
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