valuations: Vinod Karki on 4 sectors that did well this earnings season

“Financials on the other hand are doing quite well. Industrials, if you look at capital goods, utilities, energy, ex-oil and gas, I mean overall it looks quite good, auto,” says Vinod Karki, ICICI Securities.

You look at earnings and everything through a magnifying glass. What’s your verdict on the quality of earnings so far? The difference between last quarter and this quarter and the company you’re covering, how much beat estimates, how much met expectations, how much underperformed?
Vinod Karki: So if you look at the actual and expected results, it’s equal, more or less no major surprises on either side, that’s one thing. If we talk about actual earnings growth, the biggest drag on earnings is that it’s driven by commodities, oil and gas companies, metals, cement.

But if we look at the subtext, the fundamental businesses and drivers of these commodity companies,
Generally speaking, the demand situation does not look that bad.

But what is affected is the realisation which has a broad impact on the profit and which is dragging down the overall profitability of corporate India. On the other hand, financials are doing quite well. Industrials, if you see capital goods, utilities, energy, apart from oil and gas, I mean, overall it looks quite good, autos. So it is a good number. It was also not as bad as people were expecting, but there are still concerns on the demand side, so that is the point. It is more or less in line, but overall there is not a lot of excitement.
So looking at the quality of earnings, the narrative is that the market is actually getting quite valued to be expensive. How do you assess that or do you think that the valuations of the market are actually in line with the performance of corporate India?
Vinod Karki: No. So on valuation, the verdict is in. And we said look at every metric, whether it’s the spread between earnings yield and bond yield or market capitalization and GDP, which is closer to 150%, just P/E, north of 21.

It was almost 22 some time ago. So there is no denying that India’s valuations are the richest after the US, in my opinion currently in most of these parameters.

So, looking at the full calendar year so far, all macroeconomic factors for India have revised upwards or rather positively.

So we had a 50 basis point increase in GDP, and inflation was lowered a little bit. So inflation expectations came down. Then the fiscal deficit came down 20 basis points. What was 5.1 became 4.9. The current account became a surplus, and the profit expansion continues, it’s not very exciting, but it’s still growing.

NPA is at a record low. So, overall, the delta data that we have seen since the beginning of this year has been largely revised to the upside, macro factors and if you remember, we started this year with a lot of uncertainty around elections and uncertainty around monsoon.

We were finishing the year with a powerful El Niño effect. And now it’s changed to La Niña, the monsoons are looking pretty good now, and the election uncertainty is behind us.

The budget does not show any major populists or anything that would worry us in terms of productive spending of government resources. So, overall, all of this has been reflected in stock prices, which have reached quite high levels.
So, that’s the thing, and I think we’re on the verge of getting into some kind of meltdown of stock prices, especially in the SMID space. So I think something was needed to cool stock prices, but it shouldn’t be something that completely enters some kind of bear market situation.

I think that’s what we think the recent shocks from Japan and the US data, which seem to be overblown. So the two main factors in this correction were this thought process that the yen trade is over and the other is that the US is going into recession, both of which have very sharp reversals. US bond yields versus Japanese bond yields, which have risen. US bond yields are now at 4% versus 0.8% for Japan, and the yen has reversed some of that rise.

Whereas the United States, if you look at the last four or five days, the ISM data and yesterday’s unemployment data, I think all of that shows that the U.S. economy is still resilient. So both of those concerns are coming back. I mean, it shows that there was some exaggeration in the fear of those two factors, which is reversing some of those fears in the market.

What are your thoughts on the capital goods space, the way Cummins and ABB have come out, and even the commentary? Do you feel like the kind of numbers and commentary that have been reported are actually going to start to justify the high valuations in some of these places?
Vinod Karki: So across the entire capital economy, whether it’s energy or capital goods, their order book.
You see, we said that if we look at the post-COVID-19 period from 2022 onwards, every GDP reading has shown that it is driven by gross fixed capital formation, which basically means the investment rate, and the growth in the investment rate goes hand in hand with the demand for capital goods.

And that’s just building. But the second thing is valuation. So the market tends to overreact and that’s what you see in capital goods, industrial goods, valuations are generally very high.

But to say that due to high valuations demand will be weak or something like that is not the right assessment.

So, while valuations will look very high, that only reflects that growth is strong. So we don’t think you can get extraordinary returns from very high valuations, even if the underlying growth is good, to put it bluntly.

In which part of the market did the quality of earnings really surprise you positively and therefore the sentiment became even more positive than before?
Vinod Karki: So all these sectors, even energy, Coal India in general, if we look at the market where we think valuations are quite reasonable and not reflecting record high valuations, then I think it is in banks, some of the energy sectors, metals and we have seen that the outlook for these sectors looks good.

Most of these big banks were also quite reasonable, I mean they didn’t fail significantly, even the state-owned banks.

In fact, State Bank has outpaced the estimates of the largest bank. So I think these spaces look good, both in terms of valuation and growth prospects.

I want to understand the healthcare side, the pharmaceuticals, and also the hospitals, so I call it healthcare. There are a lot of healthcare mergers and acquisitions that are likely to happen. What do you think about the quality of earnings in this space, both the big pharma companies and the hospitals?
Vinod Karki: So I’m finding more and more in pharma, it’s not like you’re getting sector-specific calls in most sectors. I think it’s just become very stock-specific. So some companies are struggling, some companies are doing well.

So I think it’s become more of an inventory level analysis because each company is handling different types of products, different dynamics and so on. So we have some positives about certain companies. But it’s not like the whole sector is avoidable, I mean, avoidable or anything like that, it’s a case-by-case thing and there are certain companies where we see it as positive compared to value.