These COVID-proof sectors will continue to perform well: Devang Mehta of Centrum Wealth

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Devang Mehta, Head, Equity Advisory, Centrum Wealth, feels COVID remains a medium- term risk, but most economies are better prepared than most part of the last year. “Inflation and the stance on interest rates across the globe remain risk factors,” he said in an interview to Moneycontrol’s Sunil Shankar Matkar.

He prefers to buy leaders across the market-cap spectrum. Market leaders tend to benefit as they exhibit superior qualities of garnering more market share during tougher times, he believes. Edited Excerpts:

Q: With the fall in COVID cases, do you think FII money will return to India in the coming months?

With the downward sloping curve on the COVID front, there is a decent possibility for the return of foreign flows into Indian equities. The moderation in daily COVID-19 cases has led to an improvement in sentiment. The potential peaking of the curve is giving hopes to the market that a gradual unlocking could well be under way over the next couple of weeks, thereby stemming the decline in economic activity.

The velocity of vaccination drive would be a key monitorable for the investing community, along with COVID numbers. Domestic investors have kept the momentum going and the earnings season has also thrown more positive surprises.

The country attracted the highest-ever total foreign direct investment (FDI) inflow of $81.72 billion during 2020-21, which is 10 percent higher, compared to the financial year 2019-20, when inflows touched $74.39 billion.

Q: What are the COVID-proof sectors that could beat others in the coming quarters, even if the country faces a third wave or the next?

Exporters are slated for some good times ahead. Most IT companies have reported strong deal wins with improved visibility on growth, going forward. Management commentaries have also highlighted a strong spending environment, with a high emphasis on cloud migration. Healthcare, as a sector, has also emerged strongly in this environment and holds promise for the foreseeable future.

A majority of the banks have reported a strong sequential pickup in loan growth, led by healthy trends in retail. Deposit growth, led by a higher mix of CASA deposits, remains strong. Margins have also displayed a positive bias. An improvement in asset quality ratios is also visible for large banks. Despite raw material pressures, paints and adhesive companies have been able to post good numbers for this quarter.

We feel that sectors like healthcare, IT & automation, large banks, along with select NBFCs, and insurance, building materials, specialty and agro chemicals will continue to perform well. Select consumption-oriented businesses, both discretionary and non-discretionary, will come back as we move towards the prospects of a smart economic recovery.

Q: Do you think COVID will remain a big risk for economies? What are the other big risk areas for global markets?

COVID remains a medium-term risk, but most economies are better prepared than most of last year. A fast-rising US economy could pose a risk to reflation trade as a stronger dollar puts fund flows to emerging markets, including India, at risk. In the first quarter, the US economy accelerated at 6.4 percent YoY, its second-highest growth since 2003.

Consumer spending in the US has surged as stimulus cheques drove household incomes. This acceleration comes at a time when a devastating second wave of COVID-19 has put the nascent economic recovery in India at risk. Inflation and, hence, the stance on interest rates across the globe remains one of the risk factors.

Q: Experts are talking about inflation risk, given the rise in commodity prices and the fear of interest rate hikes in the coming quarters, though the Fed has consistently retained its stance to keep rates low by continuing to buy bonds till the actual economic recovery. Do you feel so, and is it a major risk or supportive factor for equity markets?

The inflation reports in recent weeks have stoked concern that the Fed could find itself behind the curve, and be forced to aggressively tighten policy, should its bet that inflation is transitory prove unfounded. However, the market has come around to the Fed’s expectation that inflation is set to rise over the near term but will plateau and decline in the coming months.

Higher commodity prices are likely to move the needle on the inflation front. Also, the advent of inflation across the world can put to test the theories of an extended period of low interest rates, abundant liquidity and accommodative policies. Hence, one needs to have an eye on these moving parts, along with macro and micro fundamentals.

Q: What is your investment planning and strategy towards Indian equities, given the current scenario?

We prefer to buy leaders across the market-cap spectrum. Market leaders tend to benefit as they exhibit superior qualities of garnering more market share during tough times.

One has to buy/accumulate quality businesses on dips. While wealth creation is the ultimate goal, wealth preservation is equally important in the interim. Hence, to be carried away by the rally and buying anything and everything should be avoided. The portfolio has to be balanced on both fronts, viz., India’s strengths (read consumption, IT, healthcare, agro & specialty chemicals), along with the proxies of economic recovery (building materials, corporate lenders, select capital goods).

Buying in tranches will ensure that one takes advantage of volatility rather than running away from it. It is also imperative to realign and restructure portfolios in an endeavour to cut on junk businesses and unpleasant memories.

Q: Will India fail to report expected double-digit growth in FY22, given the pressure in the first quarter of FY22 and expected pressure of a third wave of COVID-19?

The International Monetary Fund upgraded India’s economic growth forecast to 12.5 percent, a couple of weeks back. It was the quickest rate among major economies. Now, as COVID-19 cases surge the most globally, that bullish view is looking increasingly in doubt. Localised containment measures will act as a drag on growth. High-frequency data are already pointing to a deepening contraction in retail activity. That’s a key risk for an economy in which consumption makes up some 60 percent of gross domestic product.

In addition, the impetus on vaccination drive and expectation of shorter waves make economists reluctant to revisit growth forecasts. Most institutions, right from Fitch to our own central bank, have retained estimates so far. The second wave of COVID-19 cases may delay the recovery, but it is unlikely to derail it completely. Transportation and supply chain are not impacted much by this lockdown. Resumption of economic activity and the intensity of that will decide the way forward.

Q: How do you read the March quarter earnings season and have you lowered your earnings estimates of FY22, post March quarter earnings?

While the slowing down of fresh cases clearly is a positive development in India’s COVID battle, reported daily fatalities continue to pose record numbers. This could be a crucial factor for governments to decide on the lockdown policy, with nearly the entire country currently locked down.

Earnings for the third and fourth quarters have generally been in line with some extremely positive surprises, while the current quarter (Q1FY22) might look to be a disappointment with almost six weeks of a nationwide lockdown thus far. Also, inflationary and raw material pressure will hurt margins, going forward.

But with demand slated to return, post lockdown and improvement in operating efficiencies of most market leaders or listed companies, earnings could again gain traction.

Q: Returns in midcaps and smallcaps in the last one year as well as in calendar year 2021 are much higher than largecaps. Do you think smallcaps and midcaps will continue their outperformance in the coming years?

Smallcaps and midcaps have come out of a long period of underperformance. While we tend to analyse and pick businesses more on merit rather than on market cap, the emerging market leaders is one space which we feel has a lot of potential. Most of these companies are in the sub-Rs 1 lakh crore market cap bracket and eager to create wealth for patient investors.

They exhibit superior qualities of high ROE/ROCE, no/low debt, consistent growth in revenues/PAT/EBIDTA, dominant market shares, and strong corporate governance among other fundamental parameters. Companies having a visible brand, huge bargaining power, cost advantages and hugely scalable future-ready businesses make the cut.

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