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See 15-16% CAGR earnings growth in 2 years: Harsha Upadhyaya
Mon, May 11, 2015
Source : Jeni Shukla, Citrus Interactive

Harsha Upadhyaya is the Chief Investment Officer - Equity at Kotak AMC, and personally manages Kotak Opportunities Fund and Kotak Select Focus Fund. He has nearly two decades of experience in Equity Research and Fund Management. His prior stints have been with companies such as DSP BlackRock, UTI Asset Management, Reliance Group and SG Asia Securities. Harsha is a Bachelor of Engineering (Mechanical) from National Institute of Technology, Suratkal, a Post Graduate in Management (Finance) from Indian Institute of Management, Lucknow and Chartered Financial Analyst from the CFA Institute. 

In an exclusive interview with Citrus Interactive he shares his views on the equity markets and his funds.

BSE SENSEX and Nifty have fallen by 7% in the last 3 months. What are your views on the market direction going forward? How much more correction is expected?

For the first two quarters of FY15, earnings were growing at around 13-14% which was more or less in line with the expectations for the full year. However during the December quarter, we saw a serious drop in earnings mainly on account of a fall in commodity prices globally. Inventory losses was one of the main reasons for Indian companies to show a de-growth which pulled down the overall earnings for the first nine months. This situation has continued in fourth quarter as well. There is no great pick up in the local environment as well.  Other short-term issues like the prediction of a weak monsoon and uncertainty surrounding the FII tax issues are also making the market participants nervous.

We believe that there will be a reasonable pick up in earnings growth towards the end of FY16 and definitely in FY17. The inventory losses which caused erosion in margins will act as a positive because companies will start buying inventory at a lower level and margins will start to move up. Since we have already seen two rate cuts, the loan book will get re-priced with a lag if we see more cuts. That will be a big kicker. A 1% average cut in interest rate will lead to about 5% increase in earnings. As things improve volumes will pick up and working capital cycle will get shorter. In the next 2 years we expect around 15-16% CAGR earning growth – which may be back ended. For investors looking at next 24 – 36 months, this is one of the best opportunities to look at equities.

                                                                                                                               

What are the global risk factors that you see affecting the Indian markets?

There has been some bounce back on the commodity prices. If the prices continue to move up further then whatever benefits we are talking on the macro side will not be realized fully. This is the biggest risk. The US interest rate is not going to be a serious issue. The hikes will be small and gradual. World over quantitative easing is continuing which is putting pressure on their respective currencies. If everybody is devaluing their currency you can’t have one currency getting stronger. So if the interest rate goes up sharply in the US irrespective of what’s happening in the world, then the strengthening of US dollar will make their exports uncompetitive and hence hurt growth. We also don’t expect any catastrophic event (like Greece exit) with respect to Greek crisis. Europe will continue to muddle along but there will be some negative news flow every now and then.

 

What will be the key factors which will spark the next bull run in the Indian markets and which sectors will lead the rally this time?

Visibility in terms of pick-up in earnings growth coupled with restart of government spend on infrastructure could be next big triggers for the market. Any further interest rate easing will also add to the positivity. We believe domestic economy linked sectors will do well in such a scenario.  

 

Are you more bullish on large caps or midcaps at the current valuations?

Over the next 3-5 years, assuming that the economic tailwind is going to be there – midcaps are likely to outperform large caps. From the perspective of the next 12 months, the valuations of both large caps and midcaps are on similar levels. We do not see midcaps offering a discount – in fact in some cases they are more expensive than large caps. Large caps may give decent returns with lesser volatility in the short term.

 

What is your view on the Infrastructure space?

We are trying to play this mainly through the cement sector and some quality capital good names. The balance sheet strength of many infra companies have come under tremendous stress in the last 6-7 years and that continues to be the case even now. At least in the early part of the up-cycle the companies with good balance sheet strength will be able to do well. We feel cement is a clean way to play the infrastructure theme. There is reasonable clarity on future capacity additions which is going to be lower than incremental demand and financial leverage is low. If you look at historical trends, once the capacity utilization rates go beyond 80% you see pricing power in the industry. This should happen in the next 2-3 years. We are clearly seeing some activity in the Delhi-Mumbai Freight Corridor. Also new capital and cities being built in Andhra Pradesh and overall thrust on housing, smart cities and new roads by central government should benefit cement stocks.

 

What is the fund management style and philosophy of Kotak Select Focus and Kotak Opportunities Fund? The funds have beaten their benchmarks consistently.

We have always focused on the return to the shareholders, the capital allocation and whether the business model is sound. We tend to focus on longer term wealth creation possibilities. We generally have low portfolio turnover in our portfolios as compared to the industry.

Kotak Select Focus is more top-down in its investment approach wherein we take calls on few select sectors which are likely to outperform and then build positions in those sectors. It is a concentrated portfolio at the sector level. We try to diversify at the stock level with about 45 stocks. We can go up to 50% in midcaps.

Kotak Opportunities Fund is a diversified equity fund which invests across sectors and market capitalisations. The mid/ small cap exposure can go up to 40% in this fund. 

Both the funds have the highest exposure to banks, IT-software and cement & construction – forming more than 40% in both the portfolios. Are these the sectors you are most bullish on?

We are currently overweight on Auto and Cement sector. Banking sector, though has a large exposure, is more or less neutral compared to the benchmark weight. IT is currently an underweight sector.

 

The 2 funds managed by you have 37 stocks in common which is around 80% of the portfolio in terms of AUM. What really differentiates the funds?

In Kotak Select Focus, the investment approach is more of top-down wherein we select a few sectors which are expected to outperform the broader market. In this fund, we explore sizeable sectoral opportunities and take relatively aggressive bets. For example, we like agri-chemicals as a sector but we do not find many sizeable bets in those businesses, so we have not invested. However, that sector finds representation in Kotak Opportunities. When we had invested in telecom sector, we were carrying 10-11 percent in the sector as compared to about 2-3 percent in the benchmark.  So, it does not matter if that is a small sector, but we should have sizeable opportunities available for taking aggressive positions. Since we are restricting the number of sectors in Kotak Select Focus we do not want to get into too many sectors with very small weights.

Kotak Opportunities Fund on the other hand is a diversified fund which invests across sectors and market capitalisations. It is more diversified in terms of sector allocation as compared to Kotak Select Focus. In Kotak Opportunities, the allocation to mid/small cap stocks is restricted to 40 per cent as compared to 50 per cent in Kotak Select Focus.

Finally, there could be an overlap in terms of stocks between the two portfolios. The question is if you are bullish or bearish on a certain stock should it be different for different set of investors? We think it shouldn’t be. 

 

Which sectors are you avoiding at this point?

In Kotak Select Focus, sectors such as Metals, Utilities, Telecom and Media are completely absent.

 

What is your advice to individual investors at this juncture?

We do not see much downside to the market from current levels. So this is a good opportunity for retail investors to increase equity exposure through well-managed mutual funds. A staggered, disciplined approach works better. Investment horizon should ideally be at least more than 2-3 years.

 

 
 
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