We haven’t seen full extent of FII selling in emerging markets yet: Manishi Raychaudhuri

“In the entire consumer space, in a phase of continuing input cost pressures, investors would have to be very cautious. It is a lot easier, possibly a lot more advisable to play the input manufacturers, sense energy or materials for the time being,” says Manishi Raychaudhuri, Head of Asia-Pacific Equity Research and of Asia ex Japan Equity Strategy, BNP Paribas.

We saw FII sell Rs 1.4 lakh crore worth of equities last financial year. So far in April, they turn out to be buyers. It is a market which is dominated by domestic institutional investors. Is there a change on the ground? Are you telling your clients the same?
It is too early to conclude that this is a change of stance on the part of the FIIs. FIIs are selling not only in India but also across emerging markets. Starting from around October, it has continued till date and it is triggered basically by two drivers; number one, we had the Fed stance changing quite rapidly during the last quarter of 2021 in terms of monetary policy normalisation or the pace of monetary policy normalisation. Second, the conflict in Europe obviously pushed up energy prices and various other food products and other commodity prices impacting the current accounts of many emerging markets including India.

That obviously led to a concern about emerging market currencies. These two drivers are not yet behind us. In fact, I would point out that while the Fed rate hike increases, these rate hikes or at last the narrative has been digested by emerging markets. But the Fed is now going to enter into a quantitative tightening phase from around May. I do not think that is digested adequately.

I would in a nutshell recommend that investors remain cautious about FII flows in the near term. Honestly, I do not think we have seen the full extent of FII selling in emerging markets yet.

A month ago, when we talked, you said buying anything right now is like standing in front of a running train. Has that at least changed?
Yes, I do remember that phrase. As I said just now, some of those drivers including the military conflict in Eastern Europe or the Fed’s rapid change in stance as far as monetary policy normalisation pace is concerned, are still with us.

In fact, the most recent FOMC meeting minutes would show that there is a clear reference to quantitative tightening (QT), possibly up to a maximum of $95 billion per month. This is likely to be far sharper than the previous round of QT that we had seen. During 2017 to 2019, we had seen the total FII selling in Asia took a turn of possibly around 1.7 to 1% of the market cap of the Asian markets and compared to that occasion, this time around, the QT is likely to be sharper.

It is also happening at a time when the rates are likely to be hiked simultaneously. So while the situation may not appear as dire as when I had made that comment about a month ago, I would say it is still warranted.

In the FMCG space, sleeping giants like ITC are sitting at a fresh 52-week high and one can actually buy a piece of Patanjali via Ruchi Soya FPO as the shares got listed. How is it that you are scouting opportunities within FMCG at a time when we know what transpired with inflation and input cost pressures?
In general, we are very positive on the consumer space. At this point of time, if one looks at the consumer staples and consumer discretionary taken together, we are only focusing on those stocks which are the market leaders and distribution leaders in their niches and therefore they are the ones which can pass on the input cost hikes to their customers. In the entire consumer space, in a phase of continuing input cost pressures, investors would have to be very cautious. It is a lot easier, possibly a lot more advisable to play the input manufacturers, sense energy or materials for the time being.

Where is it that you feel that the exuberance is now overdone and you would want to lighten your positions or avoid some sectors, if at all?
The consumer-orientated sectors may be more expensive – consumer staples, consumer discretionary – because increase in cost of capital tends to reduce the valuations that expensive stocks tend to trade at.

Obviously we have seen part of that happening where the growth stocks have derated but we think that as a consequence of the likelihood of cost of capital going up even more, that process is likely to continue for some time longer. So, number one, avoid expensive stocks particularly the ones that do not have pricing power. I would point out that in the face of these energy costs rising, we are not too positive on the marketing and refining space.

There is this ongoing global tensions and the lockdown in China is straining supply chains for the auto sector as a whole. How are you looking at this sector?
One has to be very careful in the auto sector, particularly the companies that have clearly voiced their opinion about the supply disruption affecting the production that would pretty much fit many companies.

But the ones which are predominantly concerned with the domestic market and the ones which have a relatively low import content in their input mix are the ones which would be relatively resilient at this point of time. So basically, we are looking for, a) the input mix which we would prefer to be relatively onshore focussed. b)We are also looking at the market position of the company in their respective niche. These two things would enable that company to pass on the cost hikes to their customers. It is not an easy game at this point of time for the entire gamut of consumer discretionary and consumer staples.

There is a report saying that the telecom growth in the upcoming quarter will largely be led by ARPU growth on account of the full benefit of the tariff hikes. While subscribers are likely to remain under pressure on the back of SIM consolidation, what is your sense when it comes to the telecom space?
We tend to agree with that. We like the telecom space – both the pure plays and the conglomerates participating in that space. We think that as a consequence of the consolidation, ARPUs have been increasing and are likely to continue to do so for the foreseeable time.We have significant exposure to the telecom space across Asia and India.

What are your expectations from this season’s earnings season? Would we see earnings downgrades beginning from this quarter?
There are a few sectors where we have been already seeing earnings downgrades and they pertain largely to the consumption and the commodity user space. So consumer staples, selectively some consumer discretionaries, some of the industrials have already seen consensus EPS estimates downgrades over the past one to three months.

We would expect that to continue in this quarter as well. The sectors that should do better and which have already seen earnings estimates move up are possibly IT services. We have seen some of the banks facing earnings estimate downgrades over the past three months but there could be some recovery in the banks, particularly the private sector banks earnings estimates going forward. As yields rise, the net interest margin tends to improve. We have already seen that in the developed Asia universe and it is likely to cascade down to India as well. So it will be a mixed bag. IT services should be fine, the financials selectively should be okay. It is the consumers and commodity users that I would be cautious about.

You said that the markets have not fully priced in normalisation by central banks. As we still figure out whether inflation is structural or transient, are you changing your entire strategy on commodity packs, especially base metals?
Well, not really. The commodity exposures that we have in our Asian model portfolio includes the energy explorer space. We have selective exposures in other materials, though more so in Southeast Asia than in India. Those positions are unlikely to change in the foreseeable time horizon. We think that commodity prices shall remain buoyant for the time being. Much of the drivers of these commodity price spikes that we have seen which is enhanced demand in the developed markets are and the geopolitical tensions are unlikely to be resolved anytime soon. We are clearly maintaining our positions in these sectors for now.

What do you feel about the HDFC conglomerate following the HDFC-HDFC Bank merger? What does it mean for the other fintechs/NBFC players out there who are going to now compete with this large entity?
I cannot comment on specific instances or specific companies but in general, consolidation and therefore a relatively lower cost of capital for the consolidated entity is likely to become the order of the day going forward. In the Indian banking space, there is a degree of consolidation and therefore increase in size by inorganic means and we think that this is likely to continue further.

Now obviously some consolidation, some instances of consolidation are giving rise to entities which are way larger than what we have seen previously and we have to prepare for this. It means that not only could the cost of capital for some of these entities decline, but also their pricing power and their return on equity and the return on capital that they generate going forward could actually be boosted.

The media sector has been hot of late. What is the sense that you are getting within the media space and which are the sub sectors that you would be bullish on?
Over the longer term, we like the media space for ad revenue growth, sharp economic recovery from the previous years’ Covid lows which has obviously led to this buoyancy in the revenues of the media companies. In the near term, however, there is pressure on margins of the consumer companies which are the bulk of the contributors to this ad revenue growth and that is what makes us a bit cautious. Over the next one to two quarters, one would have to be a bit selective about the media companies. Over the longer term, they look fine though I would be avoiding the really highly valued or the more expensive exposures in the space and there are quite a few of them.