FII Bullish On Domestic Stocks Signals Confidence In Indian Economy: ICICI Securities' Vinod Karki

Domestic inflows continue to be structural as households raise their share of savings into equities.

<div class="paragraphs"><p>Vinod Karki, senior vice president of equity research at ICICI Securities Ltd. (Source: Company)</p></div>
Vinod Karki, senior vice president of equity research at ICICI Securities Ltd. (Source: Company)

Foreign institutional investors are showing bullish sentiment towards the domestic economy-facing stocks, indicating their confidence and positive outlook. There is a significant uptick in the FII stake in the broader market and domestic economy-facing stocks, according to Vinod Karki, senior vice president of equity research at ICICI Securities Ltd.

The FIIs and domestic institutional investors tend to exhibit contrasting behaviours. However, for the first time in recent memory, both the FIIs and the DIIs are net buyers on a trailing 12-month basis, Karki told NDTV Profit's Niraj Shah in an interview on Monday.

Last year saw a notable increase in foreign portfolio investors' holdings in the broader spectrum of the market, he said.

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India's position as a foreign investment destination continues to improve with a relatively higher growth outlook both in terms of gross domestic product and rising corporate profitability, augmented by a stable external environment, receding fiscal deficit and stable prices, according to ICICI Securities.

"However, high valuations remain a key dampener for flows, as one-year forward P/E remains elevated at 20.4 times or earnings yield of 4.9% versus India 10-year bond yield of 7.1%," the research firm said in an April 13 note. "The latest hotter-than expected US CPI print has further dulled the valuation picture."

Domestic inflows continue to be structural as households raise their share of savings into equities, the note said.

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Outlook On Markets

The market has seen some upward movement, driven by expectations of a favourable mandate in the current elections, Karki said. "If the election results align with these expectations, market volatility on election day might not be significantly higher."

Investment Flows

In terms of capital expenditure, the investment rate is poised to surpass previous high. Corporates have hit bottom and are now ramping up capex spending, according to the senior executive.

"The real-estate cycle is in its second year of expansion, and both the central government and states are performing strongly," he said. "Corporates have only just begun to increase their investments as well."

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Edited excerpts from the interview:

Let's try and figure out if you believe Vinod, since you are in the midst of the election season, whether post election if indeed the verdict is what the market is currently factoring in. Would it make an impact on flows, on sentiment and more or would it be status quo? Let's start off with that argument.

Vinod Karki: Yes, if you observed the market once the state election results came and some of the opinion polls came the market has been kind of warming up to the idea that there's going to be more consolidation in terms of the vote share and the outcome will be favourable. So I don't think that that will be a surprise. So some of that is I think, getting baked into the stock prices already. But nevertheless, if that is an expectation, when actually there is a strong mandate, and there's a chance of some bit of excitement in the market. It seems that the market has made some kind of up move on the expectation that we'll get a favourable mandate in this election. So  to that extent I think, once the elections are out and we have seen over the last several elections, the volatility in the markets on Election Day has been reducing significantly from 2009, 2014, 2019 and so on. I think Election Day volatility may not be very high, if it is at par with expectations and beyond that, obviously fundamentals will take over, how growth is panning out.

But I'm still wondering, in your conversations with global clients, are they waiting for the election verdict, to allocate money to India or are there other reasons around it?

Vinod Karki: Well, if you see the actions of the FPIs over the last year and particularly over the last month or so when the March numbers are available for flows across sectors. One thing is coming out clearly that the FPIs are buying into. First of all, if you see last year, they were more buyers of the broader market than just the large caps. Even in the March month we saw clear preference for domestic cyclicals over defences in fact. So which tells me that FIIs overall are very bullish on the domestic facing economy stocks.

But to answer your question whether you know they're waiting or not, I mean, the action clearly speaks that they have been increasing allocation towards broader markets, domestic facing economy stocks and things like that. So action speaks for itself. Obviously, there has been volatility in between when there are these expectations of rate cuts goes away and rate bonds in the U.S. rise. We have seen volatility around it , but overall, if you see over the last, I mean, I was just looking at some of my charts and I realised that is probably the first instance where over a trading 12 month basis both DIIs and FIIs are buyers of $20 billion-odd, in terms of stocks. Usually they are at opposite ends. If FIIs are buying at 20, the DIIS would be lower, you know, that kind of  thing. Somehow they're converging right now, which is I think resulting in these valuations remaining high. 

That can actually, you know, if the political situation gets better, growth keeps coming in and that could be one of the reasons to be a little worried because if both these large players in the market continued to be buyers then who is going to be the sellers. Last year, what happened was that the MFs and FPIs kept buying $20 billion-odd each but the supply came from promoters and some of the other FDIs. But it's not necessarily that it will follow every time and that's where greed comes in and everyone turns into a buyer and then you get into a bubble zone. So that's something I worry about, from the positive side that if everyone continues to buy then you will get a situation where the valuations will really get out of hand.

I’d love to understand from you one, is government capex still as strong as it was, is that the only factor driving capex spends or is private capex also starting to rise and what are the pockets where are you seeing telltale evidence of this?

Vinod Karki: Yes, so when you talk about a capex,  the investment rate is on the verge of breaking out of the previous high of around 34% of GDP, which was made in around 2011-12 and this time, it’s better, which is the productivity of capital is improving, and that I can substantiate that macro numbers by the ROE of the Nifty which is getting into calibration zone of more than 15%. Now, when you talk about the investment rate of 30% plus, which we're effectively talking about more than 100 trillion rupees worth of Capex because of the GDP is around 300 trillion. So when you break it up, the government contributes nothing, and it's just eight-nine trillion from the Centre and seven-eight trillion from the States. So it's 15-16 trillion, so where is the rest which makes up more than 100 trillion coming from. That's what I mean, if you look at the GDP print every quarter, it is showing that the Gross Fixed Capital Formation is leading the GDP growth, which means that a large part of the GFCF, which is made up by real estate investments by households, and corporate capex must be moving. 

What we know anecdotally and from data is that the real estate cycle is almost in the second year of its expansion. While the centre was doing pretty well now states have started to contribute for this year and they are growing faster I think than the Centre and corporates I think are just about starting to pick up in my view. So if you look at the evolution of this investment cycle this time around, the first move was made by the Centre in terms of expanding its investment. Real Estate followed on its own in terms of animal spirits somehow rose and people started buying houses and it's continuing. Typically these cycles last for five to 10 years and now States because their revenues have started rising, they're getting better stamp duty, GST and things like this are contributing. Corporates, I think have just started to bottom out and started to rise. So this biggest lift may come from the corporate side.

The other aspect of course, is what's happening to specific pockets and you know, by virtue of this capex what PSUs have done actually. Speaking of PSUs just before I get to Vinod, on that, can I get in my colleague Mihika who joins us right now to talk about a big development that's happened in terms of a policy decision, really, and it may be an isolated instance but GSPL is a stock formally in focus today for all the wrong reasons.

Mihika: So they have gotten a 47% tariff cut from the Petroleum and Natural Gas Board and this is for their key high pressure pipeline network in Gujarat. Now the authorised tariff is at 18.1 rupees per MMBtu versus 34 rupees earlier and this is also lower than the 51 rupee tariff that was originally sought by Gujarat State. Now in terms of impact while consumers could see lower prices both on households and industrials, for Gujarat state petroleum it puts a pressure on their revenue and their profits because this is a cut on the price they can charge to transport the gas via their pipeline. Now, there are many reasons for why the petroleum and natural gas board did cut the tariffs so drastically. One is higher volumes; the volume assumptions while Gujarat State  Petronet assumed 26 million metric standard cubic metres of gas per day, the board assumed 31.7. In terms of Capex assumption stands much lower. 

Now, the Gujarat State Petronet claimed a Capex of 3400, while the board considered 1800 crores and in terms of operating capex, the PNGRB approved 2600 crores of  operating Capex while the company stated 5000 crores. We also had certain brokerages that did go negative in terms of rating and their price targets where Nomura, which downgraded Gujarat State Petronet to a reduce at a 320 rupee target, which implies a 15% downside to the previous close. They've got FY 25 and 26 EBITDA estimates by 37 and 42% and last week Kotak which also reduced rating to a reduce at a target price of 360 rupees, which is a 22% downside.

Thanks a lot for that and that clearly makes GSPL the stock of the day today. Just trying to understand for gas companies, all for PSUs in general, are you constructive or would you approach them with caution, now that they are no longer at dirt cheap valuations?

Vinod Karki: You should look at broader economic cycles. What we observed is that the PSUs why they are performing you have to understand it is coming from the way the colour of the economic expansion is happening. As I said, the investment rate is leading the GDP growth. So what happens in this environment is that companies which grow by growing their balance sheets and investing they do well and bulk of the PSUs are in the capital intensive sector. So what will happen is as the investment rate is expanding with better productivity of capital, generally these companies will show better than expected growth and that is what the market cares about. I mean, one or two instances where because of regulatory reasons, you'll have cut in estimates and things like that, what the investor has to be cognisant of is that stocks perform wherever there is growth surprise. So, we continue to believe in the way the economic expansion is happening, the bulk of the companies which are related to the investment side of the economy, they will continue to show better than expected growth in general.

In fact, disappointment is continuously coming from the outperformance of the previous cycle which is the defensive sectors, be it I.T. or even FMCG and in general FMCG is getting into a situation where the broad-based consumption and low and rural consumption and things like that and continue to struggle while the valuations if you see put a PEG ratio P to G ratio, they look pretty expensive.  So do I.T. which we have been saying that at some point they will get into a good zone and growth will kind of bottom out and start looking better. But for now, the growth is firmly on the side of the cyclicals which, you know as I said FPIs, the DIIs they continue to be positive about and continue to buy these stocks.