Allegro: still an India bull

Allegro Capital Advisors is an Indian full service investment bank founded in 2002 with 200 professionals across 15 cities. Here principal founder and managing director, Kunal Kashyap discusses his views on the economic and investment outlook for India and the current stock market boom.

What's your view on the stock market and current valuation levels? Has the Sensex run up too much?

The Indian markets have rallied significantly in the last couple of years, but stock valuations are still reasonable if a long-term investment view is taken. Corporate earnings have grown in excess of 20% in each of the last three years and are expected to grow between 15-20% in each of the next two years, driven by a strong growing domestic economy, strength in manufacturing and services and booming domestic consumption.

Moreover, this growth is not confined to a few sectors, but has benefited most sectors of the economy. With this performance has come increased investor interest, especially from FIIs who have committed increasing amounts of money to the Indian equity market and growing domestic investor interest in the stock markets.

Over the past few months the broad equity indices have outrun expected earnings growth. But we believe the markets will continue to rise significantly over the next few years so long as corporate India continues to deliver. The occasional (and maybe even inevitable) corrections will provide opportunities to increase exposure to high-quality stocks, which are expected to deliver long-term growth.

At current levels, the market is priced at around 17 times 2006 earnings, which is in line with its historical average. If earnings grow around 15% per annum, the broad market should perform at least as well, if not better than this.

That said, we think the re-rating of the Indian market, which has delivered extraordinary returns over the last three years is close to, if not, over, and any further gains will be delivered by fundamental growth in corporate earnings. A sector and stock-specific approach should continue to yield good investment returns over the medium to long term.

What reasons do attribute to India's booming equity markets?

I can think of seven major growth drivers. Firstly, the country has a fast-growing and stable economy, with low inflation and stable interest rate and foreign exchange environment. Secondly, we have seen continuing economic reforms.

Thirdly, I would point to increased consumption levels on account of rising incomes and favorable demographic trends. Fourthly, there has been a revival in investment cycle with most manufacturing entities operating at near 80-90% capacity utilization levels.

Fifthly, there has been a renewed thrust on infrastructure spending, both in the public and private sectors. India is also becoming recognized globally as a source of skilled manpower and manufacturing with the ability to deliver world-class products and services.

Finally, the Indian economy is becoming increasingly integrated with the global economy, with the result that companies now have to compete at a global level, and, if successful, are able to address a global market as against the insulated Indian market of just a decade ago.

As a result of all of these factors, Indian industry has performed extraordinarily in the last few years, and is now consolidating its gains in the domestic market while increasingly looking to expand abroad. In sector after sector, be it autos and auto ancilliaries, pharma, IT services, basic metals and minerals, banking or textiles, Indian companies are aggressively expanding domestically and globally, both organically and through acquisitions. With easy access to low-cost capital, both in India and abroad, growth has never been easier for Indian industry.

International investors, who are committing increasing amounts of money to the Indian equity markets, are also recognizing the long-term India story. Also, domestic investors, long wary of investing in risky securities, are also participating in the markets, which is expected to keep the markets on a firm footing going forward.

What investment advice are you giving your private banking clients?

While still advising equities, we encourage clients to look at their portfolios in totality, including exposure to other asset classes like debt, real estate, retirement accounts, etc. and to see their equity investments as one part of their overall wealth portfolio. At present, we are recommending a 30% to 40% exposure to equities for our conservative clients and 50% to 60% exposure to equities for our more aggressive clients.

We follow a long-term approach to investing, and follow a top-down approach to identify sectors that we expect to outperform the broad economy over the next few years. Within sectors, we take a bottom-up, fundamental approach to identify promising companies, which are available at reasonable valuations.

While advising clients to stay invested in leading blue-chip stocks in our recommended sectors, we are also recommending emerging companies that may become the market leaders of tomorrow. We also look at special situations such as debt restructurings, arbitrage opportunities, etc. that emerge from time to time and can deliver superior risk-adjusted returns.

What are specific sectors is Allegro bullish and bearish on? Can you explain your bullishness vis-à-vis what's currently happening in India?

Infrastructure, construction, cement and power - as plays on increased construction and infrastructure investments that are expected to take place over the next decade.

IT services, auto ancillaries - based on the good growth prospects due to increased outsourcing.

Textiles - With the end of the MFA, the Indian textile industry should benefit from increasing exports to the US and Western European markets as well as increasing consumer spending domestically.

Autos, telecom, FMCG - as a play on increasing income levels and strong domestic growth.

Banking - increased credit offtake and leveraged consumer spending should drive growth in the Indian banking industry.

Others - companies in metals and mining, hospitality, chemicals and transportation industries.

Sectors we're currently underweight on are pharmaceuticals, oil & gas and steel.

How do you perceive the performance of Indian stock markets vis-à-vis the rest of Asia?

The Indian markets are trading at higher multiples than most Asian markets, but the fundamentals underpinning the Indian economy are also among the strongest in the world. Sustainable GDP growth of 7% to 8% per annum for the foreseeable future, and expected profit growth of 15% to 20% over the next few years make India a very attractive investment destination.

Moreover, with Indian companies aggressively expanding abroad after consolidating their hold on the domestic market, the "Indian Multinational Company" should become the norm rather than the exception. Taking into account all these factors, I believe India will continue to be perceived by the institutional and strategic investors as an attractive investment destination.