Growth of information technology companies is structurally heading to lower path, said Sukumar Rajah, senior managing director and director of portfolio management at Franklin Templeton Emerging Markets Equity-Singapore.

In an exclusive interview to CNBC-TV18, Rajah said other markets are more dependent on foreign flows compared to Indian market, which has a substantial support from the domestic flows.

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Structural factors for India still strong, long-term earnings growth seen at 12-15%, says Franklin Templeton

According to Rajah, "If I take three-five years view, the money that is coming into the equity market from domestic investors is probably going to increase rather than decrease."

Edited excerpts:

From your experience tell us what is this market telling us and if we see the internals of the market, there has been a very narrow move, six or seven the Nifty stocks have lead the market higher and in the broader market there is quite a bit of pain?

We are not in the business of predicting where the market is going to go, but from our point of view, we see a lot of opportunities. There has been a lot of momentum in some sectors and there has been lack of momentum in some sectors. As a value investor looking at long-term quality and sustainability characteristics, the universe of stocks, which are looking attractive, has increased from our point of view and that makes it very interesting market for our global and emerging market products to invest in.

The emerging markets themselves have not kept pace with the developed markets. Developed markets have their own problems; year-to-date it's not as if it’s been a runaway rally. Would you say that the Indian market generally is showing resistance at higher levels, is more susceptible to fall than rise?

I would think otherwise, because India is in a different part of the economic cycle, so we are still probably growing below trend, whereas most of the economies are growing above trend and have passed the peak. So, there is going to be economic slowdown and also potentially earnings are not going to be growing substantially in many of the other markets, whereas in India, the structural factors continue to be very strong. On top of all the problems that we had in the last few years, I think the margins have still been depressed, while some sectors have shown very good earnings growth. There are lot of other sectors, where profitability is substantially depressed and can recover meaningfully and even in the sector that has done well, there is continued scope for further earnings growth. So relative to other markets, India is still very well placed and also from demand for equities point of view, many markets might be more dependent on foreign flows, whereas the Indian market has a substantial support from the domestic flows and that’s another important differentiating factor. So overall, I would think that India would be more robust than an average emerging market in the next few years.

What kind of realistic earnings growth can we expect over the next two years for the listed companies? We were speaking with Mahesh Nandurkar of CLSA a while back and he indicated that give and take, all the positives it’s almost a 20 percent growth that they are forecasting in FY20 for Sensex earnings. Would you be in that camp?

My view is that two years’ earnings are less predictable. They are subject to a lot of micro factors, whether they play out or not, I think it’s difficult to say. However, I can say that the long term earnings growth should be anywhere between 12-15 percent and we have been growing below trend in the last few years and as margins recover in some of the sectors, there is a good probability that we can grow above trend, but whether it's 20 percent or 18-15 percent is difficult to pinpoint. But double digit growth should still support the broad market and might not give spectacular returns, I think by stock selection, we can still construct a portfolio that has very good risk return characteristics and that is our focus.

The basic point I want to understand is that because in 2017, we had so much inflow into mutual funds and a lot of retail would have perhaps entered at the top. In that sense, is there a bit of a risk to liquidity itself, the domestic liquidity because foreigners have been selling and a lot of domestic investors might now be seeing big losses in their portfolios?

There is always a possibility that a section of the investors have come back because of the momentum. But the evidence points that people are structurally allocating higher proportion of their savings to equities and equity allocation of the household savings is still in single digits and there is a scope to expand and money coming through systematic investment plan has been increasing. So, these trend points towards stability in terms of flows, while there is some possibility that some section of the investors might withdraw from the market. I wouldn’t think that the net flows coming into the market over the next few years would decrease. In fact, I would think that if I take three-five year view, the money that is coming into the equity market from domestic investors is probably going to increase rather than decrease.

How have you read the information technology sector – Accenture and Tata Consultancy Services (TCS) gave us the impression that there is a paradigm shift and they are back to their winning ways but Infosys was more subdued. Is there a sector rush? Would you buy this sector or be very choosy?

We have to understand how to value the companies based on their growth potential, margin and the free cash flow characteristics. Earlier, Indian information technology (IT) companies were growing much faster, because of their ability to gain market share in the software services space and the space was growing faster than the IT spending. So, there were two levers which helped Indian companies to grow fast. Now, I think the levers have weakened and so the growth is structurally heading lower and top of it, margins pressures as well, the earnings growth has been pretty subdued. But nevertheless, they have been generating strong cash flows and many of the companies now realise that they have to distribute more of their cash to the investors. So, we have to make realistic assumptions and then value the companies. So, some of the companies are still go in to our filters as stocks with good upside potential. We cannot speak about the target price for these companies but that is the broad thinking we have on IT services companies.

You did mention a 12-15 percent earnings growth over longer term, which are the sectors you think could lead to that growth? Are you looking purely at the consumption space or do you like banks, especially corporate facing banks?

Earnings growth will be in double-digits in a broad range of sectors. From our point of view, when we select stocks, we are looking at quality and sustainability characteristic, we are not looking at next two years earnings growth, because when we are buying a company, we are probably paying for earnings over many decades and that is imputed into the stock price. So, while they might deliver two-year earnings growth, if they do not deliver beyond that, we are going to lose a very substantial portion of the price that we pay for that particular stock. So, we are looking at those characteristics and that list is expanding but it's still less than 20 percent of the listed companies. We are playing within that space. Some sectors do better, typically, the more cyclical sectors, the more commoditised sectors and many of the companies in those sectors do not rank high on quality and sustainability characteristics, because of which our universe in those sectors would lower. Whereas, the once where the ease of doing business is high, companies can build brands and differentiate themselves. There is ability for company to build those characteristics and we find more opportunities in those sectors.