Earnings growth to pick up by FY25 end: Varun Sharma of Motilal Oswal AMC

Earnings growth is expected to pick up through the end of FY25 and improve gradually thereafter led by several growth sectors, Varun Sharma, Fund Manager, Motilal Oswal AMC, says.

India's earning growth profile continues to be one of the best globally and intermittent weaknesses provide a tactical accumulation opportunity, he said. Edited excerpts:

Tell us about the kind of strategy that you are going to follow in your Digital India Fund. How comfortable are you with valuations in the digital space?
India is seeing rapid digital penetration across industries and as a result, we intend to run a true-to-label digital portfolio. We see digital technology companies growing at phenomenal rates across sectors viz. Fintech, Foodtech, Traveltech, Mediatech, SaaS, software and platforms.

These are businesses spread across various constructs like B2C, B2B2C, C2C, B2B and even B2G. When we compare the growth rates of Digital companies vis-à-vis their core sectors, we find these companies to be growing 3x-5x their industry level growths. This presents a long term compounding opportunity in the Digital space. Traditional valuation methods have not been helpful in valuing these companies and therefore it has been difficult to value Digital companies appropriately.

We find digital companies to be quite attractively valued based on our own proprietary valuation methods. The business scale up, business strengthening, operating break-evens and profits and multi-segment development are not yet factored into prices and valuations and that provides a good opportunity to construct a remunerative strategy in this domain.

Help us understand how the Digital India fund is different from an IT-focused fund. Also give us a sense of the size of opportunity in the digital theme.
Motilal Oswal Digital India fund is a true-to-label Digital fund which will primarily have exposure to Digital companies and a small exposure to IT services industry. Most of the IT-focused funds have high exposures to low-growth IT services industry while the Motilal Digital India fund will be focused on high growth Digital space. Long term returns are determined by business scale up and growth and Motilal Oswal Digital India fund is focused on high growth Digital opportunity.

Digital is penetrating across sectors and industries and the Digital proportion of GDP is estimated to grow up to 20% of GDP by 2030 as against just 8% today. This presents a significantly large opportunity across sectors in terms of market size, growth and penetration.

Given that Donald Trump is all set to return as US President after a gap of 4 years, what is the kind of impact you see on Indian IT exporters?
While we have seen an immediate increase in yields which typically has a negative effect on valuations, the medium term opportunity is for growth and profit estimates of the US companies to improve. Indian IT exporters’ growth is determined by the financial health and performance of global corporates especially the US enterprises. As a result, one can expect IT exports industry growth estimates to improve by a couple of percentage points towards high single digits. For IT industry growth to touch double digits, discretionary spends need to come back and there is a good possibility of discretionary spends improving if clients witness healthy top line and profitability growth. While the larger IT exporters have a high revenue-base challenge, niche mid-size companies can see healthy growth based on their specific strategies.

In the past we have seen a number of hot themes like defence and railway disappoint investors after a few years. How long is the runway of growth for the digital theme?
As investors, we continue to track and compare stock price movements with business compounding. There are a few sectors where stocks ran up ahead of business growth and therefore valuations improved and consequently the margin of safety went down in those industries. As a contrast, business compounding in Digital companies has been faster than the stock price growth. As a result, we notice that valuations have gone down despite the stock prices going up. Therefore, attractive valuations, good margin of safety and long term high growth opportunity makes Digital space quite attractive from an investment standpoint.

Digital is going to be one of the most powerful themes for, not just the next few years, but several decades. With the Digital intensity rising through multiple digital devices ownership, significantly high proportion of time spent on digital devices, new generation spending most of their wallets online and the government’s thrust on digital expansion, we are likely to see an acceleration in digital growth and penetration over the next few years. Several initiatives like UPI, Fast-tags, e-way bills, ONDC, DigiLocker, BharatNet, mobile broadband etc. are expanding the digital adoption in the country. It is important to appreciate the pace at which governance and services are also moving, turning digital across the board with services like Aadhar, Umang, DigiYatra etc.

FII outflows have been one of the biggest reasons for the market downfall in the last few weeks. Are foreigners more worried about valuations and earnings growth slowdown or is it just about the China trade?
The recent FII sell-off is due to a mix of several factors including China where the government is trying to reignite economic growth. Clearly, India has been the best performing market for several years and time and again profit booking occurs. Profit booking is heightened in those sporadic instances when earnings growth is weaker. While FIIs have sold Indian equities, they continue to subscribe to IPOs and QIP opportunities reflecting the confidence they continue to have on the India story. Longer term earnings growth opportunity remains intact in India across several industries and sectors and it is imperative to remain invested in those opportunities. Digital is one of those long term growth opportunities. On the valuations front, India deserves better valuations given the plethora of reforms we have seen over the past decade viz. IBC, UPI, GST, RERA, E-way and PLI etc. These reforms will ensure superior and sustained topline and earnings growth in India vis-à-vis other emerging markets across the globe.

How bad do you think is the Q2 earnings season as a large number of NSE 100 companies have delivered disappointing numbers?
Q2 earnings have been impacted significantly by weaker earnings in commodities and energy sectors. These sectors tend to be cyclical and volatile and can impact overall earnings growth. Core earnings growth has also weakened a bit largely because of the base effect. We expect earnings growth to pick up through the end of FY25 and improve gradually thereafter led by several growth sectors. India’s earning growth profile continues to be one of the best globally and intermittent weaknesses provide a tactical accumulation opportunity.

Is most of the earnings downgrades already factored in the price or more pain is there in the offing?
We can expect a couple of quarters of streamlining in earnings growth and it should pick up thereafter. We must appreciate that the government and regulators have been quite proactive in ensuring that economic growth is robust and any potential economic issues are dealt with immediately. The way RBI proactively addressed the unsecured lending concern, the way the government built up forex reserves and used rates to keep inflation in a manageable band may have impacted growth in the near term but we have ensured that the economy is strong. Thus, healthy earnings growth will resume shortly and will be quite sustainable.