After reporting a terrible Q4 earnings, Jyotivardhan Jaipuria, head of research, BofA Merrill Lynch expects IT giant Infosys to see a slew of downgrades. "We were neutral IT, we were not overweight IT because I was worried about the price action," he said in an interview to CNBC-TV18.
Infosys' fourth quarter revenue came in much lower than expectations, net profit was slightly higher-than-expected at 3 percent year-on-year due to higher other income and lower income tax expenses.
Continuing his bearish tone Jaipuria said, earnings pain for the broader market is likely to continue going ahead. The broking firm remains underweight on FMCG pack. The FMCG stocks are poised for a downside if earnings disappoint.
Earnings growth will see a boost only if implementation of reforms is seen by the government, he added.
Below is the verbatim transcript of his interview to CNBC-TV18
Q: How are you calling IT given what you just saw from Infosys?
A: We were neutral IT, we were not overweight on it, like a lot of our peers. That was simply because I was worried about the price action. Since, the last results, the IT stocks had done very well.
My worry was, given that IT had done well and a lot of people have positioned themselves in IT, this was something that would disappoint the results. So, obviously, in some sense we were right, but in hindsight one can say we should have been underweight IT.
Q: What will this lead to, more polarization of ownership in the sector, gravitating to a couple of the outperforming names or do you think people might per se become a bit less bullish about the sector at large?
A: For the sector it was – we have seen very strong performance in most of the names. So, basically in Q1, if IT performs very strongly, pharmaceutical sector performed very well and a lot of the others did very badly.
So, to that extent, now that performance will probably give way. Performance will get a bit more neutralised and of course within the sector, people will go to the names, which are doing better. This is a phenomenon seen over the last three years where people have shifted to stocks, which have done better and have outperformed the industry rather than stocks which have done badly.
Q: Does it look like you will see significant downgrades in earnings expectations even after this quarter?
A: I think there will be. If one thinks of FY14 consensus bottom up numbers, those are like 17 percent growth, which looks totally out of whack with what is happening in India basically. There is a clear slowdown in India, margins are under pressure. If one sees core inflation that is close to 4 percent only.
So, to that extent, I think the numbers are just too optimistic, they will get downgraded significantly. I was looking at it coming below into single digit somewhere. I was thinking more like 8 percent. Hopefully, we will get 8 percent soon. People might start questioning whether 8 percent is also an optimistic number.
Q: You are saying 8 percent for all of FY14?
A: Yes, that is right.
Q: What would that mean for the market?
A: Though the analysts have a much higher numbers, a lot of the market somewhere has factored that these numbers are going to get downgraded. If one sees the trend for the last two and a half years, that is what has got played out. Analysts always start with a very high number for any fiscal year. Even if we take FY13, you go back 15 months, people were looking at a growth of some 18-19 percent.
We will probably end the year something at C4 maybe 5 percent. So, market has somewhere factored in that we are not going to get those analysts numbers. We will get downgrades, what I guess people not factoring is the extent of downgrades maybe. However, I would say most people mentally are thinking it is going to be more like 10-12 rather than 17 which is there.
So, my view is it is probably going to be 8 or something. The real thing for the market is can we get something changing. Can we either get rate cuts, which are strong and people think okay. This is like the bottom and we probably have a better phase going ahead or we get some government policy action which starts at least kick-starting projects in someway ahead of election.
So, what people want is the change -- things are very bad, things are going down but are we getting some policy action which gives us some hope that things will change soon.
Q: Is there a fear that if the delta of earnings is just marginal 2 percent over the last year, valuations might contract in 2013?
A: Yes, the valuations will contract if the view is that the next year is also going to be a bad year. This is a very odd year because it is the election year. So, for a lot of people it will soon become what is the nature and shape of the next government which will determine valuations.
However, like we get some action like we get some steep Reserve Bank of India (RBI) cut then people will say okay. We are getting somewhere close to the bottom of the earning cycle and we will pick up. If one just step back and think of the numbers, margins in FY13 are probably going to be the lowest we have had in the last eighteen years. Last time, we had margins were lower than this was probably in some 1994 or something.
So, there was a view that okay, with margins having fallen so much at some point had to revert back to mean so should we buy these. Are we buying at the bottom of the earnings cycle in, which case we maybe having three years of very strong earnings growth ahead of us probably that starts in FY14. However, somewhere in FY15 we could get that. That is the reason people nibble at the bottom hoping that they have caught low on the earning side.
Q: The other space that the market is a little cautious about now is FMCG. Do you think the trip-ups are going to show up this quarter itself? How are you guys positioning yourselves on FMCG now?
A: Unlike consensus we are underweight FMCG, we of course are big overweight on pharma. So, in some sense we are neutralizing it with the pharma overweight. The reasons are the same. Basically is it one of the most over owned segments, the stocks has done very well over the last two-three years.
There should be some pressure because inflation is high, consumer demand should start to weaken. The margin is very limited in lot of these stocks. So you could see a downside coming in the stocks if there is some mis-happening in earnings.
Q: So what will hold the market up? You are talking about some of these outperforming sectors so far, FMCG, IT. If these also start disappointing then what can hold the index up in a context where many clusters of stocks have gone back to almost 2008 lows?
A: There is one segment of the market, which is high valuations and has done very well. Those are the over owned segments. The other part is the one, which has done very badly where things are not going well at the moment, but nobody owns them.
So, last year we saw that rotation into some of these segments and the rotation has stopped simply because that whole view that we will have interest rate cuts, which would be quite sharp. This will help this segment of the market, which has now come into question. After RBI policy they seem to be indicating there is not too much of rate cuts left.
If we see some of the macro numbers inflation is coming down probably faster than what lot of the economists expected. Luckily, oil prices are also coming down. So, as we move into the year if the strength continuing then we could see RBI cuts being faster than what they seem to be indicating at the moment.
That is the real hope for the market that at some point RBI is able to cut rates faster than what everybody thinks. Then people start playing the other segment that okay we are having rate cuts. We have a slowdown at the moment and may be along with that if the government steps up the reform agenda then there is a hope that the other segment will start doing well.
Q: You guys track flows and tactical positioning in markets in some detail, what has your observation been about the liquidity picture for the market? Do you get the sense that people are pulling out a bit more cash and that adjustment as well will happen through the course of the next few weeks?
A: More than anything if we look at the global picture actually equities have had flows for 20 weeks in a row, which is the first time in 17 years that we have seen such strong flows to equity.
However, in the same period emerging markets have seen outflows. So, it has all been a phenomenon where flows have gone into developed markets. Basically gone into Japan and US and rest of the world has seen equity flows being negative. Probably that phenomenon plays out a bit.
On an overall picture the good thing is central banks are still pumping in liquidity, so there is that whole yen carry trade, which hopefully plays out for emerging markets. At some point as those markets really do well probably they will start looking more at some of the markets, which have not performed.
Otherwise, yes we have seen FIIs being very cautious over the last 15-20 days. Especially after the RBI policy that was one leg, which people were hoping will support the market which has not worked out. So, we have seen that but the hope is global liquidity is still quite easy.
Q: What about this whole trough question because that is the term that ticks one off, you heard it in the last couple of quarters, if your call is that there is probably 8 percent growth going for FY14, when do you think we can start seeing a meaningful turn in terms of earnings performance?
A: We have to hope that FY15 is better, but I think essential for that is, we get elections early. At least then -- there is a lot of wait and watch with corporate. Now because I do not think anybody wants to start any meaningful project before the new government is in place because you do not want to invest billion dollars and then find that the government is not very pro investment at that stage.
So, I think, once we have elections out of the way and hopefully we get a decent government, which gets into a pre-reform mode very early on then maybe we can get an earning cycle, which looks better.
If we go into history, there is a bit of positivity because the worst spell of earnings we have had in the last twenty years was 1997 to 2001, where earnings grew at a compounded pace of 5 percent. However, 7 years after that, earnings grew at a compounded pace of 22 percent. So, that is the sort of sharp earning spell you can have after the bottom of the cycle earnings.
Last five years we have grown earnings at 8 percent now. This is more or less similar to that earlier 1997-2001 spell that we have had. FY14 will make it 6 years, where the average earnings growth is 8 percent.
So, somewhere the hope for the market is that after five-six years of sub-par earnings growth at some point you get into this more than 15 percent earnings growth year-after-year for the next three-four years. That is what helps the market. 50 percent jump in earnings per share (EPS) in three years. Then one has a market, which looks much better. However, for that, we have to do some steps, the government has to take some steps and things have to start falling in place.
Q: What is your best case on how to approach the broader end of the market now because we are talking about the largecaps out here? Do you see two-three quarters of pain for the midcap universe, the universe that you track?
A: There will be earnings pain for them. Stock price is going to be quite volatile and we are not into some major bull run. At the same time, the way we approach is we have been a bit dispending, in the sense we are not entirely defensive. So, there are a lot of investors who have been into. I am buying consumers, pharmaceuticals and IT.
We have been a bit different because I think I have been looking at valuations and some of these rate sensitives are looking cheap. There is a possibility that we have rate cuts along the way it will start looking cheap. At some point, margins will start to inch up maybe two years later.
Two years later what is the sort of earnings growth we could get and will stocks re-rate. So we have a mix, we are overweight some of the rate sensitives, we are overweight select auto stocks, select banks and at the same time, we are overweight pharmaceuticals, which likely is a very standard thing. For me pharmaceutical stocks also hedge against the rupee because the rupee could see some weakness. If we keep continue to get the current account, which is as bad as has been recently.