Union Budget 2013 will be closely watched by the market as it would be the present UPA Government's last full Budget before general elections. This time there would be pressure on the government to raise taxes, which will impact earnings and companies, Sandeep Bhatia, executive director and head of sales, Kotak Institutional Equities says in an interview to CNBC-TV18.
At the same time, he adds that Budget alone cannot be a game changer for the market as global cues and liquidity inflows too will play key roles. According to Bhatia, market movement this year would be primarily driven by earnings. Companies delivering 15-20% earnings growth will outperform in 2013. Meanwhile, he sees the downside risk for the Indian market capped at around 7-8 percent from the current level.
Sector-wise, Bhatia is cautious on the infrastructure space. He thinks large infra companies will have to deleverage their balance sheets for a durable stock rally. "We need clear policy action. I don't see a huge rebound in this sector anytime soon," he elaborates.
Below is the edited transcript of Sandeep Bhatia's interview with CNBC-TV18
Q: How was day one of your conference? What kind of mood did you see from companies out there after what has been a fairly pedestrian earnings season?
A: The day one was huge success. We had fantastic speaker sessions. Across the board, the message coming through was that we have seen the worst parts of last year behind us and clearly now it is going to be driven primarily by earnings.
Message coming from the multiple company meetings that were going on in addition to the speaker sessions yesterday, today and day after is essentially one of a bit of a cautious optimism.
There are issues that economy faces on the macro front. Expectations from the Budget are that it will not be spend and forget kind of a Budget; it will be a reasonable and responsible Budget. To some extent therefore there would be pressure to raise taxes and that will impact earnings and companies.
Q: A lot of the focus in your conference will be about infrastructure, because this quarter’s numbers were quite poor from that sector. No great signs of the investment cycle picking up. Are your investors getting more cautious on that space or are they hopeful that things will start picking up?
A: As far as capex and infrastructure sectors are concerted, there is reason for continued caution there. I do not think balance sheet issues of the large corporates have been sorted out. Also policy action needs to be clearer. To that extent I do not think that sector is going to see a huge rebound anytime soon.
The best we can expect is maintaining the current low digit kind of earnings growth for the large well-capitalized companies and some kind of resolution for the companies which have balance sheet issues. I do not know whether we can expect the market to bail them out. Right now there is no appetite for these kinds of issuances.
Q: What do you make of the way the first couple of months have panned out? The expectation was that this calendar year would be very front-loaded in terms of returns for the market. That has not really gone through. How do you see things moving aside from this big Budget event that we are all talking about?
A: It was simplistic to assume just because September-October-November were good, similarly January-February will continue that kind of good run for the market. The market has wiped out its relative cheapness in the rally which happened in the last quarter of last year.
From hereon, it is going to be the hard slog of earnings growth and the hard slog of delivering cash flows to shareholders. That is definitely going to take much longer than a quick re-rating would take in the markets.
Let us wait and see how the Budget pans out. We also had lot of discussion about how things will be from hereon to the end of this government’s term and then thereafter what kind of coalition can come into power.
Although this is definitely going to weigh on investor’s mind, I think this year returns would primarily be driven by companies which continue to generate 15-20 percent plus earnings growth rather than being front-ended or back-ended.
Q: All those parameters on earnings or cash flow though have been pretty poor by the time we have wrapped up earnings season. What does this translate into in terms of downside risk for the market? Would you say it has grown deeper and how much lower could it be?
A: The downside risk is shallow as long as flows continue. We have seen issuances from the government and the response to that has been very good. Flows are coming into this market and downside is a function of whether we see flows coming off.
I do not see flows coming off right now, so the downside is limited. But the real issue is that the market has not been able to motor up and is now looking listless because we need much more than just re-rating to put it up to make it go forward. So, the downside at best is capped to around 7-8 percent for this market.
Q: In the last couple of quarters there has been a lot of commentary about how earnings have troughed out and the upgrade cycle will begin soon. At the end of this quarter are you more convinced that that is going to happen or is that still in the realm of hope?
A: That is still in the realm of hope. The upgrade cycle has to be driven by a sector or a bunch of companies. I do not think there is a clear winner in terms of that. It is not the infrastructure sector where we would see big upgrades coming through. Will it be with a banking sector? Yes, maybe.
We could see some kind of better numbers if the Non-Performing Loan (NPL) cycle which people expect to bottom out by this year improves and this can help earnings.
Other than the banking system I do not think consumers are going to drive upgrades. Just the banking or the IT sector can definitely see some upgrades, but as far as it is whole market I would be very careful of saying that.
Q: You had some political experts at the conference as well. Was the general sense that the diesel price hikes are here to stay, they will have every month or do people fear that come state elections starting next month you might see ad hoc kind of moves on the fuel pricing front?
A: To be honest I do not think anyone expressed any specific opinion on the fuel price hike and the impact of the state elections or the electoral calendar as such on government decision making. But the expectation is that the responsible fiscal policies that we have seen in last couple of months will continue.
If that is not the expectation then the market will see a steep fall. That is the base case assumption here for the markets right now. The way we are trading it is clearly a continuation of the same responsible policies unaffected by short-term political pressures. As far as the political outcomes are concerned, most people still expect that 2014 elections will throw-up another coalition.
The key takeaway coming through is that coalitions are here to stay. The important part is the composition of partners in the coalition and who are the people manning the key ministries, because that more than anything seems to be deciding the fate of good governance in this country.
Q: Given the kind of expectations that you are hearing about do you think the Budget will be a big game changer for the market or do you think global flows and global risk on is far more important than this local event?
A: No budget ever is a game changer other than the fact that it creates excitement for at best a couple of trading sessions. The task of writing India’s fiscal imbalances is a long task. It will probably take a good part of government’s whole five year term to get this back in shape. That is extremely important. That will be the key determinant of slightly medium-term market returns.
On top of that what is happening in the UK, US and the global position also needs to be seen. Right now the base case assumption here is Europe. It is not falling apart. It is going to stay together. The US will see political debates; discussions and a difficult bargaining that will take place between Democrats and the Republicans in the house. Base case assumptions are slow growth in the west and some kind of fiscal consolidation coming through in India.
Q: What are you picking up about flows and interest though at the gathering you have got there? Recent data seem to indicate that most people were full up on India. It was an overweight India position. Do you sense that they are looking to top up more or they are about done in the first couple of months of this year?
A: People will come and buy where valuations look compelling, management and earnings growth story look believable and they believe that government policy cannot completely derail the growth story of that company. There is appetite for Indian stocks.
There is a recognition that we had got to levels where there was value in the market, but now no longer so. It is now going to be a stock picker’s market, a hard long grind through the year and at the end of the year it will probably be stocks which will be winners rather than the whole market.
Q: In that context is it getting tougher to pick stocks? Till last year there was bipolarity in sectors in the sense that the defensives had very high premiums and high-beta did not. This year earnings have been so disparate within sectors themselves. Do you expect to see a lot of bipolarity within sectors and how individual stocks trade and where they trade at?
A: I would think that now the easy part of picking one sector and running with it and still making market beating returns just because you are aligned right way in the right sector during that phase is definitely behind us.
This is the tougher part of the market. The market has been listless because the earnings momentum is still missing. We will see very selective winners in this market.
Q: We have got in a lot of money over the last six months since the September reforms happened. Is there a risk of disappointment or disenchantment if growth or earnings do not start picking up visibly over the next couple of quarters? Could it start weighing on the patience of investors who have deployed this capital?
A: Very much so. As far as the market is concerned, it is not going to be one easy run.
Q: How global investors might react if growth does not pick up. What is the kind of profile of investors who have put in this money and how resilient they will be to this recovery taking longer?
A: Anyone who comes to India knows that this is a longer term story. I would be very surprised if people continue to focus on just short-term returns. The money which we have got has come because of cheap valuations.
From hereon, the proportion of active money which looks at specific stocks should increase. If it is just ETFs which come through for taking advantage of cheap valuations then most of that flow is definitely behind us.
Q: Have you worked out a strategy in terms of what you think is the best approach to take for the rest of this year? At the start it looked like high-beta would perform but now the market seems to be finding safety in defensives again. Have you taken that kind of stance in terms of what will hold out?
A: As far as defensives are concerned, the consumer sector is always one place where people seek to hide. Right now valuations are good, not at levels which one would be expecting big buying.
Defensives and the composition of defensives have to change. I would think auto is a good place to start. We will see interest rate cuts coming through this year that will help the auto sector.