Prabhat Awasthi of Nomura Financial Advisor says the slowdown in the economy is evident from the tepid corporate results, which is why the market has not moved ahead. He expects 9-10 percent returns from Q3 earnings.
Awasthi's house is underweight on cement, and auto (barring M&M) and overweight on FMCG space.
Below is the edited transcript of his interview to CNBC-TV18
Q: After the tired looking performance of the last few weeks, what’s the run up to the budget and beyond looking like to you?
A: We have put out our strategy report in the middle of January. Our view is that one probably will see 9-10 percent returns. Presumption is that global risks will remain contained and that is again looking like very much on the cards. A lot of the rally that happened last year was due to the fact that global risk got compressed.
We expect 9-10 percent performance. Our contingence has also been that earnings will follow the economy. Economy, all said and done, is still very slow. In this season earnings have not really come up to the expectations on a broad basis and that is what market is taking cognizance of.
So, one has a big move on risk and now one is basically looking forward to earnings. Earnings are probably growing at a very tepid pace, given the slowdown in economy.
Q: What's your sense of how this global situation will play out? Is there anything in the horizon that you hear about which can turn the tap off temporarily?
A: I don't think we are expecting a massive meltdown or a risk flare up. However, there has been a stretch in some of the currencies. There could be some pull back because one has seen only one way depreciation.
There might be a cooling off, but at this point in time the fact is that the global data has improved a little. US and Chinese data has been good. There has been no further hemorrhaging in European data.
As far as global economies are concerned, there have been no red flags in the last few months or weeks. As far as central banks are concerned, they have kept the taps on. So, I don’t think one really has anything major to worry about, as far as we can tell.
Q: Do you think the current spate of issuances might become a bit of a problem or difficult for the market to bear, despite the strong global liquidity by sort of crowding out the secondary market?
A: The issue simply is that global liquidity has taken the market up to a level. One cannot argue that one will have indefinite increase in multiples just because the global liquidity is coming in.
So, the supply catches up as the market reaches certain level. If one really looks at what the government will have between the government, the private sector and the de-leveraging that is needed in certain industries. There can be a fair amount of supply that can come through this liquidity that is coming through.
There will be a lot of paper from fiscal and the de-leveraging perspective from a lot of stressed Indian corporates. So, if one has USD 25 billion coming in, then maybe USD 10-15 billion will get soaked in by the issuances. So, that always happens post a market move. There has been hardly any equity capital raised in last two years because of the situations in the capital market.
Q: How strong is the case for further PE Multiple expansion this year? From where we have reached, can you justify more multiple expansions for India during the course of this year?
A: I personally don’t think so. We have analysed this, our view is that a lot of the multiple expansions in India happened because of the global risk remaining. It is important from Indian perspective because we don’t accuse current account deficit. So, global risk tends to have a real impact on an economy through currency or through lack of liquidity.
That risk has been taken off to a large extent off the table and the markets have reacted to that. From here, it has to be, either the Indian growth picks up or the interest rates come down meaningfully. On both these fronts we are a bit circumspect because inflation is still high. There is a fair bit of current account issues still there.
Oil prices have gone to USD 117 per barrel. That will also impact current account deficit. So, these are thorny issues which cannot be resolved overnight. On the other hand, the growth itself is going to be impacted by slowdown in investment cycle. Reforms are great things from investment perspective, but it is not a switch one can put on.
Four-five years of poor series has stopped the investment cycle. Hardly, major new projects have been planned in last two-three years. So, one is basically running off the shelf of four projects which were planned in 2007 to 2009 period and maybe 2010. Slowdown is happening on that count.
Secondly, if fiscal process is contracting, we are essentially burdening the consumers more through diesel price hikes. That is in the course of railway fare hikes and electricity tariff hikes. It’s a good thing in the long term, but in the short term they are going to depress growth.
At the end of the day if the government is going to spend less on the economy, the growth is going to be negatively impacted. From growth perspective, it will be very difficult to justify a significant expansion on earnings. The expansion in earnings can happen only from the perspective that market starts to believe that this growth will pick up in two-three years time.
However, the evidence of growth will be very patchy. Data points in the economy are poor. Cement and steel demand have poor data, commercial vehicle sales have actually gotten worse in the last three months. That is to be expected as fiscal process contracts.
There will not be too much of a scope for expansion multiples. It will probably be earnings and earnings in a slow economy will grow at their pace. They are not going to accelerate without any reason. Therefore, we will probably have scope for it a 8-10 percent growth in earnings. This is what we should get in terms of market returns on nominal basis.
Q: What have you made of the terrible underperformance of the broader market relative to the Nifty over the last few weeks? Is it justified by earnings and do you expect it to continue?
A: It is followed by outperformance earlier. In some sense, the fact is that the market ran on global liquidity, reform, hope, etc. However, reforms as are not going to turn the clock back and put India on a high growth path immediately. They will probably cause some contraction in growth by the very nature of fiscal consolidation.
The fact is that therefore there will be pressure on earnings and probably it will be higher at the level of midcaps than largecaps. These obviously have much more robust business models and are able to slow economic growth much better.
It is a combination of the two, the fact that there was a lot of rally earlier in the midcaps. They have outperformed largecaps when the global risk turned. It is just paying back plus the earnings between the two and one has the answer.
Q: This global money which has taken us higher, from your interactions with clients, what are they more focused on and if that does not show enough evidence through 2013 will they be disappointed and start selling?
A: There is a mix of both. The fact of the matter is that there is some expectation that economy will pick up from the bottom of growth that we have seen last year. That could be a disappointment. On the other hand, there are people who are say we understand that there is a fiscal consolidation with a move in the right direction.
Globally all said and done, there is very little to be had by way of growth. Therefore if India is doing the right thing then we have visibility towards much longer and durable growth in India compared to global economy.
So, I think they are both sorts. If the reform process continues, the market will hold up in terms of multiples. If it doesn’t then there is a risk because growth in the short term is not going to be anything to write home about.
So, one needs a support of reforms. However, very long term investors would probably look at more structural repair of the balance sheet than the earnings growth. They probably understand as to what the meaning of reforms is and how they will pan out in terms of how the earnings look in the short and the long term.
Q: Do you have any major expectations from the Budget in that sense on whether he can lay out maybe another roadmap aside of the ones that he has done already to take the momentum forward over the next three-six months?
A: Talking about expectations, there can be a lot. There is a tightrope walk between the fact that one needs to cut fiscal deficit and at the same time accelerate growth. Given that one needs to cut fiscal deficit, the government’s direct support to investments cannot be very high.
Therefore one would expect measures for private sector to put more capital at risk from their balance sheet. They have this amount of capital. Secondly, fiscal consolidation is important and the fact that we have run a massive current account deficit. Things that address this in the long term and some of this can be addressed through Budget.
There is a lot of policy action which is needed which can be only supplemented through the Budget. However, it is basically an overall thrust of all other ministries in terms of getting the investment cycle going and supply side responding. Third, is an expectation or sort of a wish is that even election pending so if there is nothing which happens which derails the fiscal card.
That will be a great thing from market perspective because elections are hugely not won through cutting expenditure. There is last 30 years of history on record. I was looking at the election spending growth and there is only one year (2004) when the pre-election spending was below 10 percent.
So, the austerity doesn’t usually win elections or votes. However, there is an imperative to cut down fiscal deficit from country specific perspective. This tightrope walk from market’s perspective would be really important. So, long as the fiscal in a year of election doesn’t show signs of profligacy, that itself will be a big achievement.
Q: This morning cement stocks are correcting because of results which were not very good, what’s your stand on cement for the year ahead?
A: In January, we took the cement down to underweight from overweight. That was primarily because of this very reason that if the government is going to spend less and if the investment cycle is weak, the growth in demand will be weak.
So, we have not been in the camp which is sort of looking for exhilaration in growth. We have been in the camp that thinks that the short-term pain needs to be taken for long-term positive. So, we have taken cement down, that will work well for us.
Q: Are you underweight on the investment cycle plays, the capital goods, infrastructure companies?
A: Absolutely, we underweight both those sectors, infrastructure and capital goods.
Q: Valuations are too premium and consumption is slowing and therefore those names will underperform, where do you stand in that argument?
A: I agree, there will be a slowdown in consumption. One is going to pass through lot of pain to consumer through diesel prices and all sorts of rate hikes. These are going to pinch consumer pockets.
Our view essentially is that while there will be a slowdown then discretionary are more at risk than non-discretionary. There is a consuming class in rural area, which is still very buoyant. So, we have tended to keep still an overweight on FMCG. We are underweight discretionary consumption which basically means we are not underweight autos.
Within non-discretionary, also I think the stocks like ITC is far more immune to a downturn in consumption. That is where voices tend to die down slower. Sort of don’t show much resilience or they don’t have downturns when the economy or growth is trending down.
So, those kinds of stocks are more overweight from our perspective. However, looking at the overall economy, the bright spot compared to the rest of the economy is still the consumption especially non-discretionary. We have an overweight there.
Q: You are underweight on autos then why do you have Mahindra and Mahindra (M&M) in your preferred list?
A: I think there are stock specific issues. Mahindra and Mahindra is primarily because it is not expensive stock. If one takes out everything, again all the subsidy valuations and the fact that it faces probably the least amount of competition in the segments it operates. So, one has valuation comfort.
Secondly, rural India is still our preferred place to be because there is still positivity around that economy.
Overall we are underweight but the stocks which we have got in have very specific reasons why they are there.
Q: From the consumption related basket, you seem to like media because I see Zee in your top list for 2013?
A: We have only covered two media companies and both are there right now. That is because it is a bottom-up story. Finally we are seeing what we have been. I was a media analyst for a long time and have been writing about digitalization since 1997 and finally it is happening. I think it is a positive long-term thing. So that cannot be ignored.
One is seeing transformation in the sector which will be a very long-term driver for these stocks. It changes the nature of the industry and multiple that you have got in terms of the variability of earnings. That is basically subscription is growing, that is a fantastic thing from multiple perspective.
So, I think all that essentially means that media will be a multi-year story. That is what we are reflecting rather than in the state of economy. It is a transformational change, which is going on in the industry.