Foreign money is moving out of China and into India, says Saurabh Mukherjea of Ambit Capital. In an interview with CNBC-TV18, he says that progress on the Goods and Services Tax will be the next key trigger for the market. Mukherjea is hopeful that the Reserve Bank of India will again cut repo rate by 25 basis points at its next policy review.
Ambit has a target of 23,000 for the Sensex by December, and is betting on easing commodity prices to strengthen India’s macro-economic fundamentals. He is cautious on the banking sector and bullish on oil & gas and auto sector.
Mid and small cap shares have taken a hammering over the last six months, but Mukherjea feels investors will start looking at this space again because of attractive valuations.
Q: We have had a pretty good run that got a bit punctured a bit on Friday – How are you guys feeling about the market and whether there is more traction from here?
A: Our reading is that we are seeing some reallocation of flows away from China, away from the other commodity dependent emerging markets and towards India. There are always few broad macro criteria for reallocating money to India. The rate cutting cycle continues. Gross domestic product (GDP) growth should turn around starting Q4 and there is clear foreign direct investment (FDI) and foreign institutional investors (FII) interest. The mood certainly is in India’s favour at the time.
Q: What could the range of this market be on the upside more importantly because the run from 5,500 to 5,900 has been very smooth and very fast paced?
A: I believe another 10 percent up over the next three months cannot be ruled out. If there is a breakthrough in the May 10-11meeting between state finance ministers and goods and services tax (GST), then that will be a big step forward in terms of getting the GST atleast approved in the monsoon session of parliament.
We have Q4 GDP data coming out towards the end of this month, another set of rates in the middle of June- I expect another 25 basis points rate cut and then Q4 current account data towards the end of June. If commodity prices continue sliding, we could see India getting put back on a stable rather than a negative by the credit rating agencies.
Q: In order of importance what would you rate as the biggest reason for the market to rally from hereon? Is it the fund flow activity that you are alluding to or have you seen some kind of change either in terms of earnings performance or earnings improvement that you think will be the primary riding factor?
A: The main reason for the rally has been commodity prices cooling off. It has three positive benefits in our country. It cools down the pressure on the currency, it gives the Reserve Bank of India (RBI) more room to cut rates and it cools down the budget deficit because of the way our subsidy system works. So, commodities are coming off either because of the China story taking a back seat or because of the global commodity super cycle turning south. Commodities coming off is a big plus for India and let us hope that continues going forward.
Q: It is a bit of a ironic relationship with Reserve Bank – every time there is caution in the note, but there is a rate cut too and that is generally what the market has come to accept. Would you be cautious about the financials given the takeaways from the Reserve Bank’s note on Friday or you think that is the best place to bet on?
A: I think financials is banks in particular, is a sector we have been very bearish on upon the last year. My reason for being circumspect about Indian banks is not just the rate cycle. I think that is part of the challenge but the biggest challenge is fee income and the pressure that will come on the banks is fee income from various RBI investigations and inquiries currently going on.
Q: If you do believe that there is more upside in this market which is the sector that will assume the mantel of leadership now?
A: I think amongst the frontliners- oil and gas as a play on reform, as a play both on global oil and gas cooling off but particularly as a play on reform both administered price mechanism (APM) going up and fuel price deregulation. Oil and gas would be something that we have been looking at very keenly.
Auto is a straight forward, natural play on the recovery. Maruti Suzuki, Bajaj Auto are at the forefront of that. Even Eicher Motors and Ashok Leyland are worth looking at given the CV cycle has to recover and then industrials with capital goods and Larsen and Turbo are at the forefront.
Q: I read in your report that you have explored the possibility of a full fledged bull run in the Indian equity markets. Do you do a level beyond 6,100-6,200 mark for the Indian markets because of the triggers that you alluded to?
A: We do. What we have realised is that if one looks at India, through everything we have seen in the last ten years whether it is 9/11, whether it is events of September 2008, the political scandals over the last couple of years, the trend really stays unbroken. The Indian market has trended up through all of this. If we are going ahead into an economic recovery, the trend will more than hold firm and hence from current level, valuation triggers and the hammering of smallcaps vis-à-vis the largecaps; both these triggers suggest that we could be overdue, a fairly meaningful recovery. So, 23,000 has been our Sensex year-end target. I have been saying for the last six months and we stand by that. By the calendar year-end 23,000 on the Sensex to us looks certainly doable.
Q: Just in the near-term, is the meet of the rally behind us or do you think there is more to it?
A: I think there is more to it. It does have to admit that the main trigger in the short-term will be commodity prices because of our current account deficit and how that links to the level of the rupee. However, if commodity prices are kind to India, then this rally will continue because the broader GDP data and the interest rate cuts will be supportive of the turn in the market.
Q: Just on the point that you were making about liquidity what exactly has your experience been – is it still some of the hot money as we like to terminate that is moving around little bit or are people getting more positive about the macros that you were taking about and hence there is a bit more long only money coming into the market?
A: One clear trend we have seen over the last six-seven days is that once again foreign institutional investors (FII) and domestic institutional investors (DII) are asking us about smallcaps and midcaps. They are asking about flows in smallcaps and midcaps and that is something which had almost evaporated for the last couple of months. Pessimism has crept in to such an extent that the investor interest was solely focused on fixed deposit (FD). That broadening of investor interest into smallcaps and midcaps is a fairly powerful positive sign. It suggests that confidence and desire to invest in India is coming back.
The second interesting thing is, the mutual fund inflows, equity mutual fund inflows have turned positive for the first time in two to three years. That, in turn is giving the DII some money to actually invest in the market. From that perspective, whether it is in FIIs or DIIs asking us for smallcaps and midcap blocks, equity MF flows turning into the black after long time and the domestic fund managers coming back into smallcap and midcaps, all of that suggests that there is a broadening of interest in the market which is very powerful indicator of investor confidence.
Q: What is the central risk to your premise that the market maybe setting itself up for yearly processes of building a bull phase for itself?
A: By and large, the market’s best case expectation is of election somewhere around November or March-April. If the events were to move quicker and if the monsoon session doesn’t happen for whatever reason, the market will take a knock backwards. At this point in time, that isn’t our central thinking. Our central thinking is we will have the monsoon session and thereafter politicians will be coming into electoral mode. But if that were to change, there is downside risk in the market.
Q: What is your primary takeaway been of earning season this time around and are there any stocks that can be incrementally bought on the back of good set of numbers that they have reported this quarter?
A: The clearest trend I can see is that, the consumption sector, the B2C sector seems to be coming back into life. So, if one looks at Dabur’s very strong volume growth, Hindustan Unilever Ltd decent volume growth, the demand for studded jewellery picking up as reported by Titan or the Maruti management saying three weeks ago that the worst of the downturn is behind us. There is a variety of signals that across the spectrum, the consumer is coming back and that does not surprise us. The Government spending, we reckon rose by something like 12-13 percent year-on-year in Q4. The consumer is going back into the shops. That, I think is the clearest trend. The obvious way to play that would be auto, not so much fast moving consumer goods (FMCG) as the valuations in FMCG are still too rich. But auto would be the obvious way to play that. Maruti Suzuki would be the frontline bet on that trend. The Indian consumer is gaining some sort of confidence and coming back to the shops.
Q: Looking at some of your midcaps recommendations on the points that you are making earlier- you got TVS Motor within that list. It is a stock that suffered both performance and sales is probably the lowest in ladder in some extremely competitive environment right now what makes you bullish on that story?
A: Part of it is fundamentals and part of it is valuations. On the fundamental side, over the last eight to nine years, they have had torrid time particularly at the higher end of the bike market which I think is partly because of the quality issue and partly because of the lack on focus on the bike business. They have not just lost market share but become invisible at the higher end of the bike market.
I think that is where the BMW deal is so significant. It has couple of parts to it. One, BMW will lend its technology to TVS and that will have a meaningful bearing on the quality of bikes at the higher end of the market, but it also has a contract manufacturing aspect to it where TVS will manufacture for BMW. Over and above that, my hunch is BMW will also make an equity investment into this whole joint venture construct. We don’t know the sum of it but there will be a fairly substantial number.
If one takes all of that and if one looks at this company which is trading at 6 times earnings, the market is in effect assuming that it will be wiped out and I don’t see it like that. The financials are solid but BMW deal is a turning point and two to three years from now, this could well be the Volvo-Eicher of the two wheeler market.
Q: You also picked a fairly low key banking stock – Federal Bank. What makes you bullish about that one amongst the others?
A: We have to admit that again somewhat like TVS – execution especially on the credit quality front hasn’t been great. It has been alright but not great. The challenge here is that cost income ratio is high but that in that lies the beauty of Federal Bank. It is over-capitalised and it has more equity than it requires from regulatory perspective and it has opened up lot of new branches.
The branch network has grown by one third in the last year or so. As we go into an economic recovery and the banks fills into equity base and fills into its branch network, we see ROEs rising by 300-400 basis points which should trigger off a meaningful rerating from around one time book to something like 1.4-1.5 times book. Remember, once the RBI grants whatever 5-6-7 licensees in roughly a year’s time there will be a rush for high quality banks and from that perspective, from a longer-term perspective this could well be a consolidation play as well.
Q: How would you approach a name like Bharti now? That stock has had a great run in the last one month. Earnings were nothing spectacular, but then we did see that equity investment come in from Qatar Foundation. What would the approach be?
A: You have touched upon a broader theme here. In the last five months, we have repeatedly seen strategic investors- be it Etihad, Unilever, GSK or the Qatars- we have seen strategic investors repeatedly come into the India market and bid very significant premiums to current market price (CMP) for market leading assets. Bharti falls into that camp. The signal from the Qataris is that this stock is very meaningfully undervalued and as competitive intensity abates, Bharti is the best placed company to benefit from it. The only caveat I would say is if Idea does come off 10-15 percent, then it is worth looking at. It becomes a very tasty stock. For now Bharti remains our strongest bet in telecom.
Q: Just to hang onto that theme for a bit, would you also be hopeful about other Multinational Corporations (MNC) upping their stake in their Indian subsidiaries, the likes of Procter & Gamble (P&G), Nestle etc. after what you saw with Unilever?
A: Without going into specifics of certain situations, what is evident to us is when we meet MNC management’s global teams, either in the regional headquarters in Asia or in global headquarters in London or New York. It is very clear that a range of MNCs see India very, very positively. Even more than the fund management community, the MNC strategists view India as a very promising market. What they are seeing is the stock market showing signs of a turn. They perceive it to be undervalued and there will more deals that will happen. I am pretty confident that in the next two or three months, you will see more strategic deals happening at significant premiums to market prices.
Q: Ashoka Buildcon is not well-known and not well-researched, but you guys like that stock?
A: Where we take a fair bit of comfort from is this is one of the rear construction companies where there is no balance sheet stress. SBI-Macquarie did a private equity deal seven or eight months ago which really has taken out balance sheet stress. Execution has been good over the last couple of years. It is a decent management team with private equity backing in there. Infrastructure Development Finance Company (IDFC) were the initial investors in the company and they still have a large holding. So, with quality investors, a good management team, a strong balance sheet one times price-to-book it looks to me to be a juicy construction company especially if you are a retail investor and do not have to worry about price impact. I would say buy companies like this at this stage of the economic recovery. One will benefit quite nicely over the next couple of years.
Q: The point you made about midcaps is interesting, because up until now neither has interest been very high nor have numbers bond through as also the technical problem of exiting some of these midcaps it is extremely difficult for institutional investors to do that. Are you getting a favourable response when you put forth these midcap ideas to some of your clients?
A: The last couple of weeks have been encouraging from that perspective. Till two weeks ago, nobody wanted to discuss smaller midcaps. We then started writing about the fact that the discount for small caps to large caps is at a 10-year high and such discounts typically spell a turn in the market. That combined with a degree of liquidity recovery and a confidence recovery has led to FII interest for small and midcaps coming back. Will it sustain, is the best question and the answer to that will lie with commodity prices with the Q4 GDP data and then with the RBI in the mid-June rate cycle. My sense is these sorts of heavy discounts for small and midcaps to large caps simply cannot be sustained on an ongoing basis.
Q: You have picked Motilal Oswal. It had a good set of numbers this time. The company is doing a buyback as well. What would your recommendation be there?
A: We have been buyers of Motilal for a good couple of years. Our view is that amongst the listed stockbrokers, this is the cleanest, neatest play on a market recovery. Clearly, retail investor interest in the stock market has been waning for the last couple of years. As gold comes off and as the whole regulatory intervention from the RBI into gold also makes it a less attractive play. Our reading is that the Indian retail investors will come back into equities. We are already seeing equity MF flows pick up and then next step will be retail equity flows picking up. From that perspective, this is the neatest play on a retail investor recovery at one times book value, good management, good balance sheet. I would find it a quite attractive bet. A bit of a personal disclaimer, I have some of it in personal capacity.