Jan 11, 2017 09:54 PM IST | Source: CNBC-TV18

Demonetisation pain to last till Mar; underweight on cement: UBS

Gautam Chhaochharia, Head of India Research at UBS Securities says the main impact would be felt in March as demand destruction continues. He feels the impact will last till the fourth quarter of FY17. The near-term worry due to demonetisation can still be felt, he adds.

Earnings growth is expected to remain muted in 2017, says Gautam Chhaochharia, Head of India Research at UBS Securities. A big reason for this, would be the government's move to demonetise high denominations, whose immediate impact is the cash crunch.

But he says the main impact would be felt in March as demand destruction continues. He feels the impact will last till the fourth quarter of FY17. The near-term worry due to demonetisation can still be felt, he adds.

He keeps a target of 8,800 points for Nifty by the end of 2017. The risk reward, he says, is not yet attractive in the near-term.

He expects two rate cuts by the Reserve Bank of India in 2017.

He remains underweight on cement stocks.

Below is the verbatim transcript of Gautam Chhaochharia's interview to Latha Venkatesh, Sonia Shenoy & Anuj Singhal.

Anuj: I am reading your last report, you believe a Nifty target of 8,800 by 2017 end. What is the rationale for that target?

A: The rationale is very similar to last couple of years which is we would still have a muted growth environment versus expectations while we should see a couple of rate cuts locally. However, broadly the hopes for 2018, one year forward hopes which has been a perennial element for Indian markets, should remain intact even this year and that gives us comfort on fundamental basis. So the market should sustain 17 times multiple which is at the higher end which we have seen over the last couple of years and that gives us 8,800.

Latha: What is your view of the earning season that we are stepping into, what kind of growth?

A: The Q3 earnings number on headline basis should be fine. Our bottom up analyst forecast for Q3 is around 15 percent growth for Nifty and largely driven by the sectors you mentioned. The non-commodity or the non-global commodity sectors is more in single digits. So earning season in the backdrop of demonetisation should be fine on the headline basis but the market will look beyond the headline in terms of more on the ground trend.

However, we have been saying purely from demonetisation perspective, the real impact for market to worry or not to worry for the formal sector, real estate sector to feel the impact, if any, would be more in February and March because the immediate impact is cash crunch. It does not necessarily impact the reported earnings numbers.

Sonia: You do have some IT companies like Tata Consultancy Services (TCS) on your list. Wouldn't you be concerned about the higher H1B visa cause and in general the lower consumer spending that we have seen or client spending in the technology space hitting these companies?

A: We have been bearish on IT services for the last two-and-a-half-three years and premised on the structural view that the shift to digital will be a big overhang for the Indian IT services companies. So the structural view remains intact but within that our sense is that the structural view is now widespread and is getting priced into the stocks after the derating which we have seen over last year or so.

The reason for the upgrade is the cyclical upside which we foresee in a quarter or two from now and the reason for that cyclical upside is from three factors. One, US bank spending, as per our survey, should pickup this year, more so in second half. Second, the Brexit impact also should be in the base and therefore will be supportive later this year. Third, we have, historically, seen a lag between global spending on software versus IT services and we have already seen software spending per se going up last year, which suggests IT services spending, should see a boost this year.

In terms of political or regulatory overhang from what is happening in H1B visa, to us it's a short-term overhang definitely and could impact stock performance in the near term but that will wear off in a quarter from now and our call is more a one year call. We say that because as per our analysis the H1B visa issue will not necessarily be an overhang for the Indian IT companies' business fundamentals beyond the sentiment impact for the next quarter or so.

Anuj: You have a couple of cement names as well in your list as top picks. Do you get a sense that the worst of the demonetisation impact is now priced in?

A: Cement is an underweight for us still, not so much because of demonetisation impact but more because of overoptimistic estimates, also ignoring the cost pressures from raw materials, in fact demonetisation, just to step in, our top down view still remains a base case. The demonetisation impact is likely to be at most till Q4 of FY17 and in base case unlikely to have a prolonged impact on economic activity.

Latha: Financials - year 2016 up until demonetisation was also the year of non banking financial companies (NBFCs) and the banks. What are your takeaways for these two sectors?

A: Positively bias but if you look at different segments; we still remain positive or overweight on NBFCs as well as retail focused private banks. Corporate banks, more selective; we are broadly neutral and state-owned entity (SOE) banks - neutral, but the banking view is also premised on the base case that demonetisation impact does not last beyond the March quarter and therefore whatever disruption we are seeing right now and if stock prices react strongly, it does become opportunity to get into these stocks.

Sonia: You haven't been a big fan of the metal names but that is the sector in news, not only have we seen big gains last year but now we understand that a lot of provinces in China cutting their capacity etc, so stocks like Tata Steel are surging, any investment call here or would you still stay away?

A: We were bullish on this space early last year but towards the end of last year we have downgraded the stock calls and the sector view because, in our view, in early last year the risk reward was very attractive, the stocks and sectors were pricing in as if the down cycle will likely be a prolonged one, which seems unlikely. However, now the stocks are pricing in the scenarios, you are talking about, it's already priced in and as of now we still haven't seen any reason to have a more structurally constructed view. So cyclically we do not see any negatives for metals and mining sector but the stocks are already pricing in that, so risk reward of buying these stocks at these levels is not attractive in our view.

Latha: One of the big psychological impacts of demonetisation was supposedly on consumer discretionary especially those that tend to get bought with cash, not necessarily four wheelers, anything in that space that you would worry about, keep at arm's length or is the fear overblown?

A: Near term worries still there. We have seen two-wheelers, we have seen other parts of discretionary in home improvement etc because demonetisation is two element. One, cash crunch and second, demand destruction. The cash crunch is a valid worry. Demand destruction in our view is going to be short-lived, not long-term.

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