Feb 04, 2016 07:01 PM IST | Source: CNBC-TV18

Domestic boom is coming: These sectors are likely to benefit

The Indian economy is looking in much better shape than it was, say, six months ago and both the consumption and investment engines are picking up, says Neelkanth Mishra of Credit Suisse.

The Indian economy is looking in much better shape than it was, say, six months ago and both the consumption and investment engines are picking up, says Neelkanth Mishra, India Equity Strategist for Credit Suisse, who says this has implications for a number of sectors whose stocks will make for a good investment.

In an interview with CNBC-TV18, Mishra said he was seeing traction in a number of sectors such as cement and plastics and said investors should stay away from stocks that have global exposure. Among financials, he advises investors pile into shares of retail-focused lenders.

The broad investment strategy should revolve around sticking to high quality, high growth, low debt companies, he said.

Below is the verbatim transcript of Neelkanth Mishra’s interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.

Latha: Do you think the market has put the volatility behind, do you think 7,241 is some kind of a base or are you still worried about the near-term volatility?

A: Something very important happened last night which was that the DXY sort of broke a trend. It fell very sharply, that is the trade weighted dollar and the yen appreciated, the euro appreciated. I think what it does, at least near-term is reverses the trend that we had been seeing of almost every currency depreciating against the dollar.

One of the biggest uncertainties in the market was where this trend would end and with someone from the Fed yesterday signaling that things have changed materially from December, I think the market has taken it that the Fed is going to be on an easing posture as well. So, that reduces some of the uncertainty and the panic that was gripping world markets. I think it acts as a balm, so, it was first European Central Bank (ECB) President and then the Bank of Japan (BoJ) and now the Fed stepped in.

Even risk appetite, the global risk appetite index is actually in the panic zone and generally it rebounds from there. So, we can see a risk rally. However, having said that some of the deeper concerns about the market, about the global economy as to whether the renminbi (RMB) slide can be as controlled as the People’s Bank of China (PBoC) would like to or how the loss apportioning of the fall in global commodity prices can be attributed, those concerns continue.

So, if there is a dollar weakening, maybe the commodity prices in dollar terms sort of start looking better and market says maybe this is the worst is past. So, we can see a period of stability. However, the bigger questions remain unanswered.

Sonia: I wanted to talk about a note that your colleague Sakhti Siva put out as well where she mentioned that both, a combination of trough valuations and foreign investment capitulation suggests that perhaps the Asian markets ex-Japan could be bottoming out. The only argument to that is even if the price correction gets done the fear is that there could be a protracted time correction in the market and it would take perhaps a year or two before we get those levels back, the levels that we saw at the start of 2015. Is that your fear as well?

A: I have said that before, I will say it again, that the global economy actually there are some structural adjustments happening and for most of our larger indices or rather I would say the narrower indices, the Nifty, the BSE 100, the representation of the globe is actually every high. So, if you see the pace of earnings cuts, in the last three months also we have seen Nifty forward earnings per share (EPS) fall by nearly 6 percent.

There is some local cuts happening as well but most of this is actually because people are revising down their estimates for steel and oil and all of that. So, I think the narrower indices, there is a possibility that you could see some amount of time correction.

However, I think from the domestic perspective, if you are looking at stocks, I think the domestic economy is actually looking much better than it was say six to seven months back. I think the hard indicators like oil demand growth, even cement volume growth, while cement prices have been nothing to write home about, cement volume grows in the North, in the East and perhaps the South was affected badly by floods.

So, these are hard indicators of very widespread demand that I think are looking much better. So, the domestic economy actually should not be doing that badly.

Latha: You can’t play it with finance stocks, can you? The banks have their own kind of problems; will you play any bank at all?

A: If you have retail focus lender, you don’t have exposure to companies which are technically burst then yes those are banks, some NBFCs which are still growing fast.

Latha: That is just two or three private sector banks. You don’t touch any of the economy facing banks although they have fallen a goodish bit?

A: If you are looking for a trading rally, maybe you can but I am not very good at catching trading rallies and I don’t think they are wise to chase after anyway. However, those issues are still unresolved and one of the problems also with the large liquid stocks is that they are heavily foreign institutional investors (FII) owned.

While near-term with the risk appetite perhaps stabilising, you may see some stability inflows but the fact is that the oil producing, the oil exporters are still bleeding cash and they need to keep selling their asset. So, if you have very high FII ownership, even if you have decent earnings support, you can actually still get de-rated.

So, my sense is that I think if you stay focused on good growth companies, even if they are three or four, I think you should be better off from a 12 month perspective.

Sonia: You did mention that some of the hard indicators like cement are showcasing a bit of rebound but we are not seeing that in the numbers just yet. If you look at the list of cement numbers that we have got so far whether it is names like Orient Cement, Mangalam Cement, Saurashtra Cement, the smaller ones are out, some of them still are posting losses. So, where were you noticing an improvement in demand?

A: Demand and profits are different indicators. So, because the cement industry has been able to manage pricing for quite a bit despite low utilisations, I think the profitability was being held up. What we are seeing perhaps is that the discipline of pricing has weakened in the North where prices have come down quite sharply.

However, if you are looking at cement as an indicator of what is really happening on the ground, because it affects the informal economy affects, it affects the formal economy, it reflects the pace of house construction, infrastructure construction, what you need to focus on is volumes and I think the volumes in the December quarter were actually quite good.

Latha: Would it be the commercial vehicles or even the four wheelers, two wheelers, that entire space what is your area of preference?

A: We have been very positive on four wheelers. The volume growth there – January was a blip and the volume growth there should be quite steady. We remain positive on the impact that the pay commission can have in the second half. I don’t want to sound like a broken clock but I think that is going to be a very important and very strong catalyst for the domestic economy as it starts to get implemented.

I think the weaker diesel price and the fact that the pay commission will force the railways perhaps to raise tariffs again, and mining has revived, I don’t know if you noticed, iron ore production has been going up very sharply and private miners in Odisha for example have been growing at 20-30 percent a year. We are again reaching a position of iron ore surplus.

So, I think with all of those things starting to happen and some of the projects that the government has been funding on the national highway side are finally coming to a point where actually construction is starting to happen. So, you are seeing better demand for trucks for example and I think that is again a market where it is either you are lending to them or you are producing trucks; maybe that is a good place to look at as well.

Sonia: I also wanted your thoughts on what the expectation is from the Union Budget this time around. Do you think Arun Jaitley will make the same mistakes that he made in the last two Budget’s, treat it as just a balancing of the books or do you think something radical could be unveiled in this Budget?

A: The point is that the Budget is actually a budgeting exercise. Treating it like a Budget is a mistake. I have been saying for a while, I think what matters now is the state Budget’s. This year they are spending 65 percent more than the Center. The central governments discretionary items are actually very far and few; if you remove defence, if you remove interest cost and some necessary subsidies that are given like on food, there is not too much discretion that exists.

So, I think that the Budget should be treated like a budgeting exercise. I think there will be media hoopla and therefore the markets will stay focused. We are very focused on what is going to happen. However, for the broader economy what just matters is capex this year, the government capex, is actually rising at 33 percent a year which is very exciting, very strong and I would just look for signs of that continuing.

The government just resetting the bar on national highways, just resetting the bar on railways, railways of course there is a lot of extra budgetary resources that they have as well and in particular I would be very interested to see if there is something coming for housing because housing is a win-win on all sides. The construction of housing creates jobs, it creates cement demand, steel demand and good houses are of course good for productivity as well.

So, anyway with a pay commission most likely in the second half or maybe later this year, you should see improvement in real estate markets outside the top 50-100 cities. However, bigger support from Budget would also help that.

Latha: Outside of all this, are there sectors or stocks that you would watch out for, the home improvement sector received a lot of attention and now with falling crude, paints and tiles should all be doing well. So, do you think that broadly this midcap rally will continue because there will continue to be some bright sparks and what would they be?

A: I generally don’t like the sound of midcap, not because I don’t like midcaps but just investing because something is smaller in market cap is actually not a very bright idea. So, I think if you are in the right sector, as you said, home improvement, you are decently managed, your cost base is coming down as you say and if the housing market does pickup, that is a great place to be.

If you are a plastics manufacturer, I don’t know if you saw December quarter, India’s plastics demand went up by 20 percent year-on-year (YoY). Even Reliance when they reported they gave an assessment of what plastics demand for the country was and it was up 20 percent. The trend growth has been for the last 10 years 10 percent and in December quarter, it is up 20 percent and plastics is about packaging. If you see the demand numbers coming out of most consumer staples companies, actually they have been quite strong as well.

The only place where you can actually look at midcaps as some uniform characteristic of midcaps, it is that they are low FII owned and therefore the selling pressure on them should be slightly lower. However, some of them are trading at atrocious multiples and which is why I would rather be picky and we are very selective in choosing the midcaps.

Sonia: I wanted to pick up one statement you made about commodity prices. You said that in dollar terms commodity prices could see a recovery now. You were one of the first people to call the weakness in Tata Steel and you got it right. They are expecting the numbers later today, do you expect the weakness in these steel companies to continue and at what point would you expect to see any rebound?

A: When I said commodity prices I mean the more actively traded commodity prices. What I meant there was oil and gas or maybe even aluminimum and zinc but steel generally there is very low financial interest. It is a very high volume entity and plus the concerns on China are not going away. Let us see how the indicators are – clearly signs are that the PBoC is still intervening in the rmb market. So, let us see how and where that is headed. The Chinese steel demand still seems to be coming down.

One large problem with the Indian steel producers is debt. The advantage of having a high operating leverage is that whenever the volume comes up you are fine. The problem with high financial leverage is that you can actually go down to zero and many of the Indian steel companies are actually struggling with that. So, that is another overhang to actually stay watchful for. So, our views on the steel sector per se, actually has not changed.

Latha: Since you speak about deeply indebted companies, your company was the first to point out in your House of Debt series, the extent of indebtedness in the top 10 groups. At what point will you start buying the financials. There are some seminal steps that the Reserve Bank of India (RBI) has put in, in terms of recognition and yesterday you had Jayant Sinha speaking to us on the same wavelength in terms of wanting to provide that stressed asset fund as well as capital support. Three quarters down the line, two quarters down the line, when would at least some of the top ICICI Bank’s, Axis Bank’s, SBI’s become buy for you?

A: My simple sense on the market and of course then you have to nuance it once you start taking a calls but the starting point has to be have we drawn a circle around the problem. I learnt it from a very senior investor that once the market knows what the extent of the problem is, the stocks will bounce. I think the reason why some of these banks are trading much below what you would estimate fair value should be, is that no one knows how big the problem is.

The problem also is till the time that they really come out and confess that these are the loans that we have given where we may not get our money back, the point is and what the market worries is and we worry is that they are actually throwing good money after bad.

So, I guess once the banks come out and clarify that look we may not have classified this NPA for XYZ reason but these are the stressed loans, these are the loans that we think can go bad and the market sees that that is a very believable confession, I think that is perhaps when this happens. So, it is actually up to the discretion of the banks. It is very hard to put a timeline to it.

(Copy edited by Nazim Khan, interview transcribed by Priyanka Deshpande)

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