Speaking to CNBC-TV18 Saurabh Mukherjea of Ambit Capital said that we have been accused of saying a lot of things that are thought of as sensational but facts and subsequent events have borne them out. He was responding to Ambit's report that had estimated that GDP growth will trend down from 6.4 percent in the first half of this fiscal to 0.5 percent in the second half with likelihood that growth would shrink in the third quarter of this fiscal.
He said PM Modi is clearly ringing in the changes and India will go through structural changes that will reduce black money, cost of capital and cost of land and real estate. However, he warned that such measures will entail short-term pain.
He believes the real action will begin next year as some SMEs will realise they can’t function in an environment where they have to pay full taxes. They will start winding up next year, he said.
They were expecting earnings growth to be around 6-7 percent for this fiscal year. But they have revised it down to 2-3 percent. Again, for next fiscal year, he is estimating an earnings growth of 10 percent, but he warns it will be tenuous.
In the coming months, FDs and bank deposits will give lower interest rates and hence high-networth investors will move into stock markets.
Below is the verbatim transcript of Saurabh Mukherjea’s interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.
Anuj: You recently came out with your report where you were talking about a possible de-growth and you have cut down your Sensex target. A lot of your critics believe that that is headline grabbing and not enough ground work may have been done on that. What is your response on that?
A: You are often been accused over the last couple of years of saying things which a lot of people thought was sensational but usually facts and subsequent events have borne us out. So, for the last year and a half, we have been highlighting the reset that we believe Prime Minister Narendra Modi would bring about and when we first started talking about this point of view year and a half ago, very few people paid attention but subsequent events have borne us out. Prime Minister Modi clearly is bringing the changes which will result in short-term pain for long-term economic gain.
Our fundamental view has been that India will go through a set of structural changes which will result in the formalisation of the economy, reduction in black money, reduction in the black economy, big reductions in the cost of capital and reduction in the cost of land in real estate. That ultimately creates a more efficient economy for all of us to live and work in, a more efficient manufacturing sector but it does entail short-term pain.
We can’t transit effortlessly from economy where 30-40 percent is in the informal sector into a country with lower cost of capital and lower cost of land. Hence our point of view is that you will see some short-term pain specifically in Q3 where the cash crunch will hit hard but next year the picture starts recovering quite appreciably.
Latha: Which will be the earnings turning quarter then?
A: Depends on how you look at it. Relative to where consensus was say on November 8, clearly this quarter consensus and including us – it is not as if on November 8 we knew what was coming, clearly this quarter consensus will be badly disappointed compared to what the expectations where on November 8. I think as increasingly CEOs are starting to say this could well be a quarter of de-growth for several companies.
I think the companies themselves, to be fair to them, are being fairly candid that this is a quarter in which topline and bottomline could de-grow for prominent companies. Compared to this, clearly Q4 will be better. Our reckoning is growth returns in Q4 albeit in sclerotic fashion and then in the year to March 18 a degree of normality returns. Relative to the expectations that all of us had on November 8 given March 18 growth numbers will be subpar. However, that is a cost worth bearing.
Remember, what we are getting here; our view is that in the next four years, the cost of capital drops 350 basis points. That is a big drop; we haven’t seen that sort of drop in cost of capital for the last 10-15 years in our country. It is a life changing event for most of us and you have to bear some short-term pain for that sort of structural gain.
Sonia: Have you done any rural checks over the last 10 days to understand how bad things are because the sense that we get from a lot of guys we talk to is that auto companies are expecting 25-30 percent fall in the month of November, truckers are saying things have come to a standstill. In your checks, how bad are things currently?
A: We have done 100s of calls with dealers, distributors and the corporates that we cover. We will be publishing some detailed research on this in a few hours and as you would expect, as you are alluding to, the near term impact is clearly quite substantial -- looking at topline hits for the quarter to December anywhere between 10 and 30 percent depending on who you talk to. However, in a way this quarter’s hit is a bit of a side show. I know it feels very important and very vivid for us because we are living through it, the big story starts from next year.
From January, February and March, the big story starts as a whole host of SMEs who realise that they really can’t function in a country where they have to pay full taxes, a whole host of SMEs will start winding up through next year and into 2018 as they realise they can’t function in a country with full tax and that is when the real drama begins because that is when market share starts shifting to listed company market leaders. So, whether it is in footwear, whether it is in sanitaryware or in electricals, we will start seeing market share migration I suspect from spring and summer next year and that process will continue for a couple of years.
It will lead to listed companies gaining market share, gaining earnings but for that to happen, the informal sector specifically will have to seed market share. I suspect the informal sector will take quite a beating over the next two to three years.
Latha: What is the earnings downgrade you are doing for FY17 and how are you changing FY18 earnings?
A: FY17, on November 8 I looked at our FY17 earnings estimate so on November 8 we were roughly expecting something like 6-7 percent earnings growth for the Sensex in the year to March 17. My reckoning is now in the year to March 17 earnings growth will be more like 2-3 percent. So, you have got a 400 basis points drop in our earnings growth expectations for the Sensex in the year to March 17.
In the year to March 18, we have penciled in 10 percent earnings growth. I have to confess that our expectation of 10 percent earnings growth in the year to March 18 at the moment is a little tenuous given how uncertain things are. If the Sensex delivers 10 percent earnings growth in the year to March 18 that will be the best earnings growth from the Sensex in the last four years. So, it has been a while since we saw double digit earnings growth in India. Each year the market begins with expectations of double digit earnings growth and each year the Sensex delivers sclerotic earnings growth, it could well be that the tide turns in the year to March 18.
Anuj: Two part question, a) what is the feedback from investors -- we have seen so much foreign institutional investor (FII) selling all through the last one month and that has only picked up and b) how do you approach the market from portfolio point of view then?
A: As you would expect, both because of events at home plus because of what Janet Yellen said last week in America and also given Trump’s whole point of view that he will spend a lot of government money, US bond yields are running up. That is making investors jittery because US bond yields running up is usually not a good story for emerging markets. So, both because of events in India and events abroad, there is a fair bit of investor jitteriness.
What accentuates the whole issue was going into November 8 or going into November rather, valuations in India were looking very full. I think we wrote about this in October, I spoke about it on your channel I remember in early November that valuations were looking very full. So, I think the result of that is that the market pullback that we have seen and my reckoning is that market pullback will last a little while, certainly up to the Fed announcement in early December the market jitteriness is likely to persist.
However, beyond that, there is a great deal of investor willingness to say we understand this is good for India, this is good for earnings, this is good for the country’s longer term future and in the context of India’s longer term future, there is a great deal of investor willingness to buy sector leading franchises. As I said whether it be in electricals, footwear, sanitaryware, kitchenware, FMCG, there is a great deal of investor willingness to say give me market leading franchises, give me blocks in the same and I am willing to buy at the moment or willing to buy through pain. That is what I think gives us a great deal of confidence that India will see this through and come out stronger on the other side of this dislocation.
Latha: Your report spoke of the famous five -- Asian Paints, Titan, Havells, Motilal, Centuryply. You may not want to take names but when will you start buying these, even for a portfolio why buy expensive, when will you buy?
A: I think all of us in this profession have this great hope that we can call the bottom on, on great stocks and make a name for ourselves and make a lot of money for our clients by calling the bottom on fabulous franchises. I don’t think we can pretend, we can do that given the scale of uncertainty we are seeing. I think it behooves us to say that I can see this is a great company and I can also see that it could well be that this great company has a couple of very rough quarters where it disappoints relative to wherever consensus was on November 8.
However, if I can’t call the bottom on the stock, all I can suggest to you is buy a great franchise, sit tight on it and you will make money. That is the whole point that I rammed home in my book ‘The Unusual Billionaires” and that is the point we have been making to investors over the last week or so. We can identify the market leaders, we are reasonably sure that the market leaders will gain a lot of market share over the next couple of years as the informal sector gradually melts away and therefore this is a good time to buy especially given that we can see that for the domestic HNI there will be very little space to go other than the Indian stock markets.
Coming into financial assets will make a great deal of sense for Indian high net worth investors. Within financial assets, your fixed deposits in banks will give lower and lower interest rates over the next couple of years because so much money will come into the banking system and hence coming into the stock market will make eminent sense for the HNIs. So, I can’t call the bottom, I can point you towards high quality franchises and my reckoning is that when we are doing our jobs, FIIs specifically are quite happy to buy and that trend will pickup especially post Christmas.