Indian rupee crossed its previous low on August 28, 2013 and depreciated beyond 68.80 against US dollar in today's trading session.
This fall in currency is triggered by various reasons and looking at it in isolation is not fair, says Surendra Goyal of Citi India.
Goyal said that this depreciation in rupee will spook foreign institutional investors (FIIs).
Speaking to CNBC-TV18 he said that it is very hard to assess the damage caused by demonetisation and sees a prolonged impact on sectors dependent on real estate.
On other sectors he said that IT services are likely to stay under pricing pressure whereas he is overweight on pharma and private banks.
He is underweight on autos and keeps a negative view on consumer staples and durables.
Goyal said that the next two quarters are very important from an earnings perspective and expects market to remain range-bound in the near term.
Citi has revised its market earnings multiple to 15x from 17x and has rolled its Sensex target of 30,000 from March, 2017 to September, 2017.
Below is the verbatim transcript of Surendra Goyal’s interview to Anuj Singhal, Latha Venkatesh & Sonia Shenoy.
Latha: We may see weakness in the currency would that be very negative for foreign institutional investors (FIIs)?
A: Yes, I think you have to look at multiple things here as you just said that there are number of industries which will benefit from it, but from a return perspective obviously FIIs do care about the currency. So, when we were marketing in the early to mid part of this year with a lot of FIIs, when they have a framework where they assess the relative attractiveness of market, stability of currency is a very important parameter as well.
There are like six or seven parameters and this is one of them and to that extent it will worry them. However, I think the second point here is which you mentioned earlier again I think you will have to look at it in context of other emerging markets. I think looking at it in isolation may not really help because it is a global phenomenon; what we are seeing is happening across emerging markets. I think we will have to keep the relative picture in mind.
Latha: Before that, we have a big domestic issue to tackle and I do want to ask you about demonetisation. Have you started lowering your earnings growth for FY17 itself and which sectors have you lowered it most?
A: A few things here. First of all, there are a lot of moving parts. It is very difficult for analysts to really say that the short-term impact, let us say next three to six or nine months is going to be so much demand impact while the medium term again is a challenge because this is unprecedented. We have never really seen anything of this scale and to that extent I think analysts will struggle a bit in terms of putting numbers and saying that this is going to be the impact for this year and this is going to be the impact for next year.
In certain cases we have had analysts who have kind of taken a view on certain stocks that yes, there will be a 10 percent impact but even that is some kind of a guess at this point looking at multiple factors. It is not easy to really give an explicit number that there will be a 10 percent, 15 percent or 20 percent impact.
Therefore, first, from a near term perspective, I think there will be an impact on more sectors. So, either there is a direct impact or an indirect impact; like today, somebody was asking me about a media company. Now, if their clients and the consumer space are impacted, they will see an indirect impact. So, the direct impact may not be as high. Similarly, for all other sectors, there will be some kind of an impact. Somebody was asking me on the IT sector or more on the business process outsourcing (BPO) sector that so many people have been standing in queues; does it impact in productivity and utilisation, etc? Now, this is one sector where everybody thinks that there is no impact. The point I am trying to make here is in every sector there is some kind of an indirect impact.
Where we think the impact could last a little longer is cement for example and real estate and anything related to it will see some kind of an impact. Consumer discretionary, I think it could last a bit longer and rural focused non-banking financial companies (NBFCs), etc. I think these are three or four pockets of the market where things could last a bit longer.
However, what we have done from our perspective is when we put out a note earlier this week, we have lowered our target multiple for the market because I think analysts will struggle with earnings. So, what we have done is, we have taken down the multiple from 17 times to 15 times which in some ways factors in the kind of earnings impact which could possibly come through.
Anuj: I was listening to your conversation and interesting thing is you have cut down your earnings multiple but your Sensex targets still remains the same. What explains that and is there downside risk to that?
A: Our earlier target which we had set very early in this financial year that was for March and this target that we have set is for September. So, that role forward is essentially what kind of mitigates the impact of the target multiple cut. In terms of risks I think yes, I started by saying that there are a lot of moving parts and we really need to see how things play out over the next six months. So, to that extent yes, there are a lot of moving parts both globally and in India and which is where I think analyst are finding it very difficult to forecast or change earnings.
Sonia: You were speaking about the impact that the rupee would have, but does the depreciating rupee provide a fresh opportunity to invest into either the IT or the pharmaceutical names or would you be concerned about some of the comments that are coming in from Donald Trump regarding clamp down of H1B Visas etc in the IT sector?
A: Firstly, on the IT sector, so we have been cautious or negative on this space for over two years now. We have put out multiple reports where we have highlighted that this sector if you look at the last 10 years or so, demand or revenue growth has been the primary driver. Currency is a variable in the short-term and particularly from a relative to market stand point. However, the bigger issue has always been demand and which is where we are seeing multiple challenges and we have written a lot of reports on them.
There is a significant amount of pressure on traditional service which Indian IT businesses are still doing and that is bulk of their business. There is a lot of pricing pressure. There is an impact of cloud and software as service on certain parts of the business and that business is slowing down. Investments are required in digital. So, what it all does is your growth rates are coming off. You saw NASSCOM revising the growth rate down very recently and at the same time there is a challenge from a profitability stand point. There are some large companies who will possibly have flattish operating profits this year.
I think the sector has fundamental challenges and Trump what he does I think that is unknown. If you have anything which impacts the visa situation either from a cost perspective or availability perspective that could compound this challenges even further. So, that is a sector which we remained concerned on while we admit that in the near term rupee does provide support. I think some people will definitely look at that sector as a safe place to hide kind of a sector. However, having said that one should not take their eyes away from the fundamental challenges that the sector is facing and that is the reason it is still a significant underweight in our India model portfolio.
Your second question on pharmaceutical - this is a sector where we turned overweight a few months back and we still have an overweight. We think that earnings growth there should be relatively better definitely versus IT and there was a fear that if the election results in the US were different then things would have gotten from difficult for the pharma companies. If you kind of put it altogether earnings growth in that sector is decent, the sector has underperformed, valuations are much more reasonable than we have seen in the long time. So, pharma is a sector which we are significantly overweight on.
Latha: How would you play banks? This whole demonetisation has to play through the banks. So, is it banks in general, financials that you will buy, is there a pecking order in terms of NBFC, private, public?
A: From a banks' perspective there are again lot of things to look at and while obviously the kind of deposits that we have seen are huge but at the same time you will have challenges in certain segments which in-turn will impact the business of banks. So, looking through all of that our stance if you look at for a while is we are big overweight on the private sector retail focussed banks. While there have been points of time where the state owned banks have outperformed but our view still remains that we want to stick with where earnings visibility is the highest and to that extent our big overweight still is on the private sector bank side.
Latha: What about the NBFCs, they were the screaming performers of 2016? Dislocated for the moment by demonetisation how are you playing, everything from Bajaj Finance to the Capital First to down to the Manappuram Finance, the microfinance institutions (MFIs), the Bharat Financial Inclusion how do you handle that space?
A: Interestingly, a lot of the names you mentioned we really don’t have under coverage. I started by saying that few sectors where there could be medium-term impact - rural focused NBFCs is one of them, but I really can’t go into specifics because we really don’t have coverage on a lot of these stocks.
Latha: What about consumption itself will that be an underweight? Again the Asian Paints of the world were the screaming buys of 2016. How do you approach consumer and all parts fast moving consumer goods (FMCG) to durables?
A: I started by saying that discretionary; the space in general will see possibly a more medium-term impact of what is going on. From a model portfolio perspective consumers staples, we have been negative for a while. It has been one of the big underweight for us, for while now. However, on the discretionary side what we have done in our recent note is - auto, which is consumer discretionary in some manner, so there we have kind of brought down the weightage. So, consumer both staples and durables we remain underweight and autos also we have brought down the weight in the most recent update. So, to answer your question yes, we have a cautious view on consumer in general.
Anuj: What is the view of FII investors because truth be told, the FII selling actually started in second half of October? We could look at the demonetisation day and say that that may have aggravated selling but it started before that and the Trump win and dollar strength has only added to that? Do you get a sense that at some point the selling will abate and the FII money will come back or will we have to deal with large FII selling for some time?
A: It is always a difficult call to take from a short-term perspective on what FIIs are going to do. However, the timeframe that you were talking about, I think while we are all very focused on demonetisation obviously what is happening in the US is playing a big role. Since Trump or since demonetisation, if you look at, India is down maybe 10 or so percent but even emerging markets (EMs) are down 8 percent.
I think while in India we are kind of trying to relate everything to demonetisation, definitely there are bigger global variables at play here which are impacting emerging markets in general. On the global strategy side for example even we move from overweight emerging markets or we downgraded emerging markets. We have changed our view because of what is happening in the US. I think there are multiple factors which are a near-term challenge.
Having said that what I will definitely add is India is a market which FIIs have generally liked. There are again multiple longer term or medium-term reasons to it. There are a lot of good companies in India which people would won’t to own again at a different valuation level maybe, but there are a lot of companies which are considered very good on governances, business parameters, return on equities (RoEs) etc, and to that extent it will remain an interesting market but I don’t think one can really rule out some near-term volatility.
Sonia: How would you categorise the market trend here on for the next 6-12 months? Do you get a sense that we could be heading into a protracted bear market and we could perhaps see a longer time correction even if the price correction gets over?
A: A lot will depend on data that we see. I think companies will report in January- February and people will be very keenly watching what the impact on demand has been and what managements comment from a future outlook perspective. To that extent the next two quarters are very important. If people get a sense that at least the initial impact on a lot of companies is getting over and FY18 seems like closer to a normal year, I think that could change the outlook for the market. What we have said in the recent note is yes near term we expect the market to be range bound and there are global and domestic factors which make the market volatile from a near term perspective.
Latha: This Trump victory and demonetisation was timed to a nicety almost at the same hour both struck us. Nevertheless even if the DM-EM trade doesn’t play out very badly and EMs are continued to be favoured, will India move in the pecking order somewhere lower because of demonetisation?
A: Near-term I think yes, because no investor likes uncertainty and definitely there is uncertainty from a demand perspective. To that extent, near term, people are worried for the right reasons because I don’t think any of us really can say with a lot of comfort that this is the impact. Any form of uncertainty generally is a concern for investors. So, to that extent near-term yes, does it change the medium-term investor appetite for India we don’t think so at this point but as I said we will have to watch out for a lot of data but I would believe that I don’t think it really changes the medium-term appetite for India.
Latha: What are the moving parts you will watch? All experts are telling us there are too many numbers we don’t know in terms of how much money will not come back. So what are you watching? Will you watch out for the December 6th Reserve Bank of India (RBI) monetary policy, the number of notes that don’t come back on December 31st the Budget on February 1st what are you going to watch before you make up your mind on your India position and you Sensex level?
A: You answered the question in part. Obviously the RBI policy, the Budget, I would really add the quarterly results to the mix because people want to hear from companies on what the impact has been and what they expect the impact going forward. If companies tell us that this quarter was tough but next quarter looks like we are getting back to normal. I think that will give people a lot of comfort.
Therefore, the point I am trying to make here is our medium-term view which is reflected in our Sensex target is still constructive, but yes, near term there are a lot of things and because of that we need to see over the next three months as some of the things that you spoke about and the quarterly earnings and trends play out.