Though markets will shrug off demonetisation as a one-off event the earnings are likely to see a significant impact for the next two quarters, says Dhiraj Sachdev, Senior VP and Fund Manager at HSBC Global Asset Management.
Speaking to CNBC-TV18 Sachdev said that the current market decline is a temporary window to make an entry and sees sustainable growth in the agrochemical sector despite temporary disruptions.
With the recent strengthening of the US dollar and investor focus shifting to developed markets from the emerging markets, foreign institutional investors (FII) are changing their course as well.
Sachdev said that it is difficult to estimate how FIIs will act in the near future but is hopeful that they will return back to India.
Below is the verbatim transcript of Dhiraj Sachdev’s interview to Latha Venkatesh & Sonia Shenoy on CNBC-TV18.
Latha: How does it look the situation now? Is this is a time when mutual funds should be buying bargain basement levels?
A: Clearly, there is a demand disruption happening across many segments as a result of demonetisation. The impact on the corporate earnings will be felt significantly over the next one or two quarters especially on the consumption, be it discretionary or high ticket items like real estate or jewellery. Also some of the businesses which have very high fixed cost component to contribution margin will have negative operating leverage impact. So, the earnings impact will be more pronounced there. We all have to understand the fact that the impact or the pain is only temporary in nature and will not have lasting impression given the country’s potential. So, to our mind the market will shrug off this demonetisation event as one-off in nature and look beyond especially on the normalised FY18 earnings as such.
If you actually look at the discounted cash flow valuations of many businesses that may not be materially getting impacted. So, it is unwise to extrapolate the current state of affairs far off into the future. The positives could eventually turn out to be true in the form of unorganised sector getting into the formal mechanism or organised sector gaining further strength. So, our sense is that maybe from a price perspective a lot of damage maybe done over the next few weeks before a pre-Budget rally on high expectations resumes back given the fact that government will try to elevate some of the pains in the form of lower taxes both for the corporate side or for the individuals and also high rural spending to boost consumption. From an investor’s perspective this current market decline is a temporary window of opportunity to invest. You can’t be waiting for an opportunity to get obvious and then start investing
Sonia: I was just going though some of the key holdings in your midcap equity fund and you have a relatively large exposure to the lot of rural oriented companies whether it is stocks like VST Tillers Tractors, United Phosphorus, Cholamandalam Investment and Finance Company, no one can assess what the damage to the rural economy has been because of demonetisation so far so how do you approach this space now?
A: As I clearly mentioned the impact is temporary in nature and these are very secure long-term structural business models and I don’t think that disruption will happen. The temporary disruption will elongate beyond a point. For example take the case for agro chemicals that we own in the fund. Only one-third of the farmers are aware of crop protection usage and given the food prices there is greater pressure on the farmers to improve the crop yield. This is a very sustainable business with very high degree of capital efficiency in place. We are fairly encouraged that the compounding element can happen in this business as such.
Also for example the farm mechanisation company that you talked about, the farm mechanisation is only going to be on the rise given higher degree of labour cost that is coming in the farm sector. So, we own these because of the sustainability of growth over a normalised period of time despite the temporary disruption that we may see.
Latha: You also have Dewan Housing Finance Corporation in your portfolio, basically housing finance companies; the majority chatter on the street is that housing in fact anything related to real estate will be impacted for slightly longer?
A: The real estate obviously is seeing slowdown for the last few years as well and there is obviously further postponement of demand and more than housing finance companies we believe the building materials will see a major disruption because of the housing curtailment. As far as housing finance is concerned, that business operates in many of the low ticket items as well, low ticket loans as well in tier II and tier III cities where we believe that the demand supply gap is still pretty huge.
From that perspective, I believe that housing finance business will see sustained growth in their lending book and will not see immaterial impact either in the form of nonperforming assets (NPA) or loan curtailment. So, an average ticket size of about Rs 25-30 lakh or 40 lakh is not big enough where the demand curtailment is likely to happen.
Sonia: Any other sectors that you would be bullish on now where you think that the price damage has been done and it is a good buying opportunity for the long-term investors.
A: It is not just one, there are many for example. We mentioned agro chemicals, we also own specialty chemicals for quite some time because we believe that Contract Research and Manufacturing Services (CRAMS) or an outsourcing opportunity will be material and sustainable because of demonstrated chemistry skills by many of the companies and the environment issues happening in China which results in business shifting to India.
We also like gold mortgage finance companies despite the current correction that has happened. We believe the unorganised players private money lending business will shift to organised players on the gold mortgage finance companies side. The penetration is still pretty low and these companies have domain expertise and have competitive advantage compared to banks and money lending companies or private money lenders.
We also like asset management companies or stock broking companies because we believe that eventually the financial savings would be higher because of demonetisation compared to investments on the physical asset side like real estate or gold. So, I think financial saving companies in the insurance or assets management or stock broking companies look pretty interesting.
Latha: I wanted to ask you about how your team perceives the global cues as well. I want your comments on what Mohamen El-Erian told CNBC. What is your sense? Global cues have actually moved out of emerging markets and we just had somebody pointing out data that in the past few weeks, half the money that has moved out of emerging markets has moved out of India. Where does this fit? When does foreign institutional investor (FII) selling ebb?
A: It is difficult to guess what the FIIs are doing. Even FIIs have different mandates. There exchange traded fund (ETF) money which is short-term money, there are hedge funds and there are long only FIIs. Let us not underestimate the loyalty of FIIs in the last so many years. They cumulatively own more than USD 350 billion of Indian equities and roughly more than 25 percent of the floating stock in the market. So, we believe that the long only FIIs will take any kind of correction in the emerging market and a developing market like India as an opportunity and eventually come over. So yes, off late we have seen money outflows because of dollar strengthening, US bond yields going up or Fed rate hikes, etc. but we believe eventually, as the dollar strength fades, you might see flows coming back into some of these emerging markets. So, we are hopeful on the FII flows as well returning.
Sonia: So, in the next three-six months, what kind of a downside do you see for the market? The lows we made this year have been about 7,920-7,950. We are just about there. Do you think those lows could be breached?
A: In the near-term it is possible because market has a tendency to overreact. So, the current ongoing correction can stretch further and maybe from price perspective, things can get worse before it gets better, but we do not expect it will last beyond a few weeks. Therefore, as I mentioned, there will be expectation of a pre-Budget rally. The consumption stocks still have room to go further downside because of the fact that they were quite rich and a lot of slowdown in demand or postponement of the demand is not yet played out fully or discounted fully in the stock prices. But we do not expect too much of an elongated downside in the market. These kinds of weaknesses should be used as an opportunity to buy into the markets.
Latha: We next want to ask you what you are expecting from the Budget and how you would react to various announcements. In that context, yesterday we spoke to some of the top-bankers when we had our jury round of the India Business Leader Award (IBLA) selection. If a farm loan waiver came, what would you do? Which stocks would you get rid of and which stocks would you buy?
A: Obviously the agri-related sector and especially the banking related sector, public sector undertaking (PSU) banks will be the biggest losers in farm loan waivers. We do not want that situation of early 90’s when a lot of loan waivers happen to again get repeated. It had huge negative impact on the public sector banks balance sheet. So, obviously, this is one area which will get avoided in case that happens. But we do not expect that this kind of situation will be reinforced by any of the state governments or government in particular.