Jan 13, 2017 10:12 PM IST | Source: CNBC-TV18

India expensive at current levels; like durables, banks: CLSA

The optimism around US economy's growth and a strengthening dollar are signs that IT companies are going to give out a stellar performance in the long-term, says Mahesh Nandurkar, India Strategist at CLSA.

The reintroduction of the H1B visa reform Bill has plagued the IT stocks of late, but Mahesh Nandurkar, India Strategist at CLSA, says there are more positives than negatives for the Indian IT sector.

The optimism around US economy's growth and a strengthening dollar are signs that IT companies are going to give out a stellar performance in the long-term.

Nandurkar, however, maintains an underweight on technology stocks. He says banking, consumer durables, consumer stables and global industrials, look impressive and may perform even better.

The December quarter earnings growth is mostly expected to be flat, says Nandurkar. If it were not for demonetisation, there would have been double-digit earnings growth.

Banks, if compared year-on-year, may report better numbers, he says.

He says uncertainty in the market will continue till the Union Budget 2017. The preference for India has reduced due to concerns over the taxation of foreign portfolio investors. He adds that India is expensive at current levels.

"Money from India has flown into other markets like Chinese banks," says Nandurkar.

He feels government’s focus in the upcoming Budget is expected to be on social infrastructure sector.

Below is the verbatim transcript of Mahesh Nandurkar's interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.

Sonia: It has been a pretty decent run for the market over the last one month but before that I wanted your thoughts on the IT sector and all that is playing out with the TCS and Infosys earnings and of course that big change that took place yesterday?

A: Since the Trump election, we have seen pretty decent run in the IT stocks. They have been outperforming. While there has been some uncertainty related to the Trump policy and what it means for the minimum wages on the visa staff that the Indian IT send over to the US and while if implemented, it could be margin dilutive for many of the companies but then on the same side, there are three other positives as well. First of all, many of these stocks are looking attractively valued from the perspective of their historical P/E multiples. That is point number one.

Point number two is that there is also some optimism around the US economic growth and especially the US banking financials and the retail etc. If that happens, it is clearly going to be a positive for the volume growth outlook for the Indian IT services.

Third is the dollar strengthening. There are some positives and negatives.

At the moment, we still continue to maintain our underweight call on the sector although there are some specific stocks that appear more attractive but this is one sector that we are very keenly following because we still need to understand -- in little bit more clarity -- the policies of the new US government.

Anuj: What is going to drive the market from hereon if you are saying IT is something that you will still be underweight on, do you think it is going to be banks again?

A: We continue to believe that banks and the consumption would still be the sector that will do better. I would also say some of the other value names especially on the commodity side would also be better. So we are overweight on these four sectors -- consumer staples, discretionary, banks essentially on the private banking side and also the global commodity. So these four are our favourite sectors at this point in time.

Having said that, I feel that over the next one month or so, we still have to contend with some of the uncertainties related to the Budget and especially how the various issues, which have propped up recently on the taxation issues, whether it is the definition of long-term capital gains tax or it is the taxation on foreign investors, which seems to be a topic of discussion. So till the time we get some clarity on some of these issues, probably the market just be moving sideways.

Latha: Since you said discretionary, let me come to the demonetisation impact. We are seeming to get the IndusInd Bank and the South Indian Bank telling us that the P&L was not terribly scarred, yesterday's index of industrial production (IIP) number -- however big or random number it is still not indicating doom, now the economy will reflate. Therefore what will you work with in terms of earnings for this year and for next?

A: If you look at the quarterly earnings growth trajectory so far in this year, we have Q1 and Q2 numbers, and while there have been some anomalies but if you look at the domestic sectors -- when I say domestic sectors, I mean the staples, autos, media, telecom, cement, industrials, those sectors have done reasonably well. In Q1, the earnings growth for that segment was 15 percent and similarly a number for September quarter as well. So while the overall numbers might not look that impressive, but many of these domestic sectors have done well.

If it wasn’t for the demonetisation impact, we would have probably ended the full year with a significantly higher number in the double digits, something that all the investors are keenly watching out for. That is clearly not going to be the case now with what has happened. So December quarter, we are expecting just about flattish trend on the overall domestic sectors but yes, the reported earnings growth will be much stronger because last year December quarter was very bad for banks also the March quarter. So the reported earnings will look good but on the like-to-like basis, the earnings growth is likely to be flat for most of the sectors.

Sonia: You did speak about the tax concerns as we head into the Budget. Wanted to ask you what else are you watching out for because this time it looks like it is going to be very hard for the government to boost consumption spending given that there was hardly any gains from demonetisation?

A: The jury is still out on the gains on demonetisation while the media reports indicate that the possibility of that one time RBI dividend has diminished considerably -- even if it happens, it is going to be a small number as you rightly said but we still don’t know what is the disclosure going to be under the tax amnesty scheme. So if that disclosure turns out to be Rs 1 lakh crore or Rs 1 trillion or something like that then the government will still have additional Rs 50,000 crore of tax revenues to spend. That is still an outstanding issue, so we will have to see what happens over there.

We still continue to feel that in the upcoming Budget, the government's focus will clearly be more on social infrastructure, which is something of a change as compared to what we had seen in the last couple of years. One thing that we are eagerly watching out for is the social housing or the low cost housing. Remember that, the Prime Minister did make some announcements on December 31, but even before that we had seen a pretty strong traction on the credit link subsidy scheme for the housing loans less than Rs 600,000. So that scheme was ramping up quite nicely even well before this demonetisation. So we are quite optimistic about that. So we would be keen to see what kind of allocation the government makes for those types of schemes in the upcoming Budget.

Anuj: The other important issue and since you have a lot of FII clients, what is happening with money flows because we have had a strong developed markets (DM) outperformance versus emerging market (EM) outperformance but India stands out even among EMs in terms of the outflows and even in the last one week or 10 days while we have seen some inflows back to emerging markets, at least in cash markets we haven’t seen FII inflows.

A: That is true. In general, over the last couple of years, what we have seen is the preference for India has actually reduced among the foreign investors. One of the key reasons is also the fact that the earnings growth story in India has disappointed but also there has been generally a shift towards value as a theme for the global investors.

Clearly, India is not a value market, it is a high quality but expensive market and we have seen money flowing out of India into some other North Asian markets, even the Chinese banks and so on which were considered or which are considered as value stocks. So, that theme still continues to play, but the good part is that we have seen the foreign investor weightings in India come down significantly.

I can tell you that 12 months ago, an average emerging market investor would be overweight on India to the extent of close to 5 percentage points. Now that number is down to just about 1-2 percentage points. We still have to keep in mind that the MSCI neutral benchmark for India does not take into account some of the large stocks which would ideally be there.

So, I would say that and my recent interactions with some of these global investors make me feel that the outflows should reduce and investors are now watching for the impact of the demonetisation. Some of the data that we have seen so far for the month of December, I would focus more on December than on November because November still had a lot of irregular economic transactions as well. So, December should be more representative.

So, as we go forward and we get more confirmation of the fact that the demonetisation has not really had that big an impact, I think the flows should begin to improve.

Latha: Would the clarification on that indirect tax on capital gains or indirect transfer be the ultimate that foreign investors will watch out for? Yes, affordable housing and a little bit of cut in maybe direct taxes, personal taxes, but will that tax clarification hold the key?

A: That tax clarification will be an important factor but not really the crux I would say. I think the bigger clarification would be what happens to the definition of the long term equity gains.

Sonia: Have you had an interaction with any of the investors, what has the feedback been so far, have representations been made to the government with respect to these issues?

A: Our knowledge is limited to what is there out in the media and what we understand is that the government officials have looked at the representations made. However, as far as I know, the delegations on the fund managers haven’t really heard back from the government as yet. So, yes, we would be watching out for that.

Latha: What is a good Budget for you?

A: I think a good Budget always has two simple definitions, especially in the current context and in terms of the expectations from the foreign investors and those two expectations are actually quite contrary to each other. So, on one hand we need fiscal consolidation and then on the second hand we need the government pump priming the economy. So, these two are the diverse sort of expectations.

What the government probably needs to do is to find golden mean somewhere in between. What I feel is that while according to the existing FRBM roadmap, the fiscal deficit for the next year is supposed to be 3 percent, I think the investors won’t mind if there is a bit of a relaxation on that and if we see that number moving up to let us say 3.25-3.3 percent. I think that would still be okay in my view.

The other factor to watch out for will be as I said before, the gains that the government would be making on these amnesty schemes, etc. If those gains turn out to be reasonably big, then that would still give the government enough ammunition to put money on the social schemes like housing.
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