See 20% earnings growth for FY18; market to climb wall of worry: Enam Holdings

As equity benchmarks climb to fresh record highs, skeptics have raised concerns on the fundamentals of the rally and whether earnings growth will see a pick up or not.

But Enam Holdings is upbeat on earnings and believes that they will grow 20 percent in the next year as interest rate transmission will help. Results in the previous quarter (Q3) weren’t bad either, Sridhar Sivaram, Investment Director at Enam Holdings told CNBC-TV18 in an interview. In fact, earnings going forward will surprise the Street.

“There are good times ahead…the market will continue to climb the walls of worry,” he told the channel.

A wall of worry is used to describe the financial markets' phenomenon of periodically surmounting a host of negative factors and keep rising. Generally used in connection with stock markets, Investopedia says it refers to their resilience when running into a temporary stumbling block, rather than a permanent impediment to a market advance.

Sriram further said that the Indian market was catching up with the upsurge in emerging markets and that it had underperformed EMs last year.

Speaking on risks to the market, he felt that monsoon was always over-emphasised. He highlighted a few years which witnessed poor monsoon, but the market had performed well. On crude, he said that the key risk is from events outside—geopolitical or developments in the US. "Also, rupee has appreciated and that helps our inflation," he added.

Sridhar said he is bullish on cyclicals against defensives space and saw opportunities in infrastructure, construction and capital goods.

He also said investors should be be wary of concerns in the microfinance (MFI) business. "Bad loans have gone up and the market has ignored credit rating warnings," he told the channel. Private banks will still benefit and some selective public sector ones as well. Overall, margin financials must be played selectively, he said.

Sridhar also saw pent-up demand in consumer discretionary space. As this plays out, we will see capex coming in, he added.

Below is the verbatim transcript of the interview.

Latha: You have been cautious, obviously because earnings have not shown what the market is expecting. What would you do now, the market continues to surge on liquidity despite valuation challenges?

A: We were very cautious till last year. During demonetisation, when we did our ground check, what emerged was that the ground reality was slightly better for the listed space, the organised guys, and not so good for the unorganised guys. So, we actually turned our views somewhere at that time.

Our view currently is that as Sonia mentioned that this market will continue to climb wall of worries, and as it turned out that FIIs and domestics entering the year were positioned very badly -- FIIs sold out during the demonetisation period, domestics were getting a lot of inflows but were not putting in the money because of various issues including fears of what will come in the Budget. As a result, the positioning of the market was very bad.

So, one, we think the earnings were not as bad. So, if you see the actual results of the previous quarter earnings, were not as bad. We think the earnings going forward will surprise people. So, we are very positive on the market and we think it is time to stay long.

Latha: As early as Q4 earnings could improve?

A: Our view is that next year we will see a 20 percent earnings growth and a large part of that we think is because of the interest rate transmission that is finally happened. We met possibly 50-100 companies in the last three months and it has been a unanimous view from everyone that finally they have seen transmission and just not small transmission, it is like 100-250 basis points depending on the credibility of the company.

Our calculation shows that a 1 percent transmission, leads to a 10 percent earnings growth for the market because if you see a rough math, total corporate credit is about 40 trillion and 1 percent of that is 400 billion. The corporate profitability pool total is about 4 trillion. So, 400 billion profit more that the industry gets purely because of 1 percent change. Now, this is a very simplistic calculation; not everybody gets it because there are cash rich companies and there are companies which are poor, but that is the broad math. A 1 percent reduction in interest rate will result in 10 percent profit growth.

This is also because India’s corporate profitability to GDP is at a 10-year low. So, this is also because a corporate profits over the last three to four years have not grown. So, it is a combination of factors. So, we think that interest rates itself can give you a 10 percent boost to earnings and the normal profits that you get, will be around 10 percent. So, you could end up with a 20 percent earnings growth which I think will surprise the market.

Anuj: This 20 percent will of course come on low base, for the market important point would be the CAGR. Have you done any analysis on what we can have on that front?

A: When you put these things on spreadsheet, there are companies which could have really absurd earnings growth because when I said 1 percent, 10 percent, there are companies where the profit is so low that when you save something on an interest cost to this extent, the actual impact on the profitability is quite absurd. You can’t even put it and I don’t blame, the analysts can’t even put it on the numbers.

So, we think there is enough surprise waiting to happen for next year and which is why we are slightly more bullish on the cyclical part of the economy right now that there have been a lot of work that has gone on the cyclical side be it on the roads, railways, we keep complaining that we haven’t seen anything on the ground. These things take time, so, we are almost three years for the new government and as we speak to people on the ground, the impact of that is being seen. So, we think that we will see some of the benefits even of that as we go into the next year.

Sonia: I haven’t heard you as optimistic as you are now in a very long time, but I am just going to play the devil’s advocate here – couple of issues, monsoons – there is a bit of a fear this time, crude is spiking up now because of some geopolitical risk, you think those are just issues on the margin and will not affect the market as a whole?

A: I think monsoon as a factor for the market is always over emphasised. The net result has not been so great for the same year. So, you go back in history and check 10 years and you see drought years, and see what happened. There are many years when you have had very poor monsoon but markets have done well. So, there are many other factors in play.

I also think that last year when we had poor monsoon for many years, many of the states have done a lot of work on the ground to improve the ground water level. In fact desilting of some of the lakes. Maharashtra and Madhya Pradesh in particular have done a lot of work. I think because of the lot of the good work, even if there is a poor monsoon, the feedback that we get from on the ground is that we will see through this year because last year was such an outstanding rain and they have done so much work around ground water conservation that we may not have such an impact.

As far as crude is concerned, if there is a risk to the market is a risk from outside. Geopolitical risk or something that happens in the US or something like that. However, keep in mind that currency is appreciated, that helps our inflation. So, it is a double edged sword, but I think on the ground what I am seeing right now, there are more positives than negatives and there are more skeptics than optimists. So, I think at the balance, when you see everybody euphoric, you know something is wrong. This rally I think most people have missed. So, I think there is always reason to say that earnings haven’t come, this will not happen -- I think that good times are ahead.

Latha: You are clearly making an argument for cyclicals with your interest rate.

A: Domestic plays predominantly.

Latha: What would that be, let us start with the financials which are obvious cyclical plays, which sector would you still go with NBFCs or would you go with only private banks or do public sector banks deserve a look?

A: The first is I will give a warning that I am seriously concerned about the MFI business. So, if you see ICRA has downgraded Janalakshmi and I don’t think people have taken note. Their NPAs have gone from 0.7 to 11 percent from November to February.

Latha: So demonetisation impact maybe?

A: It is a demonetisation impact. Keep in mind that microfinance is sub-prime lending, people forget that because you had such good NPA performance or the credibility of this sector has been so good that people forget that this is sub-prime lending. When you get a systemic shock that is the most dangerous thing that can happen. What we hear is there are problems in five states which includes UP, Maharashtra, Karnataka, Tamil Nadu, and Bengal. Now, that is a fairly large number in terms of the impact that will have. So, I don’t think any of them will escape this.

Some have come out already like Bharat Financial, Janalakshmi because the credit rating has downgraded, Crisil has had issued a warning. I think for whatever reason the market is ignoring credit rating warnings, I am a bit surprised because that is the biggest warning for me when a credit rating wakes up and downgrades. So, that is the warning part on this.

However, the good part is that the private banks, I still see that they will benefit and selectively on public sector because some of them have taken so much of haircut and provisioning that we could see some write back. We saw early signs of write back, and if the economy does turn even little bit, we could see some benefit. Some effort is happening but it is like two steps forward, one step backward. The IDBI incident did not help the whole cause, so, I cannot say that everything is great, but at the margins, financials is a place to play selectively.

Anuj: Would you go with companies which have assets, have decent EBITDA but the interest cost is taking most of that away?

A: That is a very dangerous path to go but a lot of opportunities are there which is if companies are deleveraging and you know that the management is serious about it, and the business is also looking up, and so you have three factors, one is the deleverage factor when they are selling assets, the other is falling interest rates and then the business itself looking up.

Anuj: Like steel for example would be part of that?

A: I would say commodities. There are selective pockets in steel but there are interesting options in commodities, in cement, in construction, in capital goods, chemicals in some of the cases. We are seeing a lot of opportunities here where some of these factors are playing out and the impact on earnings is going to be disproportionate for FY18.

Latha: Yesterday we spoke to Sobha Developers, and for the first time we got a ground report of how the Awaas Yojana could genuinely mean a lot of buyers for that Rs 10-15 lakh category of houses. Is that a theme you believe and how will you play it?

A: I had an opportunity to speak to the National Housing Bank (NHB) chairman also. I think this is an outstanding scheme because one, they have not restricted, this is not a restrictive scheme. This is an open ended scheme. Even though the provision in the Budget only said Rs 2,500 crore, in my view the government will need to budget for Rs 30,000 crore because if you see the run rate on this, roughly that is the math.

So, a person who is taking a housing today, gets an upfront benefit of Rs 2.5 lakh and from what I understand, this goes into his account. He could actually use it for any purpose. So, it is not restrictive as if it has to go into the loan account itself. So, it actually gives him the benefit to use that for some other purpose. So, this is a subvention that the government is giving and it will benefit people in the smaller towns because Rs 18 lakh and the maximum loan you can get is about 3-3.5 times your salary. So, the cap is the salary, not the value of the property. So, 18 lakh into 3, so roughly about Rs 70 lakh odd is the maximum property price, Rs 70-80 lakh, suppose you are also putting Rs 10 lakh of your own, but that is a fairly decent amount for any property outside Mumbai and Delhi and you are going to get Rs 2.5 lakh back so almost like a subvention that you are getting into your account. I think it is a brilliant scheme.

It is restricted only for the current year, keep in mind that real estate has a disproportionate impact on employment, it generates a lot of employment. So, I think this is a very well thought out scheme. I don’t think the markets really appreciated the impact of this and I am not even counting all this. When I talked about the 20 percent earnings growth, I am not even speaking of some of these schemes that the government has launched. I think this is a brilliant scheme.

Sonia: You did mention that you like infrastructure capital goods. After a very long time, I think after one or two years I am hearing a lot of experts talk about a pickup in the capex cycle. Have you had any or seen any anecdotal evidence of a real pickup in capex?

A: Very early signs. We do think that there is pent up demand in consumer discretionary. We saw that with the last two days of the year when there was a steep discount and you yourself have carried some stories on that that everything was sold out. So, there is a pent up demand as far as consumer discretionary is concerned and as this pent up demand plays out in the market, we will see capex coming.

We are seeing early signs of capex. Keep in mind that when interest rates do fall the way it is for the corporate, it does help him to think about the next capex because we have been talking about this poor capacity utilisation for three years. Some of them have got utilised as we speak. So, most promoters would have to think about the next capex at least 18 months before they actually need it and we are seeing early signs of that.

I won’t say that this is really -- everybody is putting up plants right now but we are seeing early signs. As you said, the markets climb wall of worries, this is one of the worry that people have that capex cycle is not picking up. However, on the ground things are happening; when the markets are up another 10 percent that time most people will come and say capex cycle has picked up.