Speaking to CNBC-TV18 Sanjeev Prasad, Senior Executive Director and Co-Head of Kotak Institutional Equities, said that recovery may not continue as valuations are on the higher side for a lot of stocks.
This is a reversal of the big trade one saw on passive buying at the end of June and October which were led by market expectations for loose monetary policy, he said.
The gross margin story that was valid for auto in the last two years is no longer relevant. We have to rely on core volume growth which is a challenge given all the challenges now, he said.
He is still upbeat on the banking sector. A few oil and gas names are inexpensive, he averred.
“I think we can still make a portfolio to make absolute gains,” he said.
Consumer staples won’t see a lot of downgrades, he said, adding that impact will be felt in consumer durables and auto for the next 2-3 quarters. Pain for the commercial vehicle space will be prolonged, he said.
Real estate sector will hurt from the demonetisation drive and will most likely see pain for 5-6 quarters.
Below is the verbatim transcript of Sanjeev Prasad’s interview to Latha Venkatesh & Sonia Shenoy on CNBC-TV18.
Sonia: Things have changed a lot in the last couples of days; the market seems to have taken the demonetisation scheme in its stride and has recovered quite a bit. Do you see this recovery continue?
A: I don’t think so. For the simple reason valuations are still on the higher side for a lot of stocks in the consumer staples, in the consumer durables, building materials, construction materials. This is basically just reversal of the big trade you saw on passive buying between end of June and end of October, which was entirely led by the market expectations of a very loose monetary policy of Central Banks, which continued for some time that way it has started to reverse basically now.
This is little bit of a switch over here from the large amount of passive flows that you saw in all emerging markets (EM) basically on the post Brexit trades. If you look at for the six major markets for which you get daily foreign institutional investors (FII) inflow and outflow data something like USD 23 billion came in the September quarter about USD 10 billion has gone out in October and November, so we have still a long way to go.
Also, if you look at global yields just because yields are gone up in US from a low of 1.5 to somewhere about 2.35 now that doesn’t mean the situation has normalised as far as global yields are concerned. If I look at long-term average we are way away from there. The re-rating story which everybody was playing based on low global yields that is over; gross margin story, which at least last two years was valid for section in the market, which is automobiles and consumer staples and durables even that is over.
Now we have to rely basically on core volume growth as far as Indian market is concerned and that is going to be a bit of challenge given the fact that gross domestic product (GDP) is not going to grow very faster given all the changes, which we have seen in economy in the last one month or so.
Latha: Therefore are you selling out of something? Are you expecting a protracted pain, earnings cut, rejigging your portfolio to get out of something?
A: No, we were never in the rubbish names anyway. Basically, lot of quasi comedy companies’ people have started valuing them as branded company and what not. A lot of rubbish things were going on in the markets. So, anyway we were never very excited by those names.
There are still a lot of money making opportunities. The banking sector is still fine; more so the cooperate banks where we have been slightly more positive over the last three-six months, oil and gas names are still inexpensive -- regulated utilities which logically benefit from a lower interest rates we are still positive on them.
So, we can still make a portfolio to make some absolute gains. However, I don’t think one should be relying on the macro trades which were basically what was going on for last five-seven years and that has just faced reversing and it just reversed a little bit and people already sort of feeling so much of pain.
Sonia: You don’t seem to be in the best mood this morning; you have quite a pessimistic view?
A: Look at it this way, I mean what pessimistic? It is just a reversal of a nice trade which was going on. Yields are corrected significantly on the back of very loose monetary policy that is it. You have to be realistic about life.
Sonia: How do you see the consumption theme play out because over there we have seen all of the consumption stocks fall about 15-20 percent since demonetisation was announced? Nobody knows what the numbers could look like; we will get to know starting today at least about auto sales. Do you fear that there could be a lot more earnings cuts in spaces like auto, cement, paints etc?
A: It depends on sector to sector; if you are looking at consumer staples for example I don’t think you will see a lot of downgrades. In fact you will probably be limited to a few weeks over there. If you are looking at consumer durables and autos depending on again which segments you are looking at the impact could be on an average of about two to three quarters over there.
I think commercial vehicles (CV) impact will be a long more lasting because a lot of freight operators will have to review their business models whether they want to continue the old way of dealing in black, in cash or whether they want to become part of the formal economy which means the freight tariffs have to go up and it is not easy to raise tariffs at a time when demand environment is not very conducive anywhere.
Lastly, also because goods and services tax (GST) coming in may be not in April now -- sometime in October 2017 -- people will push their buying deficiency to a post GST environment when you will probably have better fleet utilisation. So, it depends on sector to sector.
Real Estate related sectors, the pain will be a lot more prolonged. It could be as much as five to six quarters. As you said many of the stocks especially a building, construction materials somehow people have started valuing them as branded businesses, giving them 30-35 price to earnings (P/E) which honestly never made any sense to me. If there is a correction there, it is rightly so and these stocks have ultimately have to settle somewhere down the high teens, low 20s kind of P/E. They are still trading at very high valuation; You still have some way to go as far as some of the stocks are concerned.
Latha: We were just getting around to the view that the demonetisation impact on daily life hasn’t been all that bad in daily life -- vegetables, milk everything has been arriving on time so, economy but for people having to stand in lines in bank seems to have chucked along and yesterday’s gross domestic product (GDP) number were very positive as far as the consumption growth was concerned. So, pre-demonetisation, consumption wing appeared to be recovering so maybe it will recover quickly after the demonetisation cash crunch is over you don’t think; at least some part of the pain, some part of automobiles, consumer durables don’t look good to you?
A: That is what I said, there is some amount of buying of consumer durables and automobiles which was done by the salaried class so that is fine which could be the 70-80 percent of demand. However, there will be about 20-30 percent demand, which could be by small businessman, manufacturing trade services where these people will have to take a call on the business model itself whether they want to continue operating in cash and being part of the informal and black economy or whether want to become part of the formal economy.
It is a big reset moment for lot of people in black economy, so I don’t think as of now the immediate priority is to buy a motorcycle or four-wheeler. The immediate priority is to settle their finances, rethink their business models completely and the whole focus has to be on that over the next two to three quarters. We will definitely see some amount of that demand disappearing for the time being and maybe coming back over a period of time.
Sonia: You mentioned that there is still some opportunity to make money in the banking space. What about the non-banking financial companies (NBFCs) over there we have seen quite a bit of an impact but now there is some recovery in NBFC names -- like Bajaj Finance, Bajaj Finserv do you think that they still portend an good buying opportunities?
A: Ultimately, you have to look at everything in a context of valuations. Look at where the stocks run up to in the last six months. So, it is just a minor correction to be honest in some of these names. Nobody was complaining when the stocks were moving up that is a beauty of our market. When the whole trade was on passive flows coming in, yields were going down everybody was celebrating everybody thought they are fantastic fund managers and analysts and what not. Now there is a little bit of correction everybody is starting to cry about demonetisation and what not.
There is a little bit of a correction. NBFCs some of the business models have got exposed given the fact that many of them are operating in areas where the SME segment etc will start feeling some amount of pain given the fact that some of them are dealing in cash being part of the informal and black economy. So, those things are probably going to have a much more long lasting impact compared to may be something like consumer staples where the demand will probably now come back in a few weeks times.
So, NBFCs, I would most stay away from them barring the mortgage space and that too thinks like LIC Housing Finance which primary caters to the individual mortgage segment and that to bulk of the lending is to salaried class. Other NBFCs, I still think there is some pain still out there.
Latha: To the best of my knowledge, you are one of the best players of the oil trade. Now should one get out of Bharat Petroleum Corporation Ltd (BPCL), Hindustan Petroleum Corporation Ltd (HPCL) and embark on all the oil related positives Oil and Natural Gas Corporation (ONGC), Cairn India or the gas related stocks, if you could take us through your picks there?
A: Not necessarily because honestly what changes for BPCL, HPCL, Indian Oil Corporation (IOC) because crude prices have gone up by USD 5 per barrel and even if they go up another USD 5 per barrel these guys will pass on the higher prices to consumers. What option do the consumers have but to pay for higher prices? So, I don’t think much changes over there, but IOC is still a very cheap stock, a company which we continue to like. Just for the valuation of all the investments of IOC the stock is available at about 8.50 times the March 18 PE which looks pretty reasonable to me. One can still make a decent amount of money over there.
As far as oil and ONGC is concerned, my worry is even if I assume USD 55 per barrel crude price longer term, stocks seems to more or less discounting that USD 85 per barrel crude prices 10:07 unless and until crude prices rise significantly beyond that, I don’t think there is much money to be made over here. Remember stocks have done very well over the last few months anyway.
Lastly coming to the gas play something GAIL we continue to like. We are pretty positive on GAIL and Petronet LNG for any way for fairly long time. If we look at the valuation of GAIL -- it is still trading at, if we adjust for again the value of all the investment in various gas businesses and ONGC it should be available at about Rs 300, about 32 earnings per share (EPS) adjusted for a dividends from investments still available at a 10 times in the March 18 basis, so still looks attractive to us.