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Oct 11, 2012 01:24 PM IST | Source: CNBC-TV18

Earnings to be sluggish, S&P downgrade risky: Arvind Sanger

Second quarter earnings are unlikely to bring any good tide to the Indian market. Growth has been tepid this quarter while companies struggled to beat the recessionary pangs.

Second quarter earnings are unlikely to bring any good tide to the Indian market. Growth has been tepid this quarter while companies struggled to beat the recessionary pangs.

Not so positive on India Arvind Sanger, Geosphere Capital Management is concerned about the problems looming large at the Indian economy.

Also Read: Nifty to hold 5600; buy liquid largecaps on dips: Edelweiss 

In an interview to CNBC-TV18, he said that "If the euphoria does continue to wear off both in India and on a global basis there is no reason you couldn't get in India (particularly for us looking from an overseas investor) another maybe 3-4 percent weakness in the currency and another 5-6 percent weakness in the market."

Sanger adds that second quarter earnings will continue to remain sluggish while moderate improvement is expected only in December. He is expecting for a meaningful upturn in earnings in the next calendar year as implementation of reforms will be key driver of further upside.

According to him, S&P downgrade still remains a risk factor for Indian markets.

Below is the verbatim transcript of the interview

Q: What is your take on what you have seen on the global screen for the last few days? Do you think there is an air of correction in global markets now?

A: It clearly looks like the markets are taking a breather, not just in India but in global markets too. A little bit of it is some of the massive rally we have had on a risk-on mode on a global basis, a little bit of a correction on that. But, some of it is India specific because the dominant news in India over the last few weeks leading up to this week has been about all the actions being taken by the Finance Minister to implement long awaited reforms.

Also, the news flow in the last few days has started to switch back to the claims of a scandal on the part of the corruption kind of watchdogs, some of the third party or independent people who have been raising the flag on that. That again raises concerns, whether or not the government is going to get little derailed on its agenda as well as how many more skeletons might keep coming out of the closet which might create impediments to decision making.

Q: What could be the extent of a pullback if we indeed get one in the month of October?

A: If the euphoria does continue to wear off both in India and on a global basis, there is no reason you couldn't get in India another maybe 3-4 percent weakness in the currency and 5-6 percent weakness in the market.

So, basically in the US dollar terms, you would look at it as you could easily get a further 10 percent correction without any meaningful major risk off in the global markets or any major disaster in Indian political situation in terms of government falling or any such significant issue which would be a much bigger deal.

I am just talking about the normal course of if this correction continues. I am not saying that is the central case, but that is certainly one of the probable cases.

Q: Earnings season has not begun very well in the US. What do you expect to see through this earnings season from an Indian perspective? What impact may it have on stock prices?

A: I am not sure we watch the earnings on a macro basis to tell whether earnings are going to be down overall for the markets, up 5 percent or up 10 percent or wherein single digits the overall earnings would be. But when we look at many of the companies that we track, clearly earnings will continue to be sluggish. The estimates have come down sufficiently to where I am not sure there is going to be massive negative surprises. But risks to earnings are more on a moderate negative surprise and a moderate positive surprise, because nothing that has happened in the last few weeks is at all going to be helpful for what happened in the September quarter earnings.

So, whether this is the low point in earnings or whether earnings continue to stay sluggish in the December quarter, I think the jury is out. My sense is that this could be the low point in earnings growth and we may see some very moderate improvement in December. We are kind of in the trough phase and hopefully moving a little bit ahead of it in the next quarter.

Q: If you do believe that earnings are close to bottoming out now, by when do you expect an upturn?

A: For an meaningful upturn in earnings, we would have to wait till calendar 2013 and either the March or June quarter, by which point you could get some of the business confidence coming back. If the RBI does something on the rate front, that could help some consumer confidence.

Some of those things could earnings to benefit from a better economic environment. But I don't think anything meaningful is likely till March quarter at the earliest.


Q: The announcements of September from New Delhi have been received very well by the market. But now, the focus seems to have shifted to implementation and the ability to actually get those policy issues to work. Do you think that process might be challenging?

A: I think that is always the challenge in India. I heard some of the senior corporate official make the comment that India has one of the highest talk to do ratios in the world. Unfortunately, the challenge right now is going to be, if all the talk and all the policy pronouncements be converted into actual action on the ground. Some of it will involve government implementation, some of it will involve actions which give business a little more confidence to move forward. But I think when I talk to corporate executives, while there is a moderately higher optimism on the investment climate in India.

There are still concerns about the ongoing corruption investigations which makes decision making tough. It makes them more nervous about doing anything. So, whether it is from a corruption standpoint or it is from an availability of land or other infrastructure bottleneck standpoint, I think implementation is extremely important without which we will get some moderate benefit. But meaningful improvement will have to await that. So, I think that is the critical challenge. One of the reasons why the markets are not going to go straight up is over time you are going to have to see some follow-through.

Q: Post the recent rally that we have seen, are there any sectors where you feel valuations still have some room for a catch up?

A: One of the sectors that have become more intrigued in India in the last few weeks is the energy sector. One of the things that we are hearing, although there has been much talk so far about reforms, is that the government has been guilty of not allowing companies to proceed with exploration or providing a backdrop which would encourage more oil and gas production. Companies like Cairn which has been awaiting approval on developing further in their existing field new zones above or below the current producing zones, that kind of a hold up has not made much sense. I think there have been some suggestions that things like that can get resolved and things can move forward on that front.

The other area which is of interest to us is what happens to natural gas prices for all the gas producers like Reliance Industries and others, post March 2014. Again, there is a lot of debate on what kind of price is fair. But the reality on one hand is that people like Reliance are realizing USD 4.20. On the other hand gas is being imported from other places where the foreign producers are selling gas into ships. They are selling gas at their wellhead to be exported to India at USD 8 plus. So, hopefully some middle ground does emerge on that. Therefore, we think there is some value in the entire oil and gas space because more rational pricing and more rational policy could result in some exploration upside which is not completely dead in our opinion in India.

Q: PSU banks have rallied significantly from the lows. Are asset quality issues factored in and close to bottoming out?

A: I think that PSU banks have clearly benefited partly from an improving climate, partly from the bailout of the State Electricity Boards. So, in that sense they are in little better shape. But I think clearly there is optimism built in that some of the other problem areas like the power sector and also the overall economic growth which will help some of their other problem areas not coming through. There will be more policy action that will promote positive outcomes on some of the power companies as well as some improved growth outlook for India overall preventing new areas of problem developing.

Obviously, one other area, FDI in airlines would help if somebody does choose to put money into Kingfisher Airlines. So, I think some of the optimism is justified, some of it is a bit of show me. I am not sure that at this point PSU banks are expensive. But I think they still have headwinds and there still needs to be some resolution in the power sector and with Kingfisher in the airline sector. So, we are ambivalent on the way we go from here.

Q: What about infrastructure? We have seen some good rallies play out in names like L&T, BHEL. Do you think it is justified by fundamentals?

A: There is a big if at the end of that question. That big if is - if reforms are implemented. I would say at this point, stocks like L&T, BHEL which are dependent on infrastructure/power investments have had decent rebounds. Maybe a little ahead of themselves, in terms of how long it will take for any reforms to be implemented to start resulting in meaningful capex cycle improvement. So, at this point I would not be jumping on that bandwagon and I would be a little cautious.


Q: What are your expectations from Reliance Industries earnings this quarter around?

A: I don't have a specific view on a specific company. So I don't have any specific view on Reliance's earnings. But I will say that refining margins have been strong in the last few weeks and months. So, obviously that should benefit Reliance as well as any other refiner. Beyond that, I would rather not comment on a specific company.

Q: How are you reading the rupee? As a global investors that’s important for you. Do you think its up move is done for the moment?

A: The rupee had a sharp rally. It had gotten as weak as 57 and then was hovering around 55-56. After all the reform measures announced and all the policy actions by the government, it dipped below 52 and has subsequently weakened 2-2.5 percent. It is now back towards 53 levels. We think part of it is obviously going to be driven by global macro factors, part of it by India specific factors. But I don't see the rupee strengthening significantly beyond the 51 level, maybe 50.

But beyond that, we don't see the fundamentals of India's GDP growth or inflation suggesting that rupee can strengthen more than that. The risk on trade benefit to rupee is largely with us and maybe we will have a new range. Maybe, the new range is 51.50-54. That will be the range again barring any global external shocks or anything meaningfully different happening within the Indian environment.

Q: What are the key risks according to you to the current rally in your eyes? Do you see politics posing a challenge?

A: I guess I am more afraid about politics in general posing a challenge. You have several factors. You have the Comptroller and Auditor General (CAG) continuing to create political pressures for the government. Unfortunately, it seems like the understanding of economics either on the Supreme Court or CAG is not what I would consider particularly stellar. Neither would I consider Indian public's understanding of economics very stellar. They all understand corruption. That seems to have become the singular focus. So, any action taken by the government now gets looked at under the filter of who is making money out of this. It makes it difficult for the government to do anything and not be questioned.

Unfortunately, you can’t really say that the corruption focus of the public is completely unjustified. There are plenty of skeletons in the closet. So, my big concern is, is this corruption focus going to sap energy or sap the political will or the political support for the government to be able to take some of the policy actions necessary and whether the coalition partners will peel away or will support the government and what kind of horse trading will they require to accomplish that. As I have said several times in the past, I do watch Indian politics closer and I probably should, but I have no great expertise on understanding on how things will play out.

Q: What is your expectation from your conversations with peers on whether the strong flows that we have seen in September can continue into India?

A: India has had the benefit. Just when you had quantitative easing from central bankers in the west, India showed up with its basket of policy actions. So, the timing was absolutely perfect. That certainly helped inflows into India. One of the risk factors that I did not mention earlier is - there still remains a looming concern whether or not the rating agencies are going to be looking at downgrading India's sovereign rating. That is another risk factor, both for the rupee and inflows, certainly from the debt side.

So, that is one risk factor that we have to keep an eye on. Other than that, there are global factors where the risk of a meltdown in Europe and US is off the table. But that does not mean that there will not be mini crisis along the way. Clearly, one of the crises going right now is that Spain is unwilling to ask for a bailout and their political face-saving involved and trying to push that. There is some election in Spain coming up. The Prime Minister does not want to ask for a bailout right now. So, you could have some market nervousness, but I think the market nervousness is well contained in the bond market. The bond market hasn’t sold off much. But those global risks could affect inflows into India.

The other thing that could affect inflows is if we could get positive policy actions out of China. Then you could have some money go in that direction. So, there are factors that could drive inflows to reduce either on an absolute or on a relative basis. I must give credit to the Indian government for showing signs that they are not done with their policy actions. Again implementation is one thing, but in terms of at least announcing actions and trying to push the agenda forward, if the government continues to do that, then I think the inflows notwithstanding other factors will continue.

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