Jan 05, 2017 07:08 PM IST | Source: CNBC-TV18

See 20% earnings growth led by financials in FY18: DSP BlackRock

While FY17 earnings growth will be impacted due to demonetisation exercise, we expect a 20 percent growth in FY18 on account of mean reversion in financials and global cyclicals, said Anup Maheshwari, Vice President and Head of Equities & Strategy at DSP BlackRock.

Experts at DSP BlackRock Investment Managers are betting on mean reversion in financials segment to spur earnings growth. While FY17 earnings growth will be impacted due to demonetisation exercise, we expect a 20 percent growth in FY18 on account of mean reversion in financials and global cyclicals, said Anup Maheshwari, Vice President and Head of Equities & Strategy at DSP BlackRock.

Earnings growth will be concentrated around 9 players, Axis Bank, HDFC Bank, ICICI Bank, State Bank of India, ITC, M&M, and Tata Steel which will contribute about 70 percent to the 20 percent overall earnings growth in FY18, Maheshwari told CNBC-TV18.

In FY18 banks, which have undertaken a lot of risk, are likely to return to profitable levels seen two years ago, Maheshwari told CNBC-TV18.   

The market entering a safe zone as the macro situation is tricky, he said. Goods and Service Tax and Union Budget will serve as next macro triggers, he added.

Maheshwari is bullish on pharma and energy sectors, but advised investors to avoid consumer discretionary and industrial capital goods sectors.

Going ahead, Maheshwari said, the conflict between domestic and foreign flows likely to continue in short term, adding that he is hopeful of strong domestic flows from retail investors in 2017. Foreign flows will ebb and flow and we hope not to see a large net outflow at the end of the year, he added.

Below is the verbatim transcript of Anup Maheshwari’s interview to Latha Venkatesh, Anuj Singhal and Sonia Shenoy on CNBC-TV18.

Anuj: 2016 was all about domestic investors staying put while we saw a lot of foreign institutional investors (FII) outflows. What is your sense about 2017, do you see an equally strong year as far as the domestic inflows are concerned and do you think that will support the market?

A: We are definitely hopefully are strong domestic inflows. I think this conflict between foreign flows and domestic flows could remain for little while but net-net we are very positive that there is a very structural change in domestic flows, both from institutions as well as retail investors. I think it is very clear that other options have been challenging. So, it becomes a bit of a circular effect, as the markets do well there is more flow that tends to follow. So, we are hoping that we are in that sort of a cycle for now.

As far as foreign flows are concerned, that will keep ebbing and flowing, but in the last 23 odd years that they have been investing in Indian markets, they have been positive in 20 or 21. So, our assumption is you won’t see by the end of the year a very large negative outflow or anything of the sort. However, in the short run, these flows are conflicting with each other.

Latha: As we step into 2017 you can actually make a negative case. We have been waiting for the second half of the year to give us better earnings for four years now, it has not happened, and now there are more worries that the demonetisation impact could last up until FY18, there are worries that a delayed goods and services tax (GST) will compound that problem and if the NDA were to not make a mark in UP that also would take away some of the political sheen of stability that India has been enjoying. This is the bare case, you agree or can you make a bull case?

A: The macros are looking difficult; there is no escaping that fact. When you have such changes in the economy which are sort of induced upon the economy, then obviously there will be some short term challenges that will come through. So, it is very clear that GST when it comes will cause some short term confusion just like demonetisation has.

However, at the end of the day, the macros are important up to a point but we are more focused on corporate earnings. From a corporate earnings perspective, while the short term obviously looks very unclear because of demonetisation, but as we look into next year, it is quite clear to us also that the base effect will start playing through. Now, you are absolutely right that this is not play through for the last four or five years, but we have reached a point where a lot of cleaning up in banks has happened.

We have actually calculated, if next year more or less assumptions are for about a 20 percent earnings growth, around 70 percent of that 20 percent earnings growth will probably come from about 30 percent of the stocks which is about nine stocks in the Sensex and most of them are banks just reverting back to normal profitability of two years ago and to some extent some global cyclicals like Tata Motors and Tata Steel.

So, just a mean reversion itself will give you a 20 percent growth in one of these years, whether it is 2018 or slips a bit into 2019, we are not sure, but it is coming. Therefore, as you spend more time in the market, the probability of the market going higher starts increasing as the earnings growth comes through.

Sonia: Let us talk about the Budget. We have started this new segment asking all our experts if they were Finance Minister for a day, what would they do. If you were Finance Minister on Budget day, what would you do to tackle demonetisation on one hand and to meet the fiscal deficit target on the other?

A: There is so much, it is not the most envious position to be in frankly, but I think a lot of people are looking forward obviously to some level of tax reform. That is pretty much now a given in terms of expectations. It is very clear that higher taxes aren’t pulling in the numbers; it is very evident. So, hopefully while we are doing a reform of the entire system including GST, we might as well do a reform of income taxes as well. So, we are hoping for that.

I think we would also like to see little more clarity on the whole disinvestment program because that is a big gap relative to what the government should have achieved. So, next year will be pretty important. They have already indicated that they are open to strategic disinvestments, so, that will be another important factor to look forward to. The rest of it is more just oriented around government spending and I don’t think there is a challenge with the ability to spend, the issue is executing that spending. I think that is the bigger challenge.

So, we would like to see how programs are put in place for the government to start spending more to kick start the economy. So, those are some of the aspects I think that will be important in the Budget and I guess the FM hopefully is focused.

Latha: Rephrase it for us, if I were a Finance Minister I would?

A: I would cut taxes; I would spend all the things that market would want to hear typically, but logically within the constraints of the Budget. So, it is quite commendable that they have stayed within the fiscal deficit, but we definitely need the government to actually exercise its view of less government in business and actually implement some more strategic disinvestments or just raise more money to support a lot of the spending that they are planning to do.

Anuj: Apart from the FII selling the other problem for this market has been that there has been no leadership. There were two leaders of the last bull market for six or seven months, banks and consumption, and we saw both of them suffering quite a bit. If we have a start of a new bull market in 2017 at some point, what do you think could assume leadership?

A: Banks would have to play a role because they are one fourth of the market. So, it is quite unlikely you will have a strong move without the banks being involved. So, that is clearly one area.

We are hoping that some of the smaller sectors also will participate. It has to be a more broad based type of move; it can’t be just one sector dominating in this scenario. So, we are quite bullish on the energy space, we are quite positive that pharmaceutical will recover at some point in time. So, there are certain sub sectors, they may not add up too much, these two together make up another 20 percent of the index, but my sense is it will be a little more bottom up and more broad based depending on where the earnings are coming through.

So, banks will have to be an integral part of any future rally that comes through just given their weight. It is still a long term good place to be; there are short term challenges, we didn’t clearly like what they have done in terms of rate cut recently. To our mind it didn’t really add up, but apart from the short term challenges eventually it is quite clear that banks are going to be an important part of the next rally as well.


Latha: Just to carry the interest rate cut point forward, the mean reversion part setting aside, do you think there can be actual growth in consumption? Yes, we are all questioning the nature and the extent of the rate cut but it could still kick off or push up consumption you think? There is low inflation as well there is a seminal cut in rates, can we bank on a very big growth in consumption in 2017?

A: I am not sure there will be very big growth, but I think it will start coming back. Again, there is no denying the long term consumption theme at the end of the day. So, there are some very clear structural trends that are visible which are very nebulous in the short run though because of all that is going around us. However, the fact is, it is a matter of time before these come back.

However, there are leads and lags; I don’t think a rate cut like this will immediately result in much higher consumption. I think it will take some time, but there is no denying that it is a great long term theme. So, maybe not in 2017, but over the next three years, we will definitely see consumption doing a lot better.

Sonia: Would you be concerned about the tax announcements that come in the Budget especially with respect to the Central Board of Direct Taxes (CBDT) clarifications on foreign portfolio investors (FPIs) getting double taxation or even the possibility of the short-term capital gains tax, a holding period being increased from one to three years. Would that concern foreign investors?

A: I don’t think the short-term capital gains tax would concern foreign investors. It shouldn’t concern domestic investors as well beyond a point. If they change the timeframe of short-term capital gains from one to two years or three years, I think that is par for the course. We have, compared to most of the markets, a fairly liberal tax regime as far as equity capital markets are concerned. So, that is something that you just take in your stride.

I think the other aspect, the indirect taxation that they have talked about, that is definitely very retrograde, we think and it is clearly going against what the government has been indicating so far. It is very complex almost impossible to implement so it came as quite a shock for any foreign investor coming in and I hope they resolve this issue sooner than later.

Anuj: One view is that this year could be about companies which have good assets but the balance sheet has been broken and they could give good reward as far as the bottom up stock picking is concerned. Would you agree with that view?

A: There is clearly a global shift away from expensive high quality names into more value oriented names that has being happening over the last six to nine months. It is quite possible when the shifts occur that they will last for some period of time. However, it is very bottom up, frankly. There is no one answer to give you but the value style we think will do a lot of better this year.

You got to look at companies that are able to deliver some degree of earnings growth at the same time, so there could be value but they should have some earnings capability out of that asset. Just asset liquidation alone, I think goes more towards helping bankers than shareholders. The shareholders are always looking at the earnings power of the assets and wherever there is earning growth and value I think that will be a good spot to look for companies.

Latha: You have spoken a lot about value buys and about mean reversion. Give us a number what is your earnings growth for the current year where has it fallen from and what is your earnings growth for FY18?

A: For the current year, we are almost sort of through, so we are not sort of focused on the earnings growth number this year because the last couple of quarters have also disrupted things a lot. So, we are not even trying to really predict the quarter numbers of December and March beyond a point because we are assuming that it will be a lot of trends that are short-term and not necessarily reflective of the long-term earnings potential of these companies. I would rather just talk more on FY18.

As far as FY18 is concerned, currently, we are looking at about 20 percent earnings growth and that is predicated largely on mean reversion in financials. So, the assumption is that we will not have further bad loan challenges and to some extent it depends also on global cyclical.

The nine companies in the Sensex that I mentioned, which will pretty much drive 70 percent of earnings of this 20 percent growth next year, it becomes very important that they mean revert as we expect them to. So, what will take away from this 20 percent number is if this thesis doesn’t play out, but as of now that is what we are going with.

Sonia: You spoke about global cyclical, so wanted your view on some of these auto companies that have a global exposure names like Tata Motors, Bharat Forge, Motherson Sumi Systems, those market have been picking up pace. Do you see more value here?

A: Yes, we do. If you look at our portfolios, we are quite overweight on Tata Motors, for instances. It is part improvement generally overseas but it also again becomes little more stock specific. In autos particularly, you have to focus a lot on new model introductions and how the pipeline looks over the next couple of years. Therefore, from that stand point Tata Motors is showing a fairly strong cyclical potential in earnings change over the next two years relative to what they have shown before. So, you will see some element of that in the auto component as well.

Latha: What are the nine gems of yours?

A: These are largely the banks, its Axis Bank, HDFC Bank, ICICI Bank, State Bank of India (SBI), a lot of them mean reverting coupled with couple of the steady names ITC, Mahindra & Mahindra (M&M), Tata Motors, Tata Consultancy Services (TCS) and the Tata Steel. These are sort of eight or nine of the names.

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