Feb 15, 2017 04:03 PM IST | Source: CNBC-TV18

Sharp earnings recovery, runaway mkt rally unlikely soon: Birla

Market valuations are slightly beyond comfort and with no big macro events lined up, a runaway rally is unlikely, says Mahesh Patil, Co-Chief Investment Officer at Birla Sun Life AMC.

Market valuations are slightly beyond comfort and with no big macro events lined up, a runaway rally is unlikely, says Mahesh Patil, Co-Chief Investment Officer at Birla Sun Life AMC in an interview to CNBC-TV18. He feels it is better to wait-and-watch on investments as earnings recovery is likely to be slow and the implementation of Goods and Services Tax (GST) is round the corner.

Patil also spoke about his outlook on Tata Motors post the auto major’s dismal third quarter earnings show. He believes it would have helped if the management had guided better on the extent of hedging and likely foreign exchange impact. However, he prefers to focus on long-term business performance which could be boosted by new models in the pipeline.

He continues to maintain his positive outlook on consumer discretionary space as the demonetisation effect was not as pronounced as expected. Metals is another sector where there is increasing comfort that prices will remain steady, he says.

On the ongoing spat between the founders and the board of Infosys, he says some of the issues raised are not as big as to impact business. There are bigger worries like the US policies on visa and wages, he says. However, despite the headwinds the sector has the potential to outperform in the near term. 

Below is the verbatim transcript of Mahesh Patil’s interview to Latha Venkatesh & Sonia Shenoy.

Sonia: It is very interesting what is happening in the market, I want to talk about that but before that in some of your key funds you do hold Tata Motors and we can’t take our eye of the way. That stock has fallen post numbers for long-term investors how do they approach a phase like this when a quality company is going through a tough time?

A: Tata Motors again has been driven because of foreign exchange (Forex) and other issues, so one is the operating performance, but also because of currency specially lot of these companies which have got international exposure and wherever you have large hedges which carry on beyond a year I think these kind of volatility could be seen and I think getting a better clarity in terms of how the hedges would play out I think on the management side if there was more clear guidance then you wouldn’t have seen that kind of volatility or disappointment over there. So, I think that is the key reason. I think on the operating side, I think things are pretty much in-line I would say.

Sonia: Would you sell the stock, would you hold it or would you get a bit perturbed with what has taken place?

A: Clearly, the near-term because of the uncertainty around the forex side and some of the extra ordinary expenses there is probably a cut in the expectations what we had for next year. But, that doesn’t really change our longer term view on the company. I think in terms of the business side and in terms of their new models what they are putting in, so those are factors which we would look at rather than looking at the quarterly or short-term impact because of currency hedges when we are taking a view on a company, Tata Motors or any other company for that matter.

Latha: The earning season ended yesterday what is your overall comment? Is it below par or was it better than expect?

A: Looking at the fact that we had demonetisation as one big event which impacted Q3 earnings and if you take that into consideration then the earnings were fairly okay, in fact in certain cases it surprised positively, because I am not comparing the numbers but post demonetisation if we were to sit down and really cut down earnings on a lot of names especially on the consumer discretionary side, the numbers were slightly better than expectation.

I think on balance, the impact of demonetisation was not as great as what one was expecting and there are couple of factors to that. One is that many of the larger companies were able to really manage it much better, provide more credit to their whole chain and probably there was a shift from a bit from the unorganised to the organised sector where the organised players did much better especially the retail, the modern trade benefited a lot because that is where a lot of people who didn't have cash to transact, so that was a big beneficiaries that we saw in this quarterly numbers.

However, even the metal numbers were very strong on the back of strong prices on the metals front. So, there were couple of pockets of surprises.

On the banking side especially the corporate banks, I think while the stress level having gone up but the resolution is taking a lot of time over there, so there is a slight disappointment on some of these public sector undertaking (PSU) banks or the corporate banks otherwise by and large numbers were pretty much inline or I would say better than the expectations.

Latha: I wanted to ask you about the result season not necessarily in terms of topline numbers. How does it change your mix of stocks? Are you therefore going to buy more consumer discretionary where you didn’t notice any weakness or will you in fact buy two-wheelers where you expect a bounce back how have you respondent to the results in terms of your preferences?

A: Getting into the earnings season we were more overweight on some of the domestic consumer discretionary names. We couldn’t react much post the demonetisation and looking at the impact hasn’t been that great because of pure demonetisation. I think we will continue to really favour that sector. What has helped in the ensuing months has been that - a) interest rates have come down further so that helps in terms of consumer discretionary demand pick up, your mortgage rates have come down so that means a saving for the end consumer over there and b) by and large the Budget also, if you look at the thrust on the rural and agriculture, I think that is where the agriculture demand, rural consumption will pick up going forward. The rabi season also has been pretty good. People were sceptical because of demonetisation whether you would see some impact over there, so there the sowing has been fairly good around 6 percent up. So, putting all these factors together and the longer term secular trend in that space looking at the under penetration and the overall levels, this looks to be sector where longer term you could see secular kind of a growth and one needs to be positioned over there.

However, beside some of the other changes in our stances would be on the metal space. We are getting more comfort that metal prices will remain steady because initially after these sharp reflation in the metal prices which we saw in the last two or three months looking at how China growth is panning out, it looks to be much more stable now after the government has clearly inched up its push overall credit growth in China has been pretty good and also a possibility of US fiscal stimulus aiding the growth. But, more importantly on the supply side we have seen severe curtail on the supply because a lot of capacities have shut down. So, I think metals looks to be steadier at least from a medium-term perspective. Longer term I think still we are not so bullish on metals because we don’t see a commodity super cycle beginning, but from a medium-term that sector looks good.

In the oil and gas sector again where we have seen a good earnings coming through specially refining companies and the outlook on refining margins for this year also looks to be fairly good. So, these are the two sectors where again not exactly post demonetisation and quarterly numbers but incrementally where we are slightly more positive than what we were earlier.

Sonia: I wanted your thoughts on Infosys because you have a relatively high weightage in your two funds – you do have Infosys. What have you made of this full boardroom battle? Does it really affect an investor because Vishal Sikka is still here to stay?

A: We have seen the boardroom battle and we have seen both the sides presenting their case. It doesn’t really impact. I don’t think some of the issues are really as big as it should really impact their businesses over there. I think there are other issues which probably need to be looked into especially in the IT sector in terms of what is happening in US in terms of visa cost. After looking at all those factors we think that the market is probably over estimating the impact that it will have. In this sector we have seen good underperformance now for last one year. The expectations are fairly low in terms of the growth rates and so I think looking at the free cash flow generation some of these companies doing, the valuations are more reasonable.

If the markets are not likely to give any kind of a strong returns this sector can still give you around 10-12 percent kind of return from these levels without much of a downside. So, given that we are very neutral on this sector, we don’t see it but there is potential for the sector to outperform in near-term looking at the underperformance and if there is more clarity on some of the visa issues and the impact is not likely to be as great, I think you could see some potential re-rating also from these levels. So, that is the kind of a view we were taking on the sector, not overtly bullish but tactically risk rewards looks favourable at this point in time.

Latha: My sense is you fund managers have that view on the overall market as well. For the last five days we are seeing domestic institutional investors (DIIs) selling at higher levels, is there some discomfort or at least not enough comfort to buy at 8,800?

A: I mean the daily flows, one can’t teeth into it but we have seen a good rally in the market, probably not driven so much by fundamentals, I would say partly I think the numbers were not as bad as we expected early because of demonetisation impact. The liquidity has been fairly good. So the markets have been driven by liquidity flows, valuations are slightly on the higher side than what one would be comforting and even in next couple of quarters we are not seeing any sharp recovery in the earnings front. We will see a slow pickup over there.

However, we have goods and services tax (GST) again coming in sometime in July first or latest by September, so that will also be a moment for the market or for the earnings where there will be some readjustments which we see. So, that is a timeframe, so we are not seeing a runaway rally. So we will take our time really to pick stocks. I think it is going to be more stock pickers market at this point in time because there is no big macro trend at this point in time in the market. So when you are really looking at stocks, you would want to wait and see the appropriate price and then invest into the market.

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