Feb 18, 2013, 09.15 AM IST
Tushar Pradhan, CIO, HSBC AMC, says that this earnings season saw a mixed bag; there were some unexpected positive surprises and disappointment as well. However, earnings towards the end of the season have really disappointed.
The equity market has been growing weak for sometime now but still foreign institutional investors (FIIs) are not shying away from the domestic shores. According to FIIs, among emerging markets India still holds the potential as it gave one of the highest returns on equity (RoEs) last.
Tushar Pradhan, CIO, HSBC AMC agrees that India is still an attractive bet and current valuations are not at risk. He, however, is not expecting another blockbuster year.
"This earnings season was a mixed bag, companies which were expected to disappoint performed slightly better and vice versa. But earnings towards the end of the season have really disappointed," says Pradhan.
Below is the edited transcript of his interview to CNBC-TV18.
Q: What is your view on the earnings season over the last 10 days? There seemed to have been more disappointments than hits from large caps and midcaps?
A: A general continuing trend that we have seen is that, companies who are performing well tend to report early and companies which comes later have a lot of pressure. I think this earnings season was a mixed bag, companies which were expected to disappoint performed slightly better and vice versa.
We thought the pain the banking space was over in the last quarter but we saw some disappointment. Right now, we are seeing marginal disappointment. However, there are no significant reasons to get intensely worried at this point of time, because the cycle is drawing down and it is a matter of time when the cycle will troughed out and we will think that our pain is over. We are probably at the end of that cycle. But earnings towards the end of the season have really disappointed.
Q: If you work it down even in terms of sectors, like autos, FMCG, metals and PSU banks, a whole bunch of stocks seemed to be skewed on the side of disappointment. At the end of the day where would you say the huge surprise is or there it gets balanced out?
A: It has been disappointing on two-three counts. First, the top-line itself is under pressure because both GDP and IIP numbers indicate lack of growth. Plus, higher interest rate burden had hit the margins of most of these companies along with operational efficiency issues.
The top line has been difficult and the operating scale for most companies once they starts to come below a certain threshold, then it will have an impact on net margins better than expectations.
Q: Given, what you have seen with earnings do you think the current multiples of the market is justified or do you think this multiple is a function of the kind of deluge of global liquidity flows that have been coming in over the last few weeks?
A: The market fear is that, if the earnings growth numbers don't match the expectation and the estimate for GDP growth next year is about 5 percent at best, then why would an economy or a market trade at 15.5-16 times one-year forward earnings? Will these valuations sustain? I think it all depends on the popularity of the market.
Last year we saw deluge of liquidity across the globe, the alternatives for most foreign investors to choose any emerging market (EM) have been fairly limited. The, so called attractive EM of Russia and Brazil of last year have taken a lot of their sheen off and what remains is the resilience of earnings and this has kept the Indian market quite popular across most FIIs in last year.
I believe the trend to continue and do not see a dramatic alteration to the earnings scenario, even if earnings do come a little lower than expected then also I don't think the popularity will go away. I suspect that this valuation will sustain and it does not make sense to think that it should trade at this valuation.
I think India's growth story continues to remain very attractive. Indian market gave one of the highest return on equity (RoEs) across all emerging markets, and our problems are more tactical rather than strategic. I think people will be willing to invest in India and if that continues, then I don't think these valuations are at risk. But having said that, who knows if there is any other market which appears more attractive. I think it will be a quick move into that market out of India, because it already depends on the resilience of earnings.
Q: How crucial will be the Budget? Do you think most of the good news which might come is already in the public domain?
A: Both yes and no, because I think the fear of the sovereign downgrade is very real. I think the government and everyone have realizes this and I think there is a concerted effort to ensure that we present a picture of balance and pragmatism.
So, I think the fears of a pre-poll populist Budget may not be really realized, we may not really have an out-and-out all stops pulled out expenditure Budget. There will be saner heads which will call for some balance between structural reform and some of the popular stops will be actually pulled out.
I am hopeful that this Budget will be more balanced in its approach and if it is already in the market and if people already believe it will be a balanced version then it maybe in the price. The surprise will be on the upside if the government brings some strong structural reforms in the Budget and there will be disappointment if they fail to satisfy the structural story.
Q: At this point how does the calendar year looks like? Will it be an extremely volatile trading market or would you still hold out the potential of repeating a 2012 type of performance?
A: I think valuations are clearly at the upper end of the curve. In November 2011, we were trading close to 12.5-13 times and with an earnings growth of between 12 and 15 percent, last year we got a return of around 28 percent. Today, I do not think these variables are in play.
Earnings growth is below expectations. To expect another blockbuster year as we had last year might be at this point of time a little too ambitious. I think by the middle of the year if there is a pick up in government spending, followed up by the end of the year by a significant uptrend in the investment cycle then all of those equations go out of the window. So it depends on whether one is optimistic, bullish or you think nothing ever is going to happen in this country. I think return in this CY will be in the range of 12-15 percent.
Q: Would you buy anything now from the capital goods and infrastructure space ?
A: There has been a significant correction downward in all of these sectors as nothing seems to move in those sectors. Even if the investment cycle in infrastructure picks up then also it will take a long time before it starts to see revival. On the other hand, government spending which never stopped will continue to go on. I think 50 percent of the planned expenditure will continue, but will that be enough to re-rate the entire sector?
As a result, I think we need to focus on companies which will benefit from the government spend first and then start to see whether the private spenders also join into the party later in the year.
Most of these infrastructure companies will get re-rated once their order books build up again. At the moment, we are at a standstill when it comes to some companies where most of these order books are not getting translated into revenues. As and when those start to turn into revenues and we have incremental order book then it will be that things will get re-rated. But of course if one waits for that, one will already miss the bus. The re-rating happens very quickly. I think it is up to the investors to take a call.
But, if it does not happen then the wait can be much longer and I do not think the returns can come up quite quickly. On capital goods, I think we are talking about a 5 percent GDP growth rate and it has its own implication for capital goods.
Capital goods will look attractive if we have a GDP growth of 8 percent and upwards and they will get re-rated. I think there will be a selective cause for choosing companies which will yet participate in some growth.
For example, we were surprised with order reductions with some of the capital goods companies in this earnings season which means that as long as some of them continue to grow there is reason for confidence that some of these companies will continue to do well. But I fear to take a very broad brush view to say that it is safe to go back into capital goods and infrastructure at this point.
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