See FY14 GDP growth at 5.5-6%, avoid PSU banks: JPMorgan

JPMorgan is a little downbeat since he believes both monetary and fiscal stimulus are not going to come by in the current year. However, the 45 paise diesel hike indicates that the government is serious about the fiscal deficit targets. Bharat Iyer, Head of India Equity Research, JPMorgan feels that government has made very credible attempts to consolidate the fiscal position in the last six months, but it is going to come at a cost in the near-term in the form of higher inflation and lower growth.

"For FY14, we are looking at GDP growth in the region of about 5.5-6 percent and earnings growth in the range of 14 percent", he added. Talking on stocks, he is bearish on government PSU Banks & Non Banking Financial Companies (NBFCs). He sees auto companies to underperform in near-term, but M&M looks attractive to him, due to its defensive character. Below is the verbatim transcript of his interview to CNBC-TV18 Q: In the past a lowering of fiscal deficit has usually meant buoyancy for the economy, do you see any gains come in for the system for that move? A: We do see gains coming from that move. The government has made very credible attempts to consolidate the fiscal position in the last six months. However, it is going to come at a cost in the near-term in the form of higher inflation and lower growth. That is what we are worried about because the markets have priced in a higher level of growth. We believe that it is under estimating the extent of the slow down. That is the reason for our bearish stance over the last two months or so on Indian equities. Q: What is JP Morgan estimate of gross domestic product (GDP) growth, more importantly of earnings growth? A: We are looking at GDP growth in the region of about 5.5 percent to 6 percent for FY14. However, we believe that most of it will be back-ended into the second half. As by then the initiatives that the government has ceded will perhaps start playing out and one will see pre-election spending come to the fore by then. As far as the earnings growth is concerned, this is where we differ from the street. Consensus estimate are for earnings to grow at about 16 percent for fiscal 14. Whereas growth is going to be closer to 8-10 percent because 16 percent growth presumes GDP growth in excess of 6-6.5 percent. This looks unlikely at this stage because currently trend growth is 4.5-5 percent. So, that kind of leap over the next 12 months is going to be a little difficult to achieve. Q: One of the things that you have an underweight on is consumer discretionary – can you just explain the rationale? What exactly would your valuations assumptions be going into the next two fiscals? A: As far as consumer discretionary is concerned, we really have three reasons for being underweight the space. First and foremost, it has had a very good run, so valuations are expensive in our opinion. If one looks at most leading consumer discretionary stocks, they are trading at 15-20 times forward multiples. Secondly, it is a very over owned sector. Investors have piled into that space in a very substantial manner in the last two years. However, most importantly we believe that performance is going to lag expectations. One finally has this scenario where wage inflation is going meaningfully south of inflation. That is putting a lot of pressure on household Budgets. Thirdly, lower economic growth brings challenges in the form of lower employment opportunities. So, one has lower employment opportunities, inflation eating into the household Budget and wage inflation not keeping up with that. We see a very-very significant deceleration as far as discretionary spending is concerned. That really underpins our stance on this sector. _PAGEBREAK_ Q: What about power or any part of the infrastrucure? A: As far as infrastructure and power in particular is concerned, it is not that we don’t have a constructive view on that space at all. The central government utilities look very interesting-names like National Thermal Power Corporation (NTPC) and Power Grid. These are extremely well run companies, very sound balance sheets and if the government has a short at reviving the investment cycle then I am sure these companies will come into the fore there. We do like the government controlled utilities. As far as the private sector companies are concerned, we need to take a very stock specific approach. The macro is concerned, perhaps it has bottomed out and most of the risks are known. One could see some improvement going forward. However, first and foremost we have to remember that it is a pre-election year. It remains to see what kind of progress can be achieved. More importantly, the IPPs in particular are all dealing with very specific issues. One need to take a very granular approach as far as investing in IPPs is concerned. We prefer to stay invested in the central government utilities because we believe there is value there. There is visibility of earnings and if reforms start playing out they will perhaps be the first beneficiaries of it with IPPs likely to lag. As far as IPPs are concerned, they are three year play and there is deep value out there but one needs to take a granular approach out there. Q: Do you think that there could be a slippage despite the momentum that we have seen in the past three months on the diesel price hikes and that could come in the form of possibly higher food subsidy, via the Food Security Bill and other populist measures? A: It is difficult to say at this point in time. We are barely entering the new fiscal year and a variety of variables will play out as we go through the course of the year. As one has rightly pointed out it is an election year. That said the government has shown an amazing resolve as far as the fiscal consolidation effort is concerned. So, I expect that resolve to very much continue. I wouldn’t be very worried about the deficit number per say. That said if things do get difficult then what could be compromised is growth, particularly in the form of lower plan expenditure, something that we saw in fiscal 13 as well. Thus, I think the resolve to the fiscal consolidation effort will remain perhaps, but if there are roadblocks or speed-breakers down the line then perhaps what gets compromised is growth. Q: With respect to banks broadly your approach is clear. Among your top picks is ICICI Bank and among you are avoiding Bank of India, Why? A: As far as banks is concerned what we are really seeing is that it is a stressed out macro out there and perhaps things get a little worse before they get better. So, clear cut our preference for the last 18 months has been focus on the high quality private sector banks. We have not been as bullish on the state-owned banks and on the Non Banking Financial Companies (NBFCs). We continue with that strategy because as far as we see first and foremost there could be pressure on margins as far as the space is concerned. While credit growth has moderated in line with the slowdown in the economy deposit growth is trailing far behind. That means at some point in time, despite Reserve Bank of India (RBI) rate cuts one is having the scenario where some banks are to hike the deposit rates. So, this does imply that margins could be under some kind of pressure, particularly over the first six months of the year. As far as the non-performing loans (NPLs) are concerned – a slowing economy brings with it a dynamic in terms of rising NPLs too. So, that said we would prefer to stay with quality at this point in time rather than playing the higher beta names. This is the reason we prefer the most of the high quality private sector banks. We are not so positive on both the NBFCs and the state-owned banks. Q: So your list of buys would include Axis and HDFC as well? A: Yes, it would. _PAGEBREAK_ Q: What is your view on the auto space? Would it be a good time or an opportunity to buy considering the multi-year slowdown that we are suffering from? A: Yes, as far as an auto space is concerned we classify it as part of the consumer discretionary pack. We are underweight on that space. If one has to look at the auto space in terms of two different time zones – one is if looking at the next six months we would prefer to stay underweight that space. We are seeing the cyclical slowdown. In certain segments we also have elements of a sharper increase in competitive intensity and that is going to be structural. So, on a six-month basis we do believe that this is a space, which we would like to avoid. Longer-term, it is a sector with the great prospects. We have very low penetration levels as far as India is concerned. Again, there are companies with very good technology strengths and balance sheet structure. So, beyond six months I would be positive on that space, but over it I would be underweight on that space. Q: Your list says overweight on Mahindra and Mahindra (M&M) and Tata Motors is that right? Will this be a time to really buy M&M? A: M&M has defensive characteristics. It is not just an auto company, it is conglomerate. So, you have a lot of defensive structure out there in the form of their IT services business, in the form of their financial services business and their holiday business as well. Even if one looks at the auto business, both the tractor business and the utility vehicle segment, they almost have a defensive monopoly of sorts. So, they have a very good competitive structure out there. They have consistently increased market share. Competition has found it very difficult to make a dent there. So, they will be subject to the upswings and downswings that any cycle brings with it. They have their competitive structure in position. We are worried about that the lead players are not necessarily in control of their own destinies. One has a lot of new competition coming in, which they are not able to defend. So, from a competitive position’s standpoint we prefer M&M to some of the other companies. This perhaps doesn’t have the same position within their respective segments. Q: Would a rupee in equities at this juncture fetch you a lot before 2013 is out. If yes, what is it? Last year was a bonanza of 25 percent. How would this year be? A: In a one year forecast also, I think we would make about 10-12 percent in equities. That said, over the immediate term we are probably going lower before we go higher.