See earnings downgrades post Q1 results: BofA ML's Jaipuria

Jyotivardhan Jaipuria, Head of Research, BofA Merrill Lynch believes markets will continue to grapple with the same macro issues in the second half of the year as well. "I think markets will keep battling and seesawing between the benefit of lower rates versus growth still not picking up," he told CNBC-TV18 in an interview.  

China, Europe and Britain loosened monetary policy in the space of less than an hour on Thursday, signalling a growing level of alarm about the world economy, although suggestions of coordinated action were played down.
As a concern, Jaipuria says, Europe has eased off a bit because people have seen some agreement coming out of the EU summit, which was unexpected.
Asian shares paused on Friday, pressured by falls overnight in global shares as sentiment remained cautious despite new stimulus steps taken by three major central banks, with focus now pinned to the US jobs data due later in the day.
Back home, the biggest trigger for markets to rally would be if the talk of reforms actually materializes, along with crude oil prices remaining low. Jaipuria expects Sensex earnings growth to be below 10%. Moreover, he sees earnings downgrades post first quarter result performance by India Inc.
"We are concerned about a slowdown in the consumer demand," he says adding, "markets will find support if reforms pick up." Below is an edited transcript of his interview to CNBC-TV18. Watch the accompanying videos for more. Q: What did you make of all the global activity yesterday and what do you think it suggests for the market? Is it an extension of some kind of liquidity push or do you think some of these growth concerns are going to start pulling market performance down in the second half?
A: The market in the second half will also continue to grapple with the same things. Central banks will ease liquidity, they will cut rates and at the same time growth may not be as easy to kick start. The market will keep see-sawing between the benefit of lower rates versus growth still not picking up and the market showed it yesterday because we had four central banks cut rates yesterday and in the end we didn’t see the market rally as sharply as one would think. Remember that we had a rally into the run-up to this event so people had built expectations and as typically happens, people sell once the event comes. Q: How do you see risk appetite play out now that both the ECB and the EU summit are out of the way, do you think it will peter off because of concerns about growth or do you see risk appetite improve from here?
A: Everywhere we have had markets which have given a good rally. To that extent, now people will again start looking at data a little more carefully. You also have to hope that things work out in the euro zone because there is a broad agreement but finally when it comes down to implementation, you could get some hiccups which were not envisaged earlier. So we have to hope that things work out well. To that extent, somewhere maybe markets needs to consolidate or pullback a bit so that they are ready for the next leg of the rally. Q: What does the investor survey and your conversation with clients show up about money interest though because that’s the interesting thing about this series, the market has been quite well supported in terms of institutional flows?
A: People were more bearish earlier; Europe was on top of everybody’s mind. Europe now as a concern has eased off a bit because people have seen some agreement come about which in some sense when people went into the EU summit the expectation were very low so to that extent what happened was much higher than expectations. But people are still wary, they are worried about growth everywhere and everyone just hoping that the central banks are able to keep growth at a higher level and not let it fall too much. Q: Would you be surprised if you saw the market make a significant move then, something above 5,600. Is it more likely that the second half is about a correction and then again a process of consolidation?
A: A market making a move higher depends on two things; one is what happens to reforms in the country because I would say a month or six weeks back, the expectations of reforms had become quite low but now there are some expectations being built into the market that we will have some reforms going through. If these expectations materialise, if we get actual reforms being more than what people thought then that would probably be the biggest trigger for markets to go up.
The other one has been oil which has helped the market over the last six weeks because oil prices have corrected substantially. If we see oil prices remaining low then to some extent it eases a lot of inflation concerns which have been going on. So I would say these are the two critical things to watch out for. Q: How are you approaching earnings season? You are usually quite cautious going into these events. How poor or okay do you think the earnings performance is going to be?
A: It’s going to be more of the same which we have seen over the last few quarters. So earnings won’t be very good for the Sensex companies. Excluding a few aberrations, earnings growth will be under 10%. We have seen earnings being below 10. I would say the only good thing is now markets have got use to this. Over the last few quarters, people have got used to earnings being poor, margins falling off and analyst downgrading earnings.
I think we will again get earnings downgrades, we will probably see analysts cutting their earnings forecast by 2-3% for the Sensex companies. What will happen for the first time is we will see sales growth slowing. Our forecast is for this quarter sales growth at 16% will be the slowest in ten quarters. That is something which we were expecting last time also that sales have been very strong and that will start flattening out now. So that is something we will see probably this quarter. Q: What are you estimating in terms of the Sensex EPS because if you do believe that the worst of the downgrades are not behind us, from valuation standpoint how much more do you see on the downside?
A: We had Sensex EPS for FY13 of 1,200 on a top down basis. If we see now, the consensus is at 1,240, our analysts are somewhere there. To that extent probably it’s 3.5-4% that we are looking at as the downside but that’s something which we think will play out over this quarter and maybe the next quarter.
_PAGEBREAK_ Q: From your note you expect IT to be one of the biggest drivers of growth. What exactly do you expect to see this earnings season, because already on stocks like Infosys people are talking about a guidance cut, concerns on what may actually happen in terms of performance or volume growth?
A: Some of these we have to be careful what we are looking at because just on a YoY basis IT will be driving growth, but in IT it’s more or less known. The key is what is the guidance and the future outlook which the companies give because in a lot of IT companies, we look at sequential growth rather than YoY growth. If you look at pure YoY numbers then IT companies will grow quite sharply but that’s not really what the important stock price driver is. It is what they guide for the future. Q: One of the disappointments that you are going to be weary of is a stock like L&T. Is this a call about the company’s earnings or are you generally not enthused by the kind of strength the market has chosen to give capital goods faces and infrastructure faces?
A: We can’t talk on particular stocks, but if you look at that whole space what will happen is the new order inflows are going to be quite weak as we move ahead into the rest of the fiscal year. To that extent, markets will get a bit disappointed that the earnings per se are coming in good. This reflects the orders which they had got two years ago whereas the future outlook gets a bit cloudy if you don’t get new orders coming soon. So that’s really what we are trying to highlight in the segment. Q: What is the expectation from the banks this time around? Will it be the same as last quarter where private banks outperform and public sector banks have asset quality issues?
A: The broad theme would still be the same that private sector banks do much better than the public sector banks. A lot of public sector banks will have asset quality issues. There are going to be bank specific themes which will play out even within the public sector banks, because they are some which probably have written off enough in their books in terms of provisioning, so they could actually surprise a bit on the upside. But in general the public sector banks will do worse than the private sector. Q: In terms of deciding an upside for this market, how hopeful are you of the reform process getting kick-started now? We have seen some traces of it in the form of FDI in retail that maybe allowed by some Congress-led states etc. Do you think that could be the next trigger to decide an upside for the market?
A: I would not just say its one event, but it’s more like can they implement it. Clearly, the intention is right that they do want to do reforms. The economy is weak, so to that extent the trigger is there. The key is whether they can build a political consensus around it. I think no one doubts that the agenda is there and the intention is there.
Hopefully if enough political consensus comes about and people agree to doing a few measures then that is going to help the reform process. So it would be everything. It would be FDI in retail, it would be fiscal consolidation and how you can go about it including cut in subsidies. It would be getting infrastructure projects kick-started. So it’s some of these broad areas which people are generally aware of within the government. Q: The tricky one in earnings season is going to be FMCG as a basket. Are you getting more cautious on that space or do you think it can continue to enjoy the kind of polarized valuations it has versus the rest of the market?
A: I think FMCG earnings per se won’t be very different. They will probably be in-line with the street, though at some point our fear is that even FMCG will start to see some slowdown given what’s happening in the economy, especially if the monsoons don’t turn out to be as good.
So just as a stock per se, we are getting a bit cautious on the FMCG space saying that valuations are pricing in lot of good news and the next big move is to take money off the table. Tactically, you may want to do it when the markets correct a bit and markets are closer to the higher end of the trading range.
_PAGEBREAK_ Q: The equity market tends to trough out a couple of quarters before you start seeing any reasonable improvement in terms of growth etc. Where would you push that back to given the kind of situation we have on global and local growth concerns? By which quarter do you think that trough out process can start?
A: What market looks for is some catalyst which is changing. That’s why one of the big catalysts would be if we get the reform process moving or if we get a lot more reforms coming then it does not matter which quarter that growth number picks up. The trajectory is clear that now things have bottomed out and even if we get bad numbers for one-two quarters, things ultimately are going up.
The other thing which can signal that things are going to change is a rate cut cycle which looks like it’s a sustained rate cut cycle. If we get rates coming off quite a bit, our expectations start building up that we will have rate which are cut by 100-200 bps. Then markets would say at the end of it once we have the rate cut cycle happening we will start seeing growth improve.
So rather than trying to say whether the growth will bottom out this quarter or next quarter it’s more like are we getting any signals of things which are going to change now and help the growth to move to a higher trajectory again. Q: How many more quarters do you think we will have to face the single digit Sensex earnings growth and what is the bigger worry now? Is it slow sales that will plague companies or do you think on the margin line, issues like cost pressures and the way the rupee is moving is what will hit margins?
A: My view is that the margins we have seen are like a major contraction, margins over the last 18 months. We are now at margins which are probably at 8-year lows in India. Going forward it’s going to be sales which probably becomes the bigger culprit in slowdown because sales growth was extremely strong over the last 18 months and now that inflationary pressures have eased marginally, we will start to see sales growth coming off. So its sales which will lead to slower earnings growth and we will see this for the next couple of quarters. Q: How would you approach the oil and gas space specifically the frontliners like Reliance etc this earnings season, given the way crude has been moving off-late?
A: When you look at the oil space it’s like quite a mix bag. If we think of the public sector companies what are probably most critical to them are the subsidies and how much subsidy they have to bear from the government, how much government reimburses them. There is some good news that oil prices globally have come off so this overall subsidy burden for India should ease off a bit.
If we look at the other set of companies they are dependent on the refining cycle which has not been too great, refining margins globally have not done very well. To that extent, those will again reflect in the quarterly numbers this time where probably the numbers will be weak again. Q: Should the market still put out for the Reserve Bank of India and expect something in terms of rate relief towards the end of this month or do you think that’s not the biggest determinant right now and it’s not something the market should hold out for?
A: We still have a bit of time to the policy. There is a mix view that some people are expecting and are hopeful that we will get a rate cut coming while others are not sure. What will determine the RBI’s decision is probably how the monsoon pans out because that gives some indicator where inflationary pressures start to build in.
Second, if these global commodity prices which have come off quite a bit, they continue to remain at lower levels and we see them starting to inch up again. So it’s still a mix bag on whether they will cut rates or not. It is important for the market but at the moment the opinion is quite divided.