Volatility to stay; buy Tech Mah, HCL Tech: Sanju Verma

Current volatility notwithstanding, Sanju Verma of Violet Arch Capital Advisors remains positive on market and maintains March 14 Sensex target at 22,000. She is bullish on Tech Mahindra and HCL Tech, but feels the road ahead for IT will be quite bumpy.

Verma told CNBC-TV18 that she will not recommend buying HDFC Bank and ICICI Bank at present.

Discussing the Fed issue, she said that globally markets overreacted to the talks of tapering quantative easing (QE). She does not see the possibility of withdrawal of liquidity any time soon. "It is most likely to happen in early 2015."

Also read: See strong resistance at 5900; mkt to be choppy: Sukhani

Below is the verbatim transcript of her interview to CNBC-TV12

Q: We have been through a turbulent patch all the way back from 5500. How are you feeling about the market as we step into earnings season? Do you see some more pull back or more pressure for trade?

A: Last time I said that the markets will continue to be volatile. I think that is going to be the hallmark in the next few months. I do believe that the second half will be much better than the first half. The reason for my optimism stems from simply one fact, I think the markets have overreacted to all this perceived talk of pullback of liquidity by the US Fed.

My personal sense is nothing in terms of a pullback meaningfully will happen before the end of calendar year 2014. Maybe, it will happen only in early 2015. Do not forget that the US Gross Domestic Product (GDP) is still growing at sub-2 percent. The International Monetary Fund (IMF) believes that the US would do good to even clock a 1.9 percent GDP growth this calendar year. It will take a while for them to reach their terminal unemployment rate of 6 percent or thereabouts, which will be the inflection point or the trigger to push the Fed to tighten the strings and adopt a more hawkish approach.

I think the concerns with respect to the US economy showing signs of bouncing back. Therefore liquidity being pulled out is overdone. Also do not forget that government spending in the US for the last two quarters has been falling anywhere between 4-6 percent. Government spending will continue to fall at the rate of 1 percent or thereabouts for the next couple of quarters and for the next couple of years for them to actually achieve their Budget deficit of 3-4 percent.

Currently that number stands in excess of 6 percent. I do not think we need to worry with respect to liquidity pullout. Of course there are no free lunches and at some point a liquidity pullback will happen. However, I do not think that will happen in the immediate term or the medium term.

Also I am talking more global because global sentiment seems to be dictating market sentiment here as well. Do not forget that the Fed chief's term expires in January 2014 and if newspaper reports, talking to clients based out of the US, listening to market information and market gossip, if all that is anything to go by it seems that Janet Yellen will takeover as the Fed chief and she is known to be a confirmed dove. She is known to be hardcore Keynesian who believes that you need to tackle unemployment, inflation be damped to put it simply. Liquidity is here to stay for a while.

My sense also is that the Chinese reserve requirement which currently stands at 20 percent that will increasingly get pruned down. I have always maintained any 50 bps decrease in reserve requirements by the Chinese leads to a USD 66 billion inflow which through the money multiplier effect will only add to more liquidity in emerging markets (EM) including countries such as us.

I am not saying all problems are done with, but I believe if you have believed that liquidity is what has driven the USD 25 billion odd inflow into our markets last year then you certainly do not need to worry. As far as earnings growth concerns are concerned maybe they are not overdone, but I do believe that over FY13-FY15 earnings growth Compound Annual Growth Rate (CAGR) will be between 10-14 percent depending on how pessimistic or optimistic you are which I think is good given that between FY08 and FY13 earnings growth was just a dismal 7 percent.

So it will take a while before we touch the peak earnings growth of 20 percent odd which we recorded between FY03 and FY08, but FY13-FY15 will certainly be better than the preceding 5 years if that is any reason for comfort. So you have a lot of push and pull factors which will drive the markets, but at this point in time while markets will be choppy, suffice to say second half will be far better. Let us see whether the government's intent on reforms is just intent on paper or whether there are more meaningful steps that are taken to buttress what the government does by way of these rhetoric announcements every now and then.

Q: What do you do with a stock like Jindal Steel and Power (JSPL). I know that you used to track it. Its had a terrible run to put it mildly, is this a good time to go out and buy a business like that or would you avoid something like JSPL because of the corporate issues surrounding it?

A: I don’t think there is any need to go the whole hog and buy a stock like JSPL. I think the damage is far from done there. Each time the stock has fallen there has been reason to go in and put money and the stock has only chosen to disappoint. Within the metals space, if I had to take a call at this stage then Hindustan Zinc, one of the usual suspects that seems like a good bet. If you believe that the rupee will continue to trade at these levels and will not appreciate then Hindustan Zinc is a great proxy based on any perceived exchange rate depreciation going forward.

With the rupee having corrected or lost more than 9-10 percent in the June quarter against the dollar, one of the biggest beneficiaries will be Hindustan Zinc because every Rs 5 depreciation adds something like 7-8 percent to their Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) and a little more to their net profit. So, that is a positive.

The company has cash in excess of 40 percent of market cap at this point in time which again is a positive. I won't say that go and buy it because it’s trading at 4 times Enterprise value (EV) to EBITDA. So, if the stock moves up to 5 time EV to EBITDA on FY15 numbers, it gives you a price target of Rs 150, which is a great rally from here because most metal stocks are trading cheap. So, that cannot be the premise for buying something, but I think this stock also gives me comfort because last quarter numbers were excellent with EBITDA margins stable at 54 percent and thereabouts.

So, within the metals space it will have to be some of the more stable non-ferrous names. So, my pick would be Hindustan Zinc. That is what I would take a hard look at within the metal space.

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Q: The banks are under pressure today perhaps because of this news that the Reserve Bank (RBI) has asked some of these banks to set aside extra provisions in case of corporates that have un-hedged forex exposure. Do you think this could impact the profitability and how would you approach the banks now?

A: This measure was long over due. I am surprised that the RBI actually woke up late to this concern. Don’t forget that the outstanding with respect to external commercial borrowings (ECBs) currently by India Inc stands at something around USD 120 billion and the rule of thumb says that for every Rs 1 depreciation, India Inc stands to lose something between Rs 6,000-9,000 crore. There are various numbers floating around. Also don’t forget that more than 80 percent of the ECB loans were taken 5-6 years back at an exchange rate between 47-48 and more than 50 percent of the loans were taken at an exchange rate of actually between 40-45. So, unless somebody has hedged their exposures 100 percent which no one would have done because hedging costs in India have been expensive - in the region of 6 percent or thereabouts. It means that the possibility of taking a huge hit on the books is certainly there.

I wouldn’t be surprised if you see a lot of companies going in for repayment at more stiffer terms by having to refinance their loan obligations, a la Reliance Communications. Some of them may not even be able to do so, like Suzlon. So, I think stiffer provisioning norms will certainly help.

Coming back to your question on how I would approach the banking space. I would at this point in time actually be a bit circumspect. I would certainly not go and pick some of the leaders within the space like an HDFC Bank which a lot of people feel has been consistently showing 30 percent profit after tax (PAT) growth and hence is a safe bet.

Just look at the sequential credit growth number. HDFC Bank sequentially saw a negative credit growth of 0.7 percent last quarter – that is for Q4 of FY13. Same with ICICI Bank, which saw sequential credit growth of just 1.2 percent.

So, the basic business of the bank, which is lending, is certainly not doing well. Don’t forget that between mid-May and now yields have jumped up by something like 35-37 basis points all the way from 7.1 percent which is where 10-year yields were in the third week of May to something like 7.56 percent which is what we saw two days ago. So, that will certainly affect the trading portfolio of most banks.

We need to get some clarity on how banks intend to cater to asset liability mismatches which currently is not a big problem, but I think going forward this may be a bigger problem than even non-performing assets (NPAs). Most banks have been borrowing short and lending long, including some of the private sector banks, the money that they have been borrowing from the money market is humongous. So, my sense is that unless problems with respect to asset liability mismatches are firmly dealt with because this leads to higher refinancing risks and only adds to the liquidity stress in the system, one should not go the whole hog and put money into banks at this stage.

Being a contrarian on the banking space, I would still go and buy and State Bank of India (SBI) for one big reason – bulk deposits constitute just about 1 percent of SBIs deposit base. When they exited FY13, they still had Rs 40,000 crore of cash on their books. Given that most banks are facing a cash crunch and most banks have not been able to pass on any kind of repo rate reductions to end customers because they are sitting on high bulk deposits which have been very expensive, SBI certainly bucks the trend and this structural positive is what will benefit them. Q4 numbers for SBI were bad, net profit fell by 18 percent but they still did Rs 14,000 crore plus for FY13 which works out to a healthy 20 percent plus growth and I would still go and say that given the current scheme of things may be SBI from the PSU banking space and from the private banking space we continue to like Indus Ind Bank.

There is talk that at 2.5 times plus price to book this is expensive, but we have our reasons to believe that the stock should likely move up going forward to perhaps even Rs 480-490 in the interim. Don’t forget it had a sharp correction all the way from Rs 530 just about a few weeks back.

Q: Given this recent trend there has been on the currency, how would you approach information technology (IT)? What is it that you expect to see over the next couple of quarters from this sector?

A: That is a tough one to answer because you need to take a call on various things including currency, including how the US Immigration Bill will pan out. Suffice to say at this point in time that I think Infosys which is slated to declare numbers in a couple of days from now, my sense is they may not tweak their guidance from the 6-10 percent odd which they mentioned last time around to 4-6 percent, around which some of the pessimistic analysts on the street believe they will do. That said, there is no taking away from the fact that going forward the road ahead for IT will be very bumpy.

Without the out placement clause everybody knows the hit on margins will be less than 100 basis points, but were the outplacement clause to be incorporated then the hit on the margin front could be as high as 300-400 basis points and the earnings impact with the outplacement clause being incorporated could be anywhere between 8-10 percent or even more. So, these perceived negatives will certainly weigh down on IT stocks.

Coming to this particular quarter – the June ending quarter, some companies which have chosen to give wage hikes like say Tata Consultancy Services (TCS) for instance, the impact on margins will not be felt because they will be cushioned by the rupee depreciation. So, net-net I think the rupee depreciation will have a positive impact for companies with or without wage hikes to the tune of 40-60 basis points.

My personal sense is that if one has to stick ones neck out and look at IT one should for the time being stay away from some of the bigger names where people have already made money, which means for the time being it perhaps makes more sense to look at stocks which give you valuation comfort. So, I would perhaps look at an HCL Tech.

I would also go ahead and put some money into Tech Mahindra. Mahindra Satyam stops trading from tomorrow. That is a huge overhang which is out of the way. The company has done a very smart thing by deciding to extinguish out of the outstanding 50 million treasury shares, something like 35 million treasury shares. So, that speaks volumes about the company’s confidence about the road ahead. It will also lead to an improvement in return parameters and post the merger, don’t forget that earlier 46 percent of their business came from Europe, now post the merger only 33 percent of the business will come from Europe. About 40 percent plus will come from the Americas. Also, telecom which accounted for about 25 percent of their revenues, now telecom will account for just 12-13 percent of their revenues.

Last quarter, Tech Mahindra showed a dollar sequential revenue growth of 7.5 percent – out beating most peers by a long margin.

So, one should think out of the box and my sense is that the stock can easily go to Rs 1,200 or Rs 1,300 at which it would still be trading at 11 or 12 times which would still be a 10-15 percent discount to HCL Tech, given that most people believe this is somewhere in between a HCL Tech and other IT services companies.