India to see big flows from Japan, avoid PSU banks: Kotak

Valuations of private sector banks are now slightly getting stretched even though there isn’t a doubt that these institutions have better-managed balance sheets than their public sector counterparts, says Sandeep Bhatia, executive director & head of sales, Kotak Institutional Equities, in an interview to CNBC-TV18. He advised investors to have no exposure to PSU banks.

Speaking on market, Bhatia said the current flow of liquidity from the US will tend to slowdown in the next two years although it will be in abundance in Europe and Japan and India can enjoy some of the benevolence coming from Japan. Maintaining that both market and outperforming stocks are capped by valuations, Bhatia said there are not many investors on the street who would place their bets on cheaper stocks. He is doubtful of an improvement in India’s macro situation but remains bullish on the pharma sector. Below is the verbatim transcript of his interview on CNBC-TV18 Q: What is the mood on banking right now because this quarter has been so disparate in terms of earnings – good earnings from private sector but not so good from public sector banks?
A: Yes that is true. The balance sheets of the public sector are showing signs of strain. Our belief is that if the economy does not improve in the next 18 months there would be further strain on the balance sheets of the public sector banks.
The private sector banks have carved themselves a very good niche. They are focused on the retail side of the asset much more. Their balance sheet management and working processes are much more stringent. So, clearly we see less stress on the balance sheets there but valuations are getting stretched on the private sector banks. This differentiation between private sector and public sector will run for some more time but it will be clearly stretched valuation for private sector banks which have to be watched for. Q: How are you mapping the whole infra space now, which is connected to the banking world very closely. Are you seeing any signs of recovery because company earnings have been quite weak almost without exception over the last four-five days?
A: For a long time we have been saying that we do not see a quick recovery in infrastructure space. Their balance sheets are stretched, execution is still not happening, so clearly there are issues which will not go away soon. There needs to be a significant change in policy confidence, which is not going to come in a hurry. Therefore, the public sector banks will bear the brunt of this and which is why the markets have been differentiating between public sector and private sector banks.
There doesn’t seem to be a quick way out of the woods for infrastructure, and the public sector banks exposure to these companies. Q: May has almost been a bipolar kind of month for the market- huge highs; lots of liquidity and then a huge cut come last week. How would you call the next phase for trade? Are we still stepping into that range trading zone again or do you think we are now set up for a sharpish correction?
A: The market got really unnerved by the fact that there could be some cut in liquidity coming in from the United States. Although withdrawal of liquidity is going to happen, it may not happen in three months or six months, it can probably happen over two years. However, on the flip side, there is liquidity still getting generated out of Japan and Europe.
As far as the markets are concerned, in the near-term, we will still have positive flows. I don’t see a major collapse in terms of inflows as far as India is concerned. The only real issue, which is now coming through is, where do you play? Do you play the same themes that you have been playing for the last six to nine months or do you change sectors?
Unfortunately, I don’t think there should be any reason fundamentally to change gears as far as sector exposure is concerned and so the market gets capped mostly in terms of valuations for the favoured sectors. Therefore, we fall into a trading range. So, if liquidity comes through, we may see pockets of over valuation but that can’t be helped because no one wants to buy cheap stocks right now. Q: The problem though is that even while the markets were strong or weak the rupee was essentially in a declining trend. How worried are investors that you speak to about and how it is affecting their positions and holdings?
A: The broad consensus was that fundamental depreciation of the rupee is mostly done. The recent downtrend that we have seen in rupee was clearly driven by dollar strength. So, to that extent other emerging market currencies have also got hit.
Therefore, it is not India specific issue right now and to that extent anyone who is taking exposure to emerging markets has to face it, including investors in India. That is the way it is currently playing out, it is not due to India specific factors. Q: What is your call on the banking space? State Bank of India (SBI) disappointed a lot of investors last week – what would you do with that name now?
A: We have had a negative view on the entire public sector banking space though we thought that within that SBI was a better bet. Clearly, the numbers have proven that that is not the correct view.
In my opinion, it has come to a point where one has to choose where one has to bet, if at all in the public sector space and I would still stick to it. It is not going to give one any good numbers so, if one thinks one can avoid the entire public sector space, then just get out.
_PAGEBREAK_ Q: Reliance Industries is up 4 percent on KG-D6 gas development – where do you guys stand on that name?
A: We believe the stock is sideways; we don’t see major upside on the stock right now. I would think that this is not going to be a big driver to the index, at least for the next three to six months. So, we have some newsflow coming through but on a fundamental basis we would think this is fully priced. Q: You track flows quite closely – what do you think the recent moves from Japan etc could mean in terms of ramifications for the kind of money which has been coming in over the last five to six weeks?
A: Money from Japan can make a big difference to total flows. So, in terms of flows which can come in, even a one percent of flows from the total investments of Japan which are in the region of 1.6 trillion, would be in the region of over USD 100 million. So, it is a big thing in terms of what India can get.
Finally, how much we get depends upon a whole host of factors specific to India. However, as far as Japan is concerned, India can be a huge recipient of flows. We have seen that happen at times; we saw that happening in 2007. So, we wait and see how much we actually end up getting for 2013. Q: This process of the market rallying and attracting so much by way of flows increased confidence that perhaps the downside risk for us had become more limited. What would you say it is still present at going into the second half of the year? A: Downside risk for India is all self-created. We have seen that happen for the last four years. So if the question is can we create a further downside risk then - Of course yes. How much can the tide help you if you are intent on sinking and drowning? India has favourable tailwind in terms of global liquidity, but India's macro continues to remain weak. People get overtly negative at times and say that nothing can move. We got surprise last month when we saw the kind of flows, just because it seems that the government is doing something. Let us hope that flows continue. To expect anything fundamentally to change in the next 6-18 months would be asking for a lot. Q: Amongst these banking stocks that you guys are discussing I imagine there is quite a bit of debate about the non banking financial companies (NBFC) especially some of the gold NBFCs and the kind of price damage that they have seen. How are people approaching that pocket and how are you guys feeling about that kind of a space? A: Gold NBFCs were seen to be the safest bet in terms of the fact that they always have a security which seems to hold value and go up in value over time. Clearly, that is not the case. My experience in the markets for the last 20 years has shown that anything that cannot happen will happen, which has happened again with NBFCs where gold prices have fallen and therefore it showed up as the fact that this kind of lending, aggressive growth quarter after quarter, year on year cannot be sustained in the scenario of falling gold prices. So, clearly there is a revaluation of the business model of these NBFCs and now it is for those companies to show that they can go through a tough time. The reason why the likes of HDFC Bank or HDFC get the kind of valuations they do is because they have gone through long phases of negative and positive macro cycles. I don't think that is the case for NBFCs. Investors should evaluate this phase very carefully and see whether there are any longer-term structural business models that this business has thrown up. Q: Do you see new banking licenses being a trigger for any of these high-quality Non-Banking Financial Companies (NBFCs) at all? Latest one was JM Financial which went up sharply because of some corporate news flow. In the next 9 months do you see that as a trigger at all? A: There are triggers in terms of newsflows. If and when that happens there would definitely be a benefit to a listed parent of that business. It is impossible to speculate whether this will be structural or just short-term. However, I would think that any kind of newsflow based uptick in any stock price goes through a process of revaluation quickly and then we see the things stabilise. I would think that same would happen. _PAGEBREAK_ Q: Have you started becoming incrementally positive on any of these faces like Tata Steel where numbers were good this time or do you think it will still continue to frustrate investors? A: For the entire metal sector and Tata Steel as well, we have to see fundamental macro changes in the global economy which will take time. If there is any specific corporate action in terms of restructuring and sell-off and debt burden on the balance sheet reducing, that would trigger some kind of revaluation. In terms of operations it is going to be a very long haul. Q: Conversely have you turned cautious on the pharmaceutical sector? Last week was dotted with negative news from many of these stocks? A: The regulatory environment in the US is not going to be favourable for Indian and emerging market pharma businesses. The US is re-evaluating its entire regulatory process and whether they really have the capacity to audit these businesses in terms of their production processes. This is also a wakeup call for most Indian businesses which need to tighten up. India will continue to remain as one of the largest suppliers of generic medicines globally. We have seen positive impact on the Supreme Court judgement on the anti-cancer drug. Indian businesses which are able to demonstrate compliance with international global regulatory regimes will have a significant business opportunities and the Indian businesses will come around to that. I would remain positive on the pharma sector. Q: What is your sense of what the Exchange-Traded Funds (ETF) are up to? They are probably hurting both with what has happened with currency and by the end of May or at least up until this point we have not really generated too much for ourselves again  year to date (YTD)? A: Flows into ETFs have got muted a bit. One will have to wait and see if this trend reverses. As far as global flows are concerned and as long as that macro environment remains positive, liquidity is sloshing around the world and it will find its way into India too. That is the basic assumption that one has to operate with. Whether it comes in the form of ETFs, in terms of hedge funds making bets or long-only active fund managers we will see how that really plays out. As long as the broader macro liquidity environment remains positive India will see flow. Q: What about the domestic liquidity? What have your observations been for the last few weeks from that front? A: There is no let up. While there have been some portfolio churning, the macro environment on that still remains very challenging. As far as domestic fund managers are concerned they do not have a tailwind which global liquidity and macro overseas is providing for asset managers.