Investment deadlock: Is Parliament the only answer?

With confirmation that growth has troughed out, Nandan Chakraborty, MD, Institutional Equities Research, Axis Capital feels key to next step lies in the winter session of Parliament. Nilesh Shah, Deputy CEO, Axis Capital, however, is of the view that to sort out domestic hurdles, decisions can be taken outside Parliament.

While Chakraborty discussed domestic issues, overweight & underweight sectors, and suggested picks for a model portfolio, Nilesh Shah spoke on macro scenario and fund inflows into the market.

Below is the edited transcript of Shah and Chakraborty's interview with CNBC-TV18 

Q: What is the sense you are getting from the domestic investors and companies? Are you getting a sense that they also share a hope that things have troughed out?

Chakraborty: There is more or less a consensus that the growth has troughed out.  This has been a quarter full of surprises. It has also been the one in which there were a lot of negative news, for example, the public sector banks. In a lot of those areas, people have a feeling that the prices also have troughed out. Eyes are mostly on the Parliament session now. The external environment is very favourable for India. So now, we need to deal with our home grown issues.

Q: What do you expect from the market if we do have a washout of the Parliamentary session? We didn’t get that rate cut so is there any trigger for upsides over here?

Shah: If we see from a foreign fund managers’ point of view, very few of them have anything great to talk about their own countries’ politicians. If we look at any Greek fund manager, they would probably give far higher grading to our politicians than their politicians.

So, if a Parliament washout happens, it will have a negative but a temporary effect on the market. We can counter that by doing some execution on the ground. There are many reforms that have been announced and they don’t need Parliament’s approval. There are many things that can be done outside Parliament in terms of execution on the ground.

So, today the market is far more worried about the lack of investments. Investments have slowed down and even with all these reforms, one needs to see physical activity happening on ground for that to pick up. If that can be done outside Parliament; by proper land acquisition, clearer environmental norms, speedier execution in terms of permissions; like the Delhi metro rail was created ahead of commonwealth games, if we can do it over 5-10 projects, I think markets will take lot of comfort and confidence inspite of what happens in Parliament.

Q: Can you give us a sense in terms of how optimistic you would be on the real estate sector and the media sector going forward?  What would your valuation calls be on both of these specifically?

Chakraborty: There are three panel discussions on the sectors of media, retail and realty. The reason for panel discussions at this point in time is, all three sectors are sectors where one will see a turnaround in prospects. There could be a quantum jump in all the three, depending on what unfolds. This is the reason why we have had these panels and experts from the sectors to speak about them.

Today is blackout day in media as far as cable is concerned. There could be a quantum jump in advertising revenues, subscription figures and so on in media.

There are a lot of questions on whether retail FDI will permeate across all the states or not, how much time it will take, etc?  Similarly, if you look at realty, it is one of the most interest rate sensitive and capital sensitive sectors. That is again something on which a lot of questions are being asked.

These are all three sectors which can fly if things go well. One part is what the government does in the Parliament and the other part is how much confidence the government can infuse, so that the rupee stabilizes. The other part is what the government can do to convince the RBI that things are under control as far as the fiscal deficit is concerned and therefore they have a chance to start cutting interest rates. So confidence from the government will also then infuse promoters into putting up projects.

Q: Just wanted your opinion on the earnings season gone by. What did you make in terms of earnings season? If you had some amount of fresh allocation of funds post this earnings season where would you deploy it?

Shah: The earnings season has shown lot of divergence. There are companies which have done well within a sector. There are also companies that have done quite badly within the sector. Secondly, even if the company has done well in the past, because they are unable to give guidance for the future, because of volatility, markets have not taken kindly to that.

So, while we are definitely concerned about the divergence in the numbers, the market has probably punished companies a little bit harsher if they could not forecast future correctly or if they could not give guidance on the future. Not withstanding those kind of variances, what we are seeing is, probably this is the quarter where earning growths are bottoming out. From here onwards, if investment picks up then, we will see benefits in the coming quarters.

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Lastly, almost 9 months’ liquidity had remained tighter and hopefully now, liquidity will start improving, even if there are no rate actions on the policy side. The second half of the financial year is generally positive from an earnings point of view. The festival season begins over here and that’s where we will see far amount of earnings coming in. In the September quarter, we also had a delayed effect of monsoon which disrupted transportation. It disrupted movement of goods and services, so my feeling is that the September quarter probably will sign bottoming of the earnings. Hopefully, December and March onwards with the liquidity improving and with festival season sales bringing cheers, we will see earnings growth improving.

Q: Going by the arguments and the divergent numbers that you have got in the second quarter, which are the earnings you all have upgraded?

Chakraborty: I cannot talk about specific stocks on the media. What we have done is, across sectors, there are specific stocks which we have upgraded in terms of earnings and some we have downgraded. So, it really differs from stock to stock within various sectors. So, I will not say that this entire sector has been upgraded or downgraded or whatever.

Q: If you could talk in terms of ratios, was the number of upgrades clearly more than the number of downgrades? Could you have that satisfaction at all?

Chakraborty: No. I would not think so. But then, you will have to market weight that also. But in general, what you will see is that because the Sensex has largely particular type of companies - oil and gas, banking and so on, 45 percent of the whole index is oil, gas and banking alone. So, because of the unique nature of the Sensex and Nifty, what you will see is, in the broader market, the earnings growth is more than the Sensex or the Nifty.

Q: Just wanted to narrow in with regards to banking, since we have the provisioning norms which came out with the RBI policy. How worried would you be in terms of the banking earnings going forward, especially because of the public sector banks? How would you be placed on it vis-à-vis private banks on valuation basis as well?

Chakraborty: On a valuation basis, obviously the public sector banks have already forecasted the worst. The private sector banks have a clearer trajectory, which is obvious. So for most funds who want to play India rather than specific stocks, private sector banks would continue to do far better. As far as stock specific bets, you will have to choose among the public sector banks. And obviously, those which will benefit more through interest rate cuts, for example, the ones which have bulk deposits. The provisioning norms also had an effect. The stock prices have already corrected due to the norms.

Q: One another sector which ofcourse is bedeviling the public sector banks a bit is infrastructure. Some of the problems are genuine like gas availability. The problem doesn’t look like its going to be sorted out early so power will remain grounded. So, many projects will remain grounded for that matter land acquisition issues or environmental issues don’t seem to be corrected soon. So would you get a sense that even if there is a troughing out, the growth is going to be painfully slow? Even if there are upgrades in stocks, are they going to be few?

Shah: I think we need to evaluate the infrastructure sector from two different points. Firstly, certainly for the problems you mentioned. The future capacity creation is now under doubt. It’s going to take longer and it’s probably not going to happen in many cases, which means the existing capacity that has been created will now get far better return on their investment. So, companies which have already established project, created capacity or which are at the last mile stage and will create capacity over next three to six months.  They will be in a far better position than just six or 12 months ago period.

Secondly, the market is already priced in the inefficiencies on land acquisition, environmental issues, tight liquidity, interest rate concerns, and state electricity board issues, coal FSA. Anything which happens incrementally on that side and we have seen coal production jumping up, then all those things will be incrementally beneficial. Especially, to the companies which have already created capacities or are about to create capacity.

Thirdly, we will have to focus on the companies, where debt burdens are not excessive. If there is a reasonable blend of equity and debt and the entire infrastructure project is not funded out of debt. Even when the capacity comes onto stream, it will be the lenders who will benefit rather than the equity owners. So, if there is an ideal blend of debt and equity then probably equity owners will benefit significantly. As the cash flow starts reducing debt out of EV, the benefit flows into equity owners. So, if we can narrow down our search around these companies which have created capacity, are less in net debt then probably equity owners will benefit by investing into that sector. But your point remains valid that overall these sectors will have to go through a painful growth because of issues related to land, environment, interest rates, tight liquidity.

Q: What could be a high for the Nifty or the Sensex in the next six months?

Chakraborty: Let me take a step back and give you a philosophical answer to that. The obvious answer is that it will track earnings growth. India is a unique country. We are not a command economy. So, it is not like China or the US where you have the Gorilla Effect in place. The reason for the Gorilla Effect across capitalist countries is that the rich get richer and the powerful get even more powerful. India is a place where you have checks and balances so you have equal opportunities for all types of companies. Take the example of Axis Bank, where was Axis Bank 10 years back? Look at the stupendous growth that Axis Bank had in terms of its balance sheet parameters. There is an opportunity for every country depending on the management of its businesses to do fantastically well.  A lot of people around the world miss out that this is a country where good managements can have a scalar growth. So it is not just macro.