Economic cycle is unlikely to pick up in the visible future until capex cycle improves, Sanjay Mookim, Director, India Equity Strategy at Bank of America Merrill Lynch said. Demonetisation has put the brakes on the capex cycle for now. It is not only deflationary, but also 'poor for earnings’, he said. Speaking to CNBC-TV18, Mookim said that FY19 will see banks delivering reasonable growth. About 40 percent of earnings will come from banks and hence, is recommended by the investment bank. Mookim is underweight on IT, but prefers pharmaceutical sector. Metals and cyclicals too will see some more uptick. Consumer discretionary will continue to remain under pressure due to demonetisation.Below is the verbatim transcript of Sanjay Mookim's interview to Latha Venkatesh, Sonia Shenoy & Anuj Singhal. Anuj: Have you thought about changing your Sensex target of 29,000 because of what has happened globally and locally?
A: We published that target after what has happened globally and domestically, in fact our December 2016 target was 26,000, whcih is where we are at, so I do not need to change that. However, 29,000 for next year implies about 12 percent total return including the yield that one will get on the index and to me that doesn't seem too onerous to achieve.
Yes, there is uncertainty now but we have to figure out what the new normal looks like after the whole demonetisation process is absorbed by the economy. Therefore, December 2017 outlook depends upon what happens in FY19.Latha: What is the more near term implication for earnings, FY17? We have the advance tax numbers, if that is any help?
A: I do not think there is much debate that the demonetisation or remonetisation is deflationary. It is poor for earnings and much of the consumption that we have been very focused on for the last three or four quarters will take a knock. The debate is how much of a knock it is and which parts of the economy recover, at what timeframe. Obviously it is not all coincidental and not all at the same pace. Some parts will come back sooner; some parts will take longer to recover. The range of uncertainty around the consumption is a bit wider now. So the day this happened people are saying that the strategy should be to be underweight discretionary consumption until you get clarity on when this is bouncing back.
However, one cannot invest for four-five-six week outlook, which is probably as long as it takes for the cash to come back. As investors we should think about what the world looks like once adequate cash is back in the economy, once the line at the ATMs and the branches go away and that is a debate we should be having rather than how long it takes for that money to come back.
Sonia: Your 29,000 December 2017 Sensex target is predicated on what growth sectorally. Where do you see the leadership emerge from over the next six-eight months?
A: The consumer discretionary pack likely to remain under cloud. We think that in FY18 one is likely to get a low double digit growth in the total overall index, if we are lucky and that also has uncertainty band around it because we do not know what the discretionary pack will do, but if you look one year beyond, in the FY19, we expect the banks to start delivering reasonable profit growth because hopefully much of the high provisions that the banks are booking now, will have been absorbed and will have been passed us. There should be or there could be some pickup on small and medium enterprise (SME) book because of demonetisation but the large provisions that are being booked today, are unlikely to recur in FY19 or be meaningfully smaller. So when I split out by sectors, I think that much of the FY19 earnings, almost 40 percent of it will come from the banking sector which is something therefore, we recommend to clients to look at now as you should be chasing whether growth is coming from and the consumer discretionary, as I said, we will be underweight now.Anuj: I want your thoughts on two large sectors, IT and pharmaceutical. Of course pharma is more of a stock specific story and you may not want to talk individual stocks, but as a sector call do you get a sense that they could outperform in 2017?
A: We are careful on IT. There is a lot of hit that can happen to the whole sector if the noise or the commentary that has been made by the new administration that is going to come in is acted upon and the earnings hits that these companies can take can be meaningful, so yes there is this attraction that these stocks have gotten cheaper and good quality companies and so on but the potential hit is so large that we have recommended an underweight on IT. We prefer pharma instead because there are stocks picks that you can still make. There are some companies which are having their own issues right now but the new administration in the US, their position on the pharma space doesn't seem to be as bad or as detrimental to company earnings as for IT perhaps. So you are better-off looking for pharma picks than you are value fishing the IT just yet.
Latha: This is not on anybody's radar at this point in time but at some point capital goods and infrastructure should get a look in. Is there anything in that space and more importantly Larsen and Toubro (L&T), if there is a global restocking of metals, of crude? Do they get orders? Are we looking at that stock at all with interest?
A: I won't comment directly on L&T but if you think about the capex trends in India, they are unlikely to go up for a couple of reasons. One, the government doesn't have enough money and more importantly enough shovel ready projects to start releasing that money going forward and with demonetisation I would argue that policy making should be focused more alleviating the stress in rural India and providing some sort of social support rather than trying to build 10-year bridges right now, at least politically that would seem the more appropriate thing to do as well. So a) the government is unlikely to start too much of capex, beyond what it is already doing b) private sector is unlikely to start building too many new factories because utilisations aren't very high enough and with demonetisation one has probably taken a step back as well and c) in terms of capital spending in India is real estate, which is a big part of fixed capital formation and while it was looking like it might start, this demonetisation has put a bit of a brake on that. Now whether that is 6 or 9 or 12 month issue, we do not know but up until some sort of capex starts, the industrial capex cycle is very unlikely to improve, in fact the whole economic cycle is unlikely to improve until capex increases meaningfully.
So as a basket, I do not think industrial space is going to see anything meaningfully improve in the visible future that I can talk about.
Sonia: One sector that has caught everyone unaware except a few brokerages like Credit Suisse is the metal space and not too many people have been able to bank on that run. How are you positioned in metals and do you think that 2017 could also see some traction there?
A: I will contend that and say as a house we have also been very positive on cyclical from January 1 this year. In the region we have been calling the fact that it is going to see a cyclical rally and that has happened. We do think that there might be some legs to go and this is linked to the outcome of monetary policy in China. So long as the monetary conditions stay expansionary and stay supportive, the cyclical, metals and so on, should likely be a sector that continues to perform.
In India we do not have coverage, so we do not have recommendations on any of the metal sector just yet but my point from a strategy point of view is that yes, we like cyclical globally but you then have a choice whether you want to buy cyclical in India or outside. There is no reason particularly to favour an Indian cyclical just yet over one in China or anywhere else. So as a house we have been talking about cyclical but there is nothing that differentiates the Indian one from the rest of the pack.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
