Bumpy ride continues; blame realty for rural stress: Ambit

Below is the transcript of Saurabh Mukherjea’s interview with Latha Venkatesh and Reema Tendulkar on CNBC-TV18. Latha: Since this ahead of a conference, the first question is you must have touched base with a lot of people whom you have invited. What is the sense you are getting? We are getting continuous minor trickle of foreign institutional investor (FII) sells for six weeks now, are you getting a sense of any ennui with the India story? A: I think both sides of the fence whether it is the FII side of the fence or indeed the corporate India side of the fence, I think there is a degree of concern about what is happening in the economy. The economic weakness is very real, rural India is facing unprecedented rural distress and the real estate market seems to be getting weaker by the passing quarter. So I think on the corporate India side I am struggling to think of too many corporates outside the road building and T&D sector who have good news to report over the last three or four months and in a way the concern is reflected in FIIs behavior because they are saying what exactly can we buy if the underlying economic growth story is not there. So certainly for us this conference is a time to take stock for our clients, it is a time to take stock on their India portfolios, on their India holdings and the broad theme I think will emerge as we go through the conference next Monday and Tuesday. I think we will start seeing FIIs try to rotate out of cyclical sectors that is industrial, cement, frontline banks, auto and you will start seeing rotation towards sectors such as chemicals, pharmaceuticals, IT and other consumer discretionary plays which for whatever reason have been less impacted by the downturn. So, we have seen a distinct shift in the phase, distinct shift and emphasis away from cyclicals towards a different theme altogether as FIIs concern about the lack of economic recovery mount. Reema: What does this do to how the market is likely to do in the next six months? What would be your year-end Nifty or a Sensex target and have you tweaked it recently or are you likely to? A: Till three months ago our year-end target was 34,000; this is the financial year-end target was 34,000. Our earnings growth numbers for FY16 were around 16-17 percent. Over the last two to three months of travelling around the country, meeting policymakers, meeting corporates, going to rural India we have pulled back our targets quite considerably. Our earnings growth target for the Sensex for FY16 has come down from 16 percent to 9 percent. Our economic growth estimates are down to 7 percent. Reserve Bank of India (RBIs) economic growth estimate is around 7.6 percent, so, we are substantially below the RBI number. In the midst of that we have pulled back our Sensex target to 32,000 for the financial year-end. So, whilst I still think there is a reform program underway, reform program that the Prime Minister is driving seems to me to be a reset of the economy. He is pushing back the subsidy regime, he is pushing back on crony capitalism, he is pushing back on black money and all of those are good in the long run but in the short run they are causing real economic distress on the ground.

Latha: I was trying to make a positive story out of the little bit of good data that we got, we got an industrial output number for April of 4.1 percent against our own poll of about 1.2 percent that month. As well we got commercial vehicle (CV) sales which were consistently hitting better and better – 20 percent, 22 percent in some cases as well a little bit of urban demand revival people were talking about, indirect taxes was a damn good number. Are all these not adding up to anything much? A: I think just to look at high frequency indicators in totality, at a given point of time we will have a few indicators which are showing green and a few that are showing red. If I see the picture in totality, it appears to me to be an economy where growth is not picking up. It is not as if we are sliding down rapidly but if I look at the demand picture in totality, it is not evident to me either in say rail freight data, cement dispatch data, heavy goods vehicle production, exports – it is not evident to me that there is anything out there which suggests that quarter-on-quarter (QoQ) the economy is moving forward. My reckoning is, over the last six to seven months because of the pickup in rural distress driven by a variety of factors, driven by the slowdown in real estate, I think the economy has lost some steam. I am not saying we are going into a big slowdown but it is not evident to me looking at high frequency indicators in totality that the economy is going anywhere fast.

Latha: Since you just told us that economy related trends are not showing any pickup and there is a bit of frustration, both in corporate India and from FIIs, do you think we are going to see economy related stocks move down considerably? Would you expect say a 10-15 percent fall in the likes of an ICICI Bank, Axis Bank, Larsen and Toubro (L&T) – basically anything facing the economy proxies? A: The simplest way to see where the market is today is consensus expectations for FY16 Sensex EPS growth are around 16-17 percent. My reckoning is, if we get to 9-10 percent EPS growth in the current fiscal, we will be very fortunate. So, you have got around 6 percentage points of over estimation of earnings. If you assume that if India’s PE multiple stays broadly unchanged then as consensus brings down its EPS estimates over the course of the next three months say following a brutal Q1 result season, as consensus pulls down its EPS estimates, we should see the Sensex pull back towards the 25,500 mark which is around 6-7 percent down from where it is today. Cyclicals necessarily, industrial names such as L&T, frontline bank such as ICICI Bank; banks and industries necessarily will fall more than the market. So a 10-15 percent pullback in industrials, banks, auto and a 6-7 percent pullback in the market looks to me to be the most likely way for the market to find equilibrium. Expectations are a little too optimistic; my reckoning is Q1 results will broadly realign expectations with the more somber realities at the ground level.

Latha: Any point you want to add on what might the global cues add or detract from your overall view of Indian market? A: It is always difficult to say something useful on global cues. The points around tapering, the points around the Fed tightening at some stage and around Grexit are quite well known. The simple point I will make is right through the deepest, darkest days of the downturn, FII money kept coming into India. Even in this rally over the last 18 months as FII money has come what is very interesting in this rally, it is now an 18 month old rally is the bulk of the money keeps flowing into pharma, IT, FMCG and to a lesser extent into auto and banks. I struggle to think of too many rallies in my career where 1.5 years into a bull market you are still not seeing a pickup in the economy or still not seeing FIIs and large domestic investors put their bets on cyclicals. Although it is a rally, the positioning of this rally, positioning of investors has been defensive throughout and that itself gives you a sense of the weak levels of conviction in the investor community regarding this economic recovery.

Reema: I know it is early days but the monsoon has started off fairly well so would that not alleviate the rural distress that you were talking about? If in the course of the next one month we get signs that perhaps the monsoon is going to be normal would one then change the cautious view that you have on stocks like M&M Financial Services or couple of these stocks which could be negatively impacted because of rural distress? A: I don’t think the monsoon is as big a deal as people make it out to be because even for the rural economy, the bulk of the income for the rural economy I don’t think is coming from agriculture any longer. The drivers of rural distress are not so much related to rain, they are related to the fact that cash crop prices are weak throughout the world, minimum support prices (MSP) haven’t gone up for a couple of years, subsidies have been cut by 10 percent in the current Budget, subsidies were cut in the previous Budget as well and there is a large scale reverse migration of construction labour from the cities as real estate turns down, construction labour is going back to the villages and causing a glut of labour there. So, the drivers of rural distress I am afraid are fairly structural rather than something that the rain gods can address. To be fair to the government, what the government is trying to do structurally to the economy which is correct the fiscal deficit, go after black money, change the way the government itself goes about doing business is good for the country but the benefits of that are more an FY17 story, the pain is more here in now. Earnings visibility I am afraid lies in a small set of stocks say names such as Coal India, Power Grid where transmission distribution order activity boads well for Power Grid. Coal India’s volume growth numbers are consistently good and the odd midcap play such as PI Industries where you have good visibility on earnings momentum. However, those narrow set of names with earnings visibility is where I think the bulk of the investor attention will focus on in the coming three or four months.

Latha: You also have some outstanding consumer stocks, I thought I saw Pidilite and stocks like that on your list – those are I guess stocks for all seasons? A: I think the story over the next decade if you were to take a longer view of India, as these reforms that the NDA is trying to push through, my reckoning is gradually we will rebalance, the Sensex will rebalance more towards consumer discretionary names. Pidilite is one name in our Sensex 2025 list. Also banking and financial services names, names such as Kotak Mahindra Bank, IndusInd bank I think it is just a matter of time when those sorts of banks make an entry into the Sensex. We will become an index which will be lighter on metals, mining, oil and gas, heavy industrials and heavier on BFSI and consumer discretionary.