Any unfavourable verdict in the state elections, which indicates that the National Democratic Alliance government would face challenges in the 2019 elections, would result in a drastic fall in midcaps and smallcaps, said Akash Jain, Vice President - Equity Research, Ajcon Global.
Among sectors, Jain is bullish on midcap IT companies as growth is visible. He feels investors can accumulate companies in the pharma space with a 2-3 year horizon ‘as it will get re-rarted once earnings become visible.’ Taking a contrarian stance on state-run banks, Jain said the depressed valuations can be a good entry point for investors with a long waiting period and high risk appetite.
Here are excerpts from his exclusive interview with Moneycontrol's Sunil Shankar MatkarQ: The market has been highly volatile due to movement in crude oil prices and dollar-rupee. Do you expect it to remain rangebound or could it cross its previous highs in the second half of 2018?
A: We expect the market to remain rangebound as there are assembly elections lined up in several states and the Lok Sabha election in FY19. Any negative outcome which would create volatility in the market should offer investors an opportunity to value pick across sectors.
The rise in crude oil prices are due to supply-side pressures on account of sanctions imposed on Iran by the US and cut in supply from Venezuela. Rising crude prices will hurt the Indian economy and affect inflation as well. Of late, prices have corrected by around 8 percent from its recent peak on talks of Saudi Arabia and Russia raising Organisation of Petroleum Exporting Countries (OPEC) and non-OPEC oil production by 1 million barrels per day (bpd) to tackle supply constraints.
Last Thursday, oil prices dropped owing to a surprise jump in US crude inventories and expectations that OPEC and other producers could increase output at a meeting in June. Brent crude stood at $76.70 per barrel on Friday. The falling rupee against the dollar though is not of any major concern as our foreign exchange reserves are very comfortable.Q: How do you read March quarter earnings? Experts say the worst may be over for earnings and that a recovery should start from the current year. Do you think FY19 will see a revival in earnings or is there a chance of a downgrade in earnings?
A: March quarter earnings has been decent and in line with market expectations. Companies in sectors like automobiles, non-banking financial companies (NBFCs) and consumption space did well. Earnings from sectors like state-run banks, IT and pharmaceuticals were below expectations. We do expect a revival in earnings in FY19.
However, important factors like the onset of monsoons, movement of crude oil prices and recovery efforts of public sector banks (PSBs) to resolve its non-performing assets will determine earnings growth in FY19. We feel earnings in FY19 would be much better than FY18.
We are confident that economic recovery is on its way and that should help corporate earnings grow in double-digits in FY19. Infrastructure and consumption would drive earnings growth. The recent hike in steel and cement prices also reinforces our conviction that things have taken off the ground. Corporate earnings should remain strong over the next two years and that should make current valuations cheap on a forward earnings basis.Q: Will FY19 turn out to be a year of largecaps more than midcaps and smallcaps in terms of returns?
A: We would answer this question in a different manner. Considering the volatility in the market and newsflow with regard to resignation of auditors of certain companies, it is prudent to stick with quality names in this uncertain market. Most quality names are available in the largecap space. Midcaps have been witnessing consistent hammering post Union Budget 2018-19 and Securities and Exchange Board of India's (SEBI) re-allocation dictum for the mutual fund industry. Though midcaps and smallcaps have delivered excellent set of returns before this downfall, investors need to be careful while selecting stocks in the midcap space. Any unfavourable verdict in the state elections, which indicates that the National Democratic Alliance government would face challenges in the 2019 elections, would result in a drastic fall in midcaps and smallcaps.Q: Crude has dipped sharply from 3.5 year highs of $80.50 a barrel touched recently. Where do you see crude prices heading?
A: It is difficult to predict the price movement in crude oil. However, if the present price run-rate persists, then it would affect several sectors. A rise in crude oil prices would affect aviation turbine fuel, which in turn would hurt the operating profit margins of aviation companies as it accounts for around 50 percent of an airline's total operating cost. From January, Brent crude prices have witnessed a rise of about 30 percent owing to concerns that the conflict between the United States and Russia may escalate in Syria.
Margins of sectors that use crude derivatives as inputs will also come under pressure. The paint industry will be among the worst affected because almost 60 percent of its raw material usage are based on oil derivatives. While large players such as Asian Paints will be able to pass on higher costs due to their branding power, smaller players will come under pressure.
Vinyl acetate monomer (VAM) is another crude derivative that is widely used by adhesive companies such as Pidilite Industries (VAM account for 35-40 percent of its raw material cost).
Since most packing materials are now based on plastics, another crude derivative, FMCG companies will be affected. We feel there will be easing in crude prices in the times to come.Q: Do you see inflationary pressures due to higher crude oil prices and can retail inflation cross 6 percent in May or June?
A: With oil prices trading at high levels and low base, we feel retail inflation will be on an upward trajectory.Q: Do you expect a hawkish stance from the Monetary Policy Committee in June? Do you see any rate hikes in FY19?
A: We do not expect a rate hike at their June meet. However, if monsoons are not up to expectations and crude prices continue their upward trend then the committee may be forced to hike rates. India’s annual retail and wholesale inflation accelerated in April due to higher fuel and food prices. The MPC is scheduled to hold its next policy meeting on June 6 and is widely expected to hold rates after having kept them unchanged for the fourth straight time. But with faster-than-expected pace of retail and wholesale inflation, its next policy move could come as a surprise.Q: What is your view on technology and pharmaceutical stocks?
A: At current valuations, both these sectors look attractive. Both sectors seems to have bottomed out in terms of valuation. In the case of technology, we are bullish on midcap IT companies as growth is visible.
The pharma sector has its own set of problems in terms of US Food & Drug Administration compliances and President Donald Trump's focus on curbing prices on products of Indian Pharma companies. US focused pharma players may continue to witness price erosion. Pharma players focused on the Indian market will continue to do well. One can accumulate companies in the pharma space with a 2-3 year horizon as it will get re-rated once earnings become visible.Q: Almost all PSBs reported losses in Q4 on higher provisions following new norms by the Reserve Bank. Do you think the worst is over for PSBs? Would FY19 be a year of stability in earnings?
A: After attending analyst meets of all major PSBs, what we heard from most managements is that they have accounted for all the stress in NPAs and have provided for it adequately. However, we were not happy with the growth in advances in PSBs, which is in low single-digits.
We understand the banks cautious approach towards capital preservation, however they need to grow. Most PSB chiefs are focussing on recovery. For instance, Bank of India witnessed a strong recovery of around Rs 11,000 crore in Q4 FY18.
If a recovery kicks in, then we would see a strong write-back in coming quarters in most PSBs. Going forward, faster resolution of National Company Law Tribunal cases and recapitalisation by the government would add much needed strength to their balance sheets.
We would strongly recommend that the government and courts remove all hurdles for faster resolution of NCLT accounts. The deadline for resolving the same must also be followed strictly.
Having said that, we, however, do not rule out further slippages and write offs in PSBs as we are still unsure if there is more pain left in the books. Recapitalisation and recovery measures would improve the bleak picture in the PSU banking space. However, PSBs should perform on their own rather than depend on recapitalisation.
The depressed valuations can be a good entry point for investors with a long waiting period and high risk appetite. We are encouraged by the clear vision statement of State Bank of India Chairman Rajnish Kumar that by 2020 return on assets will increase to 0.9-1 percent, credit cost will fall below 2 percent and advances will increase by 12 percent CAGR.Q: Could you list out four stocks to bet on if monsoons turn out to be as good as expected this year?
M&M: Buy | Target - Rs 1,049 | Return - 16%
M&M, is the market leader in tractors with a share of 42.9 percent and is gaining market share for the last 3-4 years on new launches. Rural penetration has improved by 14 percent on yoy basis and stood at 43 percent at the end of FY18. The Company would do well in case of a normal monsoon and improved rural sentiments. The management expects volume growth for the industry as a whole at 8-10 percent in FY19 and feels 8-9 percent yearly growth is sustainable in the long-term.
The Company reported good results in Q4FY18. PAT witnessed yoy rise to touch Rs.1,155 crores in Q4FY18. EBITDA shot up 70.4 percent to Rs 1,995 crore and margin expanded 400 basis points to 15.1 percent compared to same quarter last year. Farm equipment business, which contributed 28 percent to revenue, reported healthy 41.8 percent growth year-on-year at Rs 3,716 crore with its EBIT (earnings before interest and tax) growing 55 percent to Rs 723.4 crore and margin expanding 170 basis points to 19.5 percent for the quarter ended March 2018.
Mahindra and Mahindra sold 46,849 vehicles in May, registering a 12 percent growth compared to 42,003 units sold in same month last year. The growth was driven by commercial vehicles segment that showed 15 percent growth year-on-year at 18,748 vehicles in May 2018. The passenger vehicles segment (which includes utility vehicle, cars and vans) growth was muted. It sold 20,715 vehicles under passenger vehicles sector, a growth of 2 percent YoY. "May has relatively been a subdued month compared to April. On the back of a buoyant economy, medium & heavy commercial vehicle (MHCV) division continues to outperform. Exports have also been strong with a high growth," Rajan Wadhera, President, Automotive Sector said.
With the forecast of an upcoming normal monsoon the company is confident of good growth in the coming months, he added. Domestic sales grew by 8 percent to 43,818 vehicles in May 2018 while exports shot up 134 percent to 3,031 units compared to same month last year.
Meanwhile, its farm equipment segment registered a 14 percent growth in May 2018. Tractor sales for May 2018 stood at 29,330 units against 25,749 units sold in May 2017. Domestic sales during the month increased 14 percent to 28,199 units while exports rose 9 percent to 1,131 units YoY. "We hope that the announcement of record production estimates for food grains and horticulture crops will drive positive sentiments and boost tractor demand," said Rajesh Jejurikar, President - Farm Equipment Sector.
The Company will invest an additional Rs 500 crore at its Chakan plant in Maharashtra to expand its electric vehicles portfolio. The utility vehicle major today inked two pacts with the state government regarding EVs. M&M said it will make efforts to become fully electric ready by further investing in its Chakan plant for manufacture of EVs, e-motor, controller, battery pack and other electric vehicle components for multiple mobility applications. M&M has earmarked a total outlay of Rs 900 crore for EV vertical. Apart from Rs 500 crore investment in Maharahtra, the company also plans to put in another Rs 400 crore in its other plants across the country.
We believe the Company will do well on expectations of normal monsoon forecast by IMD and expectations of MSP hike. At CMP of Rs. 902 (Face value: Rs. 5), the stock trades at a P/E of 25x on FY18 EPS. We can expect a target of Rs. 1,049 by FY19 end (25x on estimated FY19 EPS of 41.94).
M&M Financial Services: Buy | Target - Rs 544 | Return - 17.5%
Mahindra & Mahindra Financial Services is one of India’s leading non-banking finance companies focused in the rural and semi urban sector is the largest Indian tractor financier. Primarily in the business of financing purchase of new and pre-owned auto and utility vehicles, tractors, cars, commercial vehicles, construction equipments and SME Financing.
At current market price of Rs 473 (Face value: Rs 2), the stock trades at a P/BV of 3.3x which we believe is cheap as compared to other listed NBFCs. In Q4FY18, the company witnessed strong 17.8 percent YoY growth in AuM and a sharp 22 percent QoQ decline in GNPA.
The company's Q4FY18 consolidated net profit rose 79.4 percent at Rs 513.1 crore against Rs 286 crore, in the same quarter last year. The company improved its Return on Assets significantly from 1 percent in FY17 to 1.9 percent in FY18. With improving rural cash flows, recovery from NPAs would help the company to improve its ROA of 2.6-2.8 percent by FY20.
The management is optimistic on improving rural cash flow which should lead to growth of 18-20 percent in FY19 across segments. Yields were comfortable and no pressure is seen by the Management in medium term. Management expects yield range to remain between 15-17 percent, however company hinted of some funding cost pressure and can be passed to selective geography and selective product segments on keeping spreads stable. NPAs in the rural housing is expected to reduce in coming quarters as Maharashtra has improved in cash flow and which will translate towards recoveries. PCR stood at 58.1 percent in FY18. We expect a target of Rs 544 by FY19 end (P/BV of 3.2x on estimated FY19E Book Value of Rs. 170) implying an upside of 17.5 percent.
United Phosphorous (UPL): Buy | Target - Rs 810 | Return - 16%
UPL is the largest Indian agrochemical Company and is engaged in research, manufacturing, selling and distribution of agrochemicals and specialty chemicals across the globe. It is one of the best backward integrated agrochemical play with a global market share of 4 percent. The Company boasts of strong ROCE of 22 percent.
UPL’s key brands Iris, Shagun, Eros, Ulala, Atabron more than doubled volumes in FY18 and we expect it to do well in FY19. India accounts for 18 percent of total topline and has witnessed a growth of 8 percent. India business is expected to do well owing to the expectation of normal monsoon by IMD.
In Q4FY18, the Company’s topline witnessed yoy growth of 6.5 percent to touch Rs. came in at Rs5,691 crores owing to volume growth of 8% on yoy basis. Consistent growth was witnessed across regions. Revenues in Latin American market grew 7% yoy (vs. a market decline of 4%) as demand was subdued due to high channel inventories, delayed rains, and dry weather conditions in Argentina. UPL outperformed the industry in North America and Europe, aided by its herbicide portfolio in North America, and good growth in sugar beet herbicides in Europe, coupled with low opening inventories.
The operating profit (including forex impact on trade receivables and payables) for the quarter stood at Rs1,421cr, a rise by 36.9% yoy. The EBITDA margin expanded by ~554bps yoy to 25% in Q4FY18. PAT registered 6.9 percent yoy growth to reach Rs. 778 crores in the same period.
Management has guided 10-12% revenue growth in FY19 (12-15% EBITDA growth), whereas the industry is expected to grow in mid-single digits.
Management continues to invest in new product development, and expects to invest ~Rs1,500cr into overall capex in FY19, including ~Rs. 400cr on intangibles (product registrations). The company’s new product development activity remains strong.
The company offered an overall positive outlook for FY19, stating that the agrochemical industry has likely bottomed out and should resume growth.
At CMP of Rs. 695 (Face Value: Rs. 2), the stock trades at a P/E of 18x on FY18 EPS. We recommend a “Buy” with a target price of Rs.810 by FY19 end. (P/E of 18x on estimated FY19 EPS of Rs. 45).
We are bullish on the prospects of SBI as we feel that the worst is discounted in current market price and there is room for upside. Structurally, the bank is strongly placed against peers like Punjab National Bank, Bank of Baroda and Bank of India owing to higher CASA ratio, lower cost of funds ability to underwrite large corporate loans, strong branch network and largest customer base to enable cross selling, technological advancement, largest market share in digital payments, credit card business etc.
Our conviction on this PSU bank stems from the positive management commentary in its analyst meet. SBI has a given a guidance of loan CAGR of 12 percent, NIM target of 3 percent, slippages & credit cost of less than 2 percent, ROA of 0.9-1 percent, cost/income of 46 percent by end of FY20.
To unlock value from its subsidiaries, SBI General Insurance and SBI Funds and Cards management are expected to be listed next year. We believe that the bank has accounted for its NPAs and stressed assets and the worst case scenario is now behind us. Prospects of recovery are likely to increase and we expect good write-backs as well, says Bank management.
In Q4FY18, the bank’s revenue witnessed a growth of 18.6 percent on YoY basis to Rs 68,436 crore. NII stood at Rs. 19,974 crore as against Rs. 21,065 in the same quarter last year. The bank has reported net loss of Rs 7,718 crore for the quarter, against profit of Rs 2,814.8 crore reported in corresponding quarter last year due to a surge in provisions and bad loans. This was the second highest quarterly loss figure reported by any bank after Punjab National Bank reported a Q4 FY18 loss of Rs 13,417 crore.
The bank witnessed 4.9 percent advances growth on YoY basis and 6 percent QoQ to Rs 20.48 lakh crore in Q4FY18. Loan book break up as of FY18 end is 43 percent Corporate and 57 percent Retail. Management expects this mix to move toward 60:40 in favour of retail. Deposits as of FY18 end stood at Rs 27.06 lakh crore.
In terms of asset quality, Q4FY18 GNPA increased by 56 bps to 10.91 percent as against 10.35 percent QoQ. NNPA for the quarter came at 5.73 percent against 5.61 percent QoQ, which has increased by 12bps.
Management expects GNPA to reduce by Rs 50,000 crore in FY19. The bank has identified Rs 26,000 crore as stressed of which Rs 10,575 crore are from power sector. Slippage should not exceed Rs 16,000 crore from this pool. PCR on this pool is 18 percent.
In Q4FY18, slippages were to the tune of Rs 33,670 crore as against Rs 25,836 crore QoQ up by 30 percent QoQ and 22 percent YoY. Slippage ratio came at 6.9 percent for the quarter under review as against 5.29 percent QoQ.
SBI has a watch-list of assets for FY19 of Rs 25,800 crore (Note that SDR accounts slipped into Q4FY18 and 5 S4A accounts are included in the watchlist). Power-sector loans worth Rs 10,575 crore sit on its watchlist of loans for FY19, which includes all corporate special mention account (SMA)-2 loans and stressed SMA-1 loans.
The expected haircut on NCLT-1 is 52 percent (to be resolved by 1HFY19), which is lower than provisions currently held. In NCLT-2 (to be resolved by 2HFY19), the bank hopes to recover in excess of 25 percent. The bank has written back Rs 2420 crore of provisions related to NCLT accounts where there is reasonable confidence of recovery.
Non-RBI directed NCLT exposure stood at under Rs 3,000 crore (115 cases). All NCLT accounts stand classified as NPLs by the bank. Power-sector loans worth Rs 10,575 crore sit on its watchlist of loans for FY19, which includes all corporate special mention account (SMA)-2 loans and stressed SMA-1 loans. In fact, all the loans restructured earlier under various restructuring schemes of RBI - SDR, S4A etc. have been accounted as NPAs.
Overall Provision Coverage ratio for the quarter stood at 66.17 percent as against 65.9 percent QoQ. The bank has provided 75 percent against NCLT II List. The resolution for NCLT II cases is expected to happen by FY19 end. Overall PCR at 50.5 percent (without ACUA) should increase to 60 percent in FY19 as per Bank’s Chairman, which we believe is achievable.
At current market price of Rs 267, the bank trades at P/BV of 1.16 x (FY 18 Book Value stands at Rs 230) and at adjusted Book Value (after deducting Net NPAs), the stock trades at P/BV of 2.5x. Long term investors with a horizon of five years can accumulate it.
Disclaimer: The author is Vice-President - Equity Research at Ajcon Global. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.