CLSA remains overweight on India, expects 10-12% return in 12 months

The theory proved right when markets across the globe including Indian market slipped nearly 4 percent amid rising tensions between the US and North Korea. SEBI crack down on shell companies also dampened investor sentiment.

“We have seen ups and down in Indian markets were more driven by global developments than Indian developments,” said Nandurkar. If we are talking about markets corrections, then we have to look at what are the possible global concerns or risks that we are looking at.

Broadly speaking there are some geopolitical risks. Our base case remains that China story is looking reasonably Ok, the political situation is stabilising in Europe ahead of big elections. However, one big risk is what if US Fed starts to shrink the balance sheet and at what pace which investors should keep a track of.

The domestic flows are much more sustainable going forward and will help in stabilising the market. India is still a buy on dips market but investors need to moderate their return expectations keeping in view what the current CPI is and where the 10-Year bond yields are.

“With CPI of around 4-4.5% and Bond Yields at 6.5% or so, one should be happy with a return of 10-12 percent from equity markets which we think is likely in the next 12 months,” said Nandurkar.

Sectors to bet on:

CLSA is positive on Cement, Construction Pipes companies and Housing Finance Companies where the brokerage house feels that the current profitability, margins, ROEs are at a cyclical low.

Market valuation remains a concerns but CLSA a house is looking at stocks and sectors where there is some earnings upside.

Housing is one sector which CLSA is positive about; however, they are underweight on IT & pharma. These are the least-preferred sectors, it said.

Investors can buy it from a short-term view, but the global investment bank feels that the sector is ex-growth for now.

Below is the verbatim transcript of the interview.

Anuj: You may not want to talk on individual stocks but your call on Jubilant Foodworks and in fact the entire consumption basket, we have seen consumption basket do well. Do you think it deserves the kind of premium that it is trading or it just reflects the lack of other investable ideas in the market that we are seeing this kind of price earnings being attributed to the entire space?

A: The thing is valuation is probably on a much higher side for the market as a whole. Yes, some stocks are at a much higher premium than the market as a whole, but , I think what the market is focusing on and what we are focusing on, is the stocks and sectors where we think that the current profitability, current margins, current return on equities (RoEs) are at a cyclical low. We definitely feel that there are many stocks at this point in time including certain stocks in the QSR segment which believe are at a significantly lower levels of RoE and margins as compared to where the normal state would be.

So our focus is clearly on those stocks where the possibility of earnings upside can be material. Valuation is a concern with pretty much the market as a whole, so, that is the reason why we are focusing on stocks where there is a possibility of earnings upside.

Latha: I was reading your several CLSA notes and you are betting big on social expenditure or affordable housing, but how would you pick your stocks, would you pick housing finance stocks, cement, house builders like say a Larsen and Toubro (L&T), which is your pick of the pack?

A: Housing is one theme which we are very optimistic about and one of the reasons for that is clearly what you mentioned, the government support. However, our primary reason to be bullish on housing is more to do with the market driven forces, more to do with our affordability analysis which we classify as the ratio of the monthly mortgage payment as a percentage of monthly income. That ratio according to our analysis has gone down to the lowest level that we have seen in the last two decades especially for houses that cost less than Rs 40-50 lakh. So, that is basically our key thesis that the affordability, in that pocket is looking at the best level that we have seen in the last two decades.

What is really helping that call is the fact that the government is also putting a lot of emphasis and they are also putting in this housing for all program, and the expenditure is likely to go up, etc. So that clearly is the near term trigger. So the way to play that, I feel the best way to play that still is housing finance segment, the housing finance companies where we believe that the mortgage growth for the industry as a whole will be between 15-20 percent over the next five to seven years if not more. So despite the fact that there are some concerns about rise in competitive intensity and so on, we feel that the industry growth itself will offer enough room for variety of players.

So that I feel is the best way to play the theme, obviously followed by the other building material segments like cement, like the construction pipes, is the other way to play that and some of the household goods companies as well. The listed real estate stocks would not really be the best way we feel to play the affordable housing story because relatively a small part of that is coming through that segment, but yes property sector also looks interesting from the point of view of the fact that they are getting some tax incentives and also because it has been a very neglected sector for a very long period of time.

Anuj: Do you have a positive call on the other set of NBFC stocks as well, we have a lot of companies which have done well for example the likes of Edelweiss or the ones which are catering to the financial savings and we have seen a big move from real assets to financial assets, some of these companies have done well. Do you like any other NBFCs as well apart from housing finance?

A: Apart from housing finance, I would say that the financialisation of savings is a pretty structural and long term story which I think has just started playing out in India. So, it is not just the broking orientated names, or the investment bank oriented names, but also the insurance companies is also a play on that. So the other segment also looks interesting, but in the broader banking and financial space, what we also feel quite optimistic about from once again a two year to three year kind of a horizon is the corporate banking space.

I know that we are not completely out of the woods as far as the NPL story is concerned, we saw some incremental slippages coming in Q1 as well, but our belief is still that we are somewhere close to the peak of the NPL cycle and things would be improving from here on and it also fits into one of the things I said in the beginning that looking at the stocks where the current profitability is significantly lower than what we are normally used to seeing and therefore the possibility of an earnings uptick. So, the corporate banking space also looks very attractive to us.

Latha: Where does India figure in your global sweepstakes, where does CLSA Global place India in the emerging market’s pecking order?

A: Our global strategist and we as a house have been very positive on India even within the emerging market basket. At a house level, we are generally more positive on emerging markets as compared to the developed world and within emerging markets, our focus is clearly more on Asian markets and India is something that we have been consistently advising investors to be significantly overweight on. So, in fact at this point in time we are advising a pretty chunky, 50-75 percent overweight on India as we speak.

Latha: The forbidden sectors, IT and pharmaceutical; let us first start with pharmaceutical, we are seeming to get a series of bad news and yet now perhaps it is time to dip your toes in?

A: We are very closely watching the movement of the stock prices, and investor positioning on that sector. So both IT and pharmaceutical for that matter have been underweight in investor portfolios. These are also the least favoured sectors at this point in time. So, we are keenly watching out for when things begin to bottom out within the pharmaceutical healthcare space. It looks like we are getting there slowly but right now it still seems a bit too early to us, so, we would still advice underweight on pharmaceutical healthcare as of now. However, this is definitely looking like an interesting sector that we are keeping a watch for.

The other sector you mentioned, IT, IT I would probably say that if one is worried about the market trend in the near term, then probably buying IT kind of makes more tactical sense when especially some of the stocks within that, maybe in the midcap space, or even within the largecap the stocks where the growth trajectory is expected to be slightly better. However, we feel that IT is clearly ex-growth for some time to come. So IT at best can be a tactical story. You may kind of buy it with a short term view, but it is not a sector that we will buy and hold with a two or three year view.

On the contrary, I would say pharmaceutical, although does not look very attractive at this point in time, but sometime in the near term future I think the strategic story, the long story will begin to reemerge.

Anuj: A word on the market itself; you have seen so many market cycles, we are saying this time it is different because we have seen a lot of domestic sort of inflow supporting the market. Even on Monday when we had that rally, there was huge selling by foreign institutional investors (FIIs) but the domestic investors bailing the market out. Do you get a sense that the market could be immune to a big correction this time like we had in the last bull market or do you think things could still go awry?

A: The thing is that if you look at various market cycles over the last two decades or so, most often than not the Indian market have seen their ups and downs or big corrections, if I can use that word, were more driven by global developments than Indian developments and I think that continues to be the case even now. So therefore when one talks about market correction, I think one has to look at what are the possible global concerns or risks that we are looking at. So one can never really say that there are no global risks at this point in time but I would say that broadly speaking there are some geopolitical risks that keep on coming up, but I would still not be of the view that that is our base case. Those still remain a low risk probability. So, our base case still remains that the China story is looking reasonably okay at this point in time. We have seen good data points coming out on the forex reserves numbers over there, even Europe the political situation is stabilizing, we have big elections in Germany later in the year and see how the trends go over there but the expectation there once again is that the mandate may be for a united Europe which is good for the equity markets. So, basically global risks at this point in time don't appear to be too alarming with a small exception that what happens if the US Fed begins to shrink the balance sheet and at what pace, etc. So that I think remains a risk that we need to keep a track of. However, in my view, things appear to be quite okay from the global perspective and as you rightly mentioned, the domestic flows to my mind are clearly much more sustainable and much more kind of a dependable source of market stability. So, I continue to believe that it is a market that is buy on dips, but yes, we have to definitely moderate our market return expectations keeping in view what the current consumer price index (CPI) is and what the 10-year bond yields are. With the CPI of around 4-4.5 percent, with bond yields at about 6.5 percent or so, I think one should be happy with a 10-12 percent return from the equity markets which we think is likely over the next 12 months.