A growth slowdown in the global economy is imminent as risks from events such as Brexit materialize even as the Indian economy continues to remain relatively stable, though not unimpacted.Those were the takeaways with a CNBC-TV18's freewheeling interview with the top management of Credit Suisse India, which believes that Indian investors should seek refuge in high quality stocks even as some opportunities abound in select metal and bank names."We have seen USD 3 billion of net FII inflows in the and this will continue," MD and India Country CEO Mickey Doshi told CNBC-TV18, adding that more India reforms are likely to follow and support the India story.But he added he would still be worried about the global economy. "The impact of Brexit is still to play out, I think," he said."All the signs of a growth slowdown are there. The question now is what gives," CS MD and India Equity Strategist Neelkanth Mishra said. "We are watching CDS spreads, sovereign yields, EM currencies. Insurance companies and pension funds are acting as if they are afraid of running out of bonds to buy. When this starts affecting growth, this will be start affecting equities."Mishra also talked about the stock strategy that CS would follow in India, following up on its February call to buy metals stocks -- which has paid off handsomely -- while MD and Head of Research Ashish Gupta talked about state of Indian banks and whether he thinks the economy is turning around. Below is the verbatim transcript of Mickey Doshi, Neelkanth Mishra and Ashish Gupta’s interview to Anuj Singhal & Latha Venkatesh.
Latha: You are in daily touch, for the last 30 years, with a whole lot of foreign investors. We have been getting good foreign flows for the moment just as the whole world has been getting, but do you think the India story is still ticking very well with global investors? Should we expect to be on their right side?
Doshi: I think you are right. Last six months of flows have been about USD 3 billion odd of net foreign institutional investor (FII) flows into India, in line with probably the rest of the region. Having said that, my belief is that we will probably see more than the emerging market flows that others would get and the story remains relatively intact, independent of what you were saying earlier – liquidity versus valuation. I will let my colleagues talk about valuation in a bit which probably may be looking a bit stretched, but at the end of the day I do believe India is a part where we will see money coming in more than the rest. So, I remain optimistic on the country.
Why I remain optimistic is probably, I am sure, what you have been thinking. Clearly, reforms, if people believe have not happened, are on its way, vis-à-vis the growth story, India remains stronger than the rest and other destinations probably have opportunities but the way the government is operating here, I do believe that we will see more.
Anuj: The other interesting thing is that if you look at the global picture right now, world over liquidity is so strong that investors seem to be buying bonds for capital gains and equities for income. So, the world has turned upside down. Post Brexit, we have seen this phenomenal move. Do you think we are building some kind of bubble somewhere in the asset classes?
Doshi: Post Brexit obviously, one of the things which we have seen our interest rates have come down sharply and the bonds, we have seen that happen. The fear of Brexit, the initial kneejerk reaction happened. I do not think we have absorbed all the impact of Brexit. So, to an extent, possibly, globally is a worry we should be worried about. I do believe I would still be worried about global asset prices and the global scenario. India hopefully should be shielded from that to a great extent, being a standalone consumer oriented market ourselves, but yes, I would say there would be a bit of a worry.
Latha: It is not just valuation versus liquidity. The International Monetary Fund (IMF) day before yesterday downgraded a growth of all economies – global economy as well as US economy, European economy, Indian economy and yet, you are having this equity market climb and to be fair, on the other side you have also had good bank earnings in the US, signifying that something is right in the economic recovery as well which will pull and go ahead. Will the growth slowdown, prevail ultimately or maybe in the near-term itself?
Mishra: I do think that there should be a growth slowdown. There will be a growth slowdown. All the signs are that the uncertainty triggered by the Brexit is already resulting in people holding off on investments and so on and so forth. There is a lot of uncertainty. In fact, there are other stress points. We only look at the yields on bonds, but look at insurance companies, pension funds; there are large pension funds which are now printing 0.5-1 percent gains on their assets when their expected gains are 7.5 percent a year. And this has been two years in a row. So, pension funds will start showing stress.
So, the point then becomes what will fail. The thing that I know from looking at the markets over the last decade is that the failure will come at points that we are not expecting to. So we are watching credit default swap (CDS) spreads of banks, we are watching sovereign yields, we are looking at emerging market currencies, but the shock will perhaps come from somewhere else.
Now, the bigger point is, at what point do equities start showing some of this stress and I think equities are actually growth proxies. Right now, what we have seen is a kneejerk reaction of the valuations catching up. A lot of insurance companies, pension funds, etc. are almost afraid of running out of bonds to buy. You must have seen how central banks are hitting limits and therefore, they need to be buying these bonds. In terms of relative attractiveness, the equities are looking better, so we have seen that. But when this starts affecting earnings growth, I do think that at least in the developed world, you will see equities starting to come down and that will pull down our relative benchmarks. Which is why on the Indian market, at least in the near-term, I would stay a bit cautious, because the economic growth also for a few months, and we have seen some companies reporting in their numbers. The economic growth also will slow down for a few months. The year-on-year (Y-o-Y) comparisons will not look as attractive and the market will have to slowdown as well. But I do think that on a one-two-year basis I will remain quite constructive._PAGEBREAK_Anuj: How should one approach the market right now because it is now trading above median valuation, 70-80 percent index stocks are trading above median valuations, do you now seek the comfort of stocks where the growth hasn’t been there but there is at least valuation comfort or do you stay invested in some of these outperformers that is the situation right now?
Mishra: In terms of P/E multiples, we are not just above median valuations. We have been higher than this, only 4 percent of the time in the history. So we are talking about very high multiples. However, on a relative basis, we are quite okay. So if you look at the earnings yield gap of India versus the 10-year US bond yield, it is at 4 percent. It has been higher only in stressed points. So I think that on a global asset class, I don’t think we need to worry too much about absolute valuation per se.
Our preference has been for being into stocks that have good earnings growth visibility and that mean unfortunately still some of the high P/E stocks. We have in the last three-four months upgraded some metal names, we have pushed very hard on some utilities because the valuations are low and I think after 14 percent underperformance over the last three months, maybe there can be select IT stocks which can give you good trading returns.
Anuj: We have seen quite a bit of rally in banks as well. The first one that I want to discuss with you is the whole bank recapitalisation, how are you looking at that? There is one camp which believes that throwing more good money at the bad. Would you have a different view on that?
Gupta: What has happened is that the government has limited choice, it needs to support these banks and the money needs to come in, in fact our belief has been that if you see the money coming into the bank, so the amount has been largely similar over the last two years but more of the money is going into weaker banks because they need to have the minimum threshold of capital adequacy. So I think there is little choice with the government not to put in the money, the only choice is --or the other alternative is whether they privatise or not but if they are not willing to go down that route, they have to support this with this amount of capital.
Latha: Let me complete this Hindalco argument that Anuj Singhal started simply because the health of the metal sector will determine the health of the financial sector to some extent at least for the steel stocks. What is your sense? When we last met along with this Hindalco argument, you were speaking about how much restocking can push up metal prices and therefore give Indian companies a lease of life, there is some policy help of course that they have got, do you think metal companies are in a position to pay up their interest, is there some kind of valuation comfort there?
Mishra: Those are completely unrelated issues. So the debt levels in many of the companies are beyond redemption. Even if you give them mid-cycle EBITDA per tonne, they have to write-down at least half of their debt, so that is unsustainable. The longer they stay in that position, the unsustainable part of debt continues to rise. So the steel cycle revival only applies in the stock markets to companies that are not down in the dumps. So that call continues to work. We have seen steel prices in China revive; iron ore is at 60, so that restock and now we are seeing that companies are slipping up on their iron ore shipments. We have seen after the trade barriers who have moved up in India, in Europe, in the US, Chinese perhaps have realised that continue to exports are not the way forward and there are also being much more serious about consolidation. So the trends are quite positive, so the good thing is that we should not see new companies go down that route, there was a fear that almost all steel companies will go down the route but that is not going to happen.
However, what is also possible is that if there is a company with Rs 45,000 crore of debt where earlier the sustainable number was Rs 20,000 crore maybe now the sustainable number is Rs 25,000 crore, but Rs 20,000 crore still has to be written down and that 5,000 crore gain goes to the banks which is why around the same time we upgraded the metals, we also upgraded some of the banks. So that remains our thesis, that hasn’t changed at all.Anuj: The other point is from investors' point of view, two-and-a-half years back when we had this huge rally, there was a Modi premium build into the market. You talk to a lot of these global players, what is the sense you get, are we on the right path as we complete two years of the government or is there something more that they expect now?
Doshi: When he first came to power two years ago, we had a government for last ten years, was the same government and obviously one of the key message which global investors want to see was is there a change. I would have to categorically say, from a perception perspective there has been a big change. I think India was not a destination which people were looking at as closely. It clearly has become one, may it be in the capital market, may it be in the foreign direct investment (FDI) purview, may it be in terms of even merger and acquisition (M&A) activity if you look at what we have done in the last six months and how active we have been in flow coming in.
I think the global investors are positive. They have had a low oil prices and the economy doing the way, performing the way it has, has helped our cause, but at the end of the day all the events put together have attracted the capital. Going forward my perspective is it remains still attractive as I said earlier. Will we need to show more? Yes, a lot of work the government has done is not going to see the benefits overnight.
Now some of the changes are announced in the last few weeks hopefully, we will see an immediate impact. One of the big ones actually which I was disappointed with in the last two years, which hadn’t happened, was disinvestment. We just announced last Friday the Specified Undertaking of UTI (SUUTI) sale, now if it were to go through as they say it is it is about an USD 8 billion of disinvestment. That would excite me and that is one of the thing which I would be quite hopeful, I would want to see happen more over the next two-two-and-a-half years. The rest of the reforms are much longer term in nature in terms of seeing hopefully in this generation but clearly it is a longer term impact, not necessarily in the next two-and-a-half years.
Latha: Speaking about the next two and a half years itself probably in the next two and a half weeks we may get the goods and service tax (GST) amendment bill passed. We hear from the government that by December they should be able to get the states also to pass the model bill or at least a large number of them. Will that be seen as a big game changer? I am only talking about perception now; I know the implementation will take time but will that keeps us on the top of the emerging market basket?
Doshi: I think there were two aspects. One was pure perception and the second was action and in terms of actions lot of the actions are clearly long-term. I think the short-term actions people wanted to see was bank recapitalisation, bank management changes, GST being passed, land reform bill being passed and the GST was obviously was struggling because of the government’s inability in Rajya Sabha. If they get it through I think clearly it will be something taken as very positive sign.
Latha: I noticed that you didn’t mention the bankruptcy code but I really want to speak about the banks. Considering that Neelkanth has been arguing that at least immediately for the next year perhaps we are not going to see commodity prices grew to 2015 levels. Has a line been drawn in terms of stressed assets? Are the devils only what is known?
Gupta: I agree I think now most of the stress has a good amount of visibility. It may not all be classified under the head non-performing assets (NPA). However, if you look at NPA restructured, watch list, 5:25 so if you aggregate all those numbers I think the total stressed assets portfolio comes similar to what our numbers are.
The second point definitely is that with the metals rally some of the loss given default on these stressed assets has also got capped. The challenge however is that banks are not fully provided for it so there are some banks that have the capital to provide for it. Some banks which are shy of having the capital that is needed. That will be the big challenge over the next couple of years. So some of these assets move from the restructured or the watch list buckets to the NPA bucket, you will need additional provisions. In fact many of the banks do start-off just even on the NPA bucket don’t have adequate provisions. I think we definitely have visibility on what is the total quantum of the problem is but yes, we still have to go through taking the financial cost of it.
Anuj: Just to carry forward the argument. We have been talking about banks, but the real sector which has done remarkably well is non-banking finance companies (NBFC) and you still have overweight on that, and we have seen good growth of course, in all parameters, but do you get a sense that things are in exuberance phase right now? So many of these stocks are now trading at 3-5 times price to book.
Mishra: We have been downgrading some of the names as well. In fact, one of our top sells now is in NBFC. But, to put it in context, NBFCs are where a lot of the innovation is starting to happen, so using of data to lend, to bring down your risk exposure. They are also beneficiaries of this sclerosis in the banking system where despite - see, all the arguments that were earlier given, oh liquidity is too tight, we cannot cut rates, now the liquidity is also eased off but we have not seen any banks cutting rates. And if you see the bond yields, they continue to fall. So, they are the biggest beneficiaries of this expansion in the yields versus the bank rates.
However, from policy perspective, till five years back the Reserve Bank of India (RBI) and the government was afraid of letting the NBFCs grow because there was this control fetish, sometimes justified that if there is something which is not supervised on a daily basis with 15 different ratios; it is very dangerous for the economy. But the new establishment, the current establishment in the RBI and thankfully in the government seems to be much more comfortable letting the NBFCs grow and actually they are becoming part of the policy toolkit.
So, we remain very positive, but selectively because there are stocks where they are now 40-50 percent downside to our target prices. And they will always be, you can have a macro tailwind, there will always be boats that will somehow screw things up and then sink and you have to be very cautious. So, loan against property, people start going overboard and so we are seeing signs of that already and therefore, we are selectively downgrading some of these names as well._PAGEBREAK_Latha: There is a valuation comfort like you said the negatives are out and therefore there a lot of public sector banks that are being valued at 0.2 times book to maybe a maximum of 0.8 times book, so do you have therefore valuation reason to recommend buys in any of the top rung public sector banks and even in the private sector the corporate facing banks.
Gupta: We do like most of the private sector banks even the corporate lenders and the reason as I mentioned earlier is the fact that we believe they have the capital to take the provisioning cost that is going to come in.
In the public sector banks, the challenge is that while on a nominal basis the valuation may look cheap but if you built in a true cost of provisioning and the capital then they are not as cheap as the numbers you have mentioned. However, we believe going forward the other big challenge these banks will have is on the technology front and literally it will be a double whammy that at the time when pace of change is accelerating because of the technology, these banks are getting distracted on their NPA issues, on their capital issues and in fact I believe the next 10 years is going to be the time when there will be a huge acceleration in pace of change in the financial system in India.
In fact, we believe there is a huge USD 600 billion marketcap opportunity up for grab and who are the guys who are best placed to grab it and in fact that goes to the earlier question about NBFCs as well, that yes definitely the valuations are high, but if you look at the growth opportunity in the consumer and SME market - that is very-very large. Till now we had been constraint by the lack of data to lend to these markets. So if you want a consumer loan the first thing a lender asks you is for your income tax return. If 30 million people only file IT return, your consumer market is restricted to that, but now as you get multiple new sources of data, your market size can expand to a much larger scale and we believe it can be 5 times as large as currently just in the next 10 years.
Latha: In that tailwind report of this huge unified payment interface (UPI), payment banks, Aadhaar all of them coming together, the big opportunity will be in the midcap space. The Equitas and probably the others that are yet to come to market, so would you really go down that path, all the microfinance institution some of them listed, some of them yet to be listed or shortly to be listed. Is that the place where the money is to be made?
Gupta: There will be multiple places where money will be made and I think the biggest winner on this whole new development will be platform that attracts more and more customers on their platform. So the person who captures the information is really the owner of the customer. Till now customer ownership were defined as having your or mine savings account and that is going to change because even though my savings account maybe with one bank, I may be more flexible in doing transactions with other counterparties. Therefore, the customer ownership concept will change from having savings account to having data about the customer, so the real winner will be whether it is a fintech company or it is a NBFC or it is a bank is the guy with whom individuals transact more and who have the data.Latha: How are you looking at the traditional defensive piece, IT and pharmaceutical? First pharma and then IT are going into this huge downturn. Is this value time in both these spaces?
Mishra: When we upgraded the metals and some of the banks we actually cut our overweight on IT and we went into marginal underweight about three-four months back and that seems to have played out well. The reason for that was not that we somehow thought fundamentals were changing in IT but we thought that opportunity was much bigger elsewhere. And IT and pharma for the last three years have been the favourite hiding place and they are global businesses, very professional management. They have also become upscale; at least in the pharma space they were under scaled till 10 years back.
I think what has happened over the last two years in pharma because of the Food and Drug Administration (FDA) issues so on and so forth and a lot of froth that was building in because people were giving 20 times multiple to what were actually one-off earnings and as some of those one-off earnings have come off, people said oh my god, I don't understand this.
So, I do think there is value emerging again in some of these spaces. If you look at the IT sector valuation versus the market valuation, it is actually at a five year low. What was 50 percent premium five years back is now a 10 percent discount. Therefore, I do think that at a time when people are really hunting for cheap ideas, good quality, well managed companies these are starting to - but I don't think all the de-rating - I won't buy all the IT stocks. There are some stocks which are particularly beaten down where value is visible. Same I would say is on the pharma side as well. But I still don't think all the froth has gone out of the system.
Anuj: The other space which has been in unadulterated bull market is the oil marketing companies. They are getting their fair share after a really long time. Do you think these stocks can surprise on the upside just like they did on the downside over the last decade?
Mishra: I continue to think so. They are still cheap, they still offer very good dividend yield. They have been our top picks this year and they have done remarkably well and I don't think we are done yet. There is a lot of disbelief. When we started pushing them hard we found that this was actually from the sell side perspective a consensus buy but no one wanted to talk about them. The investor appetite was very low. They thought they were government run companies, they will start giving subsidies, so on and so forth.
At a time when there is good oil volume growths and over the next 10 years we should continue to see that, hopefully not 10 percent but good growth and I still think they are pretty cheap. They are investing much more wisely. Earlier the biggest fear from PSUs used to be that when capex happened a lot of money would get siphoned out. The chances are that this time those risks are also much lower. They may still misexecute because they have execution issues but I don't think deliberate siphoning of cash is going to happen. So, investors can feel much safer.
So, they have run up very well in the last three-four months. So, maybe they will take a breather but if you are looking up one year I would still be a buyer of those stocks.
Latha: You all have done seminal work on state government's budgets as well on sectors that others have not touched so far. Like your annual farm series where you looked at how much of horticulture is happening, cold chain is happening, dairy farming is happening probably because of the cell phone and the Gram Sadak Yojana. Can you tell us a little bit more about that? How will a stock market investor relate to this kind of grounds well of state spending and consumption revolution?
Mishra: That is a very big challenge for us and that is a very interesting problem to solve that I continue to believe that the central government using the famous Indian tradition of using Atishyokti Alankar that you exaggerate to drive home a point. I don't think the central government matters as much as the state government. They matter and that is why I say I am exaggerating. If you meet a government employee, 30 out of 31 times you are meeting a state government employee and going through the state budgets over the last two years I have been amazed at the kind of ambition that is emerging in the states. So, Telangana wants to give pipe drinking water to every household. Once you think about it you wonder why everyone doesn't think about it. But let us see if they are able to do it. It is Rs 40,000 crore project. Uttar Pradesh (UP) is thinking of doing metro rail project in Kanpur, Agra, Allahabad, Meerut and Varanasi. We are seeing Rajasthan move to conclusive titling of land. So, there are states which are willing to give presumptive clearances to two projects.
Latha: Will they be able to implement. Is there money, bandwidth?
Mishra: Let us see, at least now the ambitions are starting to get set. The first thing is to desire and the fact is that the political winds have changed. People have some of the monies to spend. So, the state budgets are expanding and also starting to take on much more challenging projects, which is a remarkable positive. One of the reasons we have seen FDI bump up so much is because the state governments are allowing much easier access to projects.
Now, how do you translate into the stock markets? You have to be very creative. One, you have to start looking at state level nuances. So, some of the largest consumer companies have started looking at state level planning for marketing strategies, very localised ad campaigns and so on. So, you will start seeing companies that are emerging from particular states. You will also start seeing much better indicators in terms of oil consumption, in electricity consumption and they will be beneficiaries of that.
So, one of the reasons we have been so comfortable with a coal manufacturer or a utility is that we are comfortable that household electrification is picking up and therefore power demand over the next five years can be strong and therefore coal that is being produced can be consumed and therefore buy a coal stock or an oil marketing company in the way that oil demand continues to rise at high single digits, that is the best way to play. So, you will find opportunities that rely on more bottomup growth, but you need to be very careful in translating some of these actions into earnings.
Anuj: Over the next two months of course, the next big decision from government side would be the successor to Raghuram Rajan. Do you think the choice of individual would matter or do you think the RBI legacy is going to continue in terms of the kind of policies that we have seen?
Doshi: That’s a million dollar question and you are looking at a million dollar answer. It is a combination of both. There is always being a legacy at the RBI there is no doubt about that, we have had changes every 3-5 years depending on the term, but having said that the individual will also matter and there have been a bunch of names which have been discussed in the public forum, all of them clearly have credentials to be in that seat. I think it is a combination of both to be fair. That would be my answer, but institution is in place and the deputy governors are in place to, so it is not as if it is going to be without any leadership or leadership, but it is a combination. We are all looking forward with bated breath. I think there is enough money being put.
Latha: There is a widespread expectation that it will be a dovish appointee combined with a set of dovish decisions, for instance the Fiscal Responsibility and Budget Management Act (FRBM) target could become flexible range, the monetary policy framework agreement (MPFA) itself could allow for higher inflation and of course the Governor appointee himself could be known for dovish credentials. How would you expect the market to respond, there is a near term positive in that, but should we see that as positive?
Mishra: We wanted to think very long-term, but I doubt that the market has the capacity to think really three-five years out. Market as I said reflect growth, whatever maybe the risks to the currency and inflation expectation, rates etc, I do think that it will be growth much more than anything else that the market go for.
If you get a Governor, I doubt that, so you have to be careful that an individual who appears a certain way before becoming RBI Governor could act very differently once the person becomes RBI Governor, so I won’t extrapolate from past behaviours, because once you become the RBI Governor it is a very responsible position and I think we demean the role and the individual, when we think that he will somehow go and do the government’s bidding as a RBI Governor - that I don’t think will happen and therefore I would not extrapolate from the person, but yes if the behaviour is dovish but on that point let me also make a point that I think given how the monsoon is progressing inflation will come down meaningfully starting December and so whether it is a dovish Governor or a hawkish Governor, you will see rates coming down.
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