Deutsche sees record pre-Budget rally, Sensex at 33K by Dec

Deutsche Bank continues to see pick up in domestic flows and a 15-16 percent earnings growth this year for India. 

On rate cut, Deutsche Bank is eyeing a 100 bps cut in 2015 with the cycle being shifted to March 2015. The company remains heavily overweight on financials. According to Deutsche, banks would be the best plays when government's spending revives. It further mentions that domestic cyclicals will be the key beneficiary of the growth recovery.

Meanwhile, Sanjay Agarwal, Executive Chairman (Corporate Finance) of the bank said the foreign direct investment in insurance could bring in USD 4-5 billion flows in the country.Below is verbatim transcript of the discussion:

Q: You must have done world wind tours of FII investors, what is the sense you are getting? We have got this massive USD 1.5 billion outflow in December and the global attitude towards equities in the past two weeks has been somewhat negative. Do you think we will get good flows in 2015, something like even that USD 16 billion we got last year?

Gill: I would break that up into a couple of different points. To begin with, if you look at the emerging market world, India looks differentiated at this point in time; most of our economic metrics are looking much better, much stronger.

The fact that commodity prices have come off, crude has come off is a big positive as far as India is concerned and after three decades we have a majority government at the center with a very decisive leader and that is what investors were looking at. So, regardless of what happens and even if there was a reversal of flows from emerging markets, India would be spared or treated favourably.

Also, over the last two decades, India has been very much service-focused. That in many ways then fences off the strategic investors.

Now, with this government’s focus on manufacturing and infrastructure and this whole concept of ease of doing business you will also see the overly of the strategic investors coming in besides the financial investors, add to that the earnings growth that we expect in India of 15-16 percent, I think all of it gives India a lot of tailwind.

We think the flows that you have seen in the past could pretty much get bettered this year. So, our view on foreign flows into India, both strategic and financial is very positive.

Q: Last year your theme was return of the domestic investor and we saw that play out quite beautifully. What is your theme for 2015?

Gupta: That is definitely one of the big themes for this year and which is why from a investor perspective even if you don’t get the same increase in FII investments, you may still see the market going up because of the return of the domestic equity investor.

India had USD 16 billion of FII investments last year which was lower than the FII investment in the previous year. So, despite the big BJP victory, despite a very pro-business government we actually had lower FII investment last year and yet the market went up.

One of the reasons was very strong flows into the domestic equity mutual funds which is a trend that will pick up even further pace in 2015 especially as the outlook for some of the other asset classes like property, gold or even FMPs doesn’t look as attractive as equities.

Also, why will domestic investors come back apart from better alternatives versus other asset classes, the outlook for India is very positive as we have mentioned in your strategy report, we have a Sensex target of 33,000.

This is about 20 percent upside from the current levels and is driven by factors such as growth which will be much better this year, the economy is on a mend.

There is an expectation that there will be an RBI rate cute, Deutsche Bank’s house view is for a 100 basis points worth of rate cut this year which would make India one of the few emerging markets globally where you will see a rate cut.

You also have potential for a sovereign rating upgrade as well sometime in the next 12-18 months. Put that in context, India starts to look very attractive once again amongst all the major emerging markets this year. So, that is another reason why we think both FII as well as domestic flows into equities will remain very strong this year.

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Q: Could that at least in the first quarter get somewhat smothered by this huge divestment program? The finance minister (FM) was with us on Friday and he said that he very much sticks with that target. Would that not mean taking away from monies that would otherwise have come to the secondary market?

Agarwal: There is some amount of cannibalisation that can happen but people have factored this into their portfolio allocations like the big disinvestment program is well publicised, people know the companies that are going to come to market so people have provided for those monies that are going to come in.

On the other side, we will see private sector raise capital which will essentially include banking companies that will be raising the capital.

None of the large infrastructure companies are headed to the equity capital markets anytime in near-term and then there is a whole plethora of small entrepreneurship that is happening where people are trying to do IPOs of USD 100-200 million size; that doesn’t alter the situation anyway. So, there is enough pool of capital for the government to meet its disinvestment target and not crowd out the other private sector.

Q: Is pre-Budget fresh all-time high very much possible?

Gupta: It is quite possible.

Q: On rate cuts, your overall 2015 view is 100 basis points but when is the first cut, is it January?

Gill: The next policy is in February so potentially you could see at that point in time although in the last quarter the Governor did say that it could be an off cycle cut as well. If you look at the overall macros, inflation down, commodity prices down, crude down and the fact that Indian industry could do with cheaper cost of capital I think the case has been made. We think that cut will happen sooner than later.

The question really is that will 50 basis points be transformational? I think the important issue here is signaling that you move from a consolidation phase now into a growth phase. I think given that we are a very sentiment driven economy, that signaling will have a very big positive impact.

Q: Deutsche Bank has topped the league table for the equity cash management deals or rather capital management market deals in 2014 so that was a big positive. In 2014 the theme was domestic consolidation and so, we saw the Sun Pharma-Ranbaxy deal, the Kotak-ING deal, the Jaypee-Ultratech deal, what do you think could be the theme in 2015 as far as these deals are concerned?

Agarwal: The whole of this current year you are going to see more domestic consolidation than cross border acquisitions into India and that is largely because most of the consolidation that needs to happen is in the infrastructure side.

Q: Will it happen?

Agarwal: You see some noises around that. Some deals have happened; some deals are likely to get talked about. The cash flows of these projects are broken and so, they need to go from weaker hands into stronger hands, people who can inject new equity into these businesses and some of that consolidation will continue to play out.

With this whole insurance FDI increase, some announcement of foreigners trying to increase their ownership in their Indian joint ventures is going to happen. Our ballpark estimate is that is going to allow for USD 4-5 billion of new FDI money coming into India once this whole insurance thing gets done.

Q: Your theme was that public investment will be one of the big themes for 2015. How do you play that theme? Are you trying to say that there is no capex coming, private sector is not investing; if it is going to be government investment than how does a stock market investor approach this, take a positive point on public sector companies?

Gupta: This is a driver for the economy as whole, what we are calling in the absence of or rather not the absence rather the delay in private sector capex pick up, so in the mean time we expect the government to step in whether it is Central government, State government or PSUs.

One thing to keep in mind is this commodity price decline windfall which the government of India is going to benefit USD 10-30 billion depending on what is your forecast on the oil price that dividend we expect to be used for public sector capex.

Some of it will go back in terms of correction in the fiscal but some of it will be directed towards stepping up growth whether it is investments in infrastructure, whether it is to give a boost for the Make in India program. This in terms should translate into higher economic growth for the country therefore higher corporate earnings.

You play domestic cyclicals. Banks are the best way to play these which is why we have a very heavy weight in financials whether it is private banks, whether it is non-banking financial companies (NBFCs) even select PSU banks. So it is not only PSU banks or only private banks, then after that it gets into the stock specific valuations and so on.

However, as a theme we are expecting that government led capex is going to take the economy forward while we are still waiting for the private sector capex recovery and the way to play that is through domestic cyclical.

Q: If that be the case, will market take it kindly if the fiscal deficit target is relaxed a bit to 3.8 percent instead of 3.6 percent for next year.

Gill: As Pratik rightly said, government spending is going to be the key in terms of kick starting the economy. So it is not just the question of isolating the public sector companies as the potential buys.

Just to put that into context, if you see the road sector,  we see National Highways Authority of India (NHAI) now taking on the responsibility for building roads on an Engineering, Procurement and Construction (EPC) basis rather than depending on the public-private partnership (PPP) model.

Similarly, on the power side we see National Thermal Power Corporation (NTPC) taking the leadership. Now the question is why are they taking the leadership? They are taking the leadership because currently the leverage in corporate India is high.

There has been boost with respect to everything that has happened on the macros over the last couple of years. So till there they are able to get rid of the leverage and they are able to again have stronger balance sheets a spending from them is going to be a little more muted.

However, you are building more roads and the power situation improves and the industry has a whole lot of benefits. So, like Pratik said, the benefits are going to be more secular and then you pick your cyclical in terms of the sectors that are playing out. This is actually a very good move on the part of the government and the quickest way to kick start the economy would be for public spending to increase.

Q: How do Indian investors really weigh through the global volatility, because in the past couple of days global investors are concerned about the possibilities of deflation? We got it with the average wage growth which was weak in the US because of the way the commodity prices are falling etc? How do an Indian investor or an emerging market investor deal with that?Gill: Again, if you look at the prices of crude for instances, one is, that is a great news for India given it is the largest part of an import bill. However, equally what is it signaling, it is signaling that there is not much growth happening globally. We keep saying Europe faltering from time to time, US seems to be on a steadier growth path. How does the Indian investor look at it? The Indian Investor looks at it from the point of view not so much in terms of the direct economic impact it has on the country but more from the point of view of the fact that lot of the investment that drives stock markets here is for foreign investments. When these foreign investors make that allocation they need to look at the global situation and they need to pullback, they need to re-calibrate their allocations based in terms of what is happening in various global markets. So, to that extent the Indian investor gets impacted because he knows that a lot of the fortunes of the stock markets are linked to what the foreign investors are doing. Q: Do you see low allocations into emerging markets?Gill: Like I said right at the beginning India will be spared for a change and unlike what happened last year. Even if there is lesser inflows into the emerging markets India will be treated more kindly.  Q: You gave us the level for the rupee. What do you think the 10 Year will do since 100 bases is your expectation?Gupta: Our expectation is, you will see a decline in 10 Year bonds largely inline with our Reserve Bank of India (RBI) rate cut although perhaps not as much but definitely on the way down we do expect 10 Year bonds will be lower than where they are right now a year from now. Just to add what Ravneet was mentioning earlier in the question regarding the outlook regarding the concerns on the euro zone one thing to keep in mind is that this year you will still see another trillion dollar worth of monetary expansion especially by the European Central Bank (ECB) and the Bank of Japan. To put that in context we had about seven trillion worth of quantitative easing (QE) from the various central banks around the world since 2007 till last year. This year another trillion dollars so to that extent the global central banks do have a lot of fire power to deal with the various issues whether it is the Greece election or further issues in the euro zone. So we are not as concerned as and as Ravneet mentioned international investors will make an differentiate between various emerging markets India on one side versus say perhaps lot of the oil producing countries on the other hand for example. Q: What are the chances of a rating upgrade? Is that factored in all your various calculations?Gill: So, is it yet factored in terms of our calculations? The answer to that is peripherally yes, but is it a central theme in terms of our outlook the answer is no. We were very closely with the rating agencies we speak a lot to them with respect to what is happening with India. We believe that if we can stick to the fiscal discipline that the government had shown and which was so evident in their previous budget and all the other measures that we are seeing whether it is on goods and service tax (GST), whether it is on land acquisition, in terms of insurance bill or for that matter what is happening in the power sector we think that if the government of India can continue to show this sustain in trend with respect to addressing the supply side constraints a rating upgrade is not very far off.  Q: What about the primary markets I mean are you expecting any kind of pick up in 2015? Are there lots of issues that are lined up? Agarwal: Like I said in the beginning the amount of entrepreneurship that is happening in the midcap space the people are starting up, people who access the markets with USD 100-200 million type of initial public offerings (IPOs) that is our whole slew of pipeline that is getting buildup. The other space that we have not spoken about is e-commerce and the whole digital India initiative is feeding of that and that kind of has a life of its own. So I do not see them coming to the primary markets but lot of private capital is available for these companies like you have seen.Q: They won’t come to the private markets?Agarwal: May be not this year, but there is so much private capital that is available that you can get attractive valuations even in the private markets. So, you do not really have to focus on the discipline that is required to be a publicly listed company. You can still build your business with the private capital and then wait for sometime to come to the public space.Q: You said public is the theme and public sector is the theme? You spoke about cement those that will feed of the NHAI, any other your top sectorial?Gupta: Like said financials, the some select industrials which should benefit from the whole initiative towards the government driven capex, cement, steel. Also I would say you should be cautious on sectors which will not perform as well for example telecoms, consumer’s staples and power utilities. These are sectors where we think on a relative basis when you have the entire global community as well as the domestic investor community looking to play this acceleration in India’s economic growth we think you should go more for the domestic cyclical which we think will do much better than some of these others.Q: IT?Gupta: IT not as much although we do expect the rupee to depreciate slightly but given the perspective that we do expect the domestic cyclical to do much better we think on a relative basis IT will not do as well.