Ambit Capital is apprehensive about the likelihood of a sharp surge in markets in the near term. The fears come on the back of under-pressure FII flows and impact of demonetisation playing out, according to Saurabh Mukherjea, Chief Executive Officer - Institutional Equities, Ambit Capital.
Prevailing conditions aren’t conducive for a big rally in the markets in the short term, Mukherjea told CNBC-TV18. The brokerage house had in November scrapped its FY17 Sensex target of 29,500 in view of the government’s demonetisation drive. Ambit Capital’s FY18 Sensex target stands at 29,000.
In view of the impact of demonetisation, organised players are gaining market share from the unorganised ones as can be seen from the Q3 earnings of some companies, Mukherjea said, adding, cash-oriented players have been hit hard.
Going ahead, unemployment surge due to note ban will put pressure on consumption sector, resulting in a negative effect on asset quality for non-banking sector, he said. Housing finance companies that have lent to SMEs may find some pressure in the coming quarters, he added.Below is the verbatim transcript of Saurabh Mukherjea’s interview to Latha Venkatesh, and Anuj Singhal.Anuj: What is the call on the market because last quarter was about developed markets (DMs) outperformance over emerging markets (EMs) and India has underperformed even the rest of the other emerging markets, do you get a sense that that could continue for some time or could we be in for a bit of a reversal? A: Back in November, after demonetisation was announced, we suspended our 29,000 Sensex target for the end of the current fiscal i.e. our March 2017 target. We took the view that it is difficult to make a call on earnings growth in the near term and hence our view was given that domestic flows remain reasonably strong, and earnings picture remains as bleak as it has been for the last three or four years, what we believe is by spring next year, by spring 2018, the market will be around 29,000-30,000 level. I think that is the view we continue to hold that that you have got a situation where foreign institutional investors (FII) flows have been negative, I think will stay negative, domestic flows are holding the market up in spite of very little action on the earnings front. I think that picture more likely than not will persist and hence you are likely to see the market at the 29,000-30,000 level around 12-13 months’ time. I am not one who sees a great market rally here, haven’t seen a market rally for a while and I don’t think the conditions are there for a big rally in the Indian market.Latha: We all thought that demonetisation is giving us some horrifying anecdotal stories, but the few results that have come so far, all those three banks, South Indian Bank, DCB Bank, IndusInd Bank, even smaller agri companies, Hatsun Agro, couple of companies that reported numbers today are all not showing that debilitating impact, Havells for one, consumptions companies, they are not showing that impact. Did we over fear demonetisation? A: I think that the story is playing out broadly along expected lines in so far as both the companies who are declaring strong results. Our travel to small town India whether it is north or the south, it is giving us a fairly consistent picture which is that the informal sector, the cash oriented sector which accounts for around 40-45 percent of gross domestic product (GDP), is still struggling and the formal sector is gaining market share. So, whether it be in electricals, whether it be in jewellery, in footwear, in dairy, the market share switched story i.e. cash oriented players are losing market share and the formal organised players who use the banking system for transactions, they are gaining market share. I think that story is pretty consistent. What I think will play out in the next two to four months, is that the surge in unemployment we are seeing in the informal sector and it is a very punchy surge in unemployment as informal sector workers get laid off, remember the vast majority of Indians work in the informal sector, as the unemployment surge kicks through, I think we will continue to see downward pressure on consumption whether it is two wheelers, whether it is small ticket items. I think that pressure continues as the unemployment surge picks up and people run out of savings. So, there are many chapters to be written in this. The market share gain of the formal sector giants is one of them. We are seeing that story already begin, I think that has got a long way to go. However, the down draft, the downside impact on consumption, on investment I think will be seen in the quarters ahead and similarly I think the negative effect of this on credit quality will also emerge especially for I think the non-bank lenders. Anuj: Let us discuss some sectoral calls, I am going by your last strategy report and in cement it is interesting that you have a sell call on Ultratech Cement but you have a buy call on Ambuja Cement and Shree Cement. What is driving that call? A: I am not allowed to discuss stock specific by compliance scheme. I have not got authority to discuss any stocks with any media outlet. Anuj: Sectoral call on cement?A: As with the entire building material sector, we continue to see challenges for the cement sector. So, it is reasonably evident across the country that real estate launches, interest in the real estate sector has abated. I know you will have a developer who will come on your channel every now and then and beat the trumpet saying that it is all good, but the broad picture in real estate post demonetisation is reasonably clear. The effect of that, the knock on effect of downside impact on real estate, the knock on effect on the building material sector is being felt. As I explained a minute ago, where there is a large unorganised segment, say plywood, electricals, the formal sector is gaining share. However, it is reasonably clear that in sectors like cement where there isn't a large informal sector, the volume growth story will abate as the real estate sector goes through existential challenges._PAGEBREAK_Latha: What about FMCG, that is quietly come out and performed in January and I had a conversation with Adi Godrej yesterday, we have spoken to other FMCG guys as well, and they are reporting a fairly good impressive bounce back of demand in January, after a bad November, a not so bad December?A: I think the FMCG story especially in urban India does seem to have recovered in January. My reckoning is the rural piece stays under the hammer. We were travelling around smaller towns in southern India earlier this week, smaller towns in Punjab and Haryana last week, it is reasonably clear that the informal sector unemployment surge is picking momentum and as that surge in unemployment takes momentum, you will see another demand compression in FMCG; I am fairly confident of that that the full story in FMCG hasn’t yet played out. It is also evident from looking at advertising activities. Like everybody else, I read the papers, I watch the TV channels, the almost disappearance of adverts from the sector in the press and in the media tells its own story. So, I think FMCG, we have seen one layer of impact, the immediate kind of cash freeze that took place through November-December. As the cash freeze eases, as more money comes back into the system you will see a bit of a relief for the FMCG sector especially in the urban context.However, I think the next layer impact on FMCG will be the knock on impact of the massive surge in unemployment that we are seeing in the informal sector. So, it is a complicated story. What has taken place in November is once in a generation event hopefully and the impacts of that on the economy are complex, our view remains that there are many layers of impact yet to unfold and the switch in market share from informal sector to formal sector is big that has downside impacts on unemployment or downside impacts on employment which will now feed through into the economy over the next two to three months.Anuj: Going back to your report, you have buy calls on the two largest IT companies - Infosys and Tata Consultancy Services (TCS). Do you think the pessimism on Indian largecap IT is overdone, is it a valuation call that you are taking for the sector here?
A: We have had concerns in the IT sector over the last couple of years. We were worried about the sector and ability to get their topline growth going in the right direction. The last three-four years topline growth is consistently decelerated and alongside that we have also seen a degree of margin pressure. Those concerns haven't entirely gone away but to the extent that the American economy is recovering especially US banks have recovered quite nicely. Japan is recovering, Germany is recovering and IT companies are inherently plays on the developed world. There are still grounds to hope that there will be a cyclical recovery. However, structurally yes, we continue to have concerns about Indian IT but there are grounds for hoping that there is a cyclical recovery afoot there especially in the Western banks, financial services & insurance (BFSI) and the benefits that has for the Indian IT services companies.
Latha: How do you expect the global piece to behave? We have seen foreign institutional investors (FIIs) shunning India for a better part of late last quarter. We saw a couple of days of FII return. How is Ambit parsing the global flow scene?
A: There is a USD 75 trillion of global economic activity, so hard to give a definitive picture but the relevant piece that all our clients are pointing to is that if Trump does inject a big economic stimulus in his first budget then the Fed will be forced to hike even faster than the three rate hikes that the Fed seems to be pointing to and if the Fed pushed through 1-1.5 percentage points of rate hike in this calendar year then it does become very hard for FIIs to consider investing in emerging markets, leaving aside the specifics of India, 1-1.5 percent jump in the US ten-year bond yield will make it very hard for foreign investors to consider leaving the comfort of American market. I think that is the big concern. There is very little we can do about it sitting in India, waiting and watching to see what the new US President will do in his first budget but if he injects a massive economic surplus in an economy which as it is seems to have recovered reasonably well then the implications of that is that American bond yields will rise much faster than anybody expected and therefore the FII exit from emerging markets will be much faster than anybody expected.
Anuj: Give your detailed view on non banking financial companies (NBFCs) as well because here we have had an interesting theme. Housing finance companies (HFCs) off late has done well and a couple of other microfinance companies have also bounced back. How are you approaching this space now?
A: The NBFC, HFC piece is a broad church. There is a whole spectrum of activity there. At its simplest the parts of that space which will continue to hold up are - where its formal economy oriented like giving mortgages to salaried people, difficult to see why that activity will run into major problems. Where the NBFC, HFC piece does have existential challenges where the financing went to the small and medium enterprises (SMEs) sector whose cash flows were in the wrong kind of money - that's where there is a real problem here. I cannot see how that business model holds up where you are lending money to an SME whose cash flows are not reported to the tax man through a variety of means and GST being one of them, the income tax enforcement crack downing the other, the stat business model comes under pressure because the SME itself comes under pressure. I have described on your channel before that the black money oriented SME will have existential challenges and lending therefore to that SME becomes a tricky proposition. So it is a broad church, elements of NBFC, HFC sector will continue to thrive but whenever you are doing - especially things like SME lending, loan against property (LAP) lending to businesses whose cash flows are of the wrong colour, there is a problem there.
Latha: What are you buying in the finance piece?
A: Our reckoning is that the small banks who manage to build SME lending businesses around formal sectors, if you can build a working capital, working capital finance model around formal sector, SME lending to the formal sector. I think that piece will grow in the years ahead.
The cost of funding looks likely to stay for a while both because of flush of deposits that have come into the banks. I do not think they are going to run away quickly. I cannot see Rs 15 trillion which came into the banking system over the course of November-December. So if cost of funding stays low and the smaller banks can find their SME niche, I think smaller banks are in a good position in our country.
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