Lower than expected corporate earnings growth is the biggest risk to stock prices right now, feels Abhay Laijawala, Head of Research, Deutsche Equities. In a free-wheeling chat with Moneycontrol, Laijawala said that strong inflows into mutual funds has led to the view that valuations can stay rich as long as the inflows continue.
Over the last 12 months, domestic mutual funds have net bought over Rs 70,000 crore of Indian equities, while foreign funds have net bought around Rs 60,000 crore of shares.
“Valuations are very rich at 19 times, and market is expecting earnings growth to be around 20 percent,” Laijawala said.
“If there is a resumption of earnings downgrade because of whatever reason, including GST (Goods and Services Tax), valuations will look far richer than what they are,” he said.
According to Laijawala, for the last three years, the market has started with expectations of double digit growth rates, and the growth has been negligible or in low single digits.
He expect corporate earnings for the next couple of quarters to be impacted by the transition to GST.
“Corporate India is hopeful (about earnings growth) as they have been for the last one to two years..but, now they are qualifying everything saying let us watch how the GST evolves,” Laijawala said.
“Everyone is convinced of the longer term benefits, but for the current year, they are watching the GST transition. They think there will be an impact, but no one knows how long it will last, and how deep it will be because it is something that we have never done before,” Laijawala said.
He said there are signs of a turnaround in private sector capex, partly due to government policies.
“Government has stepped up spending through industries that are capital intensive; what really excites us are the big spends on roads, defence and urban development,” he said.
According to data compiled by the Deutsche Bank, total government expenditure rose 49 percent year-on-year in April. This is crucial as private sector investments continue to be in the slow lane.
“It is difficult to get visibility on private sector capex (capital expenditure) because the economy is still in adjustment mode. We are still going through the NPL (non-performing loans) cycle; this means that lot of corporates will continue to stay on the sideline,” he said.
But Laijawala feels there are some bright spots nonetheless.
“In certain sectors, private sector capex could come back and that is probably the consequence of government action. For example in steel, the decision to levy anti-dumping duties has sent out a clear signal to steel companies that the government will not allow dumping. This could encourage two of the largest private sector steel players—Tata Steel and JSW Steel-- to revive their capex plans,” he said.
Cement is another area where there could be some capacity expansion, feels Laijawala.
“This manifests from the fact that there is a big focus on affordable housing. Also big spending on roads by the government will also lead to demand for cement. So, very selectively we are seeing signs of a turnaround in private sector capex. But it is still very small, it is not meaningful, but it is encouraging,” Laijawala said.
He said the recent developments in the banking sector on the bad loans problem was positive, but investor preference would be for private sector banks over public sector banks.
"For the past 2-3 years, the focus was mainly on recognition of non-performing loans (NPLs)," he said.
“Now, the focus has firmly moved towards resolution,” Laijawala said, referring to the RBI’s decision to identify 12 stressed accounts —constituting 25 percent of gross bad loans — for immediate resolution under the Insolvency and Bankruptcy Code.
“The worst is over for NPLs, but we have to see what is the fallout of GST on the SME (small and medium enterprise) segment,” he said.
“SME is not as big as some of the loans to the steel sector are. But there are now worries about the telecom sector, and also about SME sector delinquencies after the GST. There could be some increase in NPLs, but they won’t be as large as they were in the past,” he said.
According to Laijawala, till there is clarity on how the government and RBI are going to move on the 12 corporate NPL accounts, investors would prefer to buy shares of private sector banks.
On falling retail inflation, Laijawala said it was like a double edged sword. Consumer price index-based inflation fell to a 5-year low of 2.18 percent in May.
“Falling inflation is good from the perspective of fixed income investing and the overall financialisation of savings,” Laijawala said, adding there was a clear shift in savings from physical assets like gold and land, to financial instruments.
“From the perspective of earnings growth, it becomes worrying because a very sharp fall in inflation suggests that the nominal GDP growth could be impacted," he said.
"We have seen a very strong co-relation between nom GDP and revenue growth. So if nominal GDP is slowing, then to that extent we may see a slowdown in earnings growth. About a year back when WPI had moved from positive to negative zone that had co-related with a period of the worst earnings growth," Laijawala added.
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