The Indian market has been correcting since past seven trading sessions dragged down by poor set of third quarter earnings, political chaos and global volatility. On Monday, benchmark indices tumbled with the Sensex losing 491 points to close at 28227and the Nifty shedding 135 points to close at 8526.
Speaking to CNBC-TV18 on the sidelines of three-day Kotak Global Investor Conference, Sanjeev Prasad, Senior ED and Co-head, Kotak Institutional Equities says that though macros are improving, they are not translating into better earnings. He lowered the FY15 earnings growth expectation to 7 percent from 14 percent. According to Prasad, the market has the capability to correct a lot more but better macros and some good-ticket reforms by government can save it from severe fall. He expects a minor 5 percent correction in the market.
On Delhi election outcome, Prasad says they are unlikely to affect the market in a significant way. BJP government is doing a fantastic job and there is no reason for the market to worry in case the Aam Aadmi Party (AAP) wins the capital, he adds.
Going ahead, Prasad believes retail investors must buy good quality names on dips now. He continues to own stocks like HDFC Bank.Below is verbatim transcript of the interview:
Q: How is this cocktail of poor earnings adding to a foreign institutional investor (FII) flows? Is this why we are seeing incremental selling coming in?
A: I would think so, the stocks rallied very hard last year in expectation of reformed process ultimately translating into earnings activity picking up towards the end of the year.
Also, earning numbers picking up but macros improved quite a lot but it is not translating into micro or in terms of reforming activity or earnings numbers picking up asset.
Clearly, there was some kind of a disconnect building in between the valuations which had gone to very high levels and earnings which were not really increasing. People are now recalibrating those expectations.
To a large extent, the gap between the valuations and earnings were probably getting bridge by a combination of an improved macro which came about because of lower oil prices, very stable and benign global environment, very strong liquidity over there.
As also expectation reforms, now suddenly people are starting to question all the three things; oil prices have gone up which to some extent is negative versus expectations of USD 52 barrel, suddenly you are looking at USD 60 barrels. To that extent, improvement in macro which people had resumed may not be there obviously USD 60 barrel is still better than the average of USD 85 which you will see for the current financial year.
The second thing is now there are chances of the US rate increase happening lot faster than what people had assumed earlier looking at the data which is coming from the US. Lastly who knows about reforms process in the sense the government has intentions to do the right things.
However, clearly there are challenges in Indian parliamentary system. So put all that together the macro is starting to weaken slightly I would say but still very stable and earning numbers not coming through so suddenly you have seen this big disconnect between valuations and earnings stating on people faces now so the market has to correct to some extent.
Q: How much more you think? Just the hope of the Budget as well that growth will pick up sooner or later will keep the bottom at least protected?
A: Even in the last note we had written that there would be a small correction so that is what I am still sticking by may be another 5 percent to go I would say.
The problem with this market it does not really have the support of valuation any more. So as long as the macro conditions remain favourable as long as the government continues to do its reform process people will still give us high valuations compared to what it should be logically the space down the earnings numbers. Look at many of the companies now they are trading at ridiculous valuations in some cases.
Many of the consumer’s names, industrial names are making either very aggressive set of earnings assumptions which may not come through or a very low cost of capital perpetuity which is also very risky resumption I would say. So that is where the problem is logically this market can correct a lot more but given the fact that it is India macro story is still looking good long-term story is very intact the government is doing the right things so the people will come in and buy at lower levels.
Having said that, what we need to see the continuous reform process moving ahead. We have 5 important bills due in the Parliament in terms of discussions and passing the Budget session and the outcome of that will be very important because that would set the stage for more investment reforms and eventually investment coming through the country which in turn will drive the whole economic activity in the country so that is going to be very critical.
Q: What are your views on how to approach Larsen & Toubro (L&T) because clearly most of the analyst fraternity continues to remain prisoner to their views so they do not believe that earnings are as bad as it looks? However, the ground reality is that these earrings are pretty poor. How would you approach this stock now?
A: L&T is largely a play on the Indian investment cycle which is not picking up as yet. Even though their early signs had at least order booking and starting to look good but it is not really translating into execution revenues as yet.
There is something which we have been warning for sometime that investment activity will take another 2-4 quarters to pick up in any meaningful way. The government is trying to do all the right things in terms of land reforms, labour reforms and more transparent process for allocating resources, better approval system and so on and so forth.
However, all that is yet to translate into sufficient confidence in the private sector to start investment. The second problem is who is going to invest.
The big challenge is many of the infrastructure companies in India have very bad balance sheets, very high leveraged so they have to deleverage so they are not in a position to invest clearly.
As of now the government itself is cutting expenditure quite sharply in fact if you look at the government’s capital expenditure for the first nine months that is down 11 percent on year-on-year (YoY) basis.
Foreign spending is still not there till the time you see more confidence in the government’s policy so that is where we are. Who is going to invest is really a big issue.
On top of it the Indian banking system is hiding a lot of non performing loans (NPLs) which is probably going to get washed definitely in the fourth quarter to some extent and may be even after that some possibly structured loans get convert into NPLs. So that is the whole challenge in the infrastructure cycle.
We believe that it will turn around at some point of time but it may still be sometime away. That is where the disconnect is between what valuations or earning analyst are going to ascribe to L&T and what does the ground guarantee at this point in time.
Q: Do you suspect that at the end of this earnings season or already they are going to be earnings downgrades for the current year and will there be any upgrades for next year at all?
A: Year 2015 has been a series of continuous cuts since September as far as our numbers are concerned. At one point in time around August- October levels were looking at about 14 percent growth for the BSE 30 Index for the fiscal 2015 that has gone down to 7 percent now.
There have been some disappointments in the energy sector where the extent of gas price increase has not come through has what we had built in, subsidy sharing no clarity even now.
However, lots of domestic cyclical names are backtrack on the numbers. If you look at fiscal 2015 we are still building 16 percent growth for the BSE 30 Index similar numbers for the Nifty 50.
There would earnings cuts in auto, energy, industrials, metals and mining definitely are going forward just based on whatever assessment I have of ground level activity in the economy there would be cuts over there.
Q: Do you mean you are going for FY15 with a 7 percent earnings growth?
A: Yes. If you look at the number this quarter, we had gone in with flat numbers which is already disappointing to the extent of 2 percent even before L&T numbers got reported. This quarter numbers got supported by NTPC otherwise they would have been poorer. This quarter numbers would be negative on YoY basis for the BSE 30 Index and for the Nifty 50 also.
Q: Now 5 seats have come from Delhi, leads only and that is 3- AAP, 1- BJP and 1 – Congress. Is this just this week worry or is this going to linger on the markets?
A: I do not think this is anywhere reflecting the mood in the country. People will still focus on economic development and governance which the BJP has promised and is delivering.
The people of Delhi have may have a different view of the world, I do not now may be AAP has good connect with the common man there. Something works, what is the magic formula for AAP is some sort of a case study but it works for AAP.
However, I do not think this is some sort of referendum against Modi government. This government is doing fantastic job given the constraints of the Indian federal structure, the Indian parliamentary system and so, it will take time for all the reforms to percolate in terms of benefits for the economy, may be still a year away and so, I do not think we should get to dismounted about it
Q: What does an average retail investor do now at this point because stocks like L&T, State Bank of India (SBI) have come off quite a bit from their highs? Do you go in and buy them or do you wait for a bit until major events like the Budget pan out?
A: The best strategy for any retail investor and it is true for any long-term investor is just buy good quality names whenever you get opportunity. If any good quality company comes up based on two quarters of bad numbers and something like that then it is a good opportunity to buy.
However, do not expect any thing will turn around in the next two quarters but people make the mistake of not holding on the stocks for sufficient long period of time. The power of compounding has a very powerful thing which some how people just do not get even now. The only advice to retail investors would be buy, but stay invested for a sufficiently long period of time and that is how we make real good money.
Q: What is the mix of say Nifty stocks or mix of sectors that you would advice now? Would you go near public sector undertaking (PSU) banks at all?
A: I have being very inclined towards private banks for a long time and I think the environment which is emerging, the private sector banks will continue to take market share quite significantly away from the public sector banks.
There is clearly huge amount of NPL problems in the public sector banks and a lot of restructured loans if it does not cross 50 percent but I will not be surprised to see as much as 50 percent restructured loan book eventually turning into NPLs.
I am still very worried about the power, the telecom sectors. Nobody even talks about the NPL issues in these and the third quarter’s numbers have been weakening for the market in that sense.
Private banks still look good. They will grow at much faster rate compared to the over all rate in deposit, rate in the system. They will take market share definitely from the public sector banks.
Something like HDFC Bank does about 22 percent return on equity (ROE) compounded 18 percent for along time so those are the companies I would like to own here.
It is a bank which has delivered for a very long period of time so get into companies or own stock which will continue to deliver high growth just based on company which have high ROE obviously you still need to keep the valuation angle in mind but if you get these companies on a general market correction just go buy them.
So I am still inclined towards private banks, auto we have 2 and down numbers a bit and even on one portfolio we have cut down the weights a bit. In that space, the fact that volume recovery will take some more time, consumers will still have a decent position.
IT has been a big overweight for us in the last end of December which has worked pretty well for us. The logic at that time was good quality company is trading at pretty much near market multiples how long can you go over there.
Q: What you would do with L&T? Would you cut positions there or continue to hold?
A: I already did that last week. We had 4 percent weight in the portfolio, reduced it to two. The numbers were coming out very weak for just about every industrial company and that indicated what would happen to L&T as well.
Q: What about next year’s earnings growth as of now?
A: We are looking at 16 percent earnings growth but it will drop to about 13-14 percent by the time fourth quarter of the current year gets over.
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