Weak earnings, erratic rains and tax demand on FIIs are to be blamed for recent volatility, says Prabodh Agrawal, president and head of research at IIFL Institutional Equities. He, however, believes that Nifty valuations at current levels are reasonable, and a 10 percent correction predicted by many seems unlikely.
Agrawal sees a reasonable chance of corporate earnings growing 18-19 percent this year, because of the low base last year. He expects engineering, capital goods and consumer discretionaries like auto and white goods clocking better margins due to low raw material prices.
Agarwal says though FIIs are selling, the good news is local funds are buying. He expects earnings upgrades in cement, IT and auto sectors.
On reforms, he says passage of the GST Bill will be critical to market sentiment.
"With the Bill being referred to a select committee in the Rajya Sabha, the April 1, 2016, deadline looks a little difficult to achieve," he told CNBC-TV18.
However, he says many structural changes are taking place, but the benefit will be felt with a lag. "The government has taken many steps in last few months, which will be positive in the long-term," he adds.
Below is the edited transcript of Prabodh Agrawal’s interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.
Latha: What is this short covering bounce, the one that is now rapidly giving way? Do you think the market has spoiling for something lower than 8,100 now?
A: The markets are volatile because of bunching of several negative news; both domestic as well as extraneous and therefore, the markets could remain volatile in the near term. On the domestic side, the negative factors being the fourth quarter earning season has been disappointment; almost 1 out of 2 companies are reporting below expected numbers. We are continuously down grading our numbers.
That also creates a lot of uncertainties for FY16 outlook. While the consensus is forecasting a healthy 17-18 percent growth in earnings for FY16, there are not many believers for that number. There are other issues like the monsoon or the minimum alternate tax (MAT) issue or on the extraneous front, selling by the foreign institutional investors (FIIs), and rebalancing or redemption pressure by some large FIIs. All these bunching of negative news is creating the volatility that we are seeing.
Latha: Do you think FIIs will react very negatively to the two legislative hurdles that we saw yesterday - the land bill and the good and service tax (GST) bill. Now, clearly the land bill is going to a joint committee and therefore not likely to pass for the next few months as well the GST bill in the Rajya Sabha is getting referred to a select committee, so not in this session. Will this be taken as fresh negatives?
A: The passing of the GST would have lifted the market sentiment. That is the most important piece of legislation in the Modi government, which is now being deferred. It is incrementally a negative and we will have to wait for the monsoon session to see what kind of amendments are brought and eventually whether the bill is passed or not.
I have no doubts that the bill will be passed, but any delay means that the implementation also gets delayed. That makes the timetable of April 1st 2016 a little doubtful.
Sonia: Has the medium-term texture of this market changed or is this still a buy on every dips market?
A: The fundamental reason why one was positive on India, a year back or even six months back, is still there. The bunch of negative news that we talked about earlier will pass. Many of these concerns will be addressed. Markets will look on to better things. What I believe fundamentally while the flows can create short-term volatility but fundamentally what will be driving the market over the next 6 months, 12 months or 2 years would be the under lying earnings.
Despite FY15 being the worst year in terms of corporate profits in the last 10 years, in terms of profit after tax (PAT) growth, revenue growth, EBITDA margin, PAT margin, the forecast of 18-19 percent earning growth in FY16 is not completely outlandish.
There is a reasonable chance of that being achieved. We could see a slightly lower growth of 14-15 percent which should also be not disastrous. The reason why I am positive on the earning outlook for FY16 is because if you look at the base, it is extremely low. There are several industries where the EBITDA margins are at a multi-year or at a ten year low for example material or utilities or industrials or consumer discretionary. There is scope for gradual margin expansion in all these sectors.
Last year, we saw a collapse in revenue growth because of fall in commodity prices. If you assume a slight recovery in revenue growth and a 50 basis point expansion in EBITDA margins, then the 18-19 percent growth that we are forecasting is achievable. That makes me positive on the 6-12 months outlook on the market.
Sonia: You were telling us there is not just expectation of revenue growth but margin expansion as well because raw material costs are falling. What are the sectors that one should be looking to accumulate in this downtrend? Would you stick with the materials, the utilities or do you even go to the defensives and pick-up some of these pharma, IT names now?
A: The pro-cyclical names that are private financials will do well. Industrials will do well. Material, within material cement, although the near term outlook may not be so good, but with a 1-2 years view cement will do well. The auto segment will do well. Also, IT will do well because the rupee is beginning to depreciate and it would depreciate further as we progress. All these sectors have potential for earnings upgrade over the next say 1 or 2 years.
Latha: You said that you are positive on FY16 earnings but are you going to start picking right away? Do you think this market could give you much better levels; may be 10 percent lower levels?
A: It is possible that the market could fall by 10 percent, but I would not bet on it. That would be driven by technical factors like some very large FII selling which could pull down the market significantly in the near-term; that is unpredictable. What we are seeing is that while the FIIs are being selling, the domestic institutional investors (DIIs) are being buying which is a very positive thing. It is a long-term positive for the market.
However, in the near term bunching of FII selling due to reasons we discussed earlier like re-balancing of that portfolio or large redemption pressures, could bring down the market by another 8 or 10 percent. That kind of level may not sustain much; there is going to be a strong buying at that level and therefore, the bounce back from that level would also be very quick. So, it is very difficult to time the market to expecting another major fall and then waiting for that fall to make your positions.
Sonia: You were talking about the GST bill getting delayed as a big disappointment for the market. What is your own assessment of the Modi government’s first year in power?
A: A lot of structural changes are being done where the benefits will be felt with a lag. We all know the measures which have been taken for example passing of the insurance bill, passing of the coal and the minerals bill, the holding of the coal and the spectrum auctions, even simplification of the labour law and small factories act, the decontrol of the diesel.
Even the vision and the thrust shown by government in certain vital areas, for example the renewal energy sector or speedy implementation of the dedicated freight corridors or reinvigorating the railways or indigenising the manufacturing of defense equipments, are all long-term positive.
The short-term feel good factor is missing and the short-term impact is missing and that is why the market seems to be nervous or seems to be disappointed with the performance. These are many of these measures can be called out of the ordinary and therefore would have an impact in the long-term. By long-term, I mean next 1-2 years. In the meanwhile, I am not saying that the market should wait for the results to start coming in but in the cyclical factors will lead to earnings recovery.
The cyclical factors being the fall in commodity prices, interest rates; these are cyclical factors which will lead to a recovery in demand and therefore, the earnings growth. In the medium-term, the structural factors would start coming in. I believe the government has delivered and continues to deliver.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
