FY17 will end with zero earnings growth; H2FY18 to be good: Enam

India is in the midst of uncertainty with demonetisation, implementation of the Goods & Service Tax (GST) Bill and tepid-looking earnings playing out believes Manish Chokhani, Director of Enam Holdings. "I am cautiously optimistic," Chokhani said while discussing the outlook for 2017. GST and the upcoming UP elections will be key trigger points next year. While FY17 will end with zero earnings growth, the second half of FY18 will be spectacular for earnings, according to Chokhani. First quarter of next fiscal will remain under stress. Globally, markets are looking volatile. While the US dollar is expected to appreciate further, the euro is likely to slip. This volatility in currencies will have repercussions on emerging markets too, he says. Chokhani said India will need to fix rupee volatility for a structural bull market. It is looking difficult for EMs to enter a bull market phase. Below is the verbatim transcript of Manish Chokhani's interview to Udayan Mukherjee on CNBC-TV18.Q: How do you feel about the world today it seems so uncertain globally and locally, what your crystal ball telling you about what kind of phase we are about to enter?A: First I wish I knew crystal ball gazing is being very hazardous. This year itself which has gone by it started terribly and then did so well and then again cracked in November, but like you said if you had said that there will be Brexit, demonetisation, the arrival of Donald Trump, Italy probably thinking of leaving Europe market should have fallen apart and the fact is we are holding on and we are resilient and we are seeing for the first time emergence of domestic flows offsetting global flows and reality is the foreign inflows this year in the secondary markets have now been what barely USD 4 billion this year which is nothing on the base which they have. There is hope around India. The world certainly has never looked more scary and more volatile. India also with now demonetisation and goods and services tax (GST) is heading into a period of uncertainty and earnings look very tepid, but as you say your hopes spring eternal, there is a lot of macro things which are headwinds for us and yet they are demographic trends, entrepreneurial trends which are tailwinds for us. On balance I am cautiously optimistic that’s the best way I can sum it up.Q: What’s the global backdrop looking like, because the dollar on a tear, market did not fall after the Donald Trump victory and bond yields are rising after so long, where does it keep the global market backdrop for us?A: After 2007 we spoken on many occasions it is being completely schizophrenic -- so we go from complete euphoria to complete gloom in a matter of 6 months and I suspect it is something like that currently going on, where you have the Fed chief saying we will hike interest rates suggesting that US is doing well and at the same time the incoming president says they want to run a stimulus package, which suggest the country is not doing so well and in a country where the Federal Reserve is leverage 99:1 one would imagine a 25-50 basis point interest increase would basically bankrupt that or hike in fiscal deficit will again bankrupt that country and the unfunded liabilities that sit in the US, which by the way is the best economy out of the whole developed world it is a bit bizarre and with USD 100-150 billion infrastructure spend that Donald Trump talks about we have had a global rally in infrastructure and metal stocks forgetting that China used to spend a trillion dollars and yet these were flat on their back 12 months ago.It really confusing and I don’t think macro bets one can hazard. The clearest trade of course today is the Euro is clearly going to 0.9 against the dollar and it is going to fund the carry trade, because the dollar is surely going to rise, the Euro is surely going to fall and what repercussion that has for emerging markets is pretty grim. In that context if India loses its macro stability, which this government has done very well over the last 2-2.5 years, because we were considered fragile 5 and now we are considered one of the shining stars juxtaposed with the fact that this should be a growth market given that we have unit volume growth that the long term outlook where a long term investors have remained interested, but the short term surely FY17 I am guessing we will end with zero earnings growth.FY18 who knows what happens with GST around the corner, with UP elections around the corner what the behaviour patterns are and we are still a small economy. When I look at the profit pools and the size of the economy just doesn’t tally with the real size of this country and I suspect the answer at some point will come through currency adjustment. I can’t for the life of me fathom why the rest of the world blew up and our currency went from 40 to 70 with oil pricing falling of the way they did. Now of course they have come back and that is another headwind for us on the macro site, but unless we managed to fix currency -- I can see how we create a very long structural bull market over here.Q: Is there a case for global bull market right now in emerging markets?A: Look you have come out of 35 years of the bond market went from a high of 1980 in terms of interest rates to a low which basically has ended now -- it is a 35 year super cycle for bond which have ended and the reflation trade where every time something happened you had effectively the central banks coming to bail you out and that kept equities afloat, asset prices afloat and the gush of liquidity which went around the world -- so something has turned in the world. It seems to me in technical parlance it is an extension of a bull market rather than a new bull market in the world and people trying to keep a plateau in economies which clearly have run the best by date. If you look around at Japan, you look around at Europe, you look around indeed at most of the US really all the votes that are now coming to these nationalist right wing kind of tribal type of leaders is a reflection of that growing frustration in those economies that were ex-growth. In that scenario to call bull market is really difficult. The predication of course in US is that Trump will get USD 2.5 trillion of corporate assets stashed overseas back and you get a wave of buybacks in US, you get a tax bonanza there and that is not the stuff which makes lasting bull markets.Also with the rising dollar it is going to be tough for emerging markets -- so I can’t really make a good macro case to say that you should be here and yet when you go and do bottom up companies and you see the work which is going on over there and the relative size that gives you hope that surely this company can’t be this size 5 years later.Again I will give you a small example today the profit of just Reliance or TCS is greater than the entire fast-moving consumer goods (FMCG), auto, durables and retail sector put together. All of them put together would make about USD 4 billion and when I take auto I am including Tata Motors, but excluding the JLR piece which is overseas, when you look at it that way -- it is like where is this mythical Indian consumer.If the entire profit pool of this category if I take FMCG, durable, retail then you add even media, telecom, auto its under USD 10 billion annual profits (PAT) for this entire sector and you look at IT we make more than USD 10 billion and while we are sanguine about prospects for Indian IT services the fact it is a big profit pool USD 13-14 billion is roughly our BFSI space, oil and gas is USD 10 billion - - so it is really these 3 sectors which predicates what going to happen to earnings in India. It is not really the consumers yet and that what is perplexing that if this country has to grow it can’t be on the back of oil and gas or it can’t only be like 30-35 percent weightage for BFSI in the index -- something has to lift us off._PAGEBREAK_Q: Talking about opportunities, many great franchises have collapsed 25-30 percent since the demonetisation thing happened. Do you see it as an opportunity or do you think there will be much more pain in 2017, they may not have bottomed out yet?A: There is short term pain. As I don’t think anyone can disagree that if you basically take away half of the money stock, and you take M1 into credit growth into velocity is GDP, so if M1 itself is halved, credit growth is not happening and velocity has currently fallen off, so, GDP is going to suffer and when GDP suffers whether it is for a quarter or two, I hope it is not beyond that and I don’t think it should be beyond that, but what it means is that earnings vanish. Now, in an air pocket where our earnings have vanished and we were a growth market, in a world where interest rates are rising and something else is happening in other countries which will basically take a flood of money in that direction, you could get interesting price points. So, I am not in a rush to say that things have bottomed out. Also, we are in December, a lot of people indulge in window dressing to keep their annual NAVs up. So, what happens in January may be interesting. Also, I think a lot of people this time will watch not just the Budget but what happens to the big UP elections because the outcome of demonetisation in some sense will reflect in that election and hopefully if the ruling party gets it right, that gives a fillip to really pressing full steam ahead with reform in India which surely is needed. Then you have of course the whole line up for privatisation and stuff like that. So, if you look back next year at what could have transpired, India may have been in a very interesting space. So, for long term buyers, the next quarter seems to be a period where we should be making interesting bottoms. How sharp it happens and how deep it happens or how fast it happens, I can’t predict. However, certainly if you have some cash for the next quarter, it should be an interesting point.Q: How long will we have to wait for earnings to pick up, because 3-4 years we have had no earnings growth, we were supposed to get it this year then demonetisation happened. Next year we are expecting then GST is going to happen. At some point do you think patience might run thin that these elusive earnings recoveries like the capex cycle every year we expect it and it is not happening?A: Well the reality is this year October end India looked like it was on the kick off stage and most companies you met at that point -- well even up to the first week of November they said even post diwali things are looking really good -- so this pay commission money, the good monsoon actually had helped and thesis was playing out that we were ripe for earnings acceleration.I suspect because now the base will become low next year second half’s earnings look spectacular and by then you would have baked in GST and everything as well -- so therefore I said that this first quarter of next year is when lot of the uncertainty will come and lot of places your conviction will get tested a lot.There will be flows surely because if ETF money has come and they don’t see earnings in India there maybe flows out of here as well and is reflecting in the market that the large caps which are largely foreign owned are now trading cheaper than a lot of the midcaps. In some sense that churn is already happening, but I won’t be in the camp which has earnings in India are a mirage and they won’t come -- I think it comes with a high velocity at that point and you then won’t be surprise seeing 40-60 percent jumps in lot of companies as operating leverage kicks in and at which point you look back and say I should have been shopping around this time, which is why I say cautious optimism.It is not unbridled bullishness one would like to be, but you can’t really build that case today. I think there is room for prices or time correction and I suspect given India’s attractiveness as a long term destination for every seller, you tend to attract a buyer and therefore market doesn’t really selloff. You get rotation amongst sectors and we don’t make one low on one day where everything collapses like 2008, but from time to time things selloff and that gives you attractive entry points.Q: Do you see the domestic money panicking at all because it has been super resilient, surprisingly resilient. Do you see that getting shaken for some reason or because there are no other opportunities other than equity and stick it out?A: It is a bit of both that A: lot of money which goes to real estate clearly is not heading there. I don't think that is a case for gold on a ongoing basis and also now given the schemes and the options available there. If rates are actually going to fall there are no great advantage now going and sitting in fixed deposits or so. I am guessing that people now have the semblance that really equities is a place where I can make long term wealth creation for myself. Again we are talking of USD 1 billion a month inflow in India. In a country of whatever USD 2 trillion or USD 500 billion saving you are talking about USD 10-15 billion of equity inflow which is like 2-3 percent asset allocation. So, it is really still a trickle.We have waited for long 15-20 in my career I have waited where the allocation become more like 15-20. Given that the age profile of India is 20-25 years kind of demographic it seems like a tall ambitious order but in my lifetime I will see India doing 15 percent allocation to equity on hopefully by then USD 1-2 trillion savings. And our asset managers will become the way we look with awe at the American funds with USD 1 trillion of assets and I have seen funds there which have gone during my career from less than USD 100 billion to excess of USD 1-2 trillion. So, it is not impossible, it will happen.I don't think the current trend is something which turns easily. It may not continue, 1 billion may not become 2 billion immediately but I don't think it has become 0.5 billion also in a rush.Q: What is the phase we are in? It is not like a bull market, it is not a bear market, this middling, ambling along.A: Bull markets get created on easy liquidity and sentiment. Liquidity is tightening in the world and it is an extension of aging bull market. It is tired bull market in the west and my sense is it ends badly in the west because these currencies have no business to be where they are. If you have put USD 20 trillion of excess money supply into the world and there are no consequences for your currency and you have really X growth and there has been no change in the real living standards on bulk of the Organisation for Economic Co-operation and Development (OECD) normally these currencies should have adjusted. It adjusts only if there was new leadership and that new leadership had to be picked up by China, India. China shows some signs of it having the guts to now say we will float our currency and we will play a game of our own making and our own choice.India is still trapped in our old thinking of this great inflation differential argument. But in a world where those guys are going to deflate forever are you saying that they will be in deflation and recession and we will keep depreciating our currency because whatever we do you are not going to get an engine of experts kick-starting and getting us to supply from here. You can take the currency to Rs 100/USD. It is not going to change materially for us over here. And with manufacturing being 15-17 percent of gross domestic product (GDP) it is not like we have that much surplus to export or we have that kind of scale to export as well and it is really like I said software services which is a USD 10 billion profit pool for India on whatever, a base of USD 100 billion. That is really the business or tourism or things like that which will be panacea for us.Q: Where do you think serious money will be made in the next 4-5 years. Is it consumption, is it financials, is it capital expenditure (capex). Talk about the domestic themes.A: I am not that hopeful about capex cycle over here because if there is so much surplus capacity in the world it is like if the agricultural age ended no one then went into farming after that. In some sense the manufacturing age given the excess capacity for everything in China and B: the advent of now what we call artificial intelligence (AI) and robotics and 3D printing changes the rules of the game in manufacturing. So, if I were a manufacturing guy, I would be really hesitant to commit large capital today. Plus the rules and the regulations are changing. So, let us see where it settles and then we play the game there.Q: You say the rate of getting obsolete is very high?A: It is very fast. Even if say the best sector in India and manufacturing in some terms in terms of return on equity (RoE) has been automobiles. If the auto people now see there will be self driving cars 10 years later there may be completely different engines, and may not be oil driven that changes the rules of the game. So, today it is the old manufacturers coming and setting up capacity in India to address this market rather than saying let us now develop some technology to play the next rules of the game. So, as followers in manufacturing I am not certain we change completely.And you take our leaders like if Reliance Industries Limited (RIL) is in some sense moving from oil to telecom and really playing the whole consumer internet space with financial services, media all of that thrown in over there it suggests a certain mindset among the leaders as well. So, I am less sanguine on capex coming from private sector, it will come from the public sector inevitably and infrastructure is a big area and a big opportunity for people to make money.When you talk of exports really we don't have a big manufacturing base. We don't really have a lot of surplus on agriculture to export. That leaves you with services. And services one is outwards when you are sending where we were sending out people to Middle East or IT to go and service the west. Healthcare maybe a very large area and tourism is completely under called in India. So, these would be the areas to pick up.At some point over the next 3-4 years you get a windfall because as the world moves away from oil on the energy plate that has surely been the bottleneck for India on the current account. And if that changes and you start getting these inflows that changes the rules of the game on the rupee front and my sense is only when rupee strengthens and you get purchasing power then the average Indian goes and this whole consumption economy kick-starts because while you have talked of earnings not coming for 2-3 quarters I am more upset about the fact that for the last 4-5 years the Indian auto industry as a proxy has been stagnant at 2.6 million cars thereabouts and instead of expanding our number of cars and upgrading when I compare with China 15 years ago we both were at about 1 million cars and today China has gone from 1 million cars to 22 million cars, ahead of US and the average car unlike the Alto in India is the equivalent of a Toyota Corolla. So, it is 8x and maybe 2x-3x. It is almost a 15x-20x multiple to the Indian car market that really gives you a boom. That then kick-starts the whole capex cycle because people then want to produce capacity to service that demand and so on.Similarly take the retail sector in India the whole organised retail sector and even if you include Titan in that I don't think the profit after tax (PAT) is more than Rs 2,000 crore. It is a staggering number when you think I am addressing 1 billion people in this country. So, that is the way things will eventually play out.Q: What about financials banks, NBFCs?A: That the only way to play the whole thing and that what the market being moving towards that in this country like I said if the saving rate say 25 percent of GDP or thereabouts only half of it was going into financial savings. You have so many levers happening now that (a) the GDP grows (b) the saving rate hopefully stays at 25 percent or inches upwards in an up cycle in the economy and then the share of financial savings goes up. Within that the share of the private sector at the expense of the public sector which is today 75:25 probably flips and become 75 percent in favour of the private sector and now you have the advent of technology which the private guys and a lot of the public sector people have also grasped -- so you can start lowering your cost base and expanding these markets.I think the run for financial services whether its insurance, NBFCs, banks, microfinance, housing finance is just spectacular - - so that has to be a very large chunk of the portfolio. In the indices it already about a third, but even if you were to go half over there it in a way giving you a play on everything in some sense and that really the most economic sensitive sector here.And like I said you take USD 13-14 billion is the profit pool of the financials, USD 10 billion is IT, US 10 billion is oil and gas that really the big profit pool in India. Of that of course USD 5 billion is Reliance and Reliance itself will start showing you all the capacity expansions coming on stream from next year. You already have a semblance of a decent portfolio.Q: You are saying just to summarise that don’t expect a major bull market like 2003-2007 right now? Just pick stocks and you will be okay?A: Yes, that’s right.Q: And would you say that of the country relative to EMs as well now?A: As well, I think we do have among the best leadership in the world. It is right meaning, sometime the execution may not be what we would desire, but that the trait of a leader. You take a decision instead of saying, “oh if I do this, this can go wrong and that can go wrong”. I am less upset about that and I am hopeful and I just hoped our country votes in the right direction, because that will signify whether we will have more progress or we then go back and become a lay and buck government and that just then kills the whole thing.