FY18 to witness earnings turnaround: Ambit's Gubbi

He picked out shares of private banks and automobile companies (especially commercial vehicles makers) as those offering strongest growth potential over the medium to long term.Below is the verbatim transcript of Pramod Gubbi’s interview to Latha Venkatesh and Anuj Singhal on CNBC-TV18.Latha: One was under the impression that because Wall Street cheered even after those hawkish statements from the Fed and Asia also was in the green, India would perhaps start building. Are you a little worried that India is kind of balking and not quite emphatically going towards 8,800 or taking its near-term highs?A: No, not really. I don't think a day's movement would worry us given nothing exceptionally has seen from the global liquidity fund, which remains the main driver for markets across asset classes globally. So, unless and until we have any changes there, there is nothing on the anvil to worry even for India or elsewhere.Perhaps the European Central Bank (ECB) minutes today could shed some light whether there is any change in the tone of the ECB in terms of their bond-buying program beyond March 2017. But other than that, India, in fact, looks relatively better amongst most markets. To that extent, I don't think I would be worried about today's reaction.Anuj: The market leadership is stumbling a bit, the Bank Nifty has started to fall and there are some signs similar to last year when the Bank Nifty made a top even after a rate cut. Would that worry you the fact that we have started to see quite a bit of decline in some of the large private sector banks?A: Not really. Again, as we have maintained, there is a structural opportunity for the private sector banks given the state of the public sector banks and their ability to try credit growth and given the fundamental changes in terms of access to consumer finance be it through the form of technology or the development of micro finance and credit bureaus, which provide credit history of consumer database. There are plenty of opportunities for private sector banks provided of course they keep their asset quality in check. Again coming back to the basic quality parameters that would make up a good bank. To that extent, you could talk about the near-term weakness given the strong rally they have had. But from a medium to longer term perspective, this is perhaps one of the best places to be in India.Latha: What kind of earnings growth are you factoring in, there are people talking about 10 percent earnings growth in the second quarter itself. What is your outlook for the quarter and more importantly for the year?A: We have been consistently maintaining that the market is running ahead of itself or the street is running ahead of itself in terms of expecting earnings growth to be quite healthy time and again over the last three years. And we have seen earnings downgrades come through each and every single year. This year again, we reckon there is a bit of scope for downgrades to come through given we have already seen Q1. There is a lot of expectations from H2 to make up for that weak Q1. So, we reckon there is perhaps 3 more percentage points of downgrades to come for FY17. In any case, the market will now look ahead to FY18, we are already half-way through the year. That is where we think there is more cheer to come. After three years of consistent disappointment on the earnings growth FY18 both in the broader economy [and earnings], there is a reason to believe there is a turnaround happening, which will also feed into corporate profitability. So, FY17 more downgrades to come but I won't be worried too much given we are already half way through and more eyes are on FY18.Latha: Are you at this moment buying anything at all, are you net buyer or are you net moving into cash?A: That is tough to answer. We have always maintained that it is tough to invest in India if you look at the market as a whole. There have always been pockets which do better than others. As long as you have your sight set on that and you are able to separate the wheat from the chaff, there is always an opportunity to make money in India. So, to that extent, we remain net buyers and we remain invested in those positive looking pockets.Anuj: The other space which has done well is the discretionary consumption led by autos which keep making new highs. You still buy them, even at current valuations, do you think there is enough momentum or is it time to just take a step back?A: Valuations have always remained a challenge particularly given valuations are now being driven by the global liquidity. So, we can't deal with that. We have looked at it, we can't really second guess when it is going to change though. So, to that extent, the best way to look at these is there enough visibility that earnings growth is going to maintain or perhaps improve from here on.In autos, there are different segments and different drivers. First, the consumer-facing autos: there is enough reason to believe that there is a positive momentum there. Earnings growth is likely to sustain if not improve from here. So, we remain positive on that. From a medium-term perspective, we are also positive on the commercial vehicle space given the investments, which are happening in roads, which are likely to get higher share of the freight traffic in India. That will require more commercial vehicles. So, there is enough growth visibility built in and this sector has always produced good quality companies which always show up as attractive investments. So, I keep valuations aside and remain a buyer on this sector.Latha: Can I delve a little more into your structural opportunity in private banks. Now private banks are quite a category. There are these three big retail giants, HDFC Bank, Kotak Mahindra Bank, IndusInd Bank. There are the corporate facing banks like ICICI Bank and Axis Bank -- I don't know where you will put YES Bank and Federal Bank. And there is a long tail of small banks, Equitas, Ujjivan, RBL. Then the old guys: LVB, Karur Vysya Bank. What are you buying in this entire space?A: We would rather stick to a more bottom-up approach because there are plenty of opportunities here rather than look at the segment [as a whole]. Because remember our underlying opportunity that we see is the space vacated or gradually being vacated by the public sector banks (PSB). That leaves the opportunity open for anybody and everybody willing to put their money in the right place. Particularly in the financial space, you need a little bit of conservative approach to not get carried away by the opportunity and run ahead of the opportunity itself. So, if you have put those filters in place there are plenty of opportunities. I won't say any particular space whether it is the new generation private sector banks or the old generation regional banks, there are good quality management teams in each of these. A mix of all these segments would be the right way to look at the private-sector financial space.Anuj: More macro question: what is happening with fund flows, since you represent the sale side because we have clearly seen that the flows have ebbed over the last fortnight or even the last one month compared to the kind of run rate that we have seen from the foreign institutional investors (FIIs)?A: We have seen a change in the nature of those flows over the past several months. If you put yourself in the end investor's shoes you would be worried about where markets are in general globally. Given there is no fundamental support, it is all liquidity driven but yet you can't be sitting out and watching it pass by. To that extent, you would want to stay invested and ride it as long as it lasts. For that, you need to be able to pull out at the first sign of trouble.Exchange traded funds (ETFs) have increasingly led themselves as a vehicle of choice for that sort of an approach and that is where we are seeing the shift of money coming more through ETFs and passive funds, which provide this sort of a liquidity to exit very quickly as opposed to traditional long-only funds, which have relatively stickier liquidity requirements. That remains the situation even now.Perhaps after today's event people are watching the ECB minutes quite closely. You could see some more allocation coming through if it comes out that the ECB has no intention of reducing its bond buying program and much of that money will continue to come through ETFs.Latha: Is the bottom for this market protected, where would you place it?A: That is a difficult question. Because any sort of event in the event that liquidity dries up - I won't want to guess the bottom - there will be some sort of shake-up and that is not going to be quite nice to talk about. So, I would avoid that question.Latha: We appear to be heading toward 6 percent yield on the 10 year. How will that translate as a stock picker?A: To the extent that liquidity is benign and that has helped across sectors particularly the financial space, those who have been borrowing from the bond market. The cost of funds has gone down -- that made them more competitive, partly to drive growth, partly to boost their own margins. So, non-banking financial companies (NBFCs) is the obvious winner there and you need to identify lenders and segments where they are historically bank borrowing heavy and their shifting increasingly to bond market, that is a place where margin gains will be more and those will be the biggest beneficiaries of where yields are headed.