Good rain, base effect to lift earnings in second half: TVF Cap

Above normal monsoons and a favourable base effect will boost earnings growth in the second half of current fiscal, says TVF Capital Advisors' founder Shiv Puri. He expects healthy earnings growth in the auto, cement and consumer durables sectors.Earnings will also benefit from a boom in the rural economy after good monsoons, leading to higher tractor sales. Despite macro stability and improvement in earnings growth, markets could face volitility in September, he says. The volatility, he says, is a global event and happens almost every year in September.The IT sector is going through a transition phase, says Puri. IT is moving away from labor arbitrage and entering a phase of complete digitisation, he adds. The sector is facing short term headwinds due to this transition, but key companies are well poised to capitalise on the opportunity, he says.The healthcare sector is facing many US Food and Drug Administration (FDA) hurdles. This is only a temporary setback, he says. The big pharma names from India have huge opportunities in the US as the demand for generic drugs steadily rises.The sector he is most concerned about is fast moving consumer goods or FMCG. This is due to new entrants into the industry like Patanjali and other local players. This has made competition for FMCGs more intensive, he says. Also good monsoons have led to a low inflationary environment which is giving a touch time to FMCGs in achieving growth.Below is the verbatim transcript of Shiv Puri’s interview to Prashant Nair and Ekta Batra on CNBC-TV18. Prashant: What is your view on the market? Are we in for a decisive move from here in the near term? A: It is hard to say about the short term. Clearly you have got a period of weak trading activity in August globally but come September through November globally you have always seen volatility pick up in global markets. It is almost an annual phenomena. So, there could be some sort of near term volatility that might happen but structurally things are looking solid. I feel that the main things that matter which is the macro stability, governance and earnings growth is getting better each quarter. Prashant: Just a quick word on earnings. What is your view? That is, I presume as you said, one of the main things that matter, right? A: The view on earnings is that it is broadening and that is a very healthy sign. A year ago you were seeing some of the private sector banks doing well, some fiscal the Non-Banking Financial Company (NBFCs) doing well. A bunch of it was taking market share from the state run banks, but what you are seeing in the last quarter is that is broadening out and you are seeing earnings pick up in areas like autos, tractors, cement, some of the consumer durables like air conditioning companies. So, you are seeing some of this starting to broaden out. We are going to have from all indications a very good monsoon, well distributed and as a result in the second half of the fiscal year you should see the rural economy pick up. Also the base effect for a lot of these companies is very favourable as last year many of these sectors had depressed earnings. So, you are going to see a fair bit of earnings pick up in the second half of the year. Ekta: How would you approach the IT space because we are having this conversation at a time when Infosys is just about recovering from its 52 week low that it hit and it has not that much of a great year when you talk about stock performance for IT stocks either. Your sense in terms of whether you would be buying frontline IT now? A: IT has got a couple of things that are going on. One is that there is a little bit of what I would call a transition issue. You are seeing this move from sort of the old world labour arbitrage IT services to digitisation and that is a trend that is here to stay. It is going to get bigger, it is going to get much bigger but the transition for companies to get there could be a bit lumpy. So, we are going through that period and it is probably going to stay there for a little while. Having said that some of the frontline companies are well positioned to capitalise on this. I also feel that over the last one year you see the rupee be flat and so that is a little bit of headwind obviously for the IT services companies that are used to sort of operating in a 3-5 percent currency depreciation scenario. So, there are some short term headwinds that they need to get through before they have more of structural tailwind at their back. Prashant: One area which occupies the most space in your portfolio is financials, all kinds of financials. NBFCs, private banks, housing finance companies and more. What is your view after the tremendous run that we have had especially in some of these more niche companies? A: There one has to be very selective. By and large the opportunity that is there is so far big that I don\\'t think that these companies have hit their full potential. It is possible that some of these multiples may have moved up a little ahead of themselves but not by much and the size of the opportunity is far in excess of what we can imagine. Just one simple example is the largest housing finance company which is focused on the self employed market in tier-I, tier-II cities which we know is HDFC has a market cap of USD 39-40 billion. There are some of the companies in the rural side of economy that has an addressable market that is nearly as big where the market caps are in the single digit, USD 1 billion or less. So, there is an opportunity when you look at that across different spectrums where some of these companies will be much bigger in the years to come even if the multiple is a little high for the next three or six months. Prashant: So, if you look at the size of the opportunity the number of players and what investors are willing to play, how many future years of growth are you willing to discount right now in the price. You think you are well poised or you think it now becomes very difficult to find who you think is the winner or take a basket approach, which one works now, you think? A: As always high quality, stock specific is the best strategy to follow. That is the one that works. And just on your point of valuations again not recommending any stocks or anything like that when I am talking about any names but if you look at HDFC Bank in 2007 it traded at over five times book and if you look at what has happened since then the price to book has traded down now to about the 3-7 range but the stock has compounded at nearly 24 percent annualised and that is really just driven by growth. So, if you feel which is what we do believe that the growth for this sector has got many more years to run the valuations are still okay. Ekta: What about the entire metal space because besides the likes of say YES Bank the real story has been in the Hindalcos and Tata Steels of the world which have gone up anywhere between 50-80 percent odd. Do you see more value in a Hindalco which is say at around Rs 155 per share despite that 80 percent gain that we have seen and if you can\\'t talk stocks then the sector itself? A: I would say that the metals and commodities space is something that we have very limited knowledge on because we feel that it is largely influenced by what happens to global pricing. What the value at the London Metal Stock Exchange is rather than sort of the fundamentals of the Indian economy per se. So, that is an area that we really don\\'t have much to talk about. Prashant: What other areas are you kind of focused on, financials is one, IT we spoke a bit about, what are the other areas, themes rather? A: I think there are couple of them. One is healthcare. It is an area that is going through a temporary period of turmoil largely related to the FDA issues, related to what is happening in the US generic market. However, I think the companies that we have in India, in that space, some of the top three or five companies are really world class and they have a huge opportunity to capitalise on the world over especially the US looking for lower price drugs, looking for generic drugs and the chemistry skills in India I would say are best in the world. So there is a huge opportunity still ahead for many of these companies. We are starting to see some early signs of pickup in some of the bearing companies, basically what I call industrial consumables. These are companies like bearings and abrasives and things like that which you need on a regular basis to run a plant. So, you are starting to see a modest pickup in some of those areas as well. I think the consumer focused financing companies, the rural housing, mortgage companies, the private sector banks, I think these are structural growth stories for some time to come. Ekta: In that theme, what about the consumer space, FMCG? A: FMCG in particular I would say has a couple of issues. One is that in a low inflationary environment which is what we are in right now compared to the last three or four years, they have a tough time achieving growth. The growth rates structurally moved down and therefore it is a bit of a challenging environment on that front for them. The second thing we are noticing is that with the emergence of Patanjali and such local players that are becoming bigger, there is an era of competitive intensity that is picking up on the margin. I think finally valuations don’t allow for any of these risks to play out given they are viewed more as a safety sector to be invested in. So, I think when you add all of those three, FMCG stocks in particular still look very challenging. Prashant: If a new investor came in to your fund and handed you over – wrote you a USD 50 million or USD 100 million cheque and say I want in now, what to do you do at this point? Give me a 30 second response with things that you will buy for that investor at this point in time and how much if you could break it up a little bit? A: That is a very difficult question to answer because it is hypothetical but I would say that the areas that we just talked about which is financials, non-bank financial companies, healthcare, industrial consumables, these would be the areas that we would allocate capital to. Prashant: Just a broader point, if one steps back a little bit and looks at it, say late September of 2015 and go back and kind of remember what the situation then was, there was a bit of disappointment setting in about the pace of execution, etc locally speaking. I am just referring -- I am not looking at IT or export oriented sectors but just the local cyclicals. You look at even high flying sectors like defence, not very many or not even one private sector order has been given out from PSU defence companies in India. There was a little bit of a fatigue setting in, roads maybe was the only area which was shining but there too the government is doing most of the spending through EPC or hybrid annuity where they are taking the risk away. The private sector was not stepping in too much with too much capital and too much risk and it isn\\'t now and then this entire talk about the monsoon being great and how that is going to change things around, that started in October, stocks started rallying, market rallied. I am just trying to understand once this monsoon things gets passed are we going to look at a different kind of a reality and people are going to wonder while things aren’t that great as they were made out to be once the rains pass, I am just trying to get your thoughts on that subject, cyclicals essentially, local sectors. A: That is a multi-part question and I take it in different ways. The first thing I would say is private sector capex is probably going to be the last thing that picks up in the pickup of gross domestic product (GDP) growth. You still see most companies out there that are over leveraged, that still have balance sheet issues to figure out. Many of them have invested fair amount of capital on government contracts that have been changed for whatever reasons. As a result they are not in a position to step up. So, that is something you will see at the very end, it could be a few years away. You will see certain areas I think in infrastructure like you pointed out, roads picking up, you probably will see something happening in power. Prashant: My question is not so much about private sector capex, my question broadly is markets need a reason to kind of latch on to, that reason has been provided by monsoon and rains after two years of drought and that is a powerful trigger. Has the underlying changed so much, I am not saying will private sector capex pickup, I am saying is the underlying changing to that extent for one to take a big bullish bet on domestic sectors, inward looking sectors? A: I think that is happening across the board now almost especially in the areas that I pointed out. Earnings are broadening and that happened even before we had the data from the monsoons. The other thing is I have never seen GDP growth pickup for two quarters or three quarters and then just fall off and stay there. Once you have had four or five weak years of GDP growth which is what we have had and the pickup starts happening, it gathers momentum and it goes on for a while and that is the phase we are in.