GST, earnings to drive market from hereon: Udayan

There could be an initial pop-up in pharma stocks and they will stabilise and stay within a range, he said. "They are in a bottoming-out phase now."

Regarding specific stocks, he said, Mahanagar Gas is a good bet for investors. it listed on Friday. It deserves the kind of valuation it is trading at, he said. 

He sees the stock settling in the range of Rs 500-600 and expects the company to give returns of 15-18 percent on a compounded annual basis. Regarding the general volatility in markets, he said, it is a buy and trade-up market.

Below is the verbatim transcript of Udayan Mukherjee’s interview to Anuj Singhal & Sonia Shenoy on CNBC-TV18.

Anuj: It has been a phenomenal run for the market post the Brexit day. Most of the markets are back to the pre-Brexit highs. In India in fact, we are 2-3 percent higher. Are you surprised by the ferocity of the rally or do you think the market is being a bit complacent right now?

A: I am surprised and in all honesty, everybody will tell you that they are a bit surprised. I do not think on Brexit day, anybody would have bargained for the UK market or the London market being higher than what it was on that day after the fall. India of course, has played along with other global markets, but my sense is that everybody will admit that this has all been a bit surprising – the ferocity of the comeback. Of course, in hindsight, we know the reasons for that which is that the market has just simply chosen to focus on what the next central bank action will be. The US Fed not able to hike interest rates immediately. What the European Central Bank (ECB) might come out and do in the next few days.

So, in the short-term the market has chosen to focus on immediate liquidity triggers rather than the medium-term impact. Even on the day of the Brexit, I remember you guys asking me whether this means that the Nifty is going to a particular level and I did say that this is a call that I at least could not make, because the near-term impact of Brexit was quite unclear. The bigger impacts will play out in the medium-term and in the longer term. Those risks are ever present and have not diminished since the day, but in the near-term the market often chooses to focus on liquidity and that is what it has done this time around too.

Therefore, it is almost like markets across the world are saying, we will see what happens in 6-9 months or 9-12 months. Right now, we have got the Fed rate hike out of the way, we have got the possibility of more money coming our way from Europe and Japan, so let us party for now and we will figure out what happens later. So, that is the wisdom of the market in the near-term. You cannot question it, you cannot stand in front of it, but in the medium-term the challenges do remain.Sonia: In the near-term the two triggers that the market is most bullish on is earning and monsoon. Monsoons are playing out well so far, but what is your expectation as far as earnings go?

A: This will be a critical one, because we did have more than a glimmer of hope in the last earnings quarter. If we do get a follow up in the current quarter, the market will get very optimistic about the fact, or more confident about the fact that it is betting on the right thing, which is a durable earnings recovery and not a flash in the pan. So, this one will be a fairly critical earnings season. I am keeping my fingers crossed, but hopefully, we will see more of what we saw in the previous quarter and that is very important for the market to remain at the kind of valuation levels that it is trading at.

So, that is the central trigger locally along with goods and services tax (GST) which is in the process of getting priced in already in the market because the market clearly knows the parliament numbers now and it is taking a fair bet that in July, we will get the passage of the GST bill. So, that in a large extent is probably already in the price. Earnings will be the key determinant at least from a local perspective on whether the market can continue to grind higher from here on.

I know there is a lot of talk about the monsoon and it is very good news that we have a good monsoon this time around, but I have never been a fan of this theory of good monsoon equals to great earnings momentum for our market. We have had bull markets on bad monsoon years. I know this time it is coming on the back of two bad monsoons but I think this impact of the monsoon on earnings is a little overstated. So, that is not the top of the list of reasons according to me for which Indian market should be headed higher. Probably earnings and GST are more important reasons now.

Anuj: How do we play this market now? We have seen pharmaceutical stocks for example bounce back quite a bit from the lows. We have seen domestic economy stocks doing well. IT has taken a bit of a backseat and that has not been able to make a comeback. Tata Motors has not been able to make a comeback post Brexit. What are the key sectors or stocks that one should play right now?

A: There are two ways to do this. One is that basically, the overarching theme for the next few months, if the market is betting on the right thing, which is that a combination of monsoon sentiment, etc. will drive consumption. So, that is one major theme to play. It depends on how you want to play this consumption theme because stocks are not exactly inexpensive. So, consumption theme may not mean just buying the top-rung fast moving consumer goods (FMCG) companies.

My sense is you need to look at some of the consumption related plays and try and look at some degree of valuation comfort out there. So, if you are saying you are finding a good FMCG company at 35 price-earnings ratio (P/E) multiple, but you can find a very high quality tractor or a two-wheeler company, maybe at 15-17 P/E, chances are that you should be looking at the latter rather than the former because you have valuation comfort. I stress this point about valuation comfort because we are not trading cheap in our market. I know there is a lot of positive sentiment at this point in time, but at 8,400 Nifty, there are risks that the market might compress if there is any kind of bad news which comes up on the horizon and you could get a sharp correction. And in the event of corrections, valuations being on your side always helps, so in the consumption basket, you try and take a couple of consumer durable plays for example – the Pay Commission is also going to help on that and you choose good companies which are not in that 30 plus P/E bracket, and there are a few that you can find, at least in the consumer durable space, not in the FMCG space. In tractors and two-wheelers you can find some companies. So, in that space, the broad consumption space is something that investors can stay with at this point in time because there are tailwinds, there is no question about that.

For people who love more risk, you were talking about tea right now; there are tailwinds for some of these low quality sectors. I am not a big fan of these sectors, but for the moment there are tailwinds from sectors like tea and sugar. This will not last forever. It will last for a few weeks or months, but when the going is good, they can make you a lot of money in a very short span of time. So, from a trading perspective, you can choose some of these global commodity plays, non-metals, which basically have the rub of the green right now, and they can be interesting trading pops from here on._PAGEBREAK_

Sonia: From the front liners, how are you reading into the moves in the pharmaceutical space? Dr Reddys Laboratories has gone from Rs 2,800 to Rs 3,500 before you know it. Sun Pharmaceutical Industries has seen some recovery as well. Would you play this theme?

A: I have been quite bearish on pharmaceuticals for nearly two years now but I am quite interested to see that some of the very smart promoters in this space have started announcing buybacks. Now, that does not means that you should go out and run and do what the promoters are doing, buy their stocks, but it is a sign that promoters are saying that all risks considered, valuation levels have compressed to a point where we find value in buying our own stock.

So, as I said, you should not flock to it immediately, but my sense is that after being quite negative on this space for two years, I would now say that most of the price damage or valuation compression which was happening in pharmaceuticals with a few exceptions might actually be done. That does not mean that stocks will outperform in a major way from here because there are some challenges which remain. US Food and Drug Administration (FDA) has not gone away and you will find lots of more challenges coming up. I think the European problems which are cropping up with Brexit will also be challenging for quite a handful of pharmaceutical companies and the local pricing issues remain. But basically, the managements are slowly trying to or getting to wrap their heads around the US Food and Drug Administration (US FDA) problem and working their way through it.

So it may be safe to say that stocks have probably hit their price lows or are within 5-7 percent of their price lows now. You could get an initial pop up which you are already seeing with these buy back announcements and then stocks might slowly stabilise and stay in a range for a while, but I think you could take the call, at least I am feeling more hopeful that they are in that bottoming out phase right now and the worst of the valuation compression and the price damage probably has happened in a majority of the pharmaceutical companies.Anuj: What about Mahanagar Gas’ initial public offering (IPO)? That has seen some record subscription and we saw decent listing on Friday. Did you read that IPO and do you think it is good for more even after listing?

A: The thing with IPO listings these days is that the first day covers a lot of ground and whatever little low hanging fruit the promoters might have left, though they do not usually leave a lot on the table, but whatever they leave on the table and more gets covered up on day one of listing. And that might have happened with Mahanagar Gas. It is a good franchise; there is no doubt about that. The only issue is that growth has been slackening and in the subsequent quarters, they need to demonstrate that they can get back to 15-18 percent compounded annual growth rate (CAGR) which they have been exhibiting in the past. If they can get that going, the kind of balance sheet, the clean balance sheet that they enjoy with none of those issues which oil marketing companies came with, they deserve at least the kind of valuation that they are trading at.

So, I would not see Mahanagar Gas IPO even at the listed price. I do not see it running away. My guess would be that the stock would stabilise now in a band of Rs 500-600, in a P/E band of 15-18. It deserves that kind of P/E multiple and if the earnings growth kicks in or comes back over the next few quarters, this is the kind of stock which can give you 15-18 percent compounded return every year and with low volatility because this is essentially not a high volatility business. So, that is the kind of story long-term compounders of wealth might look at. So, I like Mahanagar Gas, I know the stock has gone up quite a bit, but once it stabilises in this Rs 500 to Rs 575-600 kind of range, longer term investors can continue to hold this name. There is no froth there.

Sonia: Since the month of February, this market has been making higher tops and higher bottoms and it has hit every single curveball for a six. Is there anything to suggest that this trend vitiated anytime soon?

A: You don't know. Right now the market is looking, the screen, as you said has not taken a false step and there are India tailwinds in earnings recover, in GST, in monsoon, in some of the new policy announcements. I am locally bullish, but globally very cautious, you can even say globally bearish and that remains a concern. I think the market is probably dismissing Brexit with less concern than it deserves and somewhere down the line, these chickens will come home to roost as well. I do not think we have put Brexit behind us or some of these issues. Longer term global economic growth is still a challenge. So, there are many issues that we need to grapple with.

So, if the world’s problems were not there, then India could be in the midst of a fairly significant expansion in P/E multiples as well. But we probably are in a modest bull market out here. I say modest because our prospects and tailwinds are being somewhat neutralised by global events and very tepid global flows. This year too, we have seen only Rs 4,000 crore of foreign institutional investor (FII) inflow so far. So, that is suggesting to me that we may be in a bull market of our own, but it may be a muted bull market for a while because the global events will keep coming in the way.

We are talking about a big upmove in the market because we have seen it from 6,800 to 8,400, but since the start of this year, the market is only up 2 percent. That does not make it a roaring bull market. So, it is a middling, muted, modest kind of a bull phase that we are in because of the global issues. But left to our own, we would have done better.

Anuj: This has been really the interesting phase. We all know that oil marketing companies have got it going after more than a decade, so that part is understood. What explains the rally in the public sector undertaking (PSU) upstream companies like Oil and Natural Gas Corporation (ONGC) and Oil India?

A: Relief that they will not have to carry the cross of the subsidy sharing burden which they have carried with the oil marketing companies for so long, else fundamentally, the two actually should not be moving together. I am not very bullish on ONGC. I have never been a big fan of that stock. It is a stock where foreign investors too, have consistently lost money. I remember the government also placing, at a much higher price, the last tranche of paper with global investors for ONGC and the stock tanked after that. Some because of the commodity collapse or the collapse in the price of crude oil, but not a big fan of this franchise at all.

Oil marketing companies are far more interesting. As you said, for 10 years they have done nothing. They have covered quite a bit of ground, but if crude keeps its head down and there is no reason to believe that crude will get into a bull market of its own anytime in the foreseeable future. I think oil marketing companies, particularly names like Indian Oil Corporation (IOC) which a lot of investors do not pay enough attention to because of its lower marketing margins compared to Bharat Petroleum Corporation (BPCL), that stock looks particularly interesting.

So, it may pause because the rally has been quite substantial over the last few days and it might be a slightly crowded trade at this point in time, but you should not say that enough is enough in oil marketing because the way underlying commodity prices are, it could be a case of a multi-year bullish phase for oil marketing companies after so many years of being out in the cold. So of the two, surely marketing companies compared to the upstream companies._PAGEBREAK_

Sonia: This two-wheeler pocket has been the darling of investors. Hero MotoCorp has gone from Rs 2,500 to Rs 3,200 in just six months and so has Bajaj Auto. But this month’s numbers are looking a bit tepid. Do you think a lot of the good news in terms of the domestic consumption pick up is already in the price, so would you still be optimistic in this space?

A: It depends on what the domestic consumption pickup is like over the next few months because we have just entered to monsoon phase. As I said, there is no one-to-one correlation, but let us see in the next few months if we get clear discernible signs of a domestic demand pick up. We have seen some glimmers of it in a few sectors. So, I am not taking it as a given, but if there is, then these stocks can do well from here on. The price point that you mentioned for Hero MotoCorp Rs 2,500, it was trading at a bombed out valuation level for a company which has a balance sheet and a pedigree like it does and from there what we have seen is a reasonable 25-30 percent kind of a rally from a bombed out valuation level. However, I do not think it captures the potential upside. If the demand growth actually picks up, that is the big if for our market right now. All of what we are discussing is predicated on a belief or a growing belief that earnings have bottomed out and domestic demand is going to pick up and maybe one year down the line or three quarters down the line, this domestic demand pick up will also slowly turn the ignition on, on the capex cycle.

Now this is the hypothesis that the market is working with which is why valuations have expanded to 17-18 times. We need corroboration for that. We need validation of that in this earnings season and in the monthly numbers which are coming through for various sectors through the next few months. If we continue to get validation, the market will grind higher. It might take periodic knocks, but it will eventually head higher. But if there is no validation, then valuations are stretched, particularly in the risky global context that we are trading in.Anuj: The other question that I wanted to ask was what is happening with the volatility index (VIX) itself. Both in the US and for our market, we have seen the VIX fall to almost 14-15 which is near a 52-week low. Is this market too complacent now? Do you think there is a bit of a risk factor here in terms of almost everyone being all-in in this market?

A: This is a huge risk factor, but these things are very difficult to time. One thing is to recognise the kind of risks that we have and the other thing is to say what do I do about it because you can get up in the morning and say these things are not looking great from a medium-term perspective and you will then come to the conclusion that you do not want to participate in the market at all. The other way to do it is to say I recognise these risks, but right now, the market is drunk on liquidity and it is focused completely in the short-term on whether global banks will only have to play with a very loose rope because of the risks that they acknowledge.

So, it is like a goldilocks scenario for traders or bullish traders right now who are saying markets have good momentum going for it and much than the Fed would like to raise interest rates, it cannot because Brexit just happened. So, they will pause. The European Central Bank probably does not want to do anymore loosening of its monetary policy, but what option does it have given that it wants to stop panic in the market and therefore, it will continue to throw more money our way. So, let us party for the moment, we will see what happens later and that makes for some kind of near-term trading momentum which investors have no choice but to participate in. And that has been my suggestion too for the last few weeks and months that you participate, but be aware of the kind of risks that you are trading with in front of you and also keep an eye on valuation levels which are expanding with not yet demonstrated earnings momentum behind you.

So there are genuine risks of the market running into rough weather globally over the next 2-3 months. It may have happened with Brexit, but it did not happen because the market chose to focus on central bank action, but at some point, it may just be a turn of a switch and we might get some major risk off in global markets. As you said, there is a huge amount of complacency in markets right now and there is a chance of a jolt. So, you participate right now, but the moment you feel that the tide is turning, you should be able to or willing to take a lot of money off the table.

Therefore, to my mind, it is not a buy and hold market like a lot of people believe, it is a buy and trade up market, but at the sign of serious trouble, you try and lighten your positions once again. So, do not play it as three-four-five year cycles. Those cycles probably we have seen in past, but nowadays, it is more like three-four-five month cycles. You take your money when you get it, but do not stay out because you will feel really bad in midst of all these powerful rallies.