Maintain Sensex target of 46,000 by March 2017: AlfAccurate

Below is the transcript of Rajesh Kothari's interview with CNBC-TV18\\'s Menaka Doshi and Senthil Chengalvarayan.Menaka: We have got a variety of things to look forward to in terms of where these markets are headed. The first event will be what Janet Yellen says this evening. Do you think it is going to have a big impact if she takes the word patience out of her commentary, a big impact on emerging market inflows specifically to India?A: I don’t think so. I think there is over analysis of each and every word of what US Fed is going to talk about. One thing we need to keep in mind is that while on one hand there can be a possibility of tightening whether it is question of June or September of 25 bps or little higher over a period of 3-4 quarters the Europe is still surplus. Quantitative easing by Europe, quantitative easing by Japan, China is also now going to be easy monetary policy. So, there are lot of offsetting factors. Number two, it cannot be that each good news is a bad news. Actually it is a good news because US economy is doing well. So, now market is treating each bad news as a good news and good news as bad news however we need to come back and focus on fundamentals and that is where the US economy is doing reasonably better compared to what people thought two years back. So, whether it is June, whether it is P capital of patience or P small, I think we are over emphasizing and over doing research on all these words.Menaka: You don’t even expect any sort of volatility in the interim?A: Volatility may happen but it is going to be very sharp volatility and it can be either way volatility. Volatility means it can be both ways. Suppose the stand is little bit soft then people will again talk about the same things again that now it is going to be postponed by another one quarter, it is more of speculation in nature. However India specific if you look at the currency movement that basically gives you the kind of a flavour of each country whether investor likes it or not and that is why the Indian currency has remained extremely stable compared to many other emerging market economies. Therefore I believe that even if suppose there is a little bit tightening which suppose today night there is an announcement , the currency stability shows that India is going to be overall better positioned compared to many other economies.

Menaka: If that is not the next big trigger for the Indian markets, what is? Do you expect it will be Q4 earnings that will change expectations from these markets either to the upside or the downside because the last quarter was very disappointing or do you expect now more policy announcements from the government to be the next big driver?A: The next big driver needs to be the on road execution. It has to be now execution driven growth by the government, by the corporates. We do not need now announcements. Policy framework has been already – last 9 months has been spent on the policy framework. Now we need on ground execution.Senthil: Year to date, that is April 2014 till today you have returned about almost 72 percent. Do you expect in the next 6-8 months to be as easy if I can put it that way?A: Markets are never easy.Senthl: Can you get these kind of returns because a lot of these returns are factoring in hope and expectation of policy. Do you see on ground taking off to give you if not these return but any where close to this?A: Last year Sensex delivered 30 percent return – FY15, from April 1 to March 31 – we are near to that. We are 72 percent up compared to market which is 30 percent . We believe that next 2-3 years is going to be back to the golden period of growth of FY03 to FY08.In FY03 to FY08 Sensex went up by 5 times, all indices. You look at any BSE indices whether it is capital goods index, PSU bank index, any index the minimum it was up was 3.8 times which was the IT index and maximum was capital goods which was 15 times in 5 years. So, what I am trying to say is that if we are going back to that kind of a golden period in terms of GDP growth which is 7 percent plus, IIP growth which is reasonably healthy growth then we can think that corporate earning growth can be 18-20 percent plus.

Menaka: Do you really think we are headed to growth of those levels again, wasn’t that a very unusual period in the history of the global economy. I know you are saying liquidity flows, monetary policy easing continues if not by the Fed by other banks but will they replace the kind of flows that he Fed had pumped into the economy over the last few years. I am not sure whether we will ever get back to FY03-FY08 levels.A: In FY03 to FY08 corporate earnings growth was 25 percent CAGR and market delivered 35 percent plus CAGR. So, market cap growth exceeded the net profit growth by quite a distant margin. Right now let us be conservative, let us assume 20-25 percent earnings CAGR which is possible and let us assume that market cap growth mirrors the earnings growth, so 20-25 percent is the Sensex what we are talking about over next 3-4 years but it is definitely possible. On top of it please keep in mind that while the liquidity from the Fed perspective may not be the same but the US economy is back on growth. It is going to be the biggest engine for the entire world economy.The quantitative easing by Japan and Europe is still continuing in a very big way. So, these two economies there was not QE in FY03-FY08 and Japan is big, it is a big driver. So, the entire liquidity perspective I am not too much worried. If we have right fundamentals then liquidity will always follow the fundamentals in my view. With new Modi government there is a lot of hope and we believe that there is going to be on ground execution which will improve may be after 3-5 months and as you see improvement in that then definitely the earnings growth can be higher.Senthil: FY03-FY08 you pointed out that the capital goods index was by far the outperformer. What do you see leading if you assume all of this happens and we have this golden period again, what will lead it?A: Capital goods has to come back because the investments will be more. In fact if you look at the Budget while there is lot of criticism of the Budget the good thing is that the government is focusing on investment led growth and not the consumption led growth. So, consumption on its own can lead to growth but government perspective is focused on investment. So, if there is more investment and you are seeing on the coal policy side what is happening then that is going to lead to improvement on the stalled projects. So, as there is more investment then definitely the capital goods indices need to do better compared to the overall market cap.

_PAGEBREAK_

Menaka: Are you deeply invested in capital goods because in your top five investments I cannot seem to see any major capital goods players.A: Yes, you are right but as a overall sector then we are invested quite heavily on the capital goods sector.Senthil: But the list I have got, you have got auto and auto ancillaries, you got private sector banks, you got select NBFCs and consumer durables as your first top five?A: That is a top five and then if you look at from the sectoral perspective then capital goods will be one of the heavy sector equivalent to auto and auto ancillaries etc.

Senthil: Your big holding really is Hitachi; your entire consumer durable holding is Hitachi. When you spoke to us last the share was about Rs 600, it has almost doubled in six months; time to sell?A: No, we are still holding for our clients for our clients in portfolio management system (PMS) and we believe that the company is on a right growth path and it is a secular story because air conditioning is becoming a necessity so from luxury to necessity and with a market cap of less than a billion dollar, it is still probably Rs 3,500 crore kind of a market cap so we believe there is a still significant opportunity if one wants to hold for next three, four, five years. The valuation will always look expensive if you look at 12 months forward but if you look at the secular growth which the industry offers and the competitive positioning which Hitachi brings in then surely it is worth holding.Menaka: Explain to me why if your big bets are on capital goods or industrials, it neither reflects on your top holdings which as the graphic plate will show consist of Hitachi, Gabriel and Sundram Fasteners, both which are auto ancillary stocks, Shree Cement and HDFC Bank. Sectors which Senthil has already pointed out are auto, private sector banks, select NBFCs, consumer durables, there is no capital goods or industrial play in either of these.A: If you look at the entire capital goods play, so what we do, we have the engineering, then we have a capital goods and then we have a construction related so this is infrastructure, so the different sectors it gets classified into, therefore it may not get reflected into that.Menaka: So, what do you like in that space in terms of stocks that work that way?Senthil: So, give us names?A: Number one of course L&T which we are holding. Then we have added the few construction stocks in our portfolio in last three to four months like we have added ITD Cementation, then we have added KNR Construction. We are holding Cummins in capital goods so, these are the few goods which we are holding in our portfolio which includes capital goods, infra and what investment led thing, that is what I was talking about that as you will see more investment into the country, this sector whether it is construction, whether it is pure capital goods…Menaka: And how are you picking companies in these sectors? Are there specific—are you looking for those which have obviously healthier balance sheets or are you looking for those targeted at certain areas of the economy which you think will be the beneficiaries of the first signs of pickup or something like that?A: First is governance, second is of course the balance sheet side and the market so, basically if you look at our approach so we have a 3 M approach which we always say. First is the market size, the market size of the industry should be reasonably big. Number two is market share and margins, so it should be in profitability. So, we generally all the companies we have in our portfolio, they are generally top five in their respective sector. So, market share and the margins and profitable market share is very important and the last is margin of safety, at what valuation we are buying into.Senthil: Let’s take valuations that you are buying into. Has governance, of course governance is very important but has the governance premium really got too expensive? We have just had Raamdeo Agrawal in the show little while ago where he spoke about Mico Bosch. He said at 30-35 times earnings you can say that is the premium you pay for governance. Today it is trading at 80-85 times so, how much of a premium will you give for governance?A: No, of course it is very clear, 2003-2008 people probably have 1000 companies which we are tracking, now all of a sudden that universe for the entire community has come down significantly, it has reduced drastically because nobody wants to play with the balance sheet which you are not too sure about the quality of such balance sheet. So, you have to pay some premium to governance, how much, that depends upon you holding period. So, if you have a three, four, five year view then you can pay little bit probably more and if you have a just less than a year view then you cannot afford to pay so high premiums. So, what we are doing is that we are very careful so we are more bottom up so top down anyway we are positive and then while picking up the stocks we buy the companies which are reasonably valued and not very extremely expensive valuation, then we avoid. Menaka: In financials which again is another sector that everybody expects will lead the economic recovery whenever we see it, one of your top picks is HDFC Bank which was a fairly common one across portfolios but what about some other banks in this space like for instance PSU banks, are you at all invested in them or ICICI Bank which has been having bit of a rough ride this year so far?A: Of course we do hold ICICI bank, it is not in our top holding. In PSU we have State Bank of India but apart from that we do not have any other major large banks. We have few NBFCs so for example we hold Shriram Transport Finance because we believe that as the medium and heavy Commercial Vehicle (MHCV) recovery happens, CV recovery then Shriram is the best play in that. We also have a Repco Home Finance so we have more NBFCs rather than more PSU banks kind of a play. We of course also have HDFC as well but in our top holding HDFC Bank is our top holding so as a combined it will be 20 percent.

_PAGEBREAK_Menaka: Do you see this sector allocation, sectors that you are positive on or you top invested sectors changing in the next year or so? So, currently you have auto, private sector banks, select NBFCs, consumer durables. Do you think other sectors will take that place in a year or so in your portfolio?A: Difficult to answer because in the sense if suppose these sectors were extremely well, suppose it shoots up and if the valuation doesn’t become that reasonable and it goes really expensive …Menaka: So, I am actually asking you for your expectation on some of these sectors?A: So, we do expect these sectors to do extremely well because these sectors can do 30 percent profit Compound annual growth rate (CAGR), like last time when we discussed about Gabriel, you were asking me can the earnings double in two and a half, three years, the answer is yes and that thesis still remains and in fact if you look at the delivery even in the third quarter for many auto ancillary companies, in second quarter also there was a consistent growth in auto ancillary companies despite the few large auto players are not doing that well because now they have diversified so for example Gabriel is a largest player in the shock absorber, with a 22 percent market share in two wheeler and 50 percent plus market share in the commercial vehicles. So, as the CV cycle improves, you will not only see two wheeler benefit but also the CV cycle will start contributing to the numbers.

Menaka: So, why aren’t we seeing any CV players amongst your top picks?A: We prefer to play through Sundaram Fasteners and Gabriel rather than playing through the CV players. Menaka: So, there is no new sector that you have got – new as in new to your top list that you have got your eye on saying this looks promising at this point in time I need to see some more data before I start putting money in for instance CV.A: One sector for example which we are watching very closely is the construction space. In the Budget also there is more allocation on the road segment, so the government is also focusing on that.Senthil: Is governance an issue there?A: No. For example ITD Cementation kind of a companies, KNR kind of companies, the balance sheets are not an issue, they are not CDR kind of cases. Even if suppose some company is CDR but the management may not be an issue, the bandwidth is strong, your order book is strong, the execution quality is very strong, these companies one can have a look at it. We are closely monitoring Ashoka Buildcon. What is happening is the traffic growth is increasing. As the traffic growth increases on one hand and the interest rate comes down on the other hand you will see the overall value - the sum of parts value will also increase significantly. So, the BOT value will all of a sudden become increasingly important play rather than just the EPC play. Senthil: Pharma, IT and FMCG you don’t seem to have them in the top holdings?A: We do hold these sector but we have recently trimmed some exposure because these three sectors have done extremely well in last 3-4 months. So, we have done some profit booking therefore they may not reflect in our top holdings. However we do hold these sectors as well.Menaka: What do you like most if you can pick a few stocks for us from within these sectors which may not already be too expensive?A: What I can tell you is what we are holding right now in portfolio. We are holding Cadila, Torrent in pharma In software all large caps, we are not holding any midcap software or smallcap software companies. So, there are large ones like Infosys and HCL Tech and TCS. So, nothing much differentiated from IT and pharma perspective.We play consumer through consumer durables rather than through FMCG. So, we prefer to have companies which are going to grow probably 2-3 times because of its size itself and that is the benefit which we see.Menaka: Are you working with any Sensex, Nifty targets for the year end at all and when do you expect earnings to recover, start showing signs of recovery?A: Earnings will show some signs of recovery from Q2 itself. You will see more accelerated growth in the second half. In Q3, the recent quarter the earnings have been disappointing because the crude crash was sharp, the decline in crude prices was very sharp and that led to for many companies inventory losses which are not yet reported properly. Therefore it is not adjusted number. So, from April 1 the new contracts will be with the new crude oil prices, raw materials are also at new prices. So, you will see the normalised number. So, form Q2 you will see some pickup and the second half surely we should see some accelerated growth and if that doesn’t happen then surely there is some issues in the entire growth story. Our target remains 46000 March 2017 which we are keeping for last one and half years. As I said FY03-FY08 same thing we believe will repeat over next 3-4 years. So, the wealth creation story will continue.