May see small near-term correction; earnings to support: Nomura

Indian markets have rallied 20 percent from their February lows amid hopes that a firm earnings recovery is finally under way following two years of flat profit growth.The share rally has ensured that prices are no longer cheap on a price-to-earnings ratio basis, and Prabhat Awasthi of Nomura says that if you're buying in this market, "you should know that you don't have valuation comfort".The Sensex, for instance, is trading at 18 times forward earnings basis, above its historical average of 15 times. (Consensus EPS forecast for FY17 is Rs 1,550 per share while the market trades close to 28,000).But still, Awasthi is confident that the expected earnings recovery will happen, which will support prices. "So it is unlikely that we will see a big correction.""From a five-year-long basis, we are in a bull market. But you are paying right up for it," he said.In the interview, he also talked about other developments such as GST and outlined his sector picks.Below is the verbatim transcript of Prabhat Awasthi’s interview to Latha Venkatesh, Anuj Singhal and Sonia Shenoy on CNBC-TV18..Sonia: The momentum has been looking very good. Do you think that this rising tide will continue and is it just an India specific issue or do you think that it is the MSCI emerging market growth which is really taking India forward as well?A: It is not really growth sort of issue which is rising, it is more of a risk. Cost of risk falling due to the yields going down dramatically post Brexit which is taking markets up and it is not only India, it is also developing markets and all developed markets as well including US market. So, it is basically a risk on sort of trade which is going on. I don't think growth view has changed that dramatically at this point in time in the last one month for this sort of market move that we have seen.Latha: Any dangers to this rally? Yes, I guess fear of negative interest rate has sent a hunt for interest yields and there is this gush of liquidity but should we be sanguine about this or are there valuation challenges lurking?A: The only worry for a market which has risen sharply from the market itself in the sense that - as you rightly said - the issue essentially is that we have seen a move from close to 7,000 to 8,500 in a very straightforward fashion and the sentiment has changed dramatically but the valuations have moved closer to 17 times and this 20 percent move that we have seen on a one year forward basis. So, you are not buying the market cheap for sure. And if it sort of rises by five percent it gets into expensive zone. So, you are buying it knowing fully well here that you don't have that kind of valuation comfort that you had when you were looking the markets at 7000 Nifty.Anuj: So, what is your sense, do you get a feeling that over the next one year earnings will pick up and the market has ready started to price that or do you get a sense that this market is now vulnerable to a big correction at least at the index level if not at the broader market level?A: There are two parts. The first question is whether the earnings have turned the corner. Our sense is that they definitely have turned the corner. We have seen that in the last quarter results that was the first quarter when you actually saw reasonable earnings growth and we know that the second half of the year actually will have very decent base impact because last year second half was very poor. So, earnings about 16-17 percent this year, maybe 15 percent post that is something that is quite possible.So, the earnings support to the market is there and the only challenge essentially is from valuations because sort of pricing in the 15-17 percent growth with far more confidence at this valuation level than you were doing earlier. So, if you take a five year view the market is definitely on a bull market simply because of the fact that the earnings will continue to lift up as the economy continues to do well. But you are paying up right now. You were not paying up earlier. So, my point simply is that from here to expect a market multiple expansion on a continuous basis is something that you cannot bet on. You can definitely bet on earnings but at 17 times you could actually see some multiple correction at some point in time. So, I don't think a big correction will take place. Sort of mild corrections that happens could happen for sure.Latha: The other big positive for the market appears to be the Goods and Services Tax (GST). Your thoughts, first what does it do the earnings and the economy and more importantly will that allow the markets to expand the multiple?A: First of all the time frame in which GST is implemented will essentially be an FY18 at best, if not even later, we don't know because if you pass the GST today states have to pass it and then you have to implement it. So, we are sitting in somewhere in July and you essentially are talking of best case fiscal 17, fiscal 18 implementation. So, first of all one must remember that in the short term it won't do much to earnings.Secondly, it is supposed to be taxed. So, essentially how does GST impact earnings because it is supposed to be revenue neutral rates. Essentially if you are doing sort of GST implementation if the tax is overall remaining the same there will be some gainers and there will be some losers. Therefore the overall market earnings in the very short term might not see that much of an impact. There will be specific sector which will benefit a lot especially in the manufacturing side because there the taxes are higher.So, taxes will be raised in services and lowered in manufacturing. Therefore manufacturing companies which have high incidents of tax will benefit, could be autos, FMCG a bunch of these companies. But the burden on consumer will increase. For example, telecom and financial services there will be more service tax that will be levied. Net base impact being neutral in the short term.The benefits of GST could also come through, to government actually it might be larger because GST will enable them to tap into larger share of earnings especially income which is not declared because of pull through impact and secondly in the very long term obviously so long as it impacts economy positively and growth positively you will see an acceleration in growth. So, it is more of longer term story than short term story.Sonia: They say that the best time to buy stocks is when the company is going through some problem or the other and that is what is happening in the technology space. Are you using this as an opportunity to buy into the tech stocks?A: That is a tougher question because the fact is that there is definitely some sort of slowdown this company is experiencing and the fact is that if you look at the last four years the tech sector has actually done pretty well except in the recent period. So, I won't say tech has gone through massive trouble compared to the market over last four years. It is only in the recent past that we have seen some sort of slowdown in the earnings. Our sense is that the slowdown might persist and therefore we are not that positive on the sector as a whole simply because of the fact that we think that there is some amount of structural slowdown that is taking place in the sector at this point in time compared to what sort of the market has believed them capable of delivering.Latha: I was going through your strategy report from Nomura. You recently upgraded Punjab National Bank (PNB) and have been positive on State Bank of India (SBI) as well as conviction buy. For public sector undertaking (PSU) banks in particular after the kind of run that we have seen do you think there is still enough risk to reward here?A: We will be more stock specific there. It is not the whole pack. We do understand that in PSU banks there are banks which have distinctly better asset quality, which have distinctly better capitalisation compared to the rest of the banks. So, as you rightly said there are stocks which we like in the space the names you alluded to. But I don't think it is an overall sort of endorsement to the overall pack.Of course the assets within the same class tend to be correlated that our view is that there are still trouble spot in this space simply because of the fact that there are banks which have much poorer underwriting. Our judgement on individual stocks is definitely based on their own sort of write downs from what we have seen in terms of incremental stress, whether we see recoveries, the way we think they have done their problems are over etc.Having said that on an overall basis given the fact that rates are coming down, liquidity is getting better. In general financial space seems to be well poised compared to what the market believed even six months ago.Latha: PNB what kind of a price target, because their non-performing loans (NPL) stand very high. Double digit NPLs and perhaps the worst is not over. We are going to see them only rising?A: Our analysis is based on a fundamental analysis which we think that they have provided pretty aggressively and our view is that you will probably get decently positive news on that front going forward.Sonia: I also notice that you are overweight on the oil and gas space. We were just speaking to the management of HPCL a while back and they indicated that gross refining margin (GRM) in some of their refineries could go up to almost double digits in the next 6-12 months. This space has already given investors great investors up until now, but are you still bullish on OMCs?A: We have been bullish on the oil and gas space with clear emphasis on either gas names or the upstream companies and that is simply because one obviously was reforms that obviously played its parts but stocks we think are still cheap given the fact that we are still seeing continued reforms in the sector. So, the price to book given their return on equity (RoE) and given sort of what we expect in terms of their earnings delivery we think there is still room left for capital appreciation in these stocks.Latha: Any other parts of the finance space that you like?A: Obviously our long term structural bullish stance on private banks is intact. We have incrementally liked the Non-Banking Financial Company (NBFC) space simply because of the fact that the liquidity in the system has gotten better which is yielding better cost of funding in addition to the fact that some of the end market on the NBFCs are starting to revive because of better economic environment.So, in general our preference essentially has been more for private space over longer period and on a compounding basis it will continue to be like that. We like the fact that PSU banks are cheap and they were getting underpriced. So, that is why we sort of like PSU banks and we upgraded some of these names that you talked about. But overall we are generally quite positive on the prospect of financials over the next 3-5 years.