More downside if monsoon disappoints; like telecom: HSBC

On IT stocks, Sriram said he was cautious because of weak earnings growth.

Broadly, he expected corporate earnings to grow 11-12 percent thsi year.

He said it would be tough for the government to achieve the divestment target of Rs 69,000 crore through the market route.

Sriram said he was bullish on Hindustan Zinc from a  two-three year perpsective. 

Below is the transcript of Jitendra Sriram’s interview with Latha Venkatesh and Sonia Shenoy. 

Latha: For starters do you think we have fallen enough. It is a good 11 percent fall from recent highs or from all time highs. Do you think this market has the potential to get much lower? 

A: I think market is at a level where it is probably - we are calling for a flat market into the year end at this point of time, so it is close to its fair valuations but I must confess that there are couple of red flags which I am no soothsayer but one part could be that in case the monsoon disappoints as the India Meteorological Department (IMD) and various other agencies have forecasted then there is obviously some kind of downside risk that could open upon market. The second could be on what happens elsewhere kind of trade. There is lot of speculation about whether China A-shares could become part of indices and so on and so forth. However, we had commented on it some time back that if there is a part inclusion it could mean about USD 5 billion inflows into that market. If that goes up to say a full inclusion then the range could be as high as maybe even USD 50 billion. 

So, it could mean that you could see some money moving into the other markets than into those markets on the passive pools of money. So, those are events beyond our ability to guesstimate in that regard. Therefore, you could have a situation where those risks could open up a little bit more outflows and maybe the market drifts down but from a fundamental standpoint I would say broadly we would be more comfortable with saying that okay, it is more like a flat market into the yearend now. 

Sonia: What about the fact that a lot of money has perhaps been moving out of India and into China. That is the sense that we get from a lot of experts. Do you see that situation continue or do you see that trend reverse because of how overheated China has become?

A: China valuations are still not as expensive as what you have relative to our market at this point and at the same time you also have an issue in terms of what happens to the passive pools of money. Now the inclusive of these A-shares into the indices could actually lead to a lot more of higher weightages for the market then. Then automatically the passive tracker would start moving money elsewhere. So, I do not think that will be dictated too much by their perception of overheating or whatever the valuation the market is trading at. So, that remains to be seen. 

I don’t really know how Morgan Stanley Capital International (MSCI) or various other index manufacturers are going to play it out. I guess that clarity will emerge only over the course of the next month or month-and-a-half but that is definitely one other red flag apart from the monsoons for our market which could lead to some outflows in case those events were to happen.

Latha: We have seen this ever shining pharmaceutical sector now beginning to show cracks, at least the performance both stocks as well as earnings was nothing to write home. Will that be a safe haven now when you see flat market or do you think that will give away?

A: From a sector wise positioning we have been underweight for the pharmaceutical sector for about two months now and partly it was more because of overheated valuations, it is not so much of earnings call, it is just that the sector valuations are probably gone maybe even exceeded one standard deviation about historical means and stuff. So, to that extent it did look a little overheated to us.

Just to put it in perspective the pharma sector weightage in various indices locally as well has doubled in the last four years. So, it is sitting on a lot of performance and obviously that means expectations have gone up for the sector which raises the risk profile and then a big block of trade in Sun Pharmaceutical Industries which has probably fuelled or fulfilled a lot of appetite for investors in the pharmaceutical space as a foreign direct investor got out and portfolio investors came into the name. So, it has taken out a lot of appetite as well.

However, having said that I would say that results per se we are not seeing too much of weakness going forward. There were certain one-off issues with some companies in terms of taking some merger or accounting related losses like Sun-Ranbaxy merger and so on which are not likely to recur and there are a bunch of exciting drugs over on the anvil which could make individual stocks more interesting look more interesting over a period of time.

_PAGEBREAK_

Sonia: What is your view on the telecom space because we have seen a fair amount of resilience and in fact as of today the telecom stocks are outperforming the market? Would you recommend buying them?

A: We are constructive on a name like Bharti Airtel. There are multiple things that are happening. One is we are finally seeing the telecom starting to rollout 4G operations now. I see a lot of press, media ads from these telecoms now pitching for the 4G architecture.

The second part is that data is clearly on a hockey stick in India which the smart phone usage, the penetration of smart phones, that eco system is slowly starting to evolve and it is starting to show up in terms of rapid surge in data revenues for all the telecoms. So, I would say that at least from a period telecoms used to be a sector which saw the maximum earnings downgrades through the period of ‘11, ’12 and ‘13. I guess that phase is now going out, the earnings are starting to stabilise, they are slowly starting to see a small amount of revenue per minute (RPM) on the customer base and data starting to takeoff. So, we would be constructive on that space. 

Latha: What about IT, even there - there were cracks in the fourth quarter performance though of course Infosys now is making is making some very bold noises. The other stocks did disappointing in their earnings. Will IT also form an equal or rising part of your portfolio?

A: No, actually that is another space we are underweight on at this point of time. It is the largest sector right now in India as per the MSCI classifications. So, clearly I would probably argue that growth from an overall perspective is still quite anemic in that sector. So we would tend to be quite selective in terms of our picks there. So it is not that overall we are very constructive about that space at this point of time.

Sonia: You are bullish on the capital goods space as well. What in capital goods are you looking at, is it the pure play names like the Larsen and Toubro (L&T) or the Bharat Heavy Electricals (BHEL) or are you looking at a lot of these road companies, some of them highly leveraged but that could be a good play for the rebound in the investment cycle?

A: There are two parts of the theme here. First of all process industries is investing in incremental capital expenditure (capex) is still going to be some time away and it is not only dictated by interest rates or anything of that kind. It is just that people are still suffering from the hangover of the capital binge of yester years. So, to that extent you still have this issue that there are capacity surpluses available across various sectors like refining, metals, cement. So it is not that you will see people come back and start spending in a hurry. 

So interest rate is only one of the variables there. The bigger thing is an excess supply out there. So, we don’t see that instantly turning. Where India genuinely has a deficit is on the infrastructure related areas whether it is railways, roads or just whole concept of defence where India is the ninth largest in terms of defence budget but unfortunately we have been the largest importer of defence items for the last many years. So in a sense there is very little manufactured in India and there is scope to at least migrate some subassemblies, some parts, components from offshore purchases to onshore manufacture and these are areas or pockets that we would be more keen to take an exposure on rather than a bunch of equipment or process industry plays which is still going to struggle a little bit before normal demand growth of the economy sucks out the surplus from the market. 

So in that regard I would say L&T is a conglomerate. It has a finger in virtually every pie of India’s economy. So there will be some pockets or the other always probably firing for it and they have been quite active in terms of their investment in the defence space as well. So, that is the name we are constructive about but not so much on the power play like the BHEL etc. 

Latha: You are not positive on power? 

A: No, we are not positive. 

_PAGEBREAK_

Latha: Just to get out of sectoral discussion the big question that is bedeviling everybody is when does the economy turn, when do the earnings turn? What is your own sense?

A: FY15 was a kind of watershed year and just to give a quick explanation here, the kind of commodity and crude carnage that you saw lead to a lot of inventory write downs also. I don’t think those are going to recur going forward. So, although FY14 at an absolute level is quite bad in the sense of growth but a part of it was because of what happened in global prices. To add to that you have this issue about obviously banks becoming tighter in terms of better recognition norms, Reserve Bank of India (RBI) coming down on the banks that they need to be more prudent on their lending practices and stuff and which is all leading to this kind of cleansing of corporate India which is probably very much required. So, those are one time adjustment factors in my view. 

Going forward I would say that earnings if I were to remove all these kind of one-off factors I would be comfortable saying 11-12 percent growth is doable for 2016 but having said that the issue is valuation wise it is still where we are having a little bit of discomfort and India still looks a little bit more expensive given the kind of state of affairs we are in.

So it might be about maybe at least about three quarters or so before you start seeing genuine improvement. However, 4Q from next year will have a very low base where we should be able to pour some reasonable growth going forward.

Sonia: In your key buy calls you have a buy or rather you are positive on Hindustan Zinc. Metals in general have not given very good returns in the last six to eight months; just tell us what the positive triggers could be for Hindustan Zinc?

A: One part that appeals to us about this company is that it is very different from all the other metal names that it is a net cash company. So, it has a huge cash balance on its books. The second part is I would suspect that when the government has a target on divestment of almost about INR 680-690 billion, there is a difficulty in achieving all of it through the market route. So you will need to do probably one or two strategic divestments as well. India’s history has been that the maximum we have done in terms of market offerings has been probably in the 350-400 range. So the delta has to come from one or two big bullet names which are like Bharat Aluminium Company (BALCO) or Zinc or something like that and in case that were to happen that would be an added trigger for people to take exposure to.

Independently of all these technical issues of a government divestment and stuff like that I would say Zinc is the one name that our global metals team is most constructive on from a two-three year perspective in a sense that we do see Zinc markets coming into a balance and it is the metal that we are most constructive on.

Latha: What about Coal India? Looks like the government is quite determined to make it a well run company?

A: True, the question is only about expectation versus deliverance. The problem has been that in the past few years normally people anticipated a certain volume number and it has disappointed in the past whatever be the reason, whether rail evacuation, whether it was mining related issue and so on. But now they seem to be plugging the very gaps that have probably been a pain point for them. In a sense these three railway lines to incrementally off take.

Now I am still not of the view that you have all it takes to achieve the 1 billion tonne target that the ministry has set out for it but there is clearly some visibility that it can attain 750-800 in that same timeframe. So, at least they are moving to a trajectory where volume growth seems to be coming back to the name. So, at the margins I would say that developments are positive on the name.