Need to see pullback in markets for FII inflows: Ambit Capital

Structurally, IT is a sector where “growth has fizzled out but valuations are still rich” compared to the weak growth prospects, he said.Below is the verbatim transcript of Saurabh Mukherjea's  interview to Anuj Singhal and Sonia Shenoy on CNBC-TV18.Anuj: What has been the feedback, we are discussing a lot of stuff about who wins, whether Hillary Clinton or Donald Trump, what is good for market whether Hillary win is good or Trump win is good, individual sectors, from your feedback what is the market pricing in and what would you be watching out for?A: Neither we nor our clients really know which way the US elections will go. We are all reading the same newspapers and looking at the same opinion polls. However, what I think is reasonably clear is that the valuations in India are rich. Both in my meetings with investors today and when I was in Europe three weeks ago, the consistent push back from investors are that Indian stocks really are very aggressively priced. So, to that extent, whether it is on the back of the selection or on the back of say the Fed hiking rates in December, we do need to see some sort of pullback in the Indian market to really pull foreign institutional investors (FII) money aggressively into India again because without that at current valuations, things are getting a little unreasonably priced in India.Sonia: Since the elections are upon us, just wanted to discuss what the impact could be on certain sectors. The IT sector is what everyone is talking about, but history has taught us that protectionist rhetoric does not always translate into any kind of actual policy whether it is immigrant visa’s being stopped or lower tax spending extra. In that context, how would you approach the IT sector towards the elections? A: Our focus has been fundamentally focused research. As a result our clients are overwhelmingly the large global long-only players. From their point of view, I don’t think that they are that focused on the rhetoric; as you rightly said most people look through the rhetoric. What they are trying to figure out is can Indian IT get back to double-digit topline growth rates and I think one has to be honest, it is hard to see how the Indian IT sector as a whole gets to double digit growth rates and how we can get to see earnings per share (EPS) growth in the vicinity of even 11-12 percent seems a little difficult. So, we have a sector where earnings growth is 6-8 percent but multiples are in the mid teens and that disconnect I think is worrying investors. The best that we can hope for is if the US dollar strengthens on the back of the US election result without going into who wins, if the US dollar strengthens on the back of the US election result or on the back of the Fed potentially hiking rates in December, the rupee weakens, that can give IT stocks a little bit of a short-term fillip. However, structurally, we do have a problem with Indian IT. It is a sector where growth has fizzled out but valuations are still rich compared to the weak growth prospects.Anuj: Let us talk about your conference a bit. In the conference you had speakers from Shree Cement; we were just discussing their numbers. This quarter has been weak for a cement companies and we have seen that uninterrupted bull market which was there in cement has sort of ebbed a bit. How are you approaching this space?A: As you are rightly saying, not just cement, I think the entire CAPEX story, the notion that there is some sort of CAPEX recovery in India I think has really got strongly questioned by the quarter one and quarter two data. By and large whatever CAPEX recovery we were having last year in the country has come to a juddering halt in the first six months of the year and in that regards any play on that CAPEX cycle obviously is getting its valuations questioned. I think cement as a whole therefore does preface that problem; rich valuations in a sector where, by and large pretty much every cement manufacturer has very difficult quarter. You can make the same point, I have seen the same sort of feedback for several other of the companies and the sectors we generally chose high class, good and clean corporate for our conferences.They are getting very enthusiastic invest the reception in that Who's-Who in Singapore have come to meet them but the challenge is the valuations and that is where we do need a bit of support from global macro in making valuations in India little bit more reasonable so that investors both domestic institutional investors (DIIs) and foreign institutional investors (FIIs) have reasonable entry points in to first trade franchises which exists in cements, which exists in the BFSI and in the entire gamut of consumers sectors. So, good companies at our conference and elsewhere, but we need to see some sensible valuations as well.Sonia: The other important sector that everyone is talking about is pharmaceuticals and both candidates, whoever comes to power, wants additional scrutiny as far as drug pricing is concerned. Do you think it could be a lose-lose situation for the pharmaceutical sector and do you think that the sector could go to the back-burner for a while? A: We have said this for a while, we have said this for a couple of years that compared to the growth prospects in America and compared to the regulatory uncertainties that the pharmaceutical sector is faces, valuations are a little over the top. Yes, there are Indian pharmaceutical stocks which are worth buying, but overall I think regulatory risks will escalate as western countries age and as the healthcare bill goes up, it is highly likely that there will be escalated regulatory scrutiny whether it is from a anti-competitive perspective, from a price collusion perspective, whether it is from an FDA safety perspective. I think enhanced regulatory scrutiny is a given for the Indian pharmaceutical sector and in that context I don’t think valuations have even now sobered down to levels where the sector as a whole makes sense to buy.Anuj: What is your sense of that news flow that came out of US regarding the pharmaceutical companies, the generic pricing and the kind of punishment we have seen for pharma stocks, anyway pharma stocks have not done too well off late? Do you get a sense that now stocks are getting at interesting valuation may be below median valuation?A: I am not an expert on the specifics of what exactly the US authorities are trying to get at here. I have read the same news paper articles as you would have. However, as I said I think the background, the sort of context in which we are operating is ever greater level of pharma expenditure by either western governments or western healthcare insurance companies and in that regards a political mandate almost to figure out ways in which to beat back pharma cost. In that context, I think variety of investigations, so I am not convinced as yet that Indian pharma valuations are bottomed out. I think there is more to go and I would still hold back. Overall in our market, we face valuation challenge and in sectors like IT and pharma wherein growth expectations are still a little too giddy I think the valuation challenge is that much greater. I will strongly push back on the notion that either in IT or in pharma there are lots of buying opportunities.Sonia: You were just telling us that overall on the market, you need to see some kind of a pullback for foreign investors to pump in fresh money. If we do get that pullback, what do you think the extent of the downside could be? A: I think you can put it around the US elections or we can put it around the Fed hiking rate sometime in the next two to three months probably at the Fed policy. I think you are looking at anywhere between 5-10 percent pullback at the market level and potentially 10-20 percent pullback in some of the richer priced stocks. That sort of pullback, I am fairly confident will bring another wave of foreign money into India. The challenge is that domestic flows are reasonably healthy. So as soon as valuations pullback, unless the foreigners are fairly prompt, the domestic money kicks in but therein my confidence is that you do have the foreigners primed for action. They really like India, there isn't that much else to like in the world outside India, they really like India, their enthusiastic response when we bring Indian companies to cities like Singapore and provided there is a valuation catalyst which gives them an excuse almost to buy India, you will see enthusiastic reception on the foreigners part of Indian stocks. Anuj: Do you have any Sensex target as of now or is that under review? A: It is the same old target that we have been discussing since June. In early June we said that at the end of FY17 fiscal, the year to March 2017, our target for March 2017 was 29,000 Sensex. We are staying with that which suggests that at the moment the market is fully valued at around on 27,000-27,500 mark. However, if the Sensex pullback for example to say 25,000 then obviously it makes life a whole lot easier. However, we are sticking to our March end target of 29,500 on the Sensex, I have not seen any earnings recovery out there to suggest that some sort of target upgrade is warranted and hence my view remains that the market is fully valued and if there is a pullback, we will be that much more enthusiastic in urging our clients to buy Indian stocks.