Next 12 months good for equities; avoid pharma, PSU banks: Ambit

India is entering a pronounced consumer credit-driven consumption phase, according to Saurabh Mukherjea, CEO-institutional equities of Ambit Capital. The economy is heading into a credit boom and next 12 months look reasonably solid, he said.Speaking to CNBC-TV18, he said funding cost for all financial institutions has come down significantly due to abundance of liquidity in the financial system. "That (liquidity), allied with squeeze in the residential housing sector, jewelry sector and black money, is resulting in consumer credit boom," he said. His Sensex year-end target remains at 29,500. However, Mukherjea is of the opinion that pharma as a sector will de-rate in coming days. He believes the cash flows related to pharma companies are risky and valuations are expensive.He is bearish on shares of public sector banks and believes there is huge opportunity in roads sector in medium to long-term. Mukherjea, in his book Unusual Billionaires: Decoding India Incs Success Stories, highlights seven companies (Asian Paints, Berger Paints, Marico, HDFC Bank, Axis Bank, Astral Poly and Page Industries) which have created unusual billionaires and discusses the same with CNBC-TV18.Below is the transcript of Saurabh Mukherjee’s interview to Anuj Singhal, Sonia Shenoy and Latha Venkatesh on CNBC-TV18.Anuj: It has been strong going for the market though off-late, we have seen one part of the market, which is IT index not doing well. But the Bank Nifty has taken care of that. What is your broader call now going forward? Do we remain in this kind of phase where the banks continue to push the market higher?A: It would appear that we are entering a fairly pronounced consumer credit driven consumption boom in India. Liquidity conditions since around April 7-8 when the outgoing RBI Governor eased the liquidity conditions, liquidity has been abundant in the wholesale market. As you and your colleagues were just discussing the abundance of wholesale liquidity has brought down funding costs for all financial institutions. That allied with the squeeze on black money, the squeeze on the jewellery sector, the squeeze on the residential housing sector is resulting in a concerted consumer credit boom.Banks and non-banking financial companies (NBFC) do not have the luxury of lending to corporates. So, money is flowing only in one direction, which is towards consumer. That will be the broad tone and tenor for India over the next 12 months provided wholesale market financing conditions remain buoyant as they currently are. It is reasonably clear that we are heading into a consumer credit boom and driven by that a consumption driven economic recovery.Sonia: Were you convinced with the turnaround that we saw in the State Bank of India (SBI) earnings? Is it just SBI specific or do you think that now the entire PSU bank is reaching an inflection point?A: I do not think, we are convinced that the banking sectors non-performing asset (NPA) problems are behind us. More generally, the entire power infrastructure NPA mess, I do not think we are out of it yet.The next ratchet down that we will see in this weak balance sheet story is the concerted step up in provisioning. On the already NPA numbers, the provisioning quantums will have to rise in the second six months of the year. So, view of the house still remains that one should stay well away from the PSU baking pack. I do not think we are out of the woods here.But the happier story, which is gradually panning out is other lenders, smaller banks, NBFCs who have got healthy balance sheets, who have got access to tier-I capital are being able to make hay while the sun shines, specifically lending to small and medium enterprises (SME) and consumers is proving to be a profitable proposition.Latha: After reading your book, I got the impression that it makes more sense to do a systematic investment plan (SIP) on these kinds of stocks. Why go to mutual funds at all? Is that your message?A: My message was intended more at the retail investor who spends his time watching programmes like this, reading personal finance magazines and agonising about how do I save money and my message to that constituency is that there are two tenets of long-term investing, which seem to work in every country in every era, which is one, buy high quality companies and two, be patient, hold these high quality companies over a long period of time.As you rightly mentioned, for identifying high quality companies, I used these two sieves, 10 percent revenue growth over 10 years and 15 percent return on capital employed (ROCE) at least 15 percent ROCE 10 years in a row. And for long periods of time, I have used 10 years as an investment period. That is the core message.Now, in that context, there are mutual funds that could also follow that philosophy, but certainly investors can create an SIP for themselves, using this philosophy just as well as they can go to a mutual fund.Latha: Seven stocks, which I should mention, Asian Paints, Berger Paints, among the paint companies, you have HDFC Bank and Axis Bank, you have Marico, you have Astral Poly and you have Page Industries. Those are the seven gems that you pick out. Let me start with the paint companies. Valuations have sky rocketed. Is there a time element as well in choosing? For instance would you advise buying Berger and Asian Paints today?A: One of the things we have been steadfast in highlighting in Ambit’s research over the last 5-6 years is if you are a long-term investor i.e. you have a horizon of at least a year, probably longer than that, 2-4 years, entry period valuations are not a critical driver of your investment returns. However, if you are short-term trader who is looking at daily, monthly, quarterly returns, then you should be worried about entry period valuations and the expensive names such as the one you highlighted might not be the ones to buy. But for fundamentally oriented long-term traders, there is no evidence in India that buying stocks at high price-earnings ratio (P/E) multiples costs them anything. If anything, my book is a firm pointer to the direction of buying high quality companies putting them in your portfolio, sitting back and letting the portfolio compound over a long period of time.Anuj: Let us address the near-term market dynamics. I am going by you strategy report. You are saying that in IT stocks, Tata Consultancy Services (TCS) is better placed than Infosys in a weak demand environment and that has played out over the last one month or so. Infosys now approaching 52-weeek low, but do you think Infosys as a stock will derate a lot more over the next 3-6 months?A: Unfortunately, our compliance will not give me permission to discuss specific stocks, but what I can say is this much that wherever you have seen high hopes of a demand pick up in the western IT context, that is where you are likely to see disappointment. It is not clear that there is a big demand recovery in western IT around the corner, partly because economic conditions especially in Europe and to some extent even in American Banking, Financial services and Insurance (BFSI), demand conditions remain muted. So, wherever you have got IT stocks, which are baking in a meaningful pick up in order flow in the coming quarters, there more likely than not, to be disappointment in those quarters.Sonia: Also, you do mention some very interesting takeaways in some of the companies like Lupin. We spoke about Berger Paints, Dish TV is another stock, but I want to focus more on the pharmaceutical space because it is very difficult to decipher where the land mines are and where the gold mines could be in this space. How do you approach this sector, the heavyweights, the likes of Lupin, Cipla, etc for the next 6-12 months?A: Our view on pharmaceuticals has been for the last 2-3 years, that the market takes an overly rosy view of the continuation or sustenance of strong ROCEs and cash flows in this sector. Also, almost as if the market sees pharmaceuticals as somewhat similar to fast-moving consumer goods (FMCG) or IT in the sustenance of cash flows, in reality pharmaceuticals is a far riskier sector than the Indian market perceives it to be. The cash flows associated with specific molecules and specific drugs are much more unpredictable than the Indian market perceives it to be. My reckoning is in totality, pharmaceuticals as a sector, will derate in the coming years as we get a more realistic picture of how risky the cash flows associated with these companies are.Without going into specifics, pharmaceuticals as a sector is overly rated in our country, rated too richly in our country and more likely than not, we will see a return to reality with regards to valuations in the pharmaceuticals sector.Latha: I also wanted your advice on metals for the near-term view. We have seen, Hindalco is one of the best performing stocks, year-to-date. What is your sense? Have these stocks run their course? Now would they be too hot to touch?A: Unfortunately, with all the metals and mining stocks in our country, they are almost 70-80 percent co-related with the underlying global metal price movements, whether it be on London Metal Exchange (LME) or in the New York Mercantile Exchange (NYMEX). The underlying metal movement has a very high bearing on the share prices of the metals and mining stocks of India.A much better way, if someone wants to do near-term trading, it is not my forte, but if someone wanted my advice on it, I would say look at three big trends which are playing out in India and try to capitalise in that. The first is a crushing of black money, especially in real estate and jewellery and a shifting of that consumption into the wide sector, specifically building materials, higher end cars, financial products and so on. Clear trend and as long as Prime Minster Modi carries on his black money attack, this trend will fructify, it is a major trend.Second is the death of public sector undertaking (PSU) banks, the gradual decline of PSU banks and the coming of age of smaller private sector lenders whether it be banks or NBFCs.The third is the gradual decline of railways and the book in the roads sector. Roads both in trucking, in lending for trucks, in building roads and running roads, the roads sector in India will blossom in the years to come and there is a big story to be played there. These three big trends are reasonably well entrenched and the remainder of this government’s life, we will see profitable trading activity in getting out of the dying leg of the trade, whether it be black money or railways or PSU banks and getting into the booming leg of the trade, which is white money consumption, private sector lending and the roads sector.Sonia: So where do you think all of this could take us by the end of the year? What do you think upside target for the Nifty could be?A: Our Sensex year-end target remains 29,500. I have not yet seen anything which suggests to me that we should upgrade our 29,500. We are keeping an eye on it. The main thing we are wary of at the moment is the European Banks. They look to be in a parlous state and given negative inflation and negative interest rates in Europe, it is difficult to see how long the European Central Bank (ECB) can carry on with its current monetary policy of negative interest rates. Negative interest rates are fundamentally distractive for a banking sector and European banks are a big worry.Back home, as I said, we seem to heading into a credit driven consumption boom. I did a round of the local shopping malls near my house over the weekend. You are getting zero percent finance on everything that you care to buy. I visited some of the websites over the weekend and again every bank is giving up to lend money for everything from buying my books to buying a washing machine. So, it is quite an interesting situation. We are all getting SMS about unsecured loans at 11 percent. So, we are heading into that boom. Let us see where that takes us. My reckoning is next 12 months look to be reasonably solid for India.