Prefer non-India stories; cautious on telecom, upbeat on IT: Neelkanth Mishra

Nimesh: First on this big telecom merger, it has been going on for a while now. It is now official that Idea Cellular is going to merge with Vodafone. Does this merit a change in your view as a sector or you think one needs to be still cautious?

A: No, I think the game has just started, so for the longest time the industry was in an equilibrium where Bharti Airtel was happy being number one, Vodafone was happy being number two, Idea Cellular was happy being number three. I don't know if they were happy about it but at least they weren't doing anything about it. Now we have three claimants trying to be the leader and there will be a clear jostling of space.

One of the companies has already claimed that they want to settle at 50 percent market share. So, the real fun is still ahead of us and while it may be exciting for the economy as a whole that we get very cheap telecom services and you see a complete disruption and how our infrastructure shapes up; I think for the companies involved in this battle it will be a very bruising one so we stay cautious.

Nimesh: The fact that the number of players in India are going to go down. The data consumption is going up, you have also mentioned in your report tracking Reliance as well that the data consumption has really gone up 10 fold for the sector. Given that you think that the pricing power will eventually come for Idea-Vodafone merger combined and for Reliance and for Bharti to survive this big data growth which we are seeing right now?

A: Right now the market shares are not settled. Once the market share settles that would be a time or when you see at least one off these three sort of throwing down their weapons and saying fine we are done, we are happy being where we are. I think that will be the point at which the constructive phase of the industry starts off. Right now we are just seeing average earning per user fall, there is going to be a lot of competitive jostling and you don't want to be there as an investor.

Nimesh: From a market point of view, market is at a new time high, valuations doesn't look that cheap at all. Earnings are going to be still iffy so to speak in that context are we going to see more highs to this rally in the near-term at least?

A: Whether we go meaningfully higher from here I think it is hard to say at this stage. What we are seeing is spectacularly high flows, strong flows both global and domestic. What we are seeing and this is something we have being flagging for a while that financial savings as a percentage of gross domestic product (GDP) is going up. What we are also seeing and we saw that data last week that loan growth is at a 63 year low, it was at this level at 1954. So, what that means is that the demand for capital is not there. The supply of capital is too strong and therefore the cost of capital has to come down.

What that means in the equity market is that valuations go high. So, we are seeing all kinds of IPO getting oversubscribed and opening 25-30 percent higher. Now, this is fairly speculative, so as an investor if I look 12 months out I think this is right now not a very strong economy.

Nimesh: I guess you are of the camp which believes that there probably could be a downside risk to the earnings and not the upside risk. So, what are you pencilling in in term of FY18-19?

A: Consensus is, till last week was at 18 percent growth for FY18. We are at 16, I mean our bottom up was at 16.

Nimesh: Is that also at risk?

A: It is. As a strategist I am allowed to talk about top-down numbers, I think we should be at single digits, maybe mid-single digits.

Nimesh: You are as a house constructive on the IT stocks for this year. However given the sharp move on the rupee in the last 2-3 weeks and the fact that there is still a bit of a hurdle in terms of the US policies, what does it makes for the IT space and within that probably will you bet on the large caps or you think there are lot of opportunities in the mid cap IT stocks to bet on?

A: I think the rupee there are lots of arguments to say that the rupee should strengthen. However what matters eventually is what the RBI thinks about it. A lot of these factors we have known for the last 2-3 years. The Reserve Bank of India (RBI) has sort of refused to let the rupee strengthen. Of course their objective generally is to keep volatility low but I do think that they try to see when the rupee is over strengthening as well. I suspect that on a trade weighted basis because when you look at the revenue growth for Indian IT companies you also look at it on a constant currency basis. The DXY is weakening, the trade weighted dollar is weakening mostly because the euro has started to strengthen. That by itself will raise a fair bit of revenue that the Indian companies will get from there as well.

So, what matters is the rupee against a basket of currencies rather than just against the US dollar. So, I think it will be less of an overhang. I would say that given the de-rating that the smaller IT companies have gone through, in terms of absolute upside, I think that is where the upside for investors could be better.

Nimesh: The other big sector which has really underperformed has been pharma. Again some bit of headwinds in terms of currency, in terms of policies in the US, is that a good bet or there are still real challenges for the IT sector in terms of US FDA issues?

A: For the pharma sector it has gone through a cycle of euphoria wherein people were giving very aggressive multiples on headline EPS, I think that froth has gone. The correction that we have seen in the last two years, I think that froth has gone. Perhaps there was a sense of the sector being oversold and we have bounced back from that. However unlike Indian IT which is actually a global cyclical, pharma has nothing to do with global cyclical revival. It is about fillings, it is about approvals, it is about FDA. I think that the change in the FDA wherein the number of ANDA approvals that they are giving every year is now jumping at 30-40 percent a year. It means that there is a lot more of supply, remember that it is an unbranded generic market.

The customer consolidation process is continuing, it has been disrupted a bit because of anti-competitive claims but I think the customer base is very consolidated. You have a surge in supply and therefore it is going to be very problematic for the companies to even maintain their revenues. All this investigation that is starting to happen on collusion to maintain high prices or to take price hikes is something that is going to force more scrutiny on some of these companies as well which is another overhang we are worried about.

So, as a sector we would say more neutralish than overweight.

Nimesh: Any sector which stands out which probably is going to be the sector of 2017. You spoke about IT briefly but beyond IT?

A: IT is a big sector. Energy could be another reasonable sized sector, not purely on the basis of oil price but the fact that if there is a global cyclical revival and refining margins could pick up. There has been a bit of a selloff in the government owned companies because of the disinvestment theme etc. I think once that is done you will see more strength. We would also want to be in companies that benefit from low cost of capital and I think there could be opportunities in some of those because their cost could actually fall much faster than what the market anticipates.

Nimesh: Coming to your conference, because that is the big conference which you host every year. This is the 20th year that you are hosting the conference. I was just looking at some numbers and it gives me a sense that the investor community which is going to be at the conference, that manages close to USD 18 trillion of money. That is a big sum that the investors manage globally and of course, part of it for India as well. You interact with a lot of your international clients as well. Broadly, what is the sense you get when you talk to international clients towards India?

A: There is definitely, what they call now, a fear of missing out (FOMO). To be honest, I do not think that people had really given up on India even during demonetisation. There was some selling which happened which was more the macro traders punting the market. But, the more medium-term investors had remained stuck. They were a bit unhappy about earnings downgrades and all of that which could be triggered by demonetisation, but they were all pretty much there because there is no alternative story hat on a medium-term basis an economy this size, there is nothing else which can come close to India. So, I think they have been around.

What we are seeing in terms of lows is something that all emerging markets are seeing. It is, in that way, very much an Asia or an emerging market trade that we are seeing. I do not see a big catch up really happened. People are still overweight India and I do not expect that to happen. In terms of sentiment, I would say that the next steps from the government in terms of the reform momentum, people are looking at how the economy adjusts around goods and service tax (GST). There is a lot of fascinating stuff happening at the state level. Those would be the developments that investors would really look out for.

Nimesh: To your mind, what could be the near-term solutions to just make sure that this whole non-performing asset (NPA) mess in the banking system is taken care of?

A: First time in a long time, we actually have a surfeit of domestic savings. Now you have to figure out how to lend. You have demand somewhere, you have supply somewhere, now do you get it there. The problem with 70 percent of our banking system, if you remove the larger public sector undertaking (PSU) banks, say 35-40 percent of the banking system is that they are not agile enough. They are not motivated enough, they are not incentivised enough to learn those skills and sort of shape themselves. That is something that the government has to do.

So, while the NPA problem is something which is very serious, it is a much more systemic issue of allowing. So, you may also see the government taking some steps in order to institutionalise or rather, put some regulatory pressure behind the financial system, not just the banking system, to get credit to where it is actually needed.

Nimesh: The consumption theme where a lot of the consumption stocks really did well on the back of the rural demand and the rural push, will that be under pressure?

A: What the consumer survey found was that at the lower end of the income spectrum, confidence levels had dipped very sharply. So there has been a deterioration, but it was done during the period of demonetisation so I guess it affected every segment. But, the worst affected are the ones which are the lower income segments.

This is something that we have been highlighting and we have been observing for almost a year. Soaps are not selling, but cars are selling. Two-wheelers are not selling, but cars are selling. So, consumer discretionary is doing okay, consumer staples is not doing okay. So, the broad base, the fact that nearly half our population is still in agriculture and now they are being forced out of agriculture is something that affects the staple's income growth.

What that does from a policy making perspective is that it puts a huge challenge of job creation for the government. There are 6-7 million people who exit agriculture every year. So the government cannot rely on the corporate sector to create jobs. So therefore, it has to focus on micro-enterprises and their creation. You will see, you should see some policy action. I am hoping that the government is working on it.

Nimesh: The Uttar Pradesh (UP) election was a big surprise on the positive side. Should one read too much into it and extrapolate that to the 2019 national elections because I guess, that is the question even your global investors are going to ask you. What is your view there?

A: Far more importantly is that UP is a sixth of India's population. It controls a State Budget which is nearly 20 percent that of the Central Budget. And if you do not get UP and Bihar right, you cannot get India right because nearly 31 percent of the population below the age of six, that so called demographic dividend is in these two states. And it happens with a lag, these are massive places, you cannot reform them with the turn of a key. If the BJP can manage this state well and do the basic things right, improve law and order, make sure electricity is available, make sure roads are good, I think we could have a very strong medium-term outlook in India.

Nimesh: Will that change the outlook for a lot of these sovereign funds or the long-only funds? Typically, you take an eight-year, 10-year view on any country. Given that it is going to be a likely stability in terms of policy reforms and the stable government in the centre, I know you track a lot of the sovereign flows as well at Credit Suisse. In terms of perspective or outlook towards India, will that change given that there is going to be assumed stability for the next 7-8 years from now?

A: To be fair, that assumption has already been there.

Nimesh: Has that been validated further with the strong UP elections?

A: You can say that there is a certain visibility. Elections actually speak a lot about the people and especially in a democracy. What the people speak for, what also matters is how you interpret their voting behaviour, it is not always the same thing. But, it says a lot about what people desire and that is a great thing. So, I think that their conviction, if at all would have been helped by the verdict that we saw in UP.

Nimesh: Now, to the global point. The theme this year, at your conference as well, is titled, 'The Beginning of a New Era'. What does this mean? Is it going to be for all of Asia or does this specifically mean that there is going to be a changing era for India?

A: It is not just for Asia or India, it is actually for the world. It is a completely globalised world and now, there are questions being raised on whether we have had too much of globalisation. I am not taking a stand on it, but that is a genuine question being asked. There are battles being fought in almost every country.

Nimesh: And everybody seems to be now looking at protecting their own territory, protecting their own jobs.

A: Let us not say everyone.

Nimesh: But the larger economies are.

A: Yes, and game theory would say that even if one or two large economies start doing that then everyone starts doing that. On the other hand, what can also happen is that there could be parallel groupings that come up because China is now promoting open trade. So, there is a lot of fascinating change which is why the theme was that this is more of a new era because technology is enabling things which we never thought were possible even 3-4 years back. We are seeing political change which we would have ruled out even six months back. We are seeing global trade, we are seeing geopolitics affect prices of commodities and that has a huge impact on which way the capital is flowing, how the trade is working out.

So, this is a very interesting time to be listening to big experts. We would have never thought that interest rates would not stay at zero forever. No we are finally seeing a reflation trade come through. There is a big challenge for everyone, not just India or China or the developed world, but for everyone that in this era of automation or this sharing economy and so on and so forth, how do you manage the growing income in equality? All these are themes and sessions at our conference. And we have a very good line-up of speakers to talk about that.

Nimesh: From here, what would be your base-case scenario? A 10-15 percent upside even from current levels or probably you will see a bit of toppish market for the rest of the year and probably a bit of a downside risk given that the earnings are not going to be supporting.

A: There is a lot still that needs to happen in the world over. For now, we have to see how the French Elections throw up good results or bad results. Right now, there is a sense of relief that the Dutch Elections went in favour of continuity. What the French do, what the Germans do, what it does to the state of Europe, Europe is a massive economy, it is actually doing surprisingly well and one hopes and our global forecast is also that it will continue to do well.

We are seeing some very interesting positive change happen in China which in the knee-jerk way, we are all attributing to local infrastructure spending which our China team believes is completely inappropriate. There are a lot of other things happening. For the first time in China, you are seeing very strong nominal gross domestic product (GDP) growth like 13 percent nominal GDP growth in an economy like China where they have been struggling with a lot of debt is actually a huge relief. That could trigger more positive.

And while China is already a very large economy, in terms of per capita GDP, purchasing power parity (PPP) adjusted it is still 15 years behind Mexico. So, there is a long way to go. So, these are the things that I would rather look at and therefore, there is a lot happening globally which the markets need to factor in.

Domestically, we will have to wait and see because as the unfortunate thing or rather from a certainty perspective is that just about the time that we can say for sure that the demonetisation disruption is behind us that the inventory cycles and the supply chain adjustments for GST will start happening.

So, this is a year where I have been saying from the beginning that will be a year where the markets are a bit disoriented. You will not know what is sustainable and what is a one-off. This is generally not a time a where you see a lot of logic in the market. So because of flows, you could see excessive highs, so I am deliberately avoiding that question whether we are going to see 15 percent higher before we correct or we correct from here.

Nimesh: While you spoke about flows being very strong, from a domestic side, does it look like it is going to sustain given that the savings ratio has gone up and that is where, probably a lot of money is coming back into the equity markets. Is that sustainable you think?

A: The nature of flows suggest that it may not sustain at these levels, but I think it will sustain because I fear there is a lot of miss-selling happening as well. So, if you look at year-on-year numbers, in February, the BSE 500 was up 35 percent year-on-year. So, you go and show someone a chart, fixed deposit 6 percent or 5 percent and see you get 35 percent returns here.

Most people, while they understand what mutual funds are now, there has been a lot of very good education that has been done by the industry, but it could be misleading. So, by June-July, you could actually see that momentum wavering off. So my sense is that it will come down a bit, but this surge in financial savings is a structural change and one hopes that a disappointment with this does not push people back into things like gold and real estate.