Recovery firmly underway but bull market can wait: Credit Suisse

An economic recovery is firmly underway and finally showed in March quarter numbers but that a lot of it is already in the price, says Neelkanth Mishra, Head - Equity Strategy, India, Credit Suisse.In an interview with CNBC-TV18, Mishra said economic recovery had proceeded from being "green shoots" to "shrubs" now and this would show up in about 15 percent growth in earnings for fiscal year 2016-17."But is this the roaring bull market that people have been waiting for where you could buy the public sector banks and industrials and junk stocks? We are not there yet. It is quite a while away," he said.Credit Suisse was among the first institutions to become positive on the metal sector -- a call that has paid off handsomely in the past few months -- and now it is betting on corporate focused banks such as ICICI Bank and Axis Bank.The call is to do with the difference between price and percieved value. "Once the market has drawn a circle around the problem, it is in the price," he told CNBC-TV18.Below is the transcript of Neekanth Mishra’s interview with Sonia Shenoy and Latha Venkatesh on CNBC-TV18.Latha: Of the lot of investors we speak with or strategists we speak with, you sound more positive, both on India growth as well as on the commodity cycle. So, we should expect some bullish noises. What is your sense first of the big call you took on the Hindalco and the metal stocks? You still will remain positive on the industrial space, the metal space?A: Not industrials, but metals, definitely yes. It is a trade that will play out over the next 6-9 months. Our views are being supported by what we are seeing outside China so far. And as the seasonal weakness plays out in most of these markets by September-October, we should see that the recovery in steel demand globally, that we are anticipating, should start to become more visible and that should support the stocks.Sonia: I am very keen to know what your own ground check has been on the green shoots, because the last time we spoke, it was still a hope of green shoots in the economy. But now, we are getting some firm evidence especially from earnings. How have you read into that? Are we making a mountain out of a molehill or are things genuinely picking up on the ground?A: We have been saying since November that the economy is reviving. We have been highlighting the fact that some of the changes that are happening in India like a third of households in West Bengal getting electrified or a third of households in Bihar getting electrified or the fact that states like Telangana and Andhra Pradesh are simplifying and easing the start of a business or the fact that most of the states now seem to have land banks, which are easing or rather reducing the timeframe from committing to a project to starting work.All of these factors and the fact that the government's expenditure on railways and highways is likely to be quite distributed -- it will show up in very defused numbers. Our macro statistics are not designed to properly capture or rather they are unable to properly capture some of these bottom up changes.Therefore, we have been tracking things like oil volumes, power volumes, cement volumes, auto volumes and they have been reasonably strong for the last 6-7 months now.So, we started saying in November that the economy is reviving, we had expected it would revive and it is reviving and we expect that momentum to continue with the stimulus -- now everyone is talking about there is going to be a Pay Commission, the monsoon is good and all of that.Now, our view is that it has started to show up now in the March quarter earnings, so while people have been looking at green shoots now, for me, they are shrubs growing now, not yet trees. So, the recovery is very much on.I fear that the market has sort of gone overboard in the sense that the price to earnings multiple (P/E) that we see now is very high. The forward price to earnings and while we are very confident that the earnings growth will come through, the market does that, it starts to price in some of these changes way too early.There are also question we are getting, is this the bull market that we have all been waiting for wherein you go and buy the junk stocks, the beaten down names, you start buying public sector undertaking (PSU) banks and so on and so forth. Unfortunately, I do not think we are there yet. That stage could be quite a while away but yes, the prints that we see for gross domestic product (GDP) should be consistently improving from here. However, the rah-rah bull market that everyone is hoping for and waiting for is something that will only revive with a lag.Latha: I want to take issue with your turning a buy on private corporate lenders. You turned buyers sometime back on Axis Bank and ICICI Bank and yet your latest report from Ashish Gupta is that while interest cover under one number companies has fallen, the chronically stressed companies remain unchanged at 32 percent and in fact, loss making companies, the share of debt has actually increased to 34 percent. Now, all these are borrowers for the corporate lending guys. Would you still persist with your faith in the ICICI and the Axis?A: You have to always differentiate between the economy and the stock picks or the stock price and the fundamentals at that time, may not always be aligned. So, once you have been able to, once the market has drawn a circle around what the problem is -- our big problem earlier was that the banks were not cauterising the problem areas and therefore, the problems would keep getting bigger and that creates a problem for the investors because they do not know how big the problem is going to be by the time it starts to get resolved.So, what has happened is that the problems are now recognised. We all know that the percentage of loans to weak corporates is not growing. That percentage itself has been well-identified and once there is less of a chance of a massive negative surprise, you would expect that the stocks would have bottomed out. That has been our call and I think that is going to work as well because India, all of the long-term thesis that people start remembering when the banks are trading at 2.5 times book, that look India is under-banked, PSU banks are going to lose share. All of those things have been relevant all this while. Some of these banks are well managed, they are investing in technology, they are going to be gaining share, they are going to grow faster than the market. So, all of that has been true all this while. We are just recognising that perhaps, at the price to book multiples that they were trading at, that the problems are factored in. That is what we are seeing._PAGEBREAK_Sonia: Coming back to that point you made about the green shoots that you have been seeing since the month of November, have you raised your earnings estimates for FY17 and FY18 based on the numbers that you have seen so far?A: Let us see what has changed. Earlier we used to see the start -- People will start introducing FY19 estimates now, but the first time FY17 estimates were introduced or FY16 estimates were introduced, they started off at 18-20 percent, year-on-year (Y-o-Y) over FY15 and then we saw FY15 go down and then we saw FY16 go down and both FY15 and FY16 ended up in low single digits. So, we have seen very low numbers.FY17 at about 18-19 percent now has held up. So, I would say that what matters for the market is the pace of cuts and a pace of cuts had accelerated to 6-7 percent every three months. Now, that seems to be slowing to about 2-2.5 percent. As the year progresses, we will actually see that slowdown to maybe 0.5-1 percent every three months and that is very positive for the market, because what matters is not just whether earnings are going up or down. What is earnings growth? If you end up the year at 15 percent earnings growth, that is very strong, because even if the market does not do anything, at least it gets 15 percent cheaper.Latha: So, at the moment, you are going with 15 percent?A: Yes, of course, I wrote about that. So, in our results summary, we have said that, I was at 12-13 percent earlier, after this quarter’s results where we have seen some numbers get bumped up. We are at 15 percent. The single digit number that we saw for FY16 was of course, there was a one off there, meaning some of the banks took massive write downs and there would be some more write downs this year as well, I fear. However, if you remove that, the numbers are starting to reflect what is 7-8 percent growth economy.Latha: I want to ask you about the midcaps as well. Now we are moving closer to the monsoon session and the chances of the GST look very bright. You have spoken about that well with the numbers stacking in favour of the amendment passing. Would you have any buys in the bigcaps because of this theme and more importantly in the midcap space, logistics or consumer staples, any buys at all?
A: Let's take GST as to the implications of the economy. I still continue to believe that from the date that it gets passed to the date that it starts to get implemented meaning the start date of GST, would at least be a year away. So on top of that in the first year, you will see a disruption in the economy, so in all the gains that people are waiting for and there will be meaningful gains and the gains will be visible with two-three year lag. Would the market have the patience to do that? I do not think so and therefore it is purely a sentiment play. It is one of those big issues on which the global investors have been waiting that so far we have seen great execution and the government is starting to work etc but where the big reforms are and GST is considered to be a big reform. So even though it has very little fundamental value for earnings in the next year or two, it has a big signalling value and so, if you are talking about it from a signalling perspective, I would think that the more meaningful impact will come in the largecaps because that is where people generally get more interested in India and start allocating more money and most of these guys cannot buy the smallcaps and the midcaps.

However, having said that in terms of clarity, we have seen that outside of the large one or two companies that have been working on GST for a while, most companies said let the bill get pass and we will do work. So once the bill gets passed then you will start seeing the news flow around logistics companies or staple companies seeing their rates go down from 29 percent to 18 percent or 20 percent and how they can retain those gains and what are they going to do with the margins and so on. So that commentary will start. So yes, some of those themes will come into play again but in the absence of immediate earning support I do not know how long that is going to last.

Sonia: I want to discuss one theme that has worked very well for the government which is the improvement in coal and in power. So now we are self-sufficient in coal, in power we have moved from a chronic shortage to surplus. How do you, as an investor, play this theme over the next 6-12 months?

A: We have been positive on coal producers and some of the utilities. I cannot take the stock names. I think they remain the best way to play this. However, we are also seeing and this is where some of the work we have done on state budgets, we have been of the view for the last several years that the exciting stuff is happening at the state level, I am exaggerating a bit but almost all the exciting stuffs seems to be happening there, for example Uttar Pradesh (UP) from October this year plans to increase its power demand by 60 percent. So going from 13 gigawatts in October '15 to 21 gigawatts starting October '16, so that is a remarkable jump. You could see consumer appliances start to improve. A state as big as UP providing that quantum of power jump, is going to be substantial. So over and above the fact and of course we yesterday put out a note on the railway's freight analysis and what has been surprising is that the quantum of railway freight shipped in April, was down 13.5 percent year-on-year and mostly it was because the average distance travelled has come down sharply.