Risk-reward not in favour of market at current levels: UBS

The Indian market does offer a positive risk-reward ratio for investors at current levels, says Gautam Chhaochharia, Head of India Research at UBS.In an interview with CNBC-TV18, Chhaochharia said the economy was seeing incipient signs of recovery but that had been priced into stocks following their recent rally."I would be a buyer of Nifty at 7,500, seller at 8,400," he said.Chhaochharia also weighed in on the delay in monsoon, saying that its positive impact is overestimated ("it directly impacts 3 percent of the GDP") but added that, on the flip side, a third straight year of weak rains would be a cause of worry, if forecasts of a strong monsoon do not play out."Nevertheless, if monsoon is good this year, rural stocks can continue to do well for two-three months," he said.The UBS analyst is cautious on infrastructure, capital goods and two wheeler stocks.Below is the verbatim transcript of Gautam Chhaochharia’s interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.Sonia: In the last couple of days the market has been a bit worried about the delay in monsoons. It has not been a big delay but a delay nevertheless. How spooked would you be and how big trigger is the monsoon going ahead? Has it been priced in already?A: Let us look at it from two parts. If monsoons are good and normal as is being forecasted, our analysis suggests that the actual fundamental impact on the economy, on demand, on rural economy is over estimated by the market. Very simplistically, direct impact of monsoon is around only on 3 percent of total gross domestic product (GDP) because agri is 15 percent [of overall GDP] and only 20 percent of agri GDP is directly influenced by monsoons. So, the positive side is overestimated, but the negative side you have to worry because this monsoon is coming on the back of two bad monsoons years. While we have seen monsoon's impact on inflation having been limited over last two years, given currently what is available, it will matter for inflation as you saw in the last consumer price index (CPI) print also. Secondly, from a broader bigger picture policy, the government has kind of ignored the last two years of monsoons and stuck to its policy stance of bringing down inflation, looking at structural reforms and not bothering about short-term stimulus or subsidies. If we have a third year of bad monsoons, it forces the government's hand and has implications, that could be a worry definitely.Latha: You have been maintaining that in any case the monsoons don’t have too much of an impact on rural demand so even assuming that the MET department just told us that in about three days they expect the rains to cover Konkan and even madhya Maharashtra. Even if the rains were 105 percent you are not going to get very excited about rural demand related stocks?A: It will be positive for sentiment and it will be a respite, but it will not trigger a huge material uptake per se. It will be backed to normalised levels of demand; it will clear up some of the messages been there in the rural India. However, if you look at forecast the agri GDP forecast which our economist has is at 3.4 percent. So, it has been already built in a normal monsoons. If you look at forecast for rural related sectors and stocks, you look at earnings estimates etc they seems to imply a normalised monsoon any which way for this year. A lot of these stocks have re-rated sharply over last two to three months. Largely driven by valuation multiple expansions because earnings estimate are any way normalised and these valuations multiples are now trading near five year peaks. So, next two to three months the momentum can continue as long as monsoons stay on track for these stocks. However, if you are looking at 6 to12 months then I would warrant some caution on some of these stocks, specifically stocks and sectors where the benefit might be over estimated by street.Sonia: What do you do with some of these stocks? You are bullish on names like Emami, you have been underweight on a couple of these space like two-wheelers etc but they have been benefiting quite a bit from the pickup in rural economy or because of the festive season etc. What do you do with these rural based spaces? A: I don’t want to comment on individual stocks per se but some companies in the agri space, fertiliser space should benefit because that space has been very constrained over last two to three years. So, normalised monsoons not just mean some uptake in demand but also clears up the capital flow, the working capital issues for some of these stocks. So, that sector should do well. If you look at two-wheelers our underweight stance has been primarily on industry structure and specifically the incumbent’s product pipeline versus the segments which are growing. So, incumbent’s product pipeline is not synced with the growing segments. You have to remember that even if we have good monsoons the operating leverage per se in two-wheelers unlike say in passenger vehicles or trucks is far lower. If you see a volume uptake, you don’t see a meaningful uptake in earnings per se. The two-three months of two-wheeler’s data which we saw initial part of the year in our view it was a largely base effect driven. Similar to other high frequency data points which has already rolled over and I won’t really use that to extrapolate over optimism in that sector. Latha: A word more on the macros? Day before we got the import-export data for May it did indicate that the fall in non-oil imports has stopped. It troughed out and in fact the non-gold imports much higher than they were in April. I am just looking at telltale signs, there was that, there was also improvement in tractor sales, improvement in commercial vehicles sales. Now I think is gone on for a goodish bit. All these are not adding up to you for signs of growth?A: In our view India economy overall has been growing and recovering for last two years not just last year to six months. It is a question of what the recovery has been priced in by market. In January, February and March we were not seeing that Indian economy is sliding but that in a markets were implying that economy is sliding. Now markets are implying that economy is not just a recovering but recovering very sharply and strongly. That is where we disagree. It is not a sharply recovering economy; it is still a gradual recovering economy.Sonia: We have these big global cues also upon us the Brexit referendum. It may not impact too much in the longer term but in the very near term if there is a Brexit that takes place what kind of a downside do you see for the market and would that be a good buying opportunity?A: Brexit obviously, if it leads to outflow from emerging markets generally then India gets affected. It is difficult to say how markets will react because it will be lot more specific technical’s and sentiment driven rather than any material fundamentals driven specifically for India. So, India does not get that affected fundamentally from Brexit. I won’t worry too much about that. Whether I would buy, we would look at buying on dips for India. Again India still looks good long-term story from a two-three years perspective. However, in our view from a near-term perspective next six months odd these levels don’t offer attractive risk reward. So, I would wait for far lower levels from a near-term perspective to turn more bullish. Latha: Would it be right to say after reading your report would it be right to conclude that you would be a buyer as the Index goes below 8,000 towards 7,500 and you would be a seller as the Index goes towards 8,400?A: Our upside scenario is 8,400, our base case is 7,500.Latha: Now that the Index is showing more tendency to progress towards 8,400 what would you get out off or advise your clients to?A: Whereever we see the over optimism on growth estimates for FY17 in terms of earnings which seems quite broad based but specifically in infra, capital goods, auto, two-wheelers, select names in bank and discretionary. Sonia: The other theme that everyone has been playing these days is the non banking finance companies (NBFCs) space. Not just the consumer financers some of the micro lenders, the small and medium-sized enterprises (SME) financers etc. You have Shriram Transport Finance as one of your top midcap picks. Is there still steam there what the kind of run-up that we have seen?A: Can’t comment on individual names but yes we still remain overweight on non bank financials broadly. All the parts of the non bank financials from mortgage to vehicle finance we do like as a secular theme. Again stocks specific depends on where they are priced right now. Sonia: If there is rural distress hypothetically if the monsoons do not progress as well as expected do you foresee any kind of sell-off in these stocks?A: Possibly, because the impact of monsoons apart from agriculture will be felt a lot more in the rural financing led companies on both sides. If we have normal monsoons, the respite will have a very exaggerated impact on rural financers in terms of lower non performing loans (NPLs) and some recovery. Similarly, on the other side, so there will be definitely lot more geared to monsoons than some of the other names. Latha: I know you don’t want to discuss stocks but if you could mention more in terms of the sector I was a little surprised by the fact that you have a buy on Bharti Airtel? That is an extremely competitive sector and where the government is trying penalties on call drops even if they have been dropped for the moment, the high spectrum charges you would still persist with a high debt company like this?A: We are still overweight telecom per se and our telecom analyst view is that the launch of 4G both from existing players as well as the new incumbent would drive a data boom which will take care of these concerns. Latha: In consumption is there no theme at all that you are playing?A: The longer term in consumption is intact and remains attractive. In that sector we would recommend a lot more stocks specific approach. In terms of themes where we have been positive and remain positive is the home improvement theme because that segment has remained a strong even in a weak macro environment over the last two years and that segment still looks good.