See 50-100 bps rate cut in 1 yr; earnings worry: Violet Arc

Sonia: It has been a choppy last one month for the market. The month of March has seen a lot of pockets especially Public Sector Undertaking (PSU) banks come off quite a bit from their highs. How are you approaching the market now?

A: The way in which the markets have staged a smart recovery today after the initial choppiness that we saw post the disappointment with no rate cut coming about that clearly tells you that while the markets will always have these bouts of knee jerk reactions. The fact of the matter is that the market is also increasingly looking at the broader and the larger picture and the larger picture in terms of three or four key parameters has an excellent story to tell you.

First, the quality of fiscal consolidation which has always been a matter of concern, there the picture is looking far more reassuring than it has ever been in the last five to six years because I am not just talking of the fact that indirect revenues have come in at Rs 5.46 lakh crore which is Rs 4,000 crore more than the budgeted estimates. I am not even talking about the Rs 1 lakh crore plus collected by way of spectrum auctions or the fact that states will have value unlocked to the tune of Rs 3.35 lakh crore by way of coal auction that happened. If you keep that aside, the fact of the matter is that steps like say the Direct Benefit Transfer (DBT) which has been effected with respect to gas cylinders, that alone has benefitted the government to the tune of Rs 8,000-9,000-crore odd.

If you are talking of Food Subsidy Bill coming into effect which obviously it has and my arithmetic tells me that if there is this DBT which is extended to the Food Security Act also leakages will be plugged in to the tune of 20-25 percent which means an additional savings to the government to the tune of Rs 20,000-25,000 crore. Add that with the fact that there will be a Rs 60,000-70,000 crore bonanza by way of oil prices continuing to stay where they are even if they were to go up by USD 10 more from say the current USD 58-59 to USD 70 or so. You still have the government saving almost anywhere between Rs 90,000-95,000 crore only by way of subsidy leakages, lower oil prices, benign commodity prices and of course the fact that the government has been on a war footing with respect to ensuring that supply constraints are eased which is the way you should be viewing this whole spectrum and coal block allocation measures that have been effected.

So the market is smart enough to look beyond credit policy as it were. Of course rate reduction today would have been a pleasant surprise but my sense is that rate reduction to the tune of 50-100 basis points over the next 12 months, I am not even saying 18 months, is certainly on the cards because there is nothing sacrosanct about this 5.8 percent number which is what the governor has targeted by way of CPI inflation for March 2016 or January 2016. What if that Consumer Price Index (CPI) number were to come in at five percent then going by the governor’s real interest rate target of 1.5 percent you have 100 basis point rate reduction on the cards. Even if CPI were to come in at 5.5 percent and not 5.8 percent then by the governor’s logic of real interest rate of 1.5 percent you still have a 50 bps rate reduction on the cards.

So we also have to look at the fact that while the monsoons could play spoil sport what simply nobody seems to be bargaining for at this point in time is that the global food index is down 18 percent year-on-year (YoY). The global cereal production stands at 2 billion tonne, the highest it has ever been in the last decade or two. So, that coupled with the fact that we have strategic food reserves and buffer stocks well in excess of 50 million tonne, assuming monsoons were to be an outlier on the negative even then things are under control. So my sense is all this coupled with the fact that for the first time after a long time we also have a Balance of Payment surplus in excess of USD 20-25 billion for the first nine months of this fiscal FY15.

All that if you put everything together and you juxtapose it against the context of only the one big negative the earning cycle has still not shown signs of recovery. So you have two ways to look at it - some of the parcels that the macro is increasingly looking far more rosier than it has ever been. On the micro bit the earnings cycle has still to pick up. So if you juxtapose these two together I would still look at FY17 which is when the earnings growth will actually kick in to the tune of 18-20 percent assuming FY16 is again modest in the region of 5-6 percent you still have scope for a PE re-rating and that is what is going to drive the Sensex and the Nifty going forward from where it is at current level.

Anuj: That point is taken. But at some point the market will face up to the reality of earnings and for last two three quarters the earnings have clearly missed estimates and this time around there is a fear that Q4 could be one of the worst that have seen in some time barring a couple of sectors. Do you think that could be a bit of a risk to the market just in the near-term?

A: I would not say that is a risk because risk is always a function of something that you do not expect. The markets have already priced in the fact that while in quarter four of FY14, the Nifty 50 companies reported an aggregate profit of Rs 73,000 crore. The market is well aware of the fact that for quarter four of FY15, the Nifty 50 companies in an aggregate will report net profit to the tune of Rs 58,000-60,000 crore which means you are talking of an 18-20 percent decline in quarter four of FY15 over quarter four of FY14. So, I think the fact that there will be negative surprises that is a given. Markets always look ahead and hence there is no reason to believe the earnings trajectory in quarter four which will be disappointing is a risk. That is it, I believe that the way you should approach this is that in the last one year, one out of every four stocks has doubled or more than doubled.

The interesting point to note also is the fact that while all of us have been going gung-ho over the fact that the healthcare index went up 70 percent and by far has been the most stellar outperformer in the last one year or so, if you look and read between the lines you will realise that actually the four or five stocks that have gone up more than 200 percent in the rally of the last one year actually come in the category of cyclicals are certainly not defensive by any stretch of imagination. Ashok Leyland, Gujarat Pipavav Port, of course there is Wockhardt as well, so these are the kind of stocks that have actually gone up more than 200 percent even within the Nifty 50 the top performer with an 88 percent run up is Maruti.

So, the fact that some of the big cyclical and non-defensive players have chosen to rally, that clearly tells you a point. Do not forget that Reliance and ITC together account for 20 percent weightage in the Sensex and both these stocks fell by between 12 to eight percent in the last one year. So, there was no participation from these two heavy weights. The metal index and the oil and gas index fell by 6 percent and 3 percent respectively. There was no participation from these two sectors. So, despite this it was purely banking, healthcare and autos. These three sectors which actually contributed to the more than 25 percent plus rally in Dollar terms that we saw.

So, imagine if there is even a wee-bit of participation and things were to normalise, be it in with respect to the metals sector, the auto sector or even some of the biggies like Reliance, etc we are in for better times and earnings in India has always been a play in contrast. So while you will have an Ashok Leyland which will report great numbers for fourth quarter, you will continue to have a Bajaj which will continue to disappoint. Ditto with pharma pack, you will continue to see a Lupin choosing to surprise you and you will perhaps continue to see a Sun Pharma irrespective of the heady run up continuing to be more pedestrian. Of course the IT sector is certainly going to disappoint because there will be a cross currency headwind effect to the tune of anywhere between 200-300 basis points.

So, the IT sector will likely show you a pedestrian growth of 12-14 percent over the next two years and not 17-18 percent which is what we have been used to. But, you will have to cherry pick. So, it is not going to be one sector versus the other, it is going to be a few stocks within a sector versus a few stocks within some other sector and it will have to be a stock picker’s market, clichéd as it may sound.

Sonia: Lest we run out of time, let me talk about some stocks that are moving on news today. SKS Microfinance is up nine percent after the RBI raised the borrowing limits for any individual by micro finance institutions (MFIs). In any case that stock has been hitting the new highs everyday. What is your own view on how to approach some of these companies like SKS and SE Investments which could benefit from this move?

A: I would like to look at the policy in greater detail with respect to what it has for micro finance institutions but if I take the liberty of digressing a bit from the question that you have asked, approaching financials as a whole I don’t subscribe to that class which believes that PSU banks are in a bear trajectory. That is what technical analysts will tell you but what the markets have chosen to display over the last one year is that the market participants are no longer reacting to earnings surprises or disappointments in the banking space.

What market participants are looking at is how well the particular bank is capitalized, its ability to face further challenges if the sluggish credit growth environment continues to prolong and what is the kind of deposit franchise that it has, that is precisely the reason despite a steep correction that you saw in a Bank of Baroda or a Union Bank which lost about 18-20 percent of their market cap post the disappointing numbers of third quarter. The fact of the matter is that people are still willing to go and place their bet on a Bank of Baroda or an SBI because of the sheer strength of their liability franchise.

A tier 1 capital adequacy ratio of more than 10 percent for SBI or at 9.6 percent plus for Bank of Baroda, that gives you comfort because in the kind of environment that we are at in the fourth quarter you saw credit growth at 11.6 percent year on year but deposit growth was just about 10.2 percent year on year (YoY) and the credit deposit ratio has been very sticky at just about 76 percent so if you put all this together in the right context then PSU banks by sheer virtue of their excellent liability franchise, for instance in the case of SBI retail deposits account for 95 percent of their total deposit base and I have been bullish on it for a long while. Though the stock has chosen to disappoint in the last few weeks the fact of the matter is that precisely for the reasons that I gave you, these are the banks that will continue to outperform and if I have to look at financials I will still place my bets on an SBI perhaps for a little bit of an alpha on a Bank of Baroda and then perhaps look at a Kotak Bank but I won’t certainly touch an HDFC Bank which still is far more expensive and there is no reason paying three times or three and a half times price to book when I can get an SBI at less than one and a half times price to book on FY17 numbers.