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Last Updated : Feb 13, 2017 10:23 PM IST | Source: CNBC-TV18

See at least two US Fed rate hikes this year: Sanjeev Prasad

The strength of the US dollar will decide the fate of the emerging markets (EMs), said Sanjeev Prasad, Senior ED & Co-Head at Kotak Institutional Equities.


The strength of the US dollar will decide the fate of the emerging markets (EMs), said Sanjeev Prasad, Senior ED & Co-Head at Kotak Institutional Equities.

“What matters for the emerging markets is where the US dollar is going. Over the last one month, starting from end of December to early part of February, you had fairly sustained weakness in the US Dollar after it peaked at around 104, it came down to below 100 levels,” he said.

Speaking to CNBC-TV18 from the sidelines of Kotak Conference which is slated to kick off this morning, Prasad said dollar will strengthen even further from the current levels.

Prasad said, Fed may hike rates at least twice this year if not thrice resulting in further strengthening of dollar and bond yields moving up. According to Prasad this may expose the emerging markets and hence, advises EMs to depend more on fundamentals and be more careful about macro-related funds.

Speaking on the recent corporate feud going on at IT bellwether Infosys, Prasad feels there is no major issue between the founders and management of Infosys. He, said, in fact, Infosys is well poised to make a transition in IT business environment. He also said IT companies look attractive based on their valuations currently.

Below is the verbatim transcript of Sanjeev Prasad’s interview to Anuj Singhal, Latha Venkatesh & Sonia Shenoy on CNBC-TV18.

Sonia: How have you read into earnings season so far? We are getting some road blocks now in terms of earnings especially in vulnerable pockets like public sector undertaking (PSU) banks? What would your overall assessment be?

A: It seems to be pretty much in line -- whatever we had thought. If you look at that top line numbers none of the sectors have beaten the numbers quite significantly barring a real estate sector and I don’t think accounting sales makes that much of a difference over there. So, very few sectors have beaten on the top line. Some companies have done well on the cost sides obviously because of demonetisation, a lot of companies have focused on the cost and controlled cost to that extent.

If you look at the BSE 30 Index for example, we were not looking at too much of growth in the net profit numbers anywhere only about 1 percent odd it has come about 2 percent higher than what our estimates were at the net profit level. However, that is largely because of 3-4 companies -- it is Dr Reddy’s Laboratories where you have seen gross margin expanding quite significantly. In case of Hero MotoCorp fair amount of cost control resulted in the net profit numbers being higher versus expectation.

ICICI Bank benefited significantly from lower than expected tax numbers. So, it is nothing great on operating side, I must say because underlying trends are still very weak.

If you look at banking sector, credit growth is down to 5 percent, if you look at the consumer sector volume numbers -- very disappointing this quarter but that was expected on the back of demonetisation.

If you look at the industrial sector in terms of ordering activity there is decline in this quarter compared to Q3 last year. So, in general the weak underlying trends which were serving this economy for some time that continues and to some extent that got aggravated by demonetisation exercise.

Latha: Let me get your view on the global flows. They have turned positive now, so would that kind of hide our blemishes? Donald Trump is now finally talking about tax regulation, so would you count on the global liquidity being on the side of the bulls?

A: It is a tricky issue, what matters for emerging market (EM) is where the US dollar is going. Over the last one month I would say starting from end of December to early part of February, you had a fairly sustained weakness in the US dollar after it peaked at Dollar Index Spot (DXY) somewhere about 104 and it came down to below 100 levels. That resulted a fair amount of macro related flows going into emerging markets in the month of January, which drove the rally in the emerging markets.

So, ultimately this is becoming more of a call on dollar in the short-term and at least the consensus view on the US dollar is that it would strengthen as we go forward given the fact that the recovery in the US is looking reasonably good.

The employment market is looking reasonably tight. Inflation is creeping up gradually to the US Fed target of 2 percent, so based on all that you could potentially see -- if not three rate hikes in 2017 by the US Fed maybe two rate hikes.

So, if that is a case that you are going to see some amount of dollar strengthening, US bonds yields moving up, also some bit of recovery in Europe and Japan then I think emerging markets may be a little bit exposed and they will have to depend more on the fundamentals now. What is the macroeconomic situation in each of the markets, what kind of economic growth we are looking at ultimately and what kind of earnings growth we are looking at?

So, I think we should be bit careful about this macro related flows. If you look at between October and December you had the US dollar strengthening, US bond yields moving up and a lot of money going out of emerging markets between and December and early this year you had some amount of US dollar weakness and you had money coming back into emerging markets. So, I don’t know whether that is the trade, which investors want to back as a big investment thesis.

Anuj: What have you made of what is going on in Infosys and in fact your entire IT sector call now because there is one argument that it is historically low valuation and the other argument of course that business itself is seeing a lot of problem. Where are you standing on it right now?

A: As far as the Infosys issue is concerned the good news over the weekend, both the board of Infosys as also the founders of Infosys have put a very strong endorsement as far as the management is concerned and Dr Vishal Sikka in particular.

So, I don’t think it is an issue between the founders of the company and the management looks like maybe the founders have some concerns with some levels of corporate governance practices, which I guess the board and the founders need to resolve. I don’t think this is really that much of a management related issue.

So, hopefully, Dr Vishal Sikka gets a freehand and he continues to do whatever he has been given the mandate for in terms of moving Infosys to the new businesses that are emerging in the IT space and the big transformation which is taking place in the industry which brings me to the second part of your question that yes, of course there is a big challenge for the industry as a whole.

The traditional model of low cost outsourcing that is clearly coming out into some amount of pressure and this is even before all the US visa, immigration issues and border tax and all that stuff. Even before that you were seeing a fair amount of pressure on the pricing and even volumes to some extent as far as the basic model is concerned.

So, now the critical issue for the company is whether they can do the transition to more the newer areas where companies are more interested and the customers are more interested in which is the combinations of analytic cloud, digital and so on and so forth. I guess Infosys thankfully has the right management in terms of hopefully making the transition.

At the end of the day, these are the smart companies. They have looked through a lot of transitions as far as the IT industry is concerned over the last 30 years. So I am not in the camp that this company will not be able to make that transition. Yes, of course there will be some challenges in terms of margins probably adjusting downwards given the general environment. But I would be still backers of this companies. Also valuations are clearly in a favour, most of the companies are now trading at between 12-14 times on a March 18 basis. If you exclude Tata Consultancy Services (TCS) so from a valuation perspective look quite interesting and if the US immigration visa issues get sorted out hopefully over the next few months you could potentially see some sort of re-ratings in these names.

Sonia: You have many interesting speakers at your conference. There is not just Dr Sikka, but Uday Kotak, Adi Godrej, Sanjiv Bajaj etc. what has the feedback been so far from all the corporate that you have interacted with?

A: As far as the conference is concerned, it is early days obviously. You have lot of commentaries from the companies with respect to their Q3 results and that is what I would focus on this point of time.

As far as Q3 results go, most of the company seem to have taken this whole demonetisation thing in their stride. Of course it had negative impact on the volumes in certain cases, but most companies are reasonably confident that they would put this issue firmly behind them over the next one quarter or so.

Other thing which is very interesting to see is how companies responded to this in terms of the amount of cost control they have managed to do -- in fact I was jokingly saying in one of the meetings that maybe India should go for permanent demonetisation because it has brought a lot of efficiency in the economy. But, jokes aside clearly the companies have tighten the belt pretty significantly. They have managed to cut a lot of cost as far as employees are concerned and even other expenses they have brought under control which I think is good.

So, I think the companies are okay in a sense they are looking positively forward to the recovery in economy. The problem is we are still not seeing too much of signs of any private sector capex.

Even if you look at the order booking activity in this quarter, it has been slightly disappointing may be it has got to do with one company number which is Bharat Heavy Electricals Ltd (BHEL), didn’t have any great set of numbers as far as order booking is concerned, although some of the smaller industrial companies like ABB, cements etc had pretty reasonable announcements on the order booking side.

So, it looks like you could see some recovery in investment cycle may be few quarters down the line, but it is still not very clear when we see a very firm recovery in the market.

Other thing which could be interesting to watch out for is what is happening on the real estate side and unfortunately the month of November and December you had a pretty sharp decline in residential sales over there, which was to be expected. Our hope is that -- this is what some of the management is also saying -- given the fact that affordability in India has improved quite dramatically over the last three-four years given the fact that real estate prices have been flat over the last three years if we exclude Mumbai. Interest rates have come down by about 150 basis points compared to where we were two years back as far as housing finance rates are concerned that has improved affordability to the extent of about 30-35 percent as far as the real estate markets are concerned.

So, hopefully at some point in time in the next three-four quarters you will start seeing some recovery over there which should be interesting because that could drive the economy going forward. So, lot of companies are slightly feeling more confident that over the next few quarters on the consumption side, on the investment side as also on the real estate side you could start seeing some recovery.

Latha: Your purchases would be what auto stocks, any of the banks, which kind of banks, which kind of NBFCs?

A: If you look at market it is not very cheap market. It is already at about 17 times on a March, 2018 basis with potentially some downgrades in earnings estimates, which could still be out there because last three-four years, we as a community have been too positive on the earning numbers. So, I don't see too much mispricing in this market barring a few segments such as corporate banks.

One good thing which we have observed in this quarter is that for the third quarter the gross non-performing loans (NPLs) numbers for the public sector banks has been fairly stable.

For the banks we track barring Oriental Bank of Commerce (OBC) and Indian Bank generally the numbers have been fairly stable of the last two to three quarters. Private banks -- we are still some increase but another one or two quarters could see the gross NPLs number peeking out.

If you do a bottom-up analysis of the bad loans or what you thought were bad assets in the economy, I think banks have more or less recognised most of the bad assets. So I think we are getting to the end of the NPL recognition problem at least. The question is how quickly we will start seeing our resolutions going forward.

The good news is there is lot of positive news on steel sector in terms of some resolutions for some of the companies each of whom have between Rs 100-300 billion of debt. If you start seeing some resolutions over there, you could see some reasonable amount of rating in the corporate banks. I think likes of ICICI Bank and State Bank of India (SBI) from a valuation perspective are still very attractive.

ICICI, if you adjust for the value of its non-banking subsidiary it available at about 1.5 times and SBI with similar base is available above 1 times in the March, 2018 book and even cheaper on a March, 2019 basis. If you start seeing some upgrades that would be a big trigger for this sector.

Second area where we see some value for mispricing is a telecom sector and more so much Reliance over there. If you start seeing some sort of industrial consolidation, which could potentially happen with a merger between Idea and Vodafone as being discussed by the companies and Reliance at some point of time relents on the pricing side because it realises that okay fine we already have consolidated industry between a combination of Idea- Vodafone on one side and Bharti and R-Jio then you could see the fundamental sector turning around pretty quickly.

If you look at Reliance valuations the core business, I would value at about Rs 1,200-1,300 per share once all the new capacities start contributing to earnings whereas the stock currently is trading at about Rs 1,050 levels which means the market is taking out somewhere about Rs 200 per share from the stock price, which is about Rs 60,000 crore of negative value being ascribed to the telecom business of Reliance compared to the Rs 600 billion of equity investment which was made by Reliance in the business. So that is an area where you could see some improvement in fundamentals and rating of the sector if you start seeing some improvement in fundamentals.

(Disclaimer: Reliance Jio is a part of Reliance Industries that owns Network 18 Media & moneycontrol.com)

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First Published on Feb 13, 2017 11:05 am
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