See earnings growing near 0% in FY17; like cement, auto: Enam

He believes earnings growth will be near 0 percent in FY17. “In FY18, to me, it looks like maybe we will get 10-12 percent earnings growth. Earnings numbers for markets were always stretched. It looks difficult whether they can be met.”

Auto sector will make a recovery, he said, adding that he is not so bearish on cement either. IT doesn’t excite him.Below is the verbatim transcript of Sridhar Sivaram’s interview to Latha Venkatesh, Anuj Singhal and Sonia Shenoy on CNBC-TV18.Anuj: 2017, is it more of 2016 you think if you are looking at the crystal ball or do you think we will have a trend in place? A: Crystal ball is looking hazier than before. I think the first six months are going to be very difficult to predict because none of us has seen events like this. We are just seeing early signs of the impact of demonetisation. I think in the medium term, this should be a positive impact but how deep is the cut in the short term is very difficult to gauge right now. So, I would rather not look at the crystal ball at all and just look at companies, earnings, and on-the-ground reports. Latha: I wanted to ask you primarily about the tax issues. We have a few of them clouding us. The Mauritius Treaty was finalised, but there is that piece which says that the general anti-avoidance rules (GAAR) can prevail over that limitation of benefit clauses in these treaties. Basically meaning that if we think something is anti-avoidance, even if it is protected by the treaty, we can go after them and tax them capital gains. Likewise, that CBDT circular of 19 questions and answers seem to give the impression that what was supposed to be a Vodafone transfer of property tax is now likely even for foreign institutional investors (FIIs), portfolios. So, will the FIIs come back after their holidays and get into accelerated selling?A: In my view, the CBDT circular is the most scary part. The Mauritius, the Singapore Treaty, I think most people have sort of built it their business models now that you have to pay tax. I have been with an FII for 20 years and I don’t think paying tax is an issue. I think the clarity of the procedures and the amount that you have to pay is the bigger concern for FIIs. So, if I go back to the CBDT circular, this is so scary that the fund pays tax in India, the investor sitting in the US because he is redeeming his units, also has to pay tax in India which is so strange. On top of that, if I am a US fund, I have to anyway pay tax in the US. So, US will claim that you have to pay tax to me anyway irrespective of what India says. So, the same sale could be taxed thrice. It is really absurd. To me, I don’t think that the government really understands what CBDT has issued and I think fortunately or unfortunately, a lot of FIIs are currently just coming back from their holiday and as they realise the gravity of this situation and the fact that they have given examples for each of them, so they have given if you are a close ended fund, you have to pay like this. There are only three or four close ended funds like Aberdeen has one, Morgan Stanley has one, so they have actually gone and given examples for everything. Feeder fund, you have given example, and many funds get affected. Some market experts have written that only smaller funds get affected; I can tell you from my experience at Morgan Stanley that Morgan Stanley funds also get affected. The onus of paying the tax is on the fund and not the investor. It is so absurd and crazy and I don’t think the government has understood the gravity of the CBDT circular. In my view, this is the scariest circular that I have seen. Even the minimum alternate tax (MAT) was not as scary. Sonia: This is a discussion that we had last week when the whole issue came to the fore but, what do you think the impact would be on the FII flows because FIIs have not come back to work in full form, do you see a big FII pullout? We have already seen a lot of that take place in 2016 already. A: I think this will have a impact on FIIs because if I am an FII and every now and then I keep getting these scares on tax, let us face it, if you take the 10 year returns for India, MSCI 10 year returns, our returns are 1-1.5 percent -- this is dollar term and if you take the last one or five years, they have been less 3-4 percent. So, it is not as if India has been returning substantially higher than the emerging market itself and with all this, we have this tax scares every now and then. I think every two to three years we get some tax scare or the other. So, I don’t think FIIs have an issue paying tax; as I said before, it’s the clarity of the taxation policy which is more important. Every now and then we get some new circular or something which is ambiguous which keeps irritating FIIs even though they have been the most loyal investors. If you see from 1994, baring two years, FIIs have invested, given positive investments to India every year, yet they are treated as if they are the ones -- hot money, they are going to take the money out. Latha: You have a lawyer for the finance minister, don’t you think that things will get sorted out?A: I sincerely hope so but I don’t think they -- I think currently they are occupied with a lot of other important issues and this circular, I am not very sure if it has been vetted by the minister. So, it could have been that it has just come through from the CBDT and I hope more market participants come out and speak about this because this needs immediate attention. We cannot wait for this after FIIs have sold a few billion dollars and the market crashes and then the government wakes up and says okay this was a mistake. I think it needs immediate attention and I hope that some representations have been made which I know and I hope more are made and the government understands the gravity of the situation. Anuj: With all this bad news, we could have easily been at 7,000-7,500 right, we are still at 8,100 and we are still holding that Brexit day low. Do you get a sense that there is some resilience in this market? A: The market does show very strong resilience at this stage. I think there is also strong domestic inflows which are supporting the market. So, that has been one of the pillar of support for this market and that may continue because the systematic investment plans (SIP), they off late have been giving almost Rs 4,000-5,000 crore a month. So, that sort of support is continuing. However, I am not very sure if that support can withstand a severe FII selling pressure if one were to happen because of these irritants that we keep getting. Sonia: After the comments that we got from prime minister Modi on Saturday evening, mini Budget of sorts that was announced, there is a fear that there could be more populist schemes announced in this Budget this time around as well. What is your own expectation? A: I do feel that, I am sure Latha will not like this comment that they may want to take a break out of this Fiscal Responsibility and Budget Management (FRBM) because the economy is going through such a difficult phase that you need to actually give a stimulus to the economy which basically means if you take a pause -- where is the money, if you want to give a stimulus, there is no money and if you have to meet the 3 percent fiscal deficit target, you are talking of cutting even more whereas taxes are going to be that much more constrained. So, I think given that the economy is in a very difficult situation, it may not be such a bad idea to take a pause for a year, stimulate the economy, give some sops. I don’t know what -- the finance minister has been talking about tax cuts, if you are going to give corporate tax cuts which basically means you are going to get lesser and lesser revenue, your indirect tax especially on petrol and fuel, they are already at such high levels. We are already back to the previous peak in terms of the retail prices and the actual dollar prices are half of that. So, we have already stretched it to the limit. So, I think it may not be such a bad idea to take a break. Most economists may not be of this view but, it will help to stimulate the economy which may not be such a bad idea because once that happens, your taxation for the years after that may benefit. Anyway with demonetisation, it is expected that the tax to GDP will go up in the medium term but there is a short term pain. So, how do you get over that? Asset sale is the other option but the government has been very slow on asset sales for whatever reason. So, those are the options that they have. Latha: My only worry is whether the excessive supply of bonds, extra supply of bonds than what the market is prepared for will mean higher yields. So what you get in terms of a fiscal boost, you may give away because the market yields may move up; that is the fear.A: Possible but you have to keep in mind that when I speak to all the bankers, what they suggest is that there will be at least Rs 3-4 lakh crore of extra deposits in the system post demonetisation. Where does that go? There isn't enough avenues to lend right now so eventually they will get part in some sort of T-bills, bonds, or 10-year, corporate bonds, wherever. So, you will have some leeway there. However, I agree with you that that risk is there. Latha: What is your sense about earnings, do you think that it is going to be just a two quarter pain or do you think the market is yet not factoring in the FY18 pain, how are you going to wade in terms of stock picking? A: My problem with this market even pre demonetisation was earnings. So, if you see the first six months, earnings growth was 4 percent whereas consensus was expecting then at least a 15-16 percent earnings growth for this year and about 18 percent for the next year. Our expectation was the earnings will be single digit. With demonetisation, I think we may end up with a near zero earnings growth for FY17. You are talking of FY18. Already if you see consensus numbers, they are talking of 12 percent for this year and 24 percent for next year because they haven’t adjusted the number so I can’t blame the analysts for that. However, to me it looks like maybe the next year we will get 10-12 percent earnings at this stage because too early to call. However, the earnings numbers for the markets were always stretched and on the ground, pre demonetisation also, things were not that great. It was just turning around. We had a good monsoon, things were turning around.It looks difficult that those numbers can be met. So, one has to be more realistic on the numbers. To be fair, the analysts are waiting for the results. So, once that happens, maybe they will cut some of the numbers. However, to me, it looks very stretched. Sonia: The two pockets that have been hit the hardest because of demonetisation is cement and autos. Are you doing anything here in this space with respect to allocation or are you just waiting to watch the data for a few more months? A: Broadly we are waiting but if I can give you my views on these two, that I do believe that autos will comeback because these are discretionary purchases but isn't as if it is a lost consumption. I postpone my decision to buy two wheeler because it is uncertain but if I need a two wheeler, I will probably buy it. So, in some of these sectors, we will see possibly a V-shaped recovery or a U-shaped recovery because I am just postponing the purchase. Cement, I think if the government pushes on this affordable housing and infrastructure, we could see that comeback also. Pricing has been reasonably stable. So, I won’t be so bearish on cement. The other thing is we know that interest rates are coming down, transmission finally is happening, so, this will benefit companies which have some leverage. Many of the cement companies do have leverage. So, from a earnings standpoint, that could be an interesting play which is to look for companies which have some sort of leverage, who are good companies and are also in the process of repaying the debt where your earnings growth could be significantly higher than the EBITDA growth because the interest cost continues to fall. So, those are the places that we are looking at in terms of themes rather than looking at a sector itself. You just look for companies which could benefit from repayment of debt and falling interest rates. Latha: You don’t touch the IT, the traditional defensives?A: IT is going through its own share of problems and with the new government in the US I think the immigration issues can only worsen from here. We have heard Vishal Sikka say yesterday about how the IT industry needs to redefine itself. Given that, I think it is a low growth sector, there may be some value hidden there, maybe 10-15 percent return, but that doesn’t excite me.