There are more headwinds rather than tailwinds for the financial sector and we remain underweight, says Deutsche Equities.
Benchmark indices are already trading near record highs but the further rally will be dependent on a recovery in earnings which looks unlikely in the near term. The S&P BSE Sensex is likely to hover around 29000 by December-end.
“Consensus earnings expectations for FY18 are on the higher side and to that extent, our senses is that until we see earnings expansion, it is difficult for the market to re-rate. We have a December-end target of 29,000 on the S&P BSE Sensex,” Abhay Laijawala, Head - India Research at Deutsche Equities said in an interview with CNBC-TV18.
“For any kind of upmove, we do need earnings to recover. The expectations for FY18 appear to be on the higher side. In the last couple of month, D-Street made revisions in FY17 numbers on account of various factors but they have not touched FY18 forecasts which made numbers look inflated,” he explains.
He further added that in the next 12 months we will witness a transition from a developing world system to a better than developed world system and that will have some impact which could lead to near-term disruptions.
Outlook for March quarter
Sectors such as IT and autos might report muted earnings growth. In the banks, earnings will look amplified on a YoY basis but with loan growth under pressure and absence of treasury gains, earnings may well just disappoint.
In the December quarter, treasury gains constituted for 20-25 percent of earnings which might not be there this time around, explains Laijawala.
Underweight & overweight sectors
There are more headwinds rather than tailwinds for the financial sector and we remain underweight. The loan growth has come off to about 4.2-4.3 percent which is a multi-decade low.
In addition, there will be pressure on net interest margins (NIMs) with banks being flushed with liquidity and slowdown in loan growth. But, within the sector we like smaller banks, said Laijawala.
“Within the private sector, smaller banks are in a positive situation because they are growing and commands a premium. In India, small is beautiful in the India banking industry,” he said.
“These banks are growing at 3x-4x the system loan growth and in addition, they are taking market share away from many of the public sector banks. The market share of PSB’s are likely to drop from 66 percent now to 60 percent and large part of the market share will be taken by these smaller banks,” said Laijawala.
Deutsche Equities is overweight on IT, autos, staple, material and utilities.
Below is the verbatim transcript of the interview.
Latha: With market so gung-ho, the first as we cast our eye on your report, you have a Sensex target that is 29,000, a tad lower than where we are already. So, you are not expecting immediate gains, some headwinds?
A: Our view is that before you really see any kind of an up move, you do need earnings to recover. At this point in time we are seeing that expectations for FY18 appear to be on the higher side. So, I think what the street has done over the last couple of months is they have made revisions to the FY17 number on account of the various factors including demonetisation. However, they have not necessarily touched their FY18 forecasts.
So, arithmetically, you have seen earnings cuts for FY17, you have not seen similar cuts for FY18 and therefore the base leads to an amplified year-on-year (YoY) increase. It is a year in which we are going to see a transition. In fact India’s taxation system is transitioning from a developing world system to better than a developed world system. That has to have its transition impact.
There will be near-term disruption and therefore our sense is that consensus earnings expectations for FY18 are on the higher side. So, to that extent, therefore our sense is that until we see earnings expansions, it is difficult to expect the markets to re-rate.
Sonia: As we head into earnings season, which are the sectors or pockets that would make you a bit cautious now where you expect earnings to be slightly on the weaker side this time around?
A: We think that sectors like IT services, sectors such as autos, these are sectors where we expect the earnings to be relatively sedate. We are also looking at banks. In the banks, obviously, earnings will appear to be amplified on a YoY basis because last year in Q4 you had the credit cost going up on account of the high provisioning. That will obviously not be there this year and therefore earnings will appear to be high.
However, with loan growth under pressure for the entire system, and with treasury gains also not being there like you had seen previously, overall earnings may probably disappoint. Remember, in the December quarter, treasury gains for the banks had constituted close to 20-25 percent of the earnings. That will obviously not be there in this quarter.
Latha: So banks may disappoint inspite of the low base?
A: That is right.
Latha: In your underweight category, you have financials, healthcare, industrials, and telecom. While others are self-explanatory, financials what would you classify as underweight? Are you not even bullish on what seems to be the evergreen sector through 2016, NBFCs?
A: Let me lay out what are thesis over here is. Our thesis as far as the overall sector is concerned is that there are more headwinds than tailwinds at this point in time. Loan growth has come off; it is at about 4.2-4.3 percent. It is a multi-decade low, and yes, this could be on account of the disintermediation. We are seeing bond markets come in and probably if you add bond markets to loan growth, then it is not as bad. However, for the banks, obviously it is lower growth.
In addition, there will be pressure on net interest margins (NIMs) as we move forward. NIMs for the banks are going to be under pressure with banks being flushed with liquidity as well as loan growth slowing down. In addition, the environment for treasury gains also appears to be muted.
Now, let us break up the sector and within the sector now let us look at the smaller banks. So, the smaller private banks are today in a very positive situation because a) they are small, and clearly there is a premium -- small is beautiful at this point in time in the Indian banking industry, and they are growing. They are probably growing at 3-4 times the system loan growth. In addition, they are taking market share away from many of the public sector banks.
So, our banks analyst Manish Karwa forecasts that public sector banks are likely to see the market share drop from 66 percent right now to probably about 60 percent in the next five years and a large part of that market share will be taken by the nimble smaller banks. In addition, we also like some of the NBFCs because obviously if the banks are going to be compelled to cut deposit rates, the wholesale funded banks, wholesale funded NBFCs will be gainers.
So, this is what therefore our strategy is, with overall underweight banks, within banks, favour smaller banks, favour those banks that are focused on retail and least focus on the corporate side.
Sonia: I was going through your top midcap ideas and it is interesting that you have a lot of interest in some of these rural plays whether it is UPL, whether it is Shriram Transport Finance, and a couple of others as well. Are you positive or are you hopeful of a good monsoon this time and is this the best time to play the rural theme?
A: There are concerns with regard to the El Nino this year and the Australian Bureau of Meteorology has forecast that there is a high risk of an El Nino setting in. However, the timing of the El Nino appears to be perhaps July or August. So, to that extent, perhaps the first part of the monsoon which is important for the kharif crop, doesn’t look like it is going to get impacted so significantly.
In addition, as a result of the very good monsoon rains last year, we have seen parts of the rural economy begin to come back. Plus, we are positive on the rural side also because we hear that the government’s revised estimates for food grain production are predicting a very robust growth. Plus, we were also very encouraged to see that horticulture production in India has also been the highest in a long time.
So, clearly, food grain production being very high, horticulture production being high, very good monsoon last year, so, there is a feel good effect coming back. In addition, the normalisation following demonetisation is also setting in. So, all of this should board very well for the rural economy particularly in the June quarter.
Latha: I have always known you for a very long time as the best expert on metals. Tell us how you will play the industrials, where is it coming in underweight? However, there is still a decent amount of higher prices for global metals, you are not touching them now, you think they are priced?
A: On metals, we are overweight. So, on materials we are overweight.
Latha: Industrials will be capital goods?
A: That is right. Materials we have been overweight now and within materials the preference is for metals and mining over the cement producers. For metals, the good times are set to continue, at least until the plenary in China in July. There is a very strong expectation that the Chinese economy will remain robust with fixed asset investment staying robust until June or July. However, perhaps some time in July we will have to see what China is doing because with pressures coming back, China may look at cooling the economy given that debt to GDP is already in excess of 250 percent.
However, yes, until then, metals do look very good. Even as far as the domestic scenario is concerned, it is very encouraging to see that the government has been very proactive on the metals front. This morning as well we have heard that the import duty, the hurdles for imports on hot rolled coils have been raised, hurdles on cold rolled coils have been reduced. So, this is very positive because this morning we have also heard that Chinese steel companies have cut steel prices and this could obviously lead to worries that Indian steel producers cut could cut prices.However, with the developments of this morning, Indian steel companies will probably be insulated from the global pricing decline. In addition, coking coal prices have moved up. I believe coking coal prices are now about USD 290 and this will probably allow Indian companies to pass on some of their pricing pressure.The Great Diwali Discount!
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