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Too early to call this a beginning of correction; can selectively buy IT, pharma & FMCG: Ambit Capital

Saurabh Mukherjea of Ambit Capital said that the key data on Q2 consumption could set the course. If retail and housing finance NPAs are good for Q2, then this cannot be called as a corrective phase.

September 25, 2017 / 05:24 PM IST

Selling pressure in the Indian market spilled over from Friday’s moves, with the Sensex and Nifty seeing a weak opening on Monday.

Midcaps continued its decline, while banking stocks and pharmaceutical names were trading weak as well.

The Nifty in the first few minutes of trade also breached 9,900-mark, marking a free-fall of sorts from its Friday moves. Having said that, experts such as Ambit Capital believe that it is still too early to call it a beginning of a major correction.

“By the time Q3 arrives, the demonetisation base will make the quarter look good, but the big question is how long will the consumer hang on?” Saurabh Mukherjea of Ambit Capital told CNBC-TV18 in an interview.

He added that the data for consumption in Q2 becomes the key. “If retail and housing finance NPAs are good in the second quarter, then this cannot be a start of a correction,” he told the channel.


The only way to make money in this market is to buy high quality names and sit tight for a long time, he said. “One could selectively look at buying IT, pharmaceuticals and FMCG names, but will stay away from financials,” he told the channel.

The other major problem is the lack of working capital among manufacturers. “There has been a problem of this for the past couple of months. With major input tax credits being ruled out by the government, this is becoming an issue for other sectors,” he said. This, along with government spending under the hammer is a challenge.

Below is the verbatim transcript of the interview:

Anuj: Your thoughts on whether we have a trigger now for a genuine correction?

A: The fiscal situation looks to be tricky given how much of the fiscal firepower the government expanded in the first four-five months of the year. I think it is too early to say that this is the beginning of a major correction because by the time Q3 comes through; demonetisation will make the year-on-year (YoY) comparables for Q3 look good.

The big unknown is how long will the Indian consumer hang in there. As some of you were saying the elements to the services sector still looks alright and specifically financial services. I think Q2 data on consumer non-performing assets (NPAs) will be critical. If consumer NPAs, if retail NPAs, if housing finance NPAs continue clipping up - I think Q1 was pretty bad for housing finance if Q2 NPAs in housing finance and retail clip up then we are in real trouble then the long awaited correction is upon us. If on the other hand retail NPAs, housing finance NPAs are alright in Q2 then I do not think I will be calling this the beginning of the big correction just yet. So it is all in the hands of the Indian consumer. He or she is the only mainstay of the economy now. I think pretty much every other part of the economy including government spending is under the hammer now.

Latha: How worried are you about the goods and services tax (GST) creating a huge growth problem. Several chief financial officers (CFOs) including Larsen's and even other steel companies input suppliers saying that working capital cycle has absolutely frozen because bills are not being paid. Will that mean that this is going to be selective and manufacturing companies are going to see a big fall or is this going to be a different kind of fall?

A: The working capital problem has been clear for the last couple of months. I have to confess the scale of it as yet is unknown; the scale of it is something we cannot get our heads around. What seems to be also the case is, there is an input tax credit problem. I think the government ruling out most of the July 2017 input tax credit claims is a big deal because a lot of manufacturers and indeed service companies were looking forward to those input tax credit claims. The fact that those have been put on the back burn is quite a big deal and in parallel, exporters are also claiming that they are not getting their duty drawbacks. So there is a challenge there on working capital. I think it is linked to input tax credit. How big the problem is. I think as yet I have to confess, we haven't been able to quite quantify. It's big but exactly how much of an issue this is, will it lead to small and medium enterprises (SMEs) NPAs for example, I do not think we can quite yet make a decisive call on that.

Latha: Starting October 3 the Sebi rule is even if you are in default with your bank or your lender by one day; you have to disclose it to the exchanges. So all those special mention accounts-1 (SMA-1) and SMA-2 lists which are there with the banks, people how have not paid for 31 days, 62 days all that has to become public knowledge. This is coming at a time when working capital is anyway scares, loans are anyway scares. You cannot even borrow from a group company and payoff and avoid the disclosure. I am little worried about October 3. Are you afraid of it?

A: I think what we have been scared of for the last six months, more than the equity market is the bond market. I think there is something like USD 60-70 billion of retail money has gone into liquid funds and short-term bond funds over the last 12-18 months. Three month commercial paper reads down to as much as 6.1 percent. I think that is where my bigger concern is, this whole SME stress issue, stress in the housing finance market and properties under construction, October 3 and corporate being forced to declare to the credit rating agencies if they have defaulted on bank loans. I think the NPA infection in the banking system looks more likely than not to spill over to the bond market and I do not think retail investors who have bought liquid funds, short-term bond funds are prepared for that. I think that is where the greater damage to retail wealth will happen; their purchases of bond funds which look likely to suffer as credit quality issues spill over into the NBFC, housing finance world.

Anuj: A lot of the money has flown into NBFC space. Are you worried about the way NBFCs have run up as an asset class?

A: Any time when you see a housing finance company or start-up clearly tells you something has gone awry. Four years ago I think around the time Raghuram Rajan took charge of the RBI, the three months CP was around 12-13 percent, it is 6.1 percent now. That almost vertical drop in the cost of money has encouraged NBFCs and housing finance companies to sort of flower up in every nook and cranny of this city which clearly suggests that too much money is chasing too few opportunities in that part of the market. When too much money chases too few opportunities, a credit quality issue will come sooner rather than later.

Latha: What would a fund manager do now? What would your advice be, going short? Make money when there is still something on the table?

A: As we have said before when the market was in bullish phase or a bearish phase, the only way to make money for the average investor plus the retail investor, the only way to make money in India is buy high quality names and sit tight for a period of time. I would not advice selling on a day like today. It is not as if suddenly overnight we will have incredible foresight into how the economy will pan out. So, strategy remains the same, find high quality cash generators and stick to them.

In IT and pharma there are few more names than usual because of the pounding those two sector have taken over the last 7-8 months.

In midcap pharma, even in large cap IT, I think there are names which make sense at these current levels. They have plenty of cash, they have got high RoCs and in the IT sector especially they have got a desire and a need to return cash to shareholders. So, if I can find a large cap IT stock which can pay 5-6 percent dividend yield, trades at 16-17 times, has a proven track record, I would buy it and sit tight. What I wouldn't do is use this as a buying opportunity to buy NBFCs, I think that is where the knife is falling the fastest, that is where the overvaluation concerns are the most pronounced in the Indian market.

Lath: So, which sectors you buy?

A: I would selectively buy IT and pharma names. I would even look at some of the FMCG names. The sector that I would stay well away from is financials in totality, especially the NBFC and housing finance companies.
first published: Sep 25, 2017 01:28 pm
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