Last Updated : Jul 16, 2018 02:53 PM IST | Source:

Udayan@Moneycontrol: Earnings growth still does not inspire confidence; 10,600 crucial for Nifty

Not so great earnings expectations and on the margin crude oil at USD 75-76 is leading FIIs to take a more dim view of the Indian market, says Udayan Mukherjee.

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The Trump administration’s decision on reimposing sanctions on Iran, the outcome of the Karnataka state elections and crude oil will be key triggers for the market in the short term, says Udayan Mukherjee, consulting editor, CNBC-TV18. In an interview with Moneycontrol’s Santosh Nair, Mukherjee says 10,600 will be a key level on the Nifty though it is early to call a trend reversal.

“Once the Nifty starts coming down below 10,600 and starts closing below that, the confidence will grow in the bears that maybe for the near-term a top has been formed at 10,750,” Mukherjee said, adding, “but we do not have enough evidence to suggest that yet.”

On company earnings, Mukherjee said there were quite a few disappointments over the last few days and that may temper market expectations.

“You are beginning to feel that you will get stuck with single digit earnings growth and that confidence of 20 percent plus growth for FY19 is still not kicking in,” he said.

According to Mukherjee, the weakness in the rupee, rising crude prices and earnings disappointments are prompting many foreign investors to sell Indian shares. It has not had much of an impact on the market so far. But Mukherjee says strong foreign fund flows are needed for the market to make a new high.

“So far, reasonably well offset by domestic institutional flows, but if this trend (of foreign fund outflows) continues, scaling much higher tops in the near-term might get difficult for the market,” Mukherjee said.

Following is the edited transcript of the discussion:

Q: What do you make of SEBI's decision to extend trading hours for equity derivatives?

A: I think it will be an unpopular decision for many brokers, even media companies, because it will double their work load. I can see where SEBI is coming from though, because I think it is true that in many markets across the world, the futures and the derivatives market actually trade after the cash market or well after the cash market closes down for the day. That partly is to allow traders to react to news which is come post markets or to be in sync with markets in other geographies. In the Indian context, the important impulse for such a decision is for the market to be able to react to any sharp movements in the European market, in the early evening stage and then as we get to the mid-evening, the markets to be responding to how the US markets open up. It is also true that some results during earnings season come post market closing and if SEBI is thinking of stock futures then you could probably see significant moves coming into the stock futures in the evening segment as well.

So in a globalised kind of environment, you cannot have an argument against the logic for such a move allowing the market to react to very key markets like the US market in the evening. My sense though, is that SEBI will probably start with only the Nifty and the Sensex futures and probably throw in a couple of important indices like the Bank Nifty before going the whole hog into stock futures and that is the right way forward, but I think it will put enormous strain on broking companies, etc. because the day starts very early and to be considering trading up to 10 o'clock at night or beyond will put a really heavy strain on resources. So this needs to be well thought-out and the initial reaction will be one of disdain and probably an unpopular one, but you will have to give it to the regulator for the logic that it thinks something like this warrants.

Q: Markets have been under pressure for the last week or so. So is this the end of the relief rally and do you see a kind of a trend reversal from here on?

A: It is too early to say that. We have seen a one way rally from sub-10,000 levels to 10,750. That is a long way to come, 7.5-8 percent in a relatively narrow period of time. So, we have had an excellent April series. The market has done well to now calm down and say, we need to digest some of these gains, particularly so because there are a couple of important events ahead of us.

First, the May 12 decision of Trump on the whole Iran impasse and if that does not go very well and fresh sanctions are imposed, you could see crude making a decisive turn towards USD 80 per barrel and that could be very negative for the Indian market, and you have got the Karnataka elections early next week and that is something which is very important for the market.

So with two events ahead of us and an 8 percent rally under your belt, I think the market has chosen to do the right thing, is to consolidate, take off some of the profits, particularly in the midcaps where there were lots of profits to take and say that, we will hang out or hold on for about 10 days and after the event, once the next direction for the market is clear, then we will take much bigger bets. Also, foreign institutional investment (FII) selling has picked up over the last few days because of the crude issue. India always turns out to be an underperformer, relatively speaking, once crude prices get on the boil and that is playing out in classic turns this time around as well.

So I think it is too early to say after a 100-point Nifty correction that the rally is over, but people will watch the 10,600 mark quite closely. Once the Nifty starts coming down below 10,600 and starts closing below that, the confidence will grow in the bears that maybe for the near-term a top has been formed at 10,750. But we do not have enough evidence to suggest that yet. It is conceivable that beyond May 12 and the Karnataka election results, the market finds enough fuel to get back above 10,750 and make a move towards 10,900, 11,000 as well. So time will tell, but the next one week we might see a somewhat range bound volatile kind of trade ahead of these very important events.

Q: Foreign capital outflows seem to be a bit of a problem. We are seeing foreign funds pull out both from equities as well as the bonds. The signal from the bond markets have been bearish so far, but the equity market has not really reacted to it in a big way. How do you see this particular trade playing out, the weakness in the bond markets and its impact on equities?

A: The rupee has already been under a lot of pressure, hovering around that 67 mark. That is an important thing for FII investors as well because it really takes away a lot from their notional gains from India investments. So the rupee is a problem and it is a vicious cycle, what causes and what leads is a difficult one because FII selling puts pressure on the rupee and then they feel pressurised in turn. But other than the rupee, I think it is crude oil which is putting India at a significant disadvantage to other emerging markets.

Anyway, earnings momentum is not very strong out here and FIIs have been disappointed over the last one week. We have had a string of negative earnings surprises. So, for not so great earnings expectations and on the margin crude oil at USD 75-76 is leading FIIs to take a more dim view of the Indian market.

In contrast you can see that there is interest picking up in markets like Brazil and Russia because they are crude plays. This is what happens typically in a soaring crude scenario. So I think it is the rupee, it is crude, it is some earnings disappointments and the fact that we have rallied about 7-8 percent is all leading to some pressure on the FII front. So far, reasonably well offset by domestic institutional flows, but if this trend continues, scaling much higher tops in the near-term might get difficult for the market.

Q: So what has been your assessment of the earnings that have been reported so far? Which were the major surprises according to you?

A: It is going okay. There have been some howlers like Axis Bank and there have been some really positive surprises like TCS, but the last week, I though marred sentiment a little bit. First, you had Siemens coming in and it is an important company and they said that order book is just not growing.

In fact there is a 4 percent decline in the current quarter with their order book. That disappointed the market, more the commentary that we are not seeing major government orders in the energy segment. And that is a bellwether kind of a stock, it is not quite L&T, but it is in that space which gives you a sense of how things are in the capex space.

IndiGo was a very bad set of numbers. The aviation turbine fuel (ATF) and the forex pressures are clearly showing, their disclosures were not good and the market is disappointed with IndiGo. HCL Technologies really disappointed with its guidance. 4-6 percent growth is quite poor, dismal for a stock like HCL Tech.

The best you can say there is that valuations are not very demanding, but the earnings picture was quite bad. Then you had a couple of consumer companies like Marico and Emami which disappointed, Hero Motocorp was not great, Ambuja was just about okay. So at the end of it, you are beginning to feel that you will get stuck with single digit earnings growth and that confidence of 20 percent plus growth for FY19 is still not kicking in.

So it is wishy-washy. There are some hits, there are some misses. The rate at which market is getting surprised on the way up with earnings is still not picking up and that is so important to get that kind of sentiment going. So I would say last week actually took away a little bit of the earnings' sheen and the confidence in a very strong earnings growth in FY19 is still just not there. It is still a matter of hope, not of conviction.

Q: What is your view generally on the aviation sector as a whole? In the short-term, clearly rising crude prices is likely to impact sentiment, but from slightly longer term view, is this a good time for investors to start looking at aviation shares?

A: The business prospects are good, but the margin prospects are somewhat dim, because the more you look at the price action of crude, you begin to feel that crude is in a very bullish trajectory. Sometimes when you look at the price chart of something, you get that sense that the commodity is looking strong and crude, all equity investors would like to believe that crude will cool down, this is just a temporary spike.

But if you are objective and you look at the price action, it is telling you that it is probably headed towards USD 80-90 per barrel. And that is not good news for the Indian market per se and for sectors which are very reliant on crude consumptions like aviation.

And ATF is such an important determinant of the margin profile of these aviation companies that it is difficult to say that aviation companies will continue to do well in the face of rising crude.

So, on one hand, there is crude and on the other hand, the rupee at USD 67 per dollar is creating all sorts of problems with the forex management of these companies as you saw with IndiGo's numbers this time around. So between ATF and forex, I think we have got a fairly potent combination for a drag on the margin and profitability profile of many of these aviation companies.

Overall, aviation, as a theme in India might continue to do well over the years, but near-term profit might become a bit of a challenge and that is exactly what the stock prices are factoring in. indiGo has had a fairly sharp fall from Rs 1,520 to Rs 1,150-1,180 kind of levels and I do not see it reclaiming that Rs 1,400-1,500 kind of levels in the near-term.

Q: Another strong set of numbers from Avenue Supermarts, close to about 73 percent rise in standalone quarterly net profits. What is your view on this one?

A: There is not much to complain about the performance as such, though between the last quarter and the current quarter, their margins have dipped and we need to look a little bit about why the margin dip has happened. Also, this is not showing up in the numbers yet, but it appears that there is more aggression from Future Retail and from Reliance in the retail space. And these are fairly well funded, strong players and once they start flexing their muscle on market share, in terms of competitive intensity, it is conceivable that Avenue Supermarts has to sacrifice margins to hold on to the kind of topline gains or store sales growth that they have been witnessing.

So we need to dig deep into their margin dip between quarters and what impact the competitive intensity in the space might actually mean. This is not a telecom kind of a scenario where Reliance's intensity is destroying the profitability profile of many of the incumbent players, but Reliance's aggression or Future Retail's aggression could have a bearing on the kind of continuous growth that Avenue Supermarts is able to report, particularly on the same store front.

So the company is good, blue blooded promoter profile and excellent earnings pedigree so far, but going forward, I am just wondering whether given the current kind of valuations at nearly 70 times, whether there is room for much upside in the stock if competitive pressures continue to build which is not to say the stock will collapse or something, but one needs to be mindful of these possibilities when you are paying nearly 70 times for a stock.

(A previous version of this interview had a question that erroneously pegged TPG-Manipal's bid for Fortis at Rs 200 per share, instead of Rs 160. The question has now been removed.)
First Published on May 7, 2018 03:09 pm
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