Will wait for clean-up before investing in banks: Ambit Cap

The Indian economy is unlikely to witness a broad-based recovery, as a stressed banking system continues to be unable to fund a turn in the investment cycle, says Pramod Gubbi of Ambit Singapore.That said, there are other sectors that exhibit signs of strength, such as automobiles, consumption and cement and investors would do well to be on these, he told CNBC-TV18 in an interview.Ambit recently upgraded its Sensex target from 22,000 to 29,500 on the assumption that recent steps by the government and the central bank to resurrect banks will have an impact. (This was primarly driven by an upward revision in Ambit's PE multiple forecast for the Sensex from 14 to 19. Its EPS forecast continues to stay at Rs 1,550.)But Gubbi said it was too soon to start buying bank shares before a clean-up is completed. Ambit also continues to stay underweight on commodity and asset-heavy sectors.Below is the transcript of Pramod Gubbi’s interview with Latha Venkatesh on CNBC-TV18.Latha: The first question is the prevailing on any investor’s mind is Brexit. Do you think we are going to see a decent amount of risk-off up until June 23 and thereafter if it is a leave vote, what?A: Given the way some risk assets have behaved and how people are positioned more towards cash, we are already beginning to see people preparing for that event. It is very difficult to say what is likely to happen in case, the leave campaign gets its way around. Clearly, there is going to be short-term volatility but in terms of a lasting impact on global markets, there is not a much clear way to say that at least from an Indian perspective, I will not think that there will be too much of a lasting impact from a structural perspective.In the short-term markets are likely to be volatile particularly currency markets and we are also heading towards a few other issues like our own repayment of loans and towards the end of the year, a potentially yet another aspect of Chinese devaluation. So, currency is going to be clearly in the middle of all this but the short-term impact could clearly be increasing volatility.Sonia: Your house was bearish for a very long time on the Indian markets and you had a 22,000 Sensex target. Finally now, that target has been upgraded to 29,500 joining a bandwagon of so many other brokerages. What made you guys turn bullish after so long?A: On the broader economic recovery, we still have our own concerns. We do not think the recovery is broad-based yet. The only thing that has changed in our view was we have been quite vocal about the fact that we are unlikely to see a sustainable investment recovery in the country without the support of a strong financial system particularly the banking system.Given the way asset quality issues have cropped up and that is clearly going to have an impact on the ability of the banking system to support any credit growth in case there is a recovery in the investment cycle, that was our biggest concern which was driving our pessimistic view.Over the last few months, what we have seen in terms of the actions of the Reserve Bank of India (RBI), and also what we have seen, although early days, in terms of the pronouncements by the Bank Board Bureau, we think there is at least a get out of jail plan for the banking system.So, from moving from a very scary situation where we would end up with the financial system not being able to support a recovery, we have come some way where we think there is reasonable clarity about how the authorities are planning to resurrect the banking system and hence any sort of recovery in credit demand will be supported by the banking system.Latha: So, would banks be a place where you would look for investments and will you buy them at current levels or will you wait for dips?A: Like I said, the beneficiary is clearly the economy more than the banks or the bank shareholders. What has changed is clearly forcing the banks to take the stress right upfront, report them and that has its own implications in terms of provisioning, credit costs and capital adequacy ratios. So, what is good for the economy may not necessarily be good for the bank shareholders. So, to that extent, I would rather wait and see the clean up to the end and also, look how the government plans to reinfuse capital before getting into.And again, there are different segments of the banking system. The private sector banks, at least the retail focused private sector banks have clearly stayed out of this mess and have benefitted to some extent by the fact that the troubled banks have vacated some areas. So those banks have had a field day in terms of taking market share.So, the resurrection of some of the troubled banks may not be that great for these banks who have been taking market share at will. So, there are different combinations, but net-net, I would think it is better to wait before you plunge into buying into banks.Sonia: I did not get the thesis behind which you guys upgraded your Sensex target. You are saying that there are still some pressure pockets even in the financial space. So, what makes you bullish? Is it a consumption theme that you are bullish on? Is it government reforms? What do you think could take the market to that target that you guys have revised the Sensex to?A: Our approach to the target was more of a very crisis sort of a situation, which is why there has not been much change in our earnings assumption. In fact, earnings assumption has come off a bit given the sort of downgrades we have seen.What has changed is clearly the multiple. We were looking at a crisis sort of a situation driven by the banking system and hence had used a multiple, which we have seen in historical crisis situations such as the Lehman crisis. So, our previous multiple was at 14 times on a Sensex earnings of 15.70. For FY17, we have lifted the crisis call off the table and that has brought the multiple to a 10-year historical average of 19x for the Sensex. Our earnings estimate has come down to 15.50 and that takes our call to 29,500.Having said that, we do see some elements of the economy recovering. Like I said, we do not agree that there is a broad based economic recovery. We do see certain substitution effects happening. We have seen road traffic consistently being improving. That has also had its effect on freight rates of fleet operators. Fleet operators have then gone and purchased commercial vehicles. That is also seen in the growth that commercial vehicle manufacturers have shown.At the same time, we have seen freight in railways falling consistently. So, clearly, one thing is balancing out the other. Similarly, we have seen real estate and gold demand fall off the cliff. The money that the consumer or the investor would have put into these assets is clearly flowing into consumer durables. We are seeing healthy demand for automobiles, consumer durables, be it electrical appliances, home appliances and so on.So, the point we are trying to make is it is not a broad based recovery but there are elements of the economy which are recovering at the expense of certain other elements. So, you are better poised to choose those segments and play those segments rather than trying to play a broader macro recovery.Latha: So, you insisted that you have not changed your earnings growth much. How much has your multiple gone up? What was your crisis multiple, what is the current multiple?A: The crisis multiple is what we had seen during previous crisis times, which was 14 times. The current multiple is 19 times, which is a 10-year historical average for the Sensex.Sonia: Where would the multiples rise, in which sectors?A: Certain sectors where we are seeing some growth coming where there is scope for earnings to be upgraded, initially the multiples get upgraded before the earnings upgrades come through. So those presumably would be in sectors, which are facing these positive substitution effects. Like I talked about be it an automobile, consumption, those sort of themes clearly play up to the substitution effect.Sonia: What are the sectors that you would be avoiding now, anything that you are still cautious on?A: We are not so sure about the commodities recovery just yet. We have had a decent run in the last couple of months but we do not see a sustainable adjustment in the demand/supply situation globally to justify that sort of a rally or at least justify sustainability of that rally.So, to that extent, we would still stay away from the commodities space, particularly those ones, which continue to have quite a stressed balance sheet. The same with certain other sectors where balance sheet stress is the order of the day and we do not see a situation where they can be recapitalised to restart another leg of growth.So, yes there are sectors, the whole asset heavy, capital intensive sectors -- for example in cement we have turned our call where we are seeing the capital addition stopping and hence, as and when we see a recovery, much of that will feed through to the bottomline. So by and large stay out of asset heavy sectors.Latha: Where do you stand on non-banking finance companies (NBFCs)? That is the part of the financial sector, which has been quite an outperformer.A: That is another classic example of the substitution we are seeing. We are seeing several of the public sector banks and a couple of private sector banks, which have been troubled by the stressed asset situation vacating certain areas of lending or at least putting breaks on credit growth.So, that has created this space for alternative lenders, be it some of the private sector banks and NBFCs who have crept in to that space and taken market share. That is clearly showing up in their performance, in their recovery and also in terms of disbursement growth. So until and unless we have a situation where the troubled banks are recapitalised and they are back to lending that sector should be in favour.