Eye pre-Budget rally in Jan; bullish on auto: Pramerica MF

Latha: What is the sense you are getting, is the correction over, have we firmly put a bottom or do you think this market will be in jitters up until pre-Budget rally sometime in late January?

A: In our opinion most of the correction is now over. The correction which happened in the Indian market is mainly on account of the global changes; the uncertainties which we witnessed over there. If you look back at the situation, now the things are stabilising globally particularly the emerging economies.

The fear which people had that some of the countries might default or might run out of steam that fear now seems to be subsiding. The US Fed through its comment has given the kind of statement which seems that at least for the next six months we do not see an interest rate hike.

In this context if you look back into India, the manner in which we handled our currency and the inflation; the combination of the two, the interest of the overseas investors particularly the foreign institutional investors (FIIs) in the Indian market is likely to rise.

So, we believe that now we are set for a pre-Budget rally; may not start immediately, it probably will start sometime in the month of January and February because the FIIs are not present in the market in significant number at this point in time. However, it looks like the worst is over for the market.

Sonia: If an investor want to ride this pre Budget rally and put money now, where do you suggest he puts money because last week was interesting; we saw lot of bluechip names see buying interest – HDFC, ICICI Bank, Infosys were all up about 3-4 percent?

A: The best way to participate in the market in our opinion is through the mutual fund route but which segment of the market is going to do well if you look at, we believe that now the capex is just 2 quarters away because the kind of raw material price corrections which has taken place in the economy and you haven’t seen any subsequent price corrections on the part of the end product which is manufactured so the entire inflation decline in the economy has taken place only on the primary goods side and if you combine the two factors the pricing power has come back to the corporate, so we are expecting capex to start in two-three quarters and if you keep that in mind, its obviously the industrials, the financials and those kind of segments where you will see a substantial outperformance which will be generated and that is where the market need to focus on.

Latha: When you say industrials and financials – can you drill it down to more specific sectors. Would you mean public sector banks when you say financials, would you mean NBFCs likewise industrials?

A: As far as the banking system is concerned with the margin recovery which we are seeing in the economy, it is the non-banking financials companies (NBFCs) and the public sector which are likely to do very well because private sectors banks were anyhow better and they were getting very good valuations. Now, there is a catching up game which needs to take place.

As far as industrials are concerned, the initial recovery on the industrial side starts with the auto ancillaries and which will escalate further to the levels where the capital goods and the various sectors whether it is infrastructure, whether it is related to the mid-sized house construction, etc all those areas will start catching up.

So, industrial will be a slightly broader segment. It is very difficult to narrow down to just one or two sectors because the economy revival will take place practically in the entire sector. So we are focusing on all the industrials be it starting from railways and it goes to the extent of house building.

Sonia: Last week and interesting trend was that the fast moving consumer goods (FMCG) stocks lost out quite a bit. It could be just a one week phenomenon – names like ITC, Hindustan Unilever (HUL) down about 5-7 percent. Would you use every dip as a buying opportunity or now since you are mentioning that cyclical will be in flavour, one could perhaps avoid defensives for a while?

A: As you have been mentioning in the past also on your channel that we are carrying underweight position on FMCG for the simple reason that this particular sector is now trading at a very high valuations and we do not see the growth sustaining to the extent what you will witness in other sectors. So there is going to be a reallocation of other funds which will take place in favour of the other sectors. So keeping that in mind probably this is not the correct time to do the averaging of these stocks and so we will continue to wait for more corrections before we look towards this sector.Latha: What about interest rates. Are we going to get a decent amount of rate cuts? What is the view on the fixed income mutual fund side?

A: We are of the view that we are not going to see a rate cut at least till the Budget or till March though the interest rates are the most discussed subject as far as the Indian market is concerned but market forgets that interest rate in combination of currency is something which is a cost of capital. By holding the currency at stable way and controlling the inflation, which the central bank Governor is continuously pointing out, actually the cost of capital is coming down and that is what you are noticing on the bond yields which are corrected now in the recent times.

We expect the rate cuts to take place only post March, only after two events – (1) when the Governor is clear that the government is on a clear fiscal consolidation path, which seems to be the case and (2) the global factors stabilise and the fear of emerging economy currencies melting away, actually reduces – that’s the only time when we believe that interest rate cut will take place and our opinion it would be very aggressive post March but till March we do not expect any interest rate cut.

Sonia: What about the auto space. Would you increase your allocation there because in the week gone by auto stocks were under bit of pressure perhaps because of valuations, one would not know but would you increase allocation in this sector now?

A: Yes of course because this is a one sector which looks like the biggest beneficiary at this point in time particularly if you see, they are getting benefit of two things together – (1) the companies raw material prices have come down and you will see the next quarter there will be margin enhancement which will take place on the corporate (2) on the end-user side, who are buying the product at this point in time, they do not buy a product at a certain price; they rather buy the cost which they incur every month and which is EMI plus combination of the fuel prices. However, fuel prices are corrected which will have a significant impact on the two-wheeler demand and as and when the rate cuts will start, which in our opinion is post March, you will notice that even that will have a significant impact on demand. So combined the two you will see that the demand is likely to rise, raw material prices are coming down and both are good news for the sector. So auto and auto ancillaries are the leader of the revival in the economy and it will be followed by other sectors.

Latha: Can you give me an idea of what you are looking at in terms of earnings growth and I will tell you two conditions from which I am coming – (1) of course because of the fall in crude prices there is going to be an overall operating efficiency and operating leverage which companies will have. We had one of the funds telling us that there could be 1.5 percentage point rise in the GDP because of the fall in crude prices (2) on the flip side many of these companies like Bajaj Auto, which had the analyst call recently, is being affected by the commodity consuming countries losing their purchasing power. Can you give me an idea of how you have trimmed your earnings growth with a respect to the facts that exports may not be the big winner it was in 2014?

A: On most of our previous discussions we were pointing out that we are very bullish on export but now we are pointing out the domestic. If you take quarter of January-February-March, most of the companies haven’t yet got the raw material benefit because the raw material which you purchase gets reprised after 90-100 days. On the primary side the raw material which they are purchasing and the other thing if you notice that not a single company in the economy which has reduced the price of the product what they are selling. Everything what you are noticing is that the corporate are getting the benefit of the price reduction or the raw material and they are not reducing any finished goods price. It means that they have pricing power.

If you put that to the next quarter, you will see roughly about 200-250 bps margin expansion for the corporate particularly those who are focused on the domestic side. Those who are focused on the exports will definitely get the margin enhancement because of the price reduction but because there is a demand pressure, they may not be able to report the margin improvement but the domestic companies will be able to report margin improvement and if you take this about 8-10 percent of the topline growth which was the case last quarter also, you are looking at the bottomline growth of 20-25 percent which is a very healthy number to look at from here onwards.