Invest in equities from 3-4 year perspective: Reliance MF

Latha: Two-three years is what we hear from everyone but at the moment, 8,400-8,500 is looking like a formidable resistance. You think it can break it in this earning cycle?A: It is very difficult to pinpoint a specific thing but what I can definitely say that in certain pockets of the market, earnings have started turn. How much of that gets reflected in this quarter will determine how they behave. More importantly, when you had cyclical low, it is very wrong to look at a quarterly basis because the upsides can also surprise you meaningfully over two-three year kind of a horizonLatha: I take your point that cyclical recovery stretches but we have been waiting for that earnings turning quarter for so many quarters now. So you see it in this quarter?A: In certain pockets yes. For example in urban discretionary side, we have started to see good improvement, whatever anecdotal data which comes through which talks about a little bit of change already happening, maybe same store growth of certain businesses have started to do well. Then we have started to see in passenger car leaders starting to deliver. So we have already seen in last quarter, a lot of leaders starting to deliver some benefits of operating levers. On a muted revenue growth also you have seen earnings expansion or EBITDA growth coming in certain categories and as we get along, this will catch fire.Reema: You actively manage your portfolio - some themes that we have been talking about of late include rural growth slowing down, some challenges in the IT sector, have you made any tactical changes in your portfolio? Not just from a two-three year point of view but just tactically because things have changed in the environment and therefore the outlook for a few sectors may not look so rosy for the next three-four quarters?A: Rural growth had slowed down a little bit early, if you see it started slowing down maybe 9 months back and the impact on prices is already there in a lot of those specific stocks. In fact growth also might bottom out and start to deliver. So our exposure primarily has been on the urban discretionary side because it has gone through three-four years of slowdown and so the base is very low there. We have been overweight on that side of the market.We think the rural thing will also start coming back because one-year of slowdown is meaningful there and if you have a reasonably good monsoon as we get along, it should stabilse and come back. But our first or early bets of the cycle are the urban discretionary space which we think will come out of the slower growth phase rapidly.Reema: What about IT?A: On the IT sector we are seeing a definite slowdown happening. The growth trends are much below normal and unfortunately they have been impacted by certain specific events like the cross currency changes, which have taken away lot of their earnings in Q4. So our case is that as there is moderate earnings growth and I think a lot of prices reflect that change as well. We see, the earnings trajectory not moving beyond a point. For example, if they are in the band of 9-10-11 percent, I think these multiples are fair enough because they are substantially cash generating solid businesses but strong growth, rapid growth is not visible in IT services business as of now.Latha: Are you seeing any improvement in the capital goods segment?A: In the short cycle, capital good stories, which are either driven by construction equipment or driven by the power T&D etc have started to see ordering improvement happening and that is a good sign.Latha: Which kind of companies are we talking about?A: For example, power T&D, transmission and distribution businesses, which have started to see significant ordering from the T&D sector. We have started to see some improvement in road ordering, road construction side of it. There is a meaningful shift which is underway and I think one of these two sectors will start the process of order book improvements in a few set of early cycle capital goods companies. Also the replacement demand has started to come back which was missing for a meaningfully long period of time, the capital goods space so that will allow for a little bit of growth there plus new ordering, which will allow for earnings growth to come back.Latha: In your Reliance Equity Opportunities Fund top 10 stocks and Reliance's top 200 but in neither of them there are any cement stocks.A: Cement business is well positioned. So I don’t have meaningful ownership at this point of time but cement as a business is well positioned for the next three-four years for growth. In the near-term they have seen certain challenges in terms of volume, the rural slowdown also has impacted them as in the last three months, we could see volumes also coming off but over the next two-three years period, it is a good space to be in and valuations have also corrected to reflect the change. So it certainly is an opportunity.Reema: How should you best play this urban discretionary recovery theme, one way perhaps is passenger vehicles as you pointed out maybe another way is a few select retail names, is there any other way to play this real estate perhaps?A: Real estate, media and entertainment. The key thing is spending coming back. The minute the business cycle start reviving on the urban side of it, job creation is there which can lead to a big change happening there. So all these factors will feed into sectors like hospitality, sectors like media and entertainment, sectors like passenger vehicles and organized retail -- these four areas are clear visible categories, which will benefit from this urban change.Latha: What kind of earnings growth are you factoring in for the current year?A: I think earnings should trend in excess of 12-15 percent this year, which has not been the case last year.Latha: Street is still sitting higher you think?A: No, I think street has also corrected post Q4 change where earnings growth was below expectations in a lot of cases. Just one point on the earnings piece also -- if you see last quarter, in fact the whole second half of last year, there was meaningful impact coming from correction in crude prices, which possibly lot of companies lost Rs 30,000-40,000 crore in terms of that impacted the reported EBITDA. Metal prices were very weak. That also impacted earnings. Then cross currency also took up a hit. So real earnings last year were okay, they were not great but they were okay and this base is good enough to derive what kind of earnings growth on the overall market is possible which we are talking about.Reema: When do you expect the turnaround to take place in capital goods sector earnings?A: In capital goods, it is a function of first ordering will take off, I think some signs are visible and that ordering piece will take off this year maybe earnings will take 12-18 months to be reflected in. Especially on the short cycle side, they will be visible early.Latha: There are a large number of banking companies where interest outgo is way above EBITDA. Many of them are not recognised, they are still standard assets in the books of banks – so how should an investor grapple with this issue?A: There are defined few corporates, which have that kind of a challenge and I think some of it is due to the cyclical challenge of the economy and also with six years of slowdown in any economy, you will have large non-performing assets (NPAs). India is not unique. India also has a second problem where there is long-term finance not easily available.

So most short-term finance or five-year finance is used to fund 10-15-20 projects. I think because we have a long cyclical challenge, we have had a lot of large assets being classified or being on challenge in terms of higher interest payments and all that.Latha: What do you do, just avoid those debt-laden companies and avoid the lenders as well, finance stocks, how are you handling it?A: The combined marketcaps of all these debt-laden companies are miniscule in the whole context because they have already collapsed to 80-90 percent from where they were. On the lenders books, if you look at the top lenders, they have seen NPA recognition starting from the last three years. It has been a long cycle. If we believe there is a large economic recovery underway over the next two-three years, then a lot of these assets can turn into standard assets. So I think we have seen the pain, we have lived the pain and I think there is a possibility of a turnaround over the next three years there.