See FY16 earnings growth at 17-18%: Birla Sun Life AMC

Below is the transcript of Mahesh Patil’s interview with CNBC-TV18's Menaka Doshi and Nigel D’Souza.Menaka: What do you make of where we are in the markets? 8,800 has come and gone, 8,900 within touching distance today. Are we running up too fast you think?A: This month has been a pretty stellar month where we had a lot of positive news coming in. We had a rate cut and also stimulus in Europe.Menaka: But both were known about, it isn’t that both came as an absolute surprise. Maybe the timing on the rate cut front was a bit of surprise but we knew that we were moving towards a downcycle in rates. Sovereign bond buying has been discussed for the last five months with regards to the European Central Bank (ECB) now?A: Right.Menaka: So would you say that these are not necessarily factors that justify the move up?A: No, I wouldn’t say that but we have seen liquidity has been pretty strong. With global liquidity there was some concerns in the latter part in the month of December where we saw some outflows. More importantly the domestic liquidity into the equity markets has been pretty steady. So, we have seen almost like Rs 5,000 crore of monthly inflows into the equity market in mutual fund industry and that is actually providing a good support for the market and more importantly no one is willing to give away because the longer term picture at least for India looks pretty good and even globally if you look India looks the only large economy which will grow, where the outlook is likely to improve over the next two or three years.So, no one is going to pull the plug soon. So the correction in the market is also won’t be very large and as earnings outlook changes this quarter might still be a bit subdued in terms of earnings.Menaka: You mean FY16?A: Yes, FY16 with rate cuts and some operating leverage kicking in, some of the company’s demand picking up, say in the consumer side which should add some impact of the lower commodity prices that should benefit. So, you should be expecting around 17-18 percent earnings growth next year.

Nigel: Taking that into account that you are expecting 17-18 percent growth we are not trading at 17 times or 15 times, currently we are around that 18-19 times odd when exactly do we become quite expensive?A: If I am not mistaken currently we are on a one year rolling forward we would be around 10-8 percent higher than long-tern average which is around 15.50. So, we are in a scenario where outlook in earnings growth in the next three years would be better than what we had seen in the last 7 years which is been in single digits. We are getting in a scenario where rate cuts would be there, you could see another 75 basis point kind of rate cut. So, cost of equity capital will go down so that can justify even a higher valuation. Most importantly liquidity conditions domestically as I mentioned early would also improve. We expect domestic money moving into equities will only increase because the ownership level is still very low. So, given these factors potential for re-rating if earnings indeed come in growth at around 17-18 percent not for next year but even for the next two to three years then even valuation re-rating from these levels can not be ruled out. As we have seen what happened when liquidity comes in so I would not really bet on valuations. I would look at earnings growth whether they coming in and in expectation if that happens then market should do fairly well even from these levels. Menaka: Many market experts have been talking of a larger correction which is not yet happened in this market place and you are saying that one should no longer expect it given the kind of momentum we have seen both in terms of the buying the liquidity all of that?A: I am not saying that I am saying corrections would come in the market. Menaka: But they have been of the 5 percent variety not necessarily the big large corrections?A: Anything between 5-10 percent is something which one should be prepared. Investors should not be too worried about those corrections because we have seen that earlier also in the biggest bull run we saw 2003 to 2008 markets corrected more than 10 percent for more than 14-15 instances when the market did that kind of a correction in that something which is in broader trend should be good and lot of investors would look to buy into the correction. Unfortunately we have not seen much supply of paper coming in so that liquidity has in the market which is already where the debt is not that great. We have seen prices move up probably much more than one would have anticipated. As a rational manager but it is difficult to find value in this point in time.

Menaka: You have launched a new fund called the Manufacturing Fund. It seems to be an area you are taking a bit bet on but it is also an area that will likely show result only in two-three years from now or maybe four if new projects is what you are betting on in terms of portfolio allocation in that fund. Talk us through where you intend to invest that money and what looks most promising to you in the manufacturing story?A: On the manufacturing side the key theme is that we believe that India in terms of competitiveness, I think we have seen especially against China because of the labour wage inflation in China also because the currency appreciation in China vis-à-vis the rupee, India’s competitiveness has increased. We have the resources in terms of labour, India contributes almost 25 percent to the labour force annually and now with topped down focus by the government also to revive the sector, it is time that the sector should do well over the next many years and India’s manufacturing share to GDP has stagnant around 15 percent for many years, for a decade or so. If you look at large economy like China, manufacturing is around 35 percent of GDP. We have a vision at least top down to take it up to 25 percent in the next ten years even if you go midway, you will see the sector growing fast but in the interim what we are betting is that as demand picks up, India itself is a large domestic market where consumption and demographics would still increase. So capacity utilisation in the existing sectors be it auto or capital good sector or anything in manufacturing – that itself will drive growth in the next few years and green field capex would take some time. The government is trying to do reforms, trying to address issues on land acquisition, labour reforms which might take time but despite that we have seen successes in sectors like automobile, in pharmaceutical.Menaka: You are convinced by the turnaround in auto?A: I think so. Initially what we thought after the election results was more the pent-up demand where we saw volumes kicking up and now you might see moderation in growth but the consumer confidence and even rate cuts, so you will see better money in the hand of the consumer. Menaka: What do you like the most in auto?A: In auto we like the four wheelers and in two wheelers also we have seen -- but there is a competitive intensity is slightly much fiercer over there. Auto ancillary is a space where things are looking much better because it is not a domestic market but lot of Indian companies have been able to cater to the global demand and scale up pretty well over there. Menaka: Would commercial vehicles be part of your bet on both (a) a revival in manufacturing within commercial vehicles and (b) revival in manufacturing in other areas that might lead to a pick up in freight?A: Yes, I think that’s another sector which we have seen, the commercial vehicles have not seen any meaningful pick up in volumes there.Menaka: So you are not so upbeat on commercial vehicles?A: No but this is a time to look at it. If you look at in India, there are not many stocks. The leading player which is domestic as well as global player, so one has to take a view also on the global front as to how we are positioned but we should see a revival in the commercial vehicles also because cut in fuel prices would also increase the profitability operators.

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Menaka: I know you are hesitant to talk about specific stocks, but that would make Tata Motors and Maruti amongst your top picks when you look at allocating, let’s say, money from this manufacturing fund at least in the initial months. Would that be fair?A: It depends again on that point what the valuations are but across auto space whether it is four wheelers, cars or commercial vehicles or two wheelers all should do fairly well and specially with companies we like companies which have strong domestic market share but also have the ability to really cater to the global market because that is where the scale and size can really grow much faster.

Nigel: Talking about the auto space and Tata motors in fact that is one of the cheapest stocks that we have in the Nifty space. The only one that trades sub ten times. With regard to that will you be playing that particular counter because in fact it’s a global play or are you expecting it to turn around, no stock specific but with regard to exposure?A: Well, one has to look at what are the key drivers of any stock we invest into, what are the key drivers for the growth. So, domestically we would expect cyclical recovery to kick in. We are at the bottom of the cycle and that’s where the surprise Delta change would come in. On the Global side it depends in terms of specific markets okay and where you are and what is the - In auto it is important to understand the new launches. So any new product launch can really add significantly add to the volume growth in near term. That is what is key and that would really drive our investment decision whether it is in four wheelers or whether it is in commercial vehicles.Nigel: Looking at the cement space, it’s a proxy to the infra play I believe and in fact if you just look at prices over the last year odd, you have been seeing every time there is an increase in prices, demand’s not really following up on that front and even earlier this month if you see, process have been increased and there is a tendency to start pulling prices back. What is going on there, what is your exposure with regard to the cement space, do you think there is more to go?A: Cement is a direct play on the domestic infrastructure play so there we have seen demand from the housing segment has been pretty strong. On the infra space we haven’t still seen any meaningful pick up over there but our sense is that we will see enough kick up on the roads. the roads. Already there is bidding for Rs 40,000 crore worth of road projects which would happen and you should see work on that progressing. Even in other infra areas like the urban transportation or metro projects, they are going on pretty well. So that demand should pick up slowly. We have seen demand in 5-6 percent kind of range.Our expectation is that next year GDP growth can be around 6.3 percent or so. So looking at a multiplier effect, you should see cement volumes pick u p slowly and capacity utilisation levels are still pretty low and we do not see any big capacity coming in and cement again as you know gestation for a new plant to come in, now their time cycles are much longer. So if demand picks up next year then you should see the capacity utilisation move up and that should do pretty well so even now in the current environment, lot of the companies are still generating decent return on capital employed.

Menaka: In infrastructure you are also invested in Max India?A: In infra we also have some exposure to the financial services sector. That is part of the mandate.Menaka: Could you comment on the restructuring they announced yesterday if you can offer one, a broad qualitative comment if possible?A: Sorry, I am not able to comment.Menaka: Some other interesting stocks from there like WAPCO for instance in infrastructure, Cummins, what is your outlook. Your funds have done very well compared to the benchmark. What do you expect will be, let’s say, the fortune of infrastructure through the course of 2015?A: Infrastructure if you break it down there are two; one is the asset owners which are there which are currently facing a lot because there is over leverage over there but there are the equipment suppliers or the industrial companies which are currently going through a downturn because you have seen the overall capital expenditure (capex) spending is at an all time low. But a lot of companies have got strong leadership positions or complete advantage and have been able to look at opportunities, not only in India but in the export market, a company like Cummins or WAPCO which has given them a good balancing when domestic market has not grown and now with domestic market likely to pick up and the stronger names, the players who have been the market leaders they should be able to get back the growth much faster over there.Nigel: With regard to the real estate market we have seen that from the time we have new Prime Minister things are looking good, the equity markets have run along but is that the temptation to put money some into real estate, real estate stocks?A: Real estate sector we have seen that the stocks haven’t really done so well for investors. Real estate prices have moved up. Normally real estate sector should do well at the later part of the cycle because that is where you will see consumer surplus savings really coming up.Nigel: So, when is a good entry point for that?A: Good entry point normally you would look at in the mid part of the cycle. We are at the bottom of the cycle, just trying to pick up. So that is where initially you will play some of the consumer discretionary and financials and at the latter part of the cycle as interest rate cuts have happened but we haven’t seen any meaningful fall in terms of mortgage rates. So if that happens and as business activity picks up, job creation happens that should provide better growth for the real estate sector but at the moment we are not so too inclined on that space.

Menaka: Will you continue to stay over weight on financials through the course of the year? Do you think much of the gains have already come in? Your view on PSU Banks and whether your outlook towards them is likely to change because right now you are skewed more towards private sector banks?A: Financials, we have been pretty over weight for the later part of last calendar year. We also launched our fund one year back in the banking and financial. Our belief was that the bottom of the economic cycle and things like to pick up. This is a sector which does well in the initial part of the rally and it played out pretty well because it is a broad proxy to the economy. Especially we have seen in the private sector banks in India especially despite the market cycle has been more compounding stories.They have been able to take market share from PSU banks. So our over weight has always been on private sector banks. More it was in the retail banks but over the last one year we have also taken exposure to banks more exposed to the corporate side because we believe that some of the stress which was there in large corporate we have seen some deleveraging over there. To a large extent the re-rating on the banking sector has happened. No longer the price to book value multiples are as cheap as they were one year back. So now it will be again banks which will be able to capitalise and grow their earnings and have a better product mix they would continue to do well.

_PAGEBREAK_Menaka: So in your assessment which ones would those be?A: Some of the banks especially on the retail side will continue to do well. Also on the corporate side focus on the small and medium enterprises those can do well as the economic cycle recovers.Menaka: PSU Banks?A: On PSU Banks we initially were quite underweight. We have corrected that we are more or less neutral now. As the economy picks up as the NPA cycle as peaked out and rate cuts, there is now a greater interest to look at PSU banks. However there again we are very selective only at banks where we are comfortable with the leadership and also banks which are well capitalised because lot of PSU banks will still require equity infusion.Menaka: Would State Bank of India (SBI) be top of the heap for you?A: In our portfolio SBI is one of our top holdings in the PSU banking space.Menaka: Does it continue to look more promising through the course of the year?A: Looks steady, more important is to be comfortable in terms of the asset quality and growth will come in. With cut in the interest rates you will see also lot of the PSU banks have got bond portfolio where they should make some gains in the next few quarters.Nigel: What about the IT space, there is not much exposure on that end? What exactly is the exposure do you think that some of the stocks will do well going ahead as well?A: We have seen last year was pretty good year for the IT sector. Going forward looking at the budgets for this year things looks to be okay. Probably it would be tad lower in terms of overall dollar revenue growth what we saw last year but IT sector should do steady. Though there were spectacular surprises negative on the positive side at least in terms of the dollar growth the cross currency movement is something which can impact some of these companies which we saw in the last quarter. That is something which might continue in for the next couple of quarter also. However broadly we expect IT sector should be inline and that is where our exposure to IT sector is neutral we are not too negative on that space.

Menaka: But I see only Infosys, HCL Tech, Tech Mahindra in some of your top ten holdings, not TCS?A: At various points in time depending on the valuations and growth we would change or vary but we would have a fair allocation across some of the larger names but we have played to prefer some of the mid size companies where we believe that the growth could be better than the industry and where the valuations are reasonable. So we always have a spectrum or growth and valuations.Menaka: Basically TCS is overvalued.A: TCS is also one of our recent holding but relatively compared to the benchmark probably it would be slightly lower.Menaka: ITC features prominently in some of your top ten. What is your outlook on that company if you can talk us through that and I will connect that to the fact that consumer staples is an area that you are underweight in, I am sort of leaving out the cigarette business and looking at some of the other FMCG related business of ITC.A: Yes, in the consumer space we have seen a lot of stocks where the valuations continue to remain pretty high. We have seen some kind of slowdown in terms of volume growth if you look at the last quarterly numbers. But India consumer will be a long term secular story. So these are the kind of stocks which normally you wouldn’t see much of a correction. If at all there could be a time correction.So selectively ITC has particularly underperformed because of government controls on their expectations.Menaka: What would you need to see for you to become a little bit more positive or sort of adjust your weightage on consumer staples, a better volume number is it across the board?A: Yes, that is the bottomline over there. The volume numbers picking up. You might see this for couple of quarters margins could actually be better.

Menaka: This is interesting because Adi Godrej was telling me, he says he saw volumes already picking up in the second half. Of course this depends on what brands you have, which parts of the market you cater to etc.A: Yes Menaka: But he said rural and urban volumes have been picking up in the second half of this year and he is seeing visible signs of a pick up already. So is this the right time to start getting into consumer staple or you will wait for little bit more evidence?A: Volumes as I mentioned, if consumer confidence is coming back, if you see spending and especially at the higher end of the chain we are seeing some down trading happen in the consumer in the last one or two years. So, that is where you could see a better growth and more the urban demand, our theme is that rural consumption would see some kind of a slow down. We have seen rural wage inflation at almost 5 year low, we have seen MSP increase have been in single digit, so that was a big driver for rural economy in the last three four years so urban economy will come back so companies which are positioned more on the urban side, there you could see a better volume surprise in the next few quarters. Menaka: I want to ask you about what you think about what the expectations from the budget are? I also want to ask you about this year in investing; how difficult is it going to be vis-à-vis last year and what some of your best bottom up picks are since that’s your articulated strategy for 2015?A: On the Budget, the Budget to some extent has lost its - -People give a lot of weightage to the Budget but lot of the things the government is doing outside so one should not really – Budget would be a direction where the government focus will be in the next few years and also in terms of fiscal consolidation, how they are trying to really balance fiscal deficit as well as growth so one would look at what the government spending is going to be because that is going to be critical for revival because private sector investment will still take some time. So, that is one thing but the focus whether what they have been seeing and the budget is really articulate in putting that numbers to some of those things whether it is the thrust on the investment side or reviving the whole manufacturing sector, so what are the kind of incentives that are given for that, that is something which one would look out for.Menaka: Investing in 2015?A: Yes, this year would be – last year would was a play where lot of themes played out so whether it was the financials or some of the other sectors and it was more top down I would say going forward it will be more bottom-up because what I men is that you will have to really look at companies where earnings growth would now be necessary to drive our performance. To large extent the hope and expectations if you see re rating happen without any change in earning happen last year and last year also was a year where a lot of fund managers generated a lot alpha. If you look at the alpha last year on an average would be around 10 percent or more compared to an average of around three, four percent over the last five years. That would be more stock specific so that would be more important to be connected in terms of the companies one is investing in terms of where the earning delta change would be to really drive our performance. So that is what I mean in terms of more of bottom up stock picking.