See retail join party soon, earnings jump from Q4: Kotak MF

Indian equity market is on a structural upswing that will be further aided by an impending cyclical recovery in economy, says Nilesh Shah, MD, Kotak Mahindra Mutual Fund.

He lists three main reasons for his optimism — improvement in earnings (best to come in the last quarter), higher salary structure of government employees and monsoon outdoing bad-rain forecast.

Talking to CNBC-TV18, Shah is confident that a "retail tsunami," is approching Indian market and advised investors to stick to quality names despite their costs. He also cautioned against pinning too much hope on pharma sector and advocates buying cyclicals. Continuing to talk about domestic investors, Shah said he expects mutual funds to bring Rs 3.5 lakh crore into the equity market in next five years, courtesy retail investors.Below is the transcript of Nilesh Shah’s interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18. Latha: Would you participate in this cheer? Do you think there are positive as a fund head at this juncture? A: Yes, we think there is a structural as well as a cyclical upswing in the Indian economy. And not withstanding the current spate of slightly below expectation results, the outlook continues to improve. The one most important thing which will benefit the corporate earnings and the recovery is that last Diwali to end of financial year, the economy was not really in the best of health. The December, 2014 quarterly results were negative. March, 2015 also showed minus four percent earnings growth. So, somewhere the base for December, 2015 on a year-on-year (Y-o-Y) basis and March, 2016 Y-o-Y basis, will look optically better. The second advantage which is happening to Indian economy is a reasonably good distribution of monsoon against the expectation of a below normal, below average monsoon and I was one of the few person who was saying that look, even the Indian Meteorological Department (IMD) forecast of below normal monsoon is better than the 2014 monsoon. But, now monsoon has come ahead of IMD expectation. The distribution has been fantastic and hopefully this will give boost to the agriculture. The third important cyclical swing which is coming in is that the public sector bank employees will get revision of their salaries. About Rs 11,000 crore will be arrears and about Rs 4,000 crore will be the additional compensation. So, that is Rs 15,000 crore worth of spending from the public sector (PSU) bank employees. And then the bigger version will be when the pay commission recommendation will get accepted for the Central Government employees and the State Government employees and that can really spurt the consumption and combination of all these things will provide cyclical recovery to Indian economy and then hopefully the government efforts on the structural side will also start coming into play. Sonia: What do you do with some of these expensive stocks now names in the FMCG space, in the auto space? Do you continue to hold them or would you churn your portfolio? A: My advice as a fund manager will be completely different from my advice as a retail investor. As a fund manager I have to generate performance on a quarterly basis, half yearly bases and while I do wish my customers give me money on a longer term bases they do evaluate me on a six months and one yearly performance. So, we will have to constantly juggle between the expensive valuations versus the relative valuation. However, to the retail investor if they are holding some of these bluechip companies which are of expensive valuation I mean be happy that you are still owning those shares. You are probably few of those lucky ones who are still holding those shares because majority of Indians probably have sold out those shares and if you have got five years return in two years and you don’t get any return over next 18 or 24 months so be it you have already earned money into your pocket. So, as a fund manager I will take a different call but to a retail investor my recommendation will be exactly opposite. Latha: You spoke about earnings being sub-par now but likely to improve. Which quarter are you expecting that improvement? Every time we expected that and the fourth quarter, it disappointed. We expect in the first quarter, it disappoints. Which quarter can earnings largely stop downgrades or at least reduce them? A: My feeling is that we will start seeing the benefit of lower base effect in December, 2015 quarter. December, 2014 witnessed about four percent negative earnings growth. That has created a lower base and that December, 2015 on a lower base optically will provide better earnings. But, the real acceleration will come towards January-March, 2016 quarter. By then we will see the benefit of PSU Bank employee spending. We will probably also see some benefit of interest rate cuts and interest rates transmission. We will also see the beginning of the festival season and that hopefully with good monsoon should result into better activity. So, combination of interest rate transmission, interest rate cuts, festival season and the lower base effect will create the support in terms of acceleration somewhere towards December, 2015 to March, 2016 quarter. But what is more important is that we also need structural headwinds to support us and which is where the current session of parliament in terms of passage of Goods and Services Tax (GST) Bill, Land Acquisition Bill, in a format which can support industrial development. Those are structural things which are necessary. Latha: Let me then get to the sectors if you are expecting a turn around. Where are the value gaps available now? Would they be public sector banks? A: From a trading point of view probably public sector banks after having corrected so much can bounce back but we need fundamental changes in the way the public sector banks are run. The first is in terms of talent. You are paying such a low salary to most senior management of public sector banks. Now unless until you pay them well, how will you attract talent. The second thing is that today public sector banks have a fairly largecap in the mid level executives. For many years they didn’t recruit sufficient number of people. Now as the senior management goes on retiring how will you fill the talent gap without paying appropriate market compensation? The second thing is related to independent decision making. We all know the problem of non- performing loans and non-performing assets but we are not seeing that determined action on part of PSU banks to go and recover their money. In very lighter vein we have seen businesses going bankrupt but not the promoters. That burden is always borne by majority PSU banks. Unless until that burden is shifted back to the promoters and the equity shareholders. Clearly the whole credit delivery mechanism of PSU bank will continue to remain chocked.Latha: I am convinced that you do not see value in the PSU banks, but where then is value? How would you bet on that turning quarter in December, which sectors? A: My focus is more on domestic cyclicals. These are the companies which have seen their capacity utilisation drop over last couple of quarters. As the aggregate demand slowed down, they also have probably run up either higher working capital debt or a project debt, not significantly but just little stretched and hence, they will be the biggest beneficiary if liquidity improves in the economy and interest rates are cut. And third, these are the companies which will benefit as the investment cycle led by the government starts picking up. In FY15, government spending was muted. But, FY16, they have started with almost Rs 100,000 crore worth of additional spending budgeted for FY16. So, the domestic cyclicals across sectors like industrials, cement, automobile, these are the sectors where today margins are muted because of the higher working capital cycle, higher interest rate, lower capacity utilisation, lower demand. Now, over the next 12-18 months, these sectors will start moving into the background and hence these companies will show more profits than probably what is anticipated by the market. So, here is the value. Sonia: Coming to the overall market picture, the flows from the domestic and the retail fraternity have increased considerably in the last couple of months and that\\'s what kept this market at 8,500 levels. Are you noticing a lot more by commitment from retail, domestic and do you think that will continue to improve through the course of the year? A: The way I see there is a tsunami coming from domestic retail investors into the financial market. I am using the word `tsunami', and let me explain it. The total holding of retail investors in equity market is about 8 percent of BSE 200 companies as on March 2015, roughly that's Rs 800,000 crore. This includes some of the shares which are in physical segment, this includes some of the shares which are with high net worth individual investors. Now against that what will be the buying by domestic retail investors and institutional investors over next five years? Mutual funds last year bought more than 65,000 crore. In first three months they have bought more than Rs 25,000 crore. So it is fair to assume that we will bring in Rs 350,000 crore over next five years in Indian equity market courtesy the support of retail investors. LIC has been buying 50,000 crore a year. It will be fair to assume that they will bring Rs 250,000 crore into equity market over next five years. The pension funds haven't invested one single naya paisa in equity market till now. Now they have been allowed to investment between 5 and 15 percent and that\\'s 200,000 crore. The only sellers from domestic institutional segment last year was private insurance companies and banks. They sold 28,000 crore last year, but going forward will it be fair to assume that they will bring 100,000 crore into equity market. It is quite possible. So, there is 900,000 crore of demand from domestic, retail and institutional investors against the total holding of 800,000 crore from the retail investors who have been selling their equity forever. You can now see the domestic tsunami which is going to come. Sonia: This month the pharmaceutical sector has come out of the woodworks and a lot of stocks like Cipla, Dr. Reddy's Laboratories (DRL) and even some of the midcap pharma names like Marksans Pharma have delivered good returns. Would you advice increasing allocation into this sector? A: In pharma the time has now come to become bit choosy. Some of the results which have come up are more one time in nature, the cross currency headwinds which are playing out in the market, be it Russian ruble, Brazilian real, these all are going to have an impact on many pharma companies whose operations are concentrated in some of the sectors, some of those countries, some of those markets. Let's remember just three months ago how largecap pharma companies beautifully corrected when the valuations were appearing little bit rich. Today pharma is almost going to the same level in terms of valuation and hence it is time to be cautious. It\\'s time to be cautious from short-term point of view and not necessarily medium to long-tem point of view.