Indian stocks have shown some resilience lately following the recent correction. In an interview with Moneycontrol's Santosh Nair, veteran journalist and financial commentator Udayan Mukherjee said the Nifty may have formed a short-term floor at 10,000.
“The market was losing some of its downward momentum, as I said last week,” he said. “A lot of the selling because of the year-end (capital gains) phenomenon. That has come to an end.”
He added that the RBI’s policy decision and monetary policy stance last week and the subsequent sharp fall in bond yields also helped markets. “The Nifty could go up to 10,500 or so levels.”
Udayan talked about the earnings season, which gets underway Friday when Infosys reports quarterly numbers Thursday.
“Some sectors will give you a sense of recovery; some will take away from this incipient recovery,” he said, adding that consumer discretionary sectors such as auto and select industrials could post strong numbers.
Some of the recovery will be driven by topline growth – such as in metals thanks to the bounceback in prices -- rather than margin expansion.
Net-net, earnings could be up 6 percent for both the quarter and full year, according to Udayan, who termed FY18 earnings growth as “disappointing”.
“We started the year with expectations of 18-20 percent growth forecast. Every year over the past seven years, we’ve started of talking about double-digit growth and fell short,” he said.
“FY19 is in the realm of hope,” he added. “GST is stabilizing, there is continuing low base effect and we have seen some earnings recovery.”
But Udayan wasn’t so confident of the 24-25 percent earnings growth that market is penciling in.
Discussing sectors, he said that following the recent correction, when fresh money comes in, it will go into stocks where there is earnings visibility.
Below is the full transcript of the interview
Q: There has been a distinct change in the mood since our last discussion a week ago and it’s mainly to do with the credit policy and RBI's dovish outlook on inflation. How much do you think this rally is sustainable?
A: We did speak about the fact last week that the market was losing some of its downward momentum. While there was no great visible upward momentum, on the way down, the Nifty was not sustaining below 10,000. That was the first sign that a lot of the selling was to do with the March 31 year-end phenomenon or because of the capital gains that had come to an end, and technically the market was in a slightly better footing.
You are right in pointing out that over the last one week or so, it is the fundamental factor of the RBI policy and the bond yields cooling down which might have helped the markets also and that is an important point because one of the risk factors, the macro risk factors which the equity market was grappling with was the fact that interest rates were expected to go up and bond yields had actually shot up quite a it. The benchmark going up to nearly 7.8 percent. Since then, we have seen a fairly significant cool-down in the bond yield below 7.2 percent which is about 60 basis points cooling off, not insignificant.
Now, you can question whether the RBI's optimism about inflation cooling down in the second half is overly optimistic and where that optimism is coming from, but from the tone of the central bank, it is quite clear that they are in no rush to hike interest rates immediately. So in the next six months at least, I do not think the market should pencil in any rate hike in India unless crude goes on the boil or something unexpected happens. Now that is one of the risk factors abating for the stock market which has resulted in some of the financial stocks actually staging a recovery, NBFCs, even some of the corporate and public sector banks which lose the most because of bond yields going up. So I do not think we should celebrate a bond party or a big bear market in bond yields or anything like that, but the intermediate cool-down is something which will ensure that 10,000 remains a floor for the Nifty at least for the near-term.
Q: The focus has once again shifted to quarterly earnings. But newspapers seem to have different takes with some saying there could be a partial recovery, and one of them expecting a strong pickup. So what is your view on how this earnings season could play out?
A: I do not think it will be any different from what we have seen in the previous quarter which is that some sectors will give you a sense of a recovery, but some sectors might take away from this insipient recovery that we are witnessing. Net-net, I do not expect any major jump in earnings. Maybe the Nifty earnings will go up six-odd percent for the current quarter which means that in FY18, after the last quarter, we will still be reporting no more than 5-6 percent earnings growth all companies put together for this financial year which is way below where we started the year. I remember when we started FY18, everybody was talking about 18-19 percent or 18-20 percent kind of earnings growth particularly so because we had a good base in the demonetisation period and the market was supposed to lift off on that kind of a low base comparison. However, now we find that for whatever reason corporate banks, public sector banks, pharmaceuticals, whatever sectors, we are now going to end with no more than 5-6 percent Nifty earnings growth, maybe 6-7 percent Sensex earnings growth. That, if you want to call a spade a spade, is frankly very disappointing.
We are now running into FY19 where I again find everybody is talking about 24-25 percent earnings growth. That, to a large extent depends on global factors. It depends on how financials pan out in terms of their earnings particularly if we have fairly onerous kind of provisioning requirements on NPAs for FY19 as well. So I was reading a brokerage report which pointed out that FY18, if we end at 5-6 percent earnings growth Nifty, it is going to be the seventh year of consecutive single digit earnings growth for the index. I do not remember a bad patch as this in a long time. So every year for the last seven years, we have started the year by talking about 18-20 percent earnings growth and we fall into single digits, sometimes no earnings growth. So this is continuing even now as of FY18. So FY19 is still very much in the realm of hope. With GST stabilising and with another low base effect, with some recovery which is visible in sectors like auto, consumption, even industrials, I certainly hope there will be double digit earnings growth next year, but not so confident about this 24-25 percent number that everybody is talking about.
Q: Coming to this quarter's earnings, what do you think the talking point is likely to be? Will it be growth in topline, margin expansion or bottomline growth?
A: No, I do not think there will be significant margin expansion at all. In fact, I expect this quarter to be a bit of a struggle in terms of operating margins. You will probably get some topline growth particularly in certain sectors where we have seen strong monthly numbers but how much of it actually flows down to the bottomline is a matter of question. So I will give you a sense of how I feel about different sectoral breakups. I think the good numbers will still come in from consumers which means it will be autos where we have clearly seen very strong momentum in the monthly numbers. It will be from some of the FMCG companies where they are seeing decent volume growth and I think you will find that other than consumption and autos, even in discretionary consumption, some of the numbers may not be too bad.
Other than that, last couple of quarters, we have seen some encouraging signs in some of what we like to call industrials which means capex related, construction, capital goods kind of companies. Not all of them, but some of them will probably report good double digit earnings growth for the current quarter. So consumption, maybe some pockets of industrials will have pretty okay numbers. Metals will also be good, but because metal prices globally have been strong, but the very strong base effect which they enjoyed now is beginning to wane off because 3-4 quarters back, the numbers had started improving already. So while metals will be good, in terms of percentage gains, they may not look as good as they appeared a few quarters back. So metals will be okay, let us say okay plus. And then you have IT where the stocks will probably respond positively and the guidance will still be about 7-9 percent growth next year. But it is not rocket in terms of a massive positive surprise in terms of the numbers. But the numbers might just about be stable.
On the other hand, you will probably have fairly significant disappointments in non-retail financials. So you take out the few retail private sector banks, they will be good. Other than that, PSU banks, corporate banks, maybe some NBFCs will report fairly insipid numbers in some cases, howlers, I imagine. Pharmaceuticals will continue to be challenging, so that is another sector which will not do well in most part. Telecom will be very bad I imagine but the market is already pricing in that bad news. So, these are some sectors which will not do very well. Some financials, telecom, maybe cement because pricing is still weak and pharmaceuticals. So these are the bad pockets, those are the good pockets, so net-net I still see us coming out with just about 5-6 percent kind of growth for the quarter.
Q: You mentioned auto, consumer discretionary and consumption in general doing well during the quarter, and we have already seen that in the stock performance. Over the last one month fairly good interest has been seen in auto stocks and also consumer discretionary. How does one play these sectors from here on?
A: It is a good point. If you are asking whether you can still chase these stocks because they are the ones where the money is going in and valuations are beginning to look quite lofty in many of these cases, that point is taken. But a lot of money went out in February and March. If that money is coming in, the first vote of call will still be where there is visible earnings growth and where there is a sense quality. And it is no surprise to me that some of the retail private sector banks and some of the high quality consumption names like your Titans of the world, they are actually flirting with all-time highs with the market still down 8-9 percent from its all-time highs, the index that is. So the first flush of money is going in where there is visible growth. So it is going in the high quality auto names, it is going into some of these high quality consumer franchises and it is going into some of the unquestionably good quality retail bank or NBFC kind of place also helped by the fact that bond yields have cooled down. So, to answer your question, some of these good companies will continue to get more expensive as long as the market is looking strong and we are in the midst of this recovery phase.
There is another thing which might happen is that some of these defensive sectors like IT which got in a lot of the money, when the Nifty was flirting with that 9,900-10,000 level, may ease off a little bit. You can see that stocks like Infosys have given up a bit over the last few days and midcaps are getting that money because people are now saying that this is a recovery phase, markets reverting to its mean after two bad F&O series and we want to get back into some of these highly beaten down midcaps, maybe some of those other sectors which have got bruised and battered in the fairly significant correction. So the market's mood right now is different. People in the market are probably believing that 10,000 holds for the moment. We have probably started a journey towards 10,500-10,600 even those kind of levels. And if that plays out, that reversion to mean, 11,200 to 9,900 then back 10,500 kind of levels, then some of the beaten down midcaps, some of the non –defensive sectors in the market, the Bank Nifty notably will also probably participate in this pull back move.
Q: Coming back to Infosys, the stock has come off over the last few days as you pointed out. Do you expect any surprise this Friday when it declares March quarter result?
A: No I do not, but the fact is that expectations are very low from the IT sector in terms of earnings, not so much from stock price performance. Stocks have done well after the pullback which started a couple of months or around 45 days back. But in terms of earnings the market is remarkably patient with IT. They are saying slowly but surely a bottom is being put in place with the business cycle there and over the next couple of years, maybe IT will get back to double digit earnings growth slowly. So we need to be patient out here. And therefore, the market is pricing in about a 7-9 percent kind of an FY19 growth guidance from Infosys and the company will stick to that. It will not be significantly more than that. This quarter again will be a question of 1.5-2 percent kind of a constant currency growth which again is not terrible, but not great growth in terms of the history of the company. So we are stuck somewhere in between out here where earnings growth is still not galloping yet, there is no significant acceleration, there is hope that the worst is behind us and slowly there is a bit of repair or a process of mending which is going on in the IT space and investors want to be positioned in this space and slowly make 10-12 percent kind of returns over the next couple of years on good balance sheet and good management kind of holdings. So that is the general view on IT. But I do not expect any fireworks from Infosys either with their quarterly numbers or with the FY19 guidance this Friday.
Q: Overall liquidity flows continue to remain robust and foreign investor flows picked up in March. But there has been a sharp drop of close to 60 percent in mutual fund net inflows. Do you see that as a cause for concern or think it could reverse now that markets have started doing well again?
A: April will be a very crucial month because March always is tricky with year-end phenomenon and now this time doubly so because of the long-term capital gains tax angle so it is conceivable that a lot of the selling that you saw in March in mutual funds is because of the long-term capital gains issue and I think it may have started reversing looking at the DII numbers over the last few days with the start of the new series in April. So April's numbers will be very important to see.
Now, I think we need to see these mutual fund numbers, they are worrisome to answer your question, but we need to see them in a slightly more granular detail. I think the dip in net inflows into pure equity funds is particularly worrisome, but the big damage in inflows or the net inflows has been caused by high redemptions. Now redemptions may be a factor of the capital gains tax issue or the March 31 deadline. So people might have sold ahead of the financial year ending which is why we will have to see in April, both given the recovery in the market and the fact that the year end is over, whether we are going to see far fewer redemptions, far less redemptions in April than we saw in March. But we do need to get into a double digit number which is Rs 10,000 crore plus from that Rs 6,000-odd crore that we saw in March in the month of April because this, in a sense is really the true technical oxygen for the market, the kind of DII money which has been coming in for the last many months. If there, the markets start losing its confidence that flows are now going to stabilise at maybe 60-65 percent of the run rate, the run rate has been 16,000-18,000 crore monthly for the last many months. If that comes down to Rs 10,000 crore a month, we got Rs 6,000 crore only in March, so I am assuming some bounce back, but if it is only around Rs 10,000-11,000 crore given the kind of supply of paper that we have in the pipeline, I have a feeling that the market might struggle to take out 10,500-10,600 on the way up. So in my head it is a technical risk and for the moment, one would say despite the cooling down of bond yields, the markets stuck in a range of 10,000 on the floor and maybe 10,600 on the way up, if we get to those kind of levels during the course of the April series.
Q: Some macro data is expected later this week. What’s your view on how the industrial output figures for February are likely to be?
A: Those numbers have been recovering but I am not terribly happy with the PMI services numbers and if you look at the composite PMI service plus manufacturing numbers, they are not great for the last month or so but at a micro level, a lot of companies, particularly the consumption-based ones are not reporting bad numbers. So, crude has not gone on the boil, completely last week was a softish kind of week for crude oil prices. So overall the macro is floating around. There is still some rhetoric coming in on the trade war possibility keeping global markets volatile. So overall it is still a little up in the air and you have got Karnataka elections coming up in May which is a macro risk for the market in that sense. So I say, keeping all that in perspective, given that we are going to see a modest, but not across the board earnings recovery in the fourth quarter, still ending way below what we had pencilled in earlier, we probably are in a situation with the market saying we had two very bad months in February and March. A lot of the macro bad news got priced in. now let us see how the micro plays out. Let us hope that the interest rate thing actually simmers down, one risk less for the market and we can stabilise for a couple of months, maybe April and the first half of May is that field of stability between 10,000 and 10,500 where the market tries to work with some kind of a base and then we need fresh data. We need to be convinced that this trade way will not blow up into a full-fledged one, we need to be convinced that crude is not significantly going above USD 70. We need better political news and we need some sign that earnings growth accelerate a little bit more over the next couple of quarters and GST rates stabilise over April, May and June. If all of this happens, these are fresh triggers for the market, we will then be in a position to determine whether the market needs to make one more swing down to that 10,000 and sub-10,000 levels or we have more or less put a short-term, medium-term bottom in place and we can work with this range and as the year progresses and ends, we can work our way back towards that 11,000 level. For now, we are in the middle innings and therefore trading a middle ground in the trading range between 10,000 and 11,000.
Q: We have seen some of the recent IPOs not getting off to a great start. Do you see any opportunities among the IPOs which have been listed over the last 4-5 months?
A: No, frankly for a brief answer to your question because I am quite worried about the primary market space. I think valuations at which many of these IPOs came in were quite excessive because promoters wanted to milk the midcap frenzy and most of these IPOs were midcaps in any case and they came in at valuations which were frankly very lofty in isolation. In relation to the overall frothy valuation in the midcap space, generally, maybe they looked at par, but in the primary space, if you are going to enter at that kind of valuation which leaves nothing on the table, then with every kind of a turbulent phase in the market, you will find IPOs actually going down below their issue price which has happened in so many cases in terms of the recent listings of the last 3-4 months. You have seen what happened to the highly doubted ICICI securities which did not do very well on listing and the first day was frankly quite terrible. So IPOs need to rethink their pricing and if the retail money into the market actually settling at a lower level stung by the performance of February and March, then I think many of these IPOs particularly the midcap variety IPOs will struggle with subscriptions and with post listing performance over the next few months, I would advise a lot of caution about the primary market going into the next half of the year because promoters are being very opportunistic given overall midcap valuations at the prices at which they are bringing their companies to the market and that presents a significant risk to a lot of investors who are getting in. that is not to paint everybody with the same brush. While valuations are high, some of these companies, some of these companies are excellent franchises which are coming to the market and even if there is post listing turbulence over the medium-term, investors will make money, but 70-80 percent of the IPOs which are getting listed are probably coming in at fair plus valuations and investors need to be cognisant of those risks.
