A lot of calls have been coming in saying 2011 will be a challenging year. These calls have come from the country's leading investment banks as India faced a rocky first month.RDD
Nandan Chakraborty, Managing Director, Institutional Equities at ENAM, in an interview with CNBC-TV18's managing editor Udayan Mukherjee sees the first half of 2011 as a major test for the Indian market, in terms of politics, the Fed's QE program and capex.
Below is a verbatim transcript of his interview. For complete details watch the accompanying videos.
Q: The first month has been quite awful. Do you think the rest of the year will mirror what January has been like?
A: I am part of the consensus which does think that till summer, it will be very challenging. Where it will be a real challenge for the investors is how you take the flip to the second half. If you look at the first half there are obvious challenges. Whatever is related to politics is affecting both, the consumption sector in terms of inflation and it is also affecting the capex sector. Incrementally, the GDP growth of India is capex related.
But on the other hand, if you look at the second half of this year, hopefully, even while you and I get depressed about things, the government will make measures - how to improve liquidity, try to solve this nature of how you can make it from serial to parallel in terms of the stages of capex, to set up power, coal stuff etc.
Another challenge that India is facing right now is how to get liquidity in, maybe in terms of bonds or amnesty. These are things that the government is also thinking of now. Towards the second half, you will have a better political situation than now hopefully.
Secondly, this quantitative easing (QE) program of the Fed has to run its course for the first six months because that's what they programmed. The US Congress has not extended the QE too much until they see it properly working. I don't think there will be any positive surprise in the QE in the first half, which means that in the second half there is a possibility of that also working out. These are things which will come in the second half.
Thirdly, if you look at capex, you have three legs. One is government capex, one is PPP which is largely now power and highways and the third is industrial capex. Industrial capex has been dead. The reason for that are not really interest rates. Reason for that is global outlook. Until people are confident of the global outlook, this will take a little bit of time because you make a five or 10 year plan not based on interest rates. That will start to pick up in the second half.
As far as the government capex is concerned, they have to be a little more confident of revenue generation. They might do something in the budget in terms of raising excise duties, some amount of divestment. Once they get a meaningful sum, they will be more confident on the government capex part of it. The PPP is the real leg which is continuing now. There, in both power transmissions, specifically, as well as the highway side because of various reasons that's what is getting delayed. There is a limit to how much you can delay that.
While it affects earnings it has to be made up. It will have to be done in the second half. These are things that we really need to look at in the second half and therefore, the challenge for investors will be how to be defensive and yet not so defensive that you are paying a high valuation and then to move into a more capex oriented portfolio.
Q: But you are sure that's the right strategy or tactical way to approach it that throughout the first three-six months, you look for opportunities to position yourself for the second half?
A: Yes but how do you do it? You can only study it and then see what happens at that price. Each of the hypothesis that I have laid out, what is actually happening to it to be able to monitor it.
Q: Its not a given?
A: Its not a given, it's only logically that I have told you certain steps.
Q: Does it worry you that too many people are thinking like you, that there is almost consensus that after the first six months things will improve in India?
A: Yes, and it is worrying because there are two points in that. One is 90% of the time the consensus is right and the problem is which 10% is the one that you are right and others are wrong and that's very difficult to figure out.
The other thing is having said this, the fears that you have today, in almost all aspects whether its money flowing to the US back from emerging markets or whether it's a local situation in terms of inflation and politics etc, still despite all that the market is at 19,000.
What does that mean in terms of flows? Let's take first the FIIs. Part of the money is India dedicated funds. In terms of stages normally what happens is first people get rid of their very aggressive stocks or those have already fallen.
Q: Banks have gone?
A: Banks are not really very aggressive. I will say more the capex related part. Banks is a fair mix of everything. There is an amount of secularity in banks. There is the consumer side, the housing finance side which is large part of credit growth which people don't realize.
At the first stage people get rid of all their really aggressive bets. Then they get rid of at the margin all the midcaps. Those two have really fallen, so then the third stage comes when the defensives fall. If you look at even the last 10 years history and if you look at various indices how they have performed up and down, when the defensives fall much sharper than the rest of the market is usually the bottom.
Q: So you think FMCG and IT will fall before this process is over?
A: Yes. In terms of flows, you had the FIIs which have done their bit. What they are left with is defensives. There has been a lot of selling but not a flood of selling. It has been in small dribbles. A lot of that is India dedicated funds which anyway they are long only and not much can happen.
Secondly, our perspective is based on the previous runs and there were a lot of hedge funds at that time. They are hardly active now. The third is the ETF and the emerging markets allocation funds. That part has not fallen yet because their whole thinking is -while right now you have money flowing into the dollar currencies, after six months how much the dollar can fall and how much the US can sustain its recovery is still a question mark.
Q: Is that money that patient six months out? Would they be thinking like that?
A: It is long only money. They will have to make major allocations. India is just a dot in that whole allocation. The question is if unemployment rate in absolute terms in the US is still high, does it make sense for them to move it more into the US. Right now you are seeing a rise in terms of your current account deficit, capex in terms of which are usually the first moves. At a basic level, all this is government spending. Corporate and consumer spending has not happened in the US.
The other part is about local mutual funds. We had a USD 6 billion outflow last year. That is not repeatable. So, that has sort of reached its base.
Q: But insurance?
A: In insurance, we have had USD 1.3 billion in the last calendar. This quarter is what people would look forward to and here again you have a rough estimate of 25-30% fall versus the previous January-March. The reason for that is twofold. One is the products moving more from equity to debt and the other is some churn because of ULIPs.
In flows, things do not really look that good and you have issuance, the issuance calendar from the government and from power realty and so on. This year money will be required. The government requires money, the private sector requires money. That will not derail the market because it is always a chicken or egg demand-supply but that will keep a lid on how much the market can go up.
Q: Is it a case of upsides being restricted or serious downsides still existing from this 19,000 level?
A: We did some very rough calculations on what is the absolute low and what is the absolute high it can go. Obviously, it did not reach that. The way we have structured it is basically saying that the lowest it can go is when you are comparing with bonds. Take the G-sec yield of 8.2% and maybe a little bit of it may increase but let us stick to 8.2% for now. If you take the inverse of that which would be the PE, so earnings yield, the inverse of that is the PE.
Q: So 12.5%?
A: Yes. If you work out the calculation, you will reach a Sensex level of 15,500 but that is like you are assuming zero growth because when you invest in equity you have growth. In this, you are saying that you are investing equivalent to a bond which is zero growth which is not possible.
Realistically speaking, roughly about 16,500-17,000 will probably be the bottom. We are at 19,000. If you look at the upside, the things that I have talked about in terms of capex growth etc which will happen in the second half, you will notice that people will also start factoring in FY13 by the second half of this year.
Yes, FY11 and FY12 may be a risk in terms of both, consumption and capex but on the consumption side, we are expecting de-rating rather than a huge fall in earnings growth.
As far as the capex side is concerned, you are already seeing the de-rating and you are going to have earnings growth that is basically postponed. If you look at that, then you have an FY13 which consensus EPS is 1,500 odd. Even if you take 1,400 and put a median PE over the last five years of 16 and even if you de-rate that to 15, because ROE is falling in India, you will get roughly 23,000 as something that could be there by the second half.
Q: That is also not being terribly aggressive. You are using just 15-16 PEs?
A: That is a median PE. If things are great and the US money comes back here, so it could be anything.
Q: So 17,000 to 23,000-24,000 seems like the band for you?
A: 17,000 to 23,000.
Q: But that is assuming you get that Rs 1,275 earnings for 2011? You are sanguine about that?
A: It really depends on the capex because the capex cycle affects the banking sector also and it depends on oil prices because that is oil and gas sector. These are the two great variables. So far, not too many analysts including us have de-rated based on probability of what may happen. We are basing it today, on our immediate term outlook. That will be a bit clearer as time goes on.
Q: What's your gut feel - are earnings at risk this year?
A: On the capex side yes, it is at risk.
Q: You could get sub 1,250 by the end of the year?
A: Could be.
Q: The cuts if it came, where would it come from?
A: It will come from capex and oil.
Q: The infrastructure stocks?
A: L&T's capex, on a secular basis, is something that just has to happen. L&T is a case where it's RoC and RoE is double that of any of its competitors. Therefore, it's very difficult for competitors to cut margins beyond an extent. Here, the de-rating is already happening.
It's a case of when do you catch a falling knife but if you were to take an FY12 basis, this capex has to come back. The power transmission, the industrial capex and the highways are embroiled in a lot of issues but these things have to come back. On a two year bet, those are the ones which will fly the most.
Q: When you say capex could be at risk, what kind of sectors do you mean?
A: Basically, it's your infrastructure and power.
Q: What about global commodity stocks - how much of a swing factor could that be?
A: Not much because people have been bullish on commodities because of liquidity for sometime and that's already factored into the prices. You have one or two large metal companies which are setting up large projects in both, metals and power. Some of these are specific bets that can be taken but in general, metals, especially, on the non-ferrous side; a lot is factored already into the prices.
Q: What about banks, that's a quarter of the index?
A: Banks are one area where we have made it overweight from underweight. It is not that the concerns have gone but largely because a lot of the fear has already been discounted for right now which is why we have moved it from an underweight position to an overweight position in the strategy report.
Q: Tactically, could it still test your patience for a while longer?
A: Yes. For the next two-three months it could be a problem because most people are actually expecting, including us, a small pre-budget rally. That is like a consensus call. That is related to two things. One is politically things coming together so that parliament can function smoothly and the second part is on interest rates because there will be a peaking off of inflation as the bumper crop comes in.
Once all that happens, all that newsflow would lead to a pre-budget rally but after that on the budget itself, nobody has any good expectations out of it. Most people, including us are expecting roll backs and so on. The government needs money.
Q: That is the concern. After what the Reserve Bank said, the government might actually have a fiscally prudent budget and that's not great news for the market, is it?
A: Yes that is a problem. There are no expectations out of the budget.
Q: When you say 17,000 -23,000, what are the factors which could drive it back potentially to 17,000, what are the risks this year?
A: Largely, it's your money flows to the US versus emerging markets. The other is whether Congress, BJP and the allies of Congress are able to sort out their differences, to let parliament run and how to implement various hurdles that we are facing in capex.
Right now, it seems to be a stalemate. When the Congress came to power, everybody was excited because we thought that every issue they will have a majority. Now, it almost seems that for every issue whether its opening up FDI, whether it's GST, they will have to either ally with their opposition or specific parts of their allies. That becomes difficult to forecast. The market is more scared of uncertainty than of the real issue.
Q: Can it get any worse than what it is already or do you think the risks are to the upside that after this there might actually be some positive news later in the year?
A: On a risk return basis, if you take a one year call, definitely, the return is higher than the risk. As far as the short-term is concerned, the main thing will be how the US consumption proceeds and the Christmas retail sales didn't give any clue. It's been neither good nor bad.
Just like we look at the US for funds and China looks at the US in terms of its exports, the US looks at Europe and Japan etc in terms of its exports and equally important is its own domestic growth. That domestic growth looks high, in terms of YoY basis but in absolute terms it's still quite low.
Q: But what's better for India in the middle of the year, an S&P at 1,400 plus means the US galloping away or a US which falters with growth in the middle, in terms of liquidity and how India might perform in that context?
A: Because we are headed into capex as the main driver, a better world market is better for us. In this particular situation, because a comparison with the US or China is a second order difference. Right now the first thing is that world growth is good and decent. Then you will have industrial capex kicking off as well.
In a normal market, the worse the US does, the more flows come to emerging markets and India is uniquely linked to the value of the currency, unlike China or any other country. This is because the US and India are both, twin deficit countries. So you run a fiscal deficit and a current account deficit. The stronger the rupee, generally more flows come in because it's through oil etc.
Q: What are you telling your clients to do on the defensives now because that's the tricky call according to you? For the next three-four months what would you do?
A: Our portfolio strategy is for the year. We will have to fine tune it a little bit for the next two months. The essential call that we are saying is that the FMCG in particular, the commodity prices have risen so fast and in such a huge magnitude that I don't think they give a degree of comfort in terms of earnings growth.
Q: You saw it in HUL as well this quarter?
A: Yes, HUL and another company was actually one of our top sells in the strategy report that we released a couple of weeks back. That is more medium-term, in terms of the next six-nine months outlook rather than a strategic all.
Q: The other company was ACC, so you were negative on cement too?
A: We were negative on cement in general and ACC in particular. There are two separate issues in this. ACC, amongst cement companies, is the least vulnerable to all factors which affect the cement industry which is one of the reasons why its valuation is high like if you think about its concentration in South India, if you think about how much dependence it has on imported coal.
Then if you impute a peak valuation that you saw a year or two back into FY13 and say - let me use that peak valuation and then see what returns I will get from now till then on the stock price, you are not getting more than 10% per annum. That means the best of FY13 has already been factored in. That's my problem with the cement sector.
Q: And IT?
A: On IT, we have tactically moved to a slightly overweight position but on a strategic basis we would be neutral. We would not go very overweight at this point in time. In the very near term, FMCG and IT may do better but on a six month basis the last stage of the market when it cracks is always the defensive's falling.
Q: You have Maruti in your top list of stocks. Are you are saying that you shouldn't right off autos just yet?
A: We had the largest overweight position in autos relative to the Nifty last year. We have moved that to a neutral position. It's a massive downgrade. The reasons for doing that is in the auto sector, the volumes are absolutely of no concern as of yet. Your capacities are full up as you have seen in some of the auto ancillaries as well. You are seeing no discounts.
The problem comes in terms of the margins, whether it is commodity prices or interest rates. Cars, relatively, are never that affected because an increase in EMI doesn't matter that much. It is more a demand led thing rather than the cost of paying for it.
When you look at commercial vehicles for example, even though we have got a high upside on the commercial vehicle companies, those are the most at risk if things were to worsen. If you look at the large cap universe, the most cyclical, in the last 10 years is commercial vehicles because that's where it hits.
The EMI increase cannot be sustained beyond a point so that's more vulnerable. Even though we still have a good target price upside, which is why we have not moved underweight but we have moved it back to a neutral position in auto.
Q: You said that you have a set of assumptions for the second half of this year but things need to be monitored, you can't take it for granted. Three-four months down the line what would convince you that your theory is playing out as you expected it or its getting derailed and you need to relook at your strategy piece?
A: Two things. One is what happens to the US consumer spend which is obviously linked to how everything pans out in the US which also affects the value of the US dollar etc. Secondly, one or two things being done by the government to show that the problems that we see in capex so far are being solved intelligently.
Q: Give me an example or two?
A: At a micro level, how do you get sand into Mumbai? Construction is being held up because of lack of availability of sand. This is a very micro problem but each of these issues has to have a solution. It can't just be a solution-less thing which is going on for months together.
One has to be practical and say - what is the best way out, so that you have a series of in principle approvals, so a promoter knows what to do. Right now it is uncertain. You can't have an industry with uncertainty. If it's not possible I will scrap the project but you cant be uncertain about things.
Post a Comment