 "Macro indicators in place to drive higher growth rates: Manish Kumar")
With growth expected to improve in the next couple of quarters and given multiple tailwinds in the form of lower interest rates, debt reduction and savings due to lower commodity prices, expect corporate earnings growth to be in double digits in FY17, says Manish Kumar in an interview to Vishal Chhabria. Edited excerpts:
Is there an improvement in the economy?
The macroeconomic indicators seem to be in place to drive growth rates higher. Unlike in the past, global commodity prices have now collapsed, bringing inflation down significantly. Moreover, interest rates are down 100-150 basis points (bps) and could fall further. Importantly, the government’s fiscal position is much better and the rupee is one of the best performing currencies amongst emerging markets. So, the construct for growth is there due to low interest rates, this is typically followed by improvement in demand and higher investment. Therefore, we expect growth to improve in the next 6-12 months.
Right now the signs of visibility may be low and we are not saying that growth has come back. But, the construct for growth to resume is in place. We expect some triggers to be visible in the next 3-6 months. Firstly, as per IMD estimates, an above normal rainfall is expected. Secondly, the Seventh Pay Commission being implemented in the second half of FY17 would result in more income in the hands of government employees. These two factors combined are expected to have a positive impact on the overall demand going forward.
Moreover with better availability of coal at lower prices and implementation of UDAY scheme, the finances of SEBs are likely to improve, which would result in higher demand for power. The impact from the pick-up in infrastructure projects including roadways, railways and the defence sector, etc. are expected to be felt over the coming years. All these factors coming together will improve the overall investment environment. While we are not expecting the growth to jump sharply, we expect it to go up from the current level of 7%.
What are your earnings expectations for financial year 2016-17?
We were relatively conservative last year and expected subdued corporate earnings growth in FY16. We would not be surprised if earnings growth revives in FY17. As one-third of our index is positively leveraged to commodities, corporate earnings suffered because of the fall prices, which was responsible for practically no earnings growth in FY16. With a lower base and a slight acceleration in the gross domestic product (GDP) growth to 7.5 per cent and along with benefits of savings on commodities, lower interest rates, some de-leveraging in corporate balance sheets, aggregate corporate earnings growth could achieve low double digit growth in FY17.
Which areas will drive earnings growth?
We are positive on private sector banks, automobile and telecom stocks. In automobiles, we have a preference for companies that either have a global franchise or strong rural presence. We are also positive on select cement and engineering stocks.
Are you also expecting these stocks to do better?
Yes, that is the reason why we have a preference for these companies. Some of these companies may not necessarily be the best in terms of earnings growth, however given their stock prices we believe they are priced attractively due to the earnings growth expectations. For instance, certain companies may be priced for an earnings decline but the decline may not be as much as the market is expecting. In some other companies, the earnings growth paradigm is looking good for FY18. Considering that the market is forward looking, and as we progress in FY17, the market will start focusing on FY18 earnings growth, which would result in improved returns for investors.
You mentioned that the defence policy cleared recently will take some time to play out. When do you expect the ball to start rolling?
For most of the defence projects, one is the announcement and the other is the issuance of orders and its translation into revenues for companies. Many projects have long gestation periods. While some of the orders are for buying certain kinds of vehicles/equipment, which are of shorter duration, most others are big projects where the companies have an obligation to meet the offset clause i.e. to manufacture a proportion in India for imports undertaken which will result in some revenues for Indian companies. These projects may take a lot of time for execution. Moreover, when we look at the Union Budget FY17, the allocation for the defence sector has not gone up sizeably which further indicates that fiscal constraints will not allow the government to go at a fast pace. So, while it is a huge opportunity, the benefits would come gradually over the years.
Is it the right time to start looking at the capex cycle?
While we expect the recovery cycle to take off at some stage, the Capex cycle is the second derivative of growth. First, the growth has to come and then Capex cycle will follow. Therefore, we are underweight on the Capex theme though positive on select companies in EPC and Power T&D industries. Sectors like metals and power, where there is huge over capacity either globally (metals) or domestically (power) are not expected to witness huge investments. We expect investments in roadways, railways, defence, and also in other forms of infrastructure like water/waste management. We believe that the Capex theme is a three year story.
Have commodity prices bottomed out?
We would like to look at metals and oil differently. Tactically, it appears prices of metals have bottomed out because we are seeing production squeezes in China. However, whether it's steel or aluminium, these are investment-linked commodities. So, once a country has gone through a huge investment phase, which China has, requirement of metals declines leading to a prolonged period of benign prices. Our view is that metal prices may not rally significantly and, hence, could remain sideways. Therefore, we are structurally negative on metal companies, although we keep taking tactical calls.
Oil prices, however, seem to have formed a structural bottom and the ability of prices to move northward is much higher. Unlike metals, oil is a consumption commodity. Therefore, even if there is a slowdown in China, it means the pace of growth in consumption may decline. However, chances are that consumption would still go up. There will rarely be a situation where demand is down by 10-20 per cent. Excess supply in oil is also just about 1-2 per cent or about two years of incremental consumption. Secondly, most of the marginal capacity that has come in the past five years has been from shale, which is more costly to produce. So, over the next two years or earlier, oil prices are likely to move northwards in the range of $60 or above. Therefore, we are positive on upstream oil companies.
What kind of inflows do you anticipate into emerging markets from foreign investors?
While we expect moderate flows into emerging markets this year, we also believe there could be periodic outflows depending on actions of global central banks. Hence, we do not expect a huge rally in the domestic market and expect markets to be range-bound in the near term. Currently, we are in the middle of ‘risk on’ rally, but if the US were to raise rates, which we expect to happen twice this calendar year, this may result in some pull back.
What kind of trend do you see in bond yields and what's the outlook for 2016?
Given that the markets have witnessed a rally in the 10-year GoI bond, which is currently at about 7.4% levels and on account of the expected supply of government securities in the first half of FY17, our outlook over the next 12 months is neutral to positive.
Will you be taking any kind of credit risk?
Since the spread had shrunk significantly and therefore the risk was not priced appropriately, we were more inclined towards government bonds than corporate bonds. Going ahead, if spreads increase and present an adequate opportunity for investments, we would be inclined to increase our exposure to corporate bonds.
What are your expectations, given the Reserve Bank of India (RBI)’s rate cut? With banks being slow in passing rate cuts, how soon do you expect transmission to pick up?
The rate cut is happening gradually. Given recent inflation readings and likelihood of a normal monsoon, we expect RBI to continue with its accommodative stance. The cut in small savings rates was an important move. This would enable banks to lower deposit rates and pass it on to borrowers. Given weakness in credit demand, we expect interest rates to come down further.
One reason for the delay in transmission of earlier cuts has been the asset quality challenges faced by banks. Banks are trying to manage their P&L by not bringing down rates quickly. With asset quality challenges getting addressed gradually, banks' ability to pass on cuts will be higher. We expect better transmission in the second half of FY17.
Are you still bearish on PSU banks?
The reasons are obvious and one of them being that as a franchise they could have done a better job of managing their asset quality. They are also starved of capital. These factors will restrict their ability to grow profitability. PSU banks are expected to go through one more year of serious challenges. Yes, some of them have done a relatively better job of establishing a good liability franchise and let me not take that away from them. However, it's difficult to imagine PSU banks as a category to do well. Thus we would like to play it selectively and only through the top one or two banks.
How will the coming of new banks – payments and small banks – impact the sector?
These are very niche banks. The impact that these banks will have on the economy is that they will bring a lot of unbanked people into the fold of mainstream banking. Therefore, we will be a better penetrated banking sector. Further, payments bank can do well not just riding on unbanked customers but even on the existing customer base, but that would be more transaction driven. Broadly speaking, these banks would be complimenting the existing banking architecture rather than being competitive.
Is there an improvement in the economy?
The macroeconomic indicators seem to be in place to drive growth rates higher. Unlike in the past, global commodity prices have now collapsed, bringing inflation down significantly. Moreover, interest rates are down 100-150 basis points (bps) and could fall further. Importantly, the government’s fiscal position is much better and the rupee is one of the best performing currencies amongst emerging markets. So, the construct for growth is there due to low interest rates, this is typically followed by improvement in demand and higher investment. Therefore, we expect growth to improve in the next 6-12 months.
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But, looking at various indicators, it looks a pickup in economic growth is still some time away? Where and when is this growth going to come from?
Right now the signs of visibility may be low and we are not saying that growth has come back. But, the construct for growth to resume is in place. We expect some triggers to be visible in the next 3-6 months. Firstly, as per IMD estimates, an above normal rainfall is expected. Secondly, the Seventh Pay Commission being implemented in the second half of FY17 would result in more income in the hands of government employees. These two factors combined are expected to have a positive impact on the overall demand going forward.
Moreover with better availability of coal at lower prices and implementation of UDAY scheme, the finances of SEBs are likely to improve, which would result in higher demand for power. The impact from the pick-up in infrastructure projects including roadways, railways and the defence sector, etc. are expected to be felt over the coming years. All these factors coming together will improve the overall investment environment. While we are not expecting the growth to jump sharply, we expect it to go up from the current level of 7%.
What are your earnings expectations for financial year 2016-17?
We were relatively conservative last year and expected subdued corporate earnings growth in FY16. We would not be surprised if earnings growth revives in FY17. As one-third of our index is positively leveraged to commodities, corporate earnings suffered because of the fall prices, which was responsible for practically no earnings growth in FY16. With a lower base and a slight acceleration in the gross domestic product (GDP) growth to 7.5 per cent and along with benefits of savings on commodities, lower interest rates, some de-leveraging in corporate balance sheets, aggregate corporate earnings growth could achieve low double digit growth in FY17.
Which areas will drive earnings growth?
We are positive on private sector banks, automobile and telecom stocks. In automobiles, we have a preference for companies that either have a global franchise or strong rural presence. We are also positive on select cement and engineering stocks.
Are you also expecting these stocks to do better?
Yes, that is the reason why we have a preference for these companies. Some of these companies may not necessarily be the best in terms of earnings growth, however given their stock prices we believe they are priced attractively due to the earnings growth expectations. For instance, certain companies may be priced for an earnings decline but the decline may not be as much as the market is expecting. In some other companies, the earnings growth paradigm is looking good for FY18. Considering that the market is forward looking, and as we progress in FY17, the market will start focusing on FY18 earnings growth, which would result in improved returns for investors.
You mentioned that the defence policy cleared recently will take some time to play out. When do you expect the ball to start rolling?
For most of the defence projects, one is the announcement and the other is the issuance of orders and its translation into revenues for companies. Many projects have long gestation periods. While some of the orders are for buying certain kinds of vehicles/equipment, which are of shorter duration, most others are big projects where the companies have an obligation to meet the offset clause i.e. to manufacture a proportion in India for imports undertaken which will result in some revenues for Indian companies. These projects may take a lot of time for execution. Moreover, when we look at the Union Budget FY17, the allocation for the defence sector has not gone up sizeably which further indicates that fiscal constraints will not allow the government to go at a fast pace. So, while it is a huge opportunity, the benefits would come gradually over the years.
Is it the right time to start looking at the capex cycle?
While we expect the recovery cycle to take off at some stage, the Capex cycle is the second derivative of growth. First, the growth has to come and then Capex cycle will follow. Therefore, we are underweight on the Capex theme though positive on select companies in EPC and Power T&D industries. Sectors like metals and power, where there is huge over capacity either globally (metals) or domestically (power) are not expected to witness huge investments. We expect investments in roadways, railways, defence, and also in other forms of infrastructure like water/waste management. We believe that the Capex theme is a three year story.
Have commodity prices bottomed out?
We would like to look at metals and oil differently. Tactically, it appears prices of metals have bottomed out because we are seeing production squeezes in China. However, whether it's steel or aluminium, these are investment-linked commodities. So, once a country has gone through a huge investment phase, which China has, requirement of metals declines leading to a prolonged period of benign prices. Our view is that metal prices may not rally significantly and, hence, could remain sideways. Therefore, we are structurally negative on metal companies, although we keep taking tactical calls.
Oil prices, however, seem to have formed a structural bottom and the ability of prices to move northward is much higher. Unlike metals, oil is a consumption commodity. Therefore, even if there is a slowdown in China, it means the pace of growth in consumption may decline. However, chances are that consumption would still go up. There will rarely be a situation where demand is down by 10-20 per cent. Excess supply in oil is also just about 1-2 per cent or about two years of incremental consumption. Secondly, most of the marginal capacity that has come in the past five years has been from shale, which is more costly to produce. So, over the next two years or earlier, oil prices are likely to move northwards in the range of $60 or above. Therefore, we are positive on upstream oil companies.
What kind of inflows do you anticipate into emerging markets from foreign investors?
While we expect moderate flows into emerging markets this year, we also believe there could be periodic outflows depending on actions of global central banks. Hence, we do not expect a huge rally in the domestic market and expect markets to be range-bound in the near term. Currently, we are in the middle of ‘risk on’ rally, but if the US were to raise rates, which we expect to happen twice this calendar year, this may result in some pull back.
What kind of trend do you see in bond yields and what's the outlook for 2016?
Given that the markets have witnessed a rally in the 10-year GoI bond, which is currently at about 7.4% levels and on account of the expected supply of government securities in the first half of FY17, our outlook over the next 12 months is neutral to positive.
Will you be taking any kind of credit risk?
Since the spread had shrunk significantly and therefore the risk was not priced appropriately, we were more inclined towards government bonds than corporate bonds. Going ahead, if spreads increase and present an adequate opportunity for investments, we would be inclined to increase our exposure to corporate bonds.
What are your expectations, given the Reserve Bank of India (RBI)’s rate cut? With banks being slow in passing rate cuts, how soon do you expect transmission to pick up?
The rate cut is happening gradually. Given recent inflation readings and likelihood of a normal monsoon, we expect RBI to continue with its accommodative stance. The cut in small savings rates was an important move. This would enable banks to lower deposit rates and pass it on to borrowers. Given weakness in credit demand, we expect interest rates to come down further.
One reason for the delay in transmission of earlier cuts has been the asset quality challenges faced by banks. Banks are trying to manage their P&L by not bringing down rates quickly. With asset quality challenges getting addressed gradually, banks' ability to pass on cuts will be higher. We expect better transmission in the second half of FY17.
Are you still bearish on PSU banks?
The reasons are obvious and one of them being that as a franchise they could have done a better job of managing their asset quality. They are also starved of capital. These factors will restrict their ability to grow profitability. PSU banks are expected to go through one more year of serious challenges. Yes, some of them have done a relatively better job of establishing a good liability franchise and let me not take that away from them. However, it's difficult to imagine PSU banks as a category to do well. Thus we would like to play it selectively and only through the top one or two banks.
How will the coming of new banks – payments and small banks – impact the sector?
These are very niche banks. The impact that these banks will have on the economy is that they will bring a lot of unbanked people into the fold of mainstream banking. Therefore, we will be a better penetrated banking sector. Further, payments bank can do well not just riding on unbanked customers but even on the existing customer base, but that would be more transaction driven. Broadly speaking, these banks would be complimenting the existing banking architecture rather than being competitive.