 "Domestic, foreign investors rooting for Modi: Nick Paulson-Ellis")
As the country prepares for polls, domestic and foreign investors are keenly watching political formations and the impact they will have on economic growth.
In a no holds barred interview, Nick Paulson-Ellis, country head of Espirito Santo Securities, talks to Vishal Chhabria and Malini Bhupta on economic recovery, governance standards in India, expectations of foreign investors and the spectacular rise of Narendra Modi.
Going into the second half, everybody was talking of a pick-up in economic growth. How do you see things for Indian markets and economy, and what are you saying to your investors how to play this market (pre-elections)?
There is a lot of stress, which is not showing. Like the MCA deciding to change the accounting policy for foreign currency debt. The rupee has move from 45 to over 60, it is a massive change in the affordability of debt. So people can show the impact on their balance sheet till 2020. Overall, it’s going to be a difficult earnings season and we are going to face a choppy market.
In the last 12 months, we have seen the Sensex trading in the 18,000-21,000 range, and I don’t see a breakout from this range. An underlying improvement in the capex cycle which drives sustainable GDP growth, would be the most important driver. Hence, you can trade in this band and you can still find good and performing businesses, but you have to be careful.
The unknown is the political scenario. It is quite possible that you have a (Narendra) Modi-driven rally, built mainly on sentiment. Modi is well supported by the investment community, both foreign and domestic, because the desire for change is so strong, after the inadequacies of the current administration. This is something quite difficult to quantify.
Have you made any internal assessment on which way the sentiments are blowing as the country heads for elections?
Like everybody else we also rely on external polls. However, there hasn’t been a major national poll done after Modi was announced as BJP’s prime ministerial candidate. So we don’t know the Modi effect.
Polling pre-Modi looked like BJP getting 160-odd seats, which means it will have to line up a large number of coalition partners. Modi probably is a more difficult person for some coalition partners to accept, so BJP needs to get more seats for a strong mandate and the ability to nominate Modi as PM. That’s the kind of mandate investors want.
You mentioned about the weak capex cycle. So, how do you see the earnings trajectory, and what is the market factoring in these?
We have done a study of 400 companies which shows demand and growth is anaemic and there are no indicators of a turn in earnings. A sustained recovery depends on investment, which requires resolution on the issues around project clearances. There’s been some progress, but it’s been slow. Hence we are saying it will take 18 months for the investment cycle to turn.
For the last three years, Espirito Santo has been rating companies based on corporate governance standards. Do you see a pattern or red flags?
As often happens, governance deteriorates in times of economic stress as promoters find ways to show better profitability and this is visible in India too.
However, in 2013 some very important changes have happened like the passage of the Companies Bill, which surprisingly got passed in the last session, as well as proposed changes to Clause 49 by Sebi. The new Companies Bill will replace the courts, which should improve timely dispute resolution.
If one looks at the pharma, where most companies have an amber rating, the returns have been phenomenal?
Bad governance, which is marked in red, is when there is a greater risk of destroying shareholder value. Sometimes a company can have an amber rating and there can be subtleties to accounting practices which we think is a little bit too aggressive. Generally, corporate governance standards in pharma companies are high, with the exception of Ranbaxy, as it's a highly regulated industry.
What about PSU banks?
The big issue around PSU banks is that lending is determined by political objectives. The priorities of local politicians can drive lending which is normally bad lending. In general terms, private sector banks have good governance standards, with the exception of certain issues at Yes Bank.
What is wrong with YES Bank?
With Yes Bank we have issues around conflict between the two promoter groups, underlying asset quality, and promoter dominance.
Are FIIs still interested in India, what are they saying?
FIIs are interested in India. India, for all its current challenges, is not alone. All emerging markets are going through a difficult phase; China, Brazil, South Africa, all of them have their own challenges.
So, you have to look at India in that context. If you look at the last five years, it has been a disaster. Whether India exploits or is undermined by its demographics will likely be determined by the policy choices over the next two administrations.
In a no holds barred interview, Nick Paulson-Ellis, country head of Espirito Santo Securities, talks to Vishal Chhabria and Malini Bhupta on economic recovery, governance standards in India, expectations of foreign investors and the spectacular rise of Narendra Modi.
Going into the second half, everybody was talking of a pick-up in economic growth. How do you see things for Indian markets and economy, and what are you saying to your investors how to play this market (pre-elections)?
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My sense is that you have to navigate through a very difficult Q2 number for GDP, and earnings growth will also be materially impacted in the September quarter. Exporters will do well (IT and pharma), but others will not.
There is a lot of stress, which is not showing. Like the MCA deciding to change the accounting policy for foreign currency debt. The rupee has move from 45 to over 60, it is a massive change in the affordability of debt. So people can show the impact on their balance sheet till 2020. Overall, it’s going to be a difficult earnings season and we are going to face a choppy market.
In the last 12 months, we have seen the Sensex trading in the 18,000-21,000 range, and I don’t see a breakout from this range. An underlying improvement in the capex cycle which drives sustainable GDP growth, would be the most important driver. Hence, you can trade in this band and you can still find good and performing businesses, but you have to be careful.
The unknown is the political scenario. It is quite possible that you have a (Narendra) Modi-driven rally, built mainly on sentiment. Modi is well supported by the investment community, both foreign and domestic, because the desire for change is so strong, after the inadequacies of the current administration. This is something quite difficult to quantify.
Have you made any internal assessment on which way the sentiments are blowing as the country heads for elections?
Like everybody else we also rely on external polls. However, there hasn’t been a major national poll done after Modi was announced as BJP’s prime ministerial candidate. So we don’t know the Modi effect.
Polling pre-Modi looked like BJP getting 160-odd seats, which means it will have to line up a large number of coalition partners. Modi probably is a more difficult person for some coalition partners to accept, so BJP needs to get more seats for a strong mandate and the ability to nominate Modi as PM. That’s the kind of mandate investors want.
You mentioned about the weak capex cycle. So, how do you see the earnings trajectory, and what is the market factoring in these?
We have done a study of 400 companies which shows demand and growth is anaemic and there are no indicators of a turn in earnings. A sustained recovery depends on investment, which requires resolution on the issues around project clearances. There’s been some progress, but it’s been slow. Hence we are saying it will take 18 months for the investment cycle to turn.
For the last three years, Espirito Santo has been rating companies based on corporate governance standards. Do you see a pattern or red flags?
As often happens, governance deteriorates in times of economic stress as promoters find ways to show better profitability and this is visible in India too.
However, in 2013 some very important changes have happened like the passage of the Companies Bill, which surprisingly got passed in the last session, as well as proposed changes to Clause 49 by Sebi. The new Companies Bill will replace the courts, which should improve timely dispute resolution.
If one looks at the pharma, where most companies have an amber rating, the returns have been phenomenal?
Bad governance, which is marked in red, is when there is a greater risk of destroying shareholder value. Sometimes a company can have an amber rating and there can be subtleties to accounting practices which we think is a little bit too aggressive. Generally, corporate governance standards in pharma companies are high, with the exception of Ranbaxy, as it's a highly regulated industry.
What about PSU banks?
The big issue around PSU banks is that lending is determined by political objectives. The priorities of local politicians can drive lending which is normally bad lending. In general terms, private sector banks have good governance standards, with the exception of certain issues at Yes Bank.
What is wrong with YES Bank?
With Yes Bank we have issues around conflict between the two promoter groups, underlying asset quality, and promoter dominance.
Are FIIs still interested in India, what are they saying?
FIIs are interested in India. India, for all its current challenges, is not alone. All emerging markets are going through a difficult phase; China, Brazil, South Africa, all of them have their own challenges.
So, you have to look at India in that context. If you look at the last five years, it has been a disaster. Whether India exploits or is undermined by its demographics will likely be determined by the policy choices over the next two administrations.