Pre-Budget rally on cards; banks, infra stocks may shine: Pankaj Pandey

Sectors like FMCG and auto could be the first to recover from the demonetisation pain

With less than a month before Finance Minister Arun Jaitely presents Union Budget for 2017-18, a pre-Budget rally, led by banking, infratructure and capital goods stocks, may be in the offing, believes PANKAJ PANDEY, who heads retail research at ICICI Securities. In an interview with Aprajita Sharma, Pandey extensively talks about the aftermath of the government’s move to demonetise high-denomination currency notes, and says sectors like FMCG and automobile could be the first to recover from the demonetisation pain. 

Do you expect a pre-Budget rally in the market? 

After the anticipated aftermath of demonetisation, all eyes will be on the Budget, and investors will expect a slew of reforms to be announced in the Budget 2017. In such a scenario, there is a high chance that markets will witness a pre-Budget rally. The sectors that can hog the limelight in the event of such a rally would be infrastructure, capital goods, agriculture-based sectors and banks.

Stocks from sectors with high cash transactions, such as real estate, consumer durables, automobile and FMCG, have fallen the most since the government’s demonetisation move on November 8. Are valuations in these sectors factoring in the demonetisation impact, or more pain is left? 

The impact of demonetisation is estimated to be limited in the staple category of FMCG. However, the discretionary segment is hit hard. We believe that this will be a near-term disruption for the sector (estimated till the second half of 2016-17) and the demand scenario will improve with revival in the rural demand from the first quarter of next financial year. 

The growth in the FMCG industry is going to be driven by volume, along with realisation growth compared to only price-led growth in 2016. We expect demand to be driven by rural India, which accounts for 40 per cent of total FMCG sales and two-thirds of total retail outlets. The incremental government spend towards rural development in the wake of its aim to double rural income would be among key demand drivers in calendar year 2017.

Automobile is also expected to witness a recovery, as we believe that the demonetisation impact will lead to a demand deferment and not loss of demand due to high finance penetration.

The demonetisation pain will be elongated in the real estate space, where speculative demand in the secondary market after demonetisation could keep primary market prices and sales volumes under pressure, especially in the luxury/high-ticket residential segments. Similarly, the consumer discretionary sector is likely to witness slower demand recovery, with consumers prioritising their expenses towards essentials.

As the uncertainty over demonetisation is expected to linger on, which sectors would you advise to avoid and where should one park money? 

We expect sectors like banking, capital goods, FMCG, auto and logistics to do well in CY17. We believe the real estate sector as a whole could face challenges going ahead. Similarly, the real estate slowdown will also have an impact on cement demand, as 60 per cent of sales come from the housing segment.

What could bring momentum to banking stocks in 2017? What are key risks? 

Demonetisation is seen as a positive for the economy as a whole, and for the banking sector in the long run. Demonetisation will have a positive impact on two to three fronts – higher deposit accretion, treasury gains and gradual improvement in efficiency. Phasing out of old currency notes and withdrawal restrictions together have led to a surge in low-cost deposits which is margin-accretive and could have a positive impact of 5-15 per cent on profit after tax. With greater acceptance of digital channels, including e-wallets and plastic money, transaction volumes and subsequent fee income could get a boost in the long run. Lower cost of digital transactions will also aid lowering banks’ operating costs. With higher liquidity, the interest rate trajectory is moving southwards; this will lead banks to garner treasury gains, supporting earnings to the tune of 12-20 per cent.

Despite positives, there are some concerns that can keep banks’ profitability at bay. Amid increased proportion of deposit base, longer than anticipated slowdown in credit demand from the corporate segment could have a negative impact on margin. In addition, banks also face the risk of higher delinquencies from exposure to small businesses and LAP, which has been impacted by a liquidity crunch. 

To counter a slowdown in credit demand, steep cuts in marginal cost lending rate (MCLR) have been undertaken by leading banks. This move is seen providing impetus to the lacklustre credit demand, especially from the retail segment. With passage of interest benefit, banks could face some margin pressure in the initial phase. However, the move will help drive balance sheet growth which will ultimately benefit the economy as a whole.

Which sectors stand insulated from demonetisation? Are valuations attractive in those sectors?

Sectors like information technology, pharmaceuticals, oil & gas, metals and power are largely immune to demonetisation move. However, they have their own share of problems: Pharma, for example, is facing pricing probe in the US, and IT continues to face challenges like immigration rules after President-elect Donald Trump takes charge at White House, and continued uncertainty around Brexit and European geographies. Similarly, a healthy portion of the overall steel demand comes from the real estate sector. And, with demonetisation, the consumption for long steel products could witness some near-term pressure. 

In the power space, we like regulated utilities. Similarly, in the oil & gas space, we continue to remain positive on gas utilities, in spite of re-rating of multiples on account of favourable government policies and lower domestic gas prices.