Suresh Mahadevan, MD and Head of India Equities and Gautam Chhaochharia, ED and Head of India Mid-cap research, UBS Securities India express their views on global as well as Indian markets. In an interview with Vishal Chhabria and Sheetal Agarwal they say that markets may remain under pressure in the near term, but look attractive from a longer term horizon. Edited excerpts:
What are the chances of a double-dip in the US? And, what is your view on Indian markets?
Suresh Mahadevan (SM): Globally, we do not think we are going to enter a double dip recession. Specifically coming back to India I think clearly the biggest risk from the equity market perspective is flows. I think the big risk in the immediate short term is some of the FIIs panicking and getting out of India. But at the same time if you are taking a slightly longer term view this is a fantastic opportunity not to buy the market but to buy specific stocks. In the short term there could be further weakness primarily due to global factors that typically affects sentiment and liquidity. I think some of these developments may help India because if global commodity prices do come down that is better for us our inflation will come down and the tightening will stop. The corporates will be in a much better mindset to start the investments again. So there are some positives in it for India.
SM: It is always very difficult to predict that because markets overreact on both sides of the mean. The world is a much better place than it was in 2008. Maybe we can go to 10-11 times earnings and that is not fair value that is just overreaction. So, at 11 times earnings, Nifty will be close to 4,400 levels and Sensex could fall to 14,300 levels. Thus, markets can correct by another 10 per cent in the worst case scenario, in my view.
At the global level there has been a clear rush for getting into safe heavens, how do you see things unfolding over there?
SM: UBS global view is not very drastic and we are not calling for a double dip. However, I think it is very likely that the emerging markets will perform better over developed markets. Because the growth is higher, the balance sheets are in better shape and also valuations are attractive vis-à-vis growth. Within Asia also we are following the same logic and we are over-weight on India and China markets and we are underweight on markets such as Korea and Taiwan which are a lot more dependent on exports. I also think there is one important thing which maybe people are missing that the tightening cycle has pretty much run its course in India. We may see one more hike but my sense is that we are at the top end of that cycle which also bodes well for equities. I think from these levels you should get good returns if you are taking a medium term view but the problem is that today you buy at 16,500 levels markets may correct further to 14,000 given stock markets over react. However, the weakness won’t be a prolonged one.
Gautam: Compared to 2009, we are already two years ahead, in two years earnings pace has gone up a lot for India. We can’t compare at same 9,000 levels for Indian markets.
If u compare 2008 and 2011, how do you think India has changed from an investment perspective?
SM: If u look at cumulative flows it is very clear that more and more people are looking at India. However, the last 2 years have been a little bit disappointing, particularly, on the reform and policy fronts. But having said that I think India will grow despite all this. Of course, we will have our cycles. Even in 2009 we grow at only 6.8 per cent. But that is still a good number.
Gautam: So they have experienced that. On the way down in 2009 and on the way up they experienced and saw on mere numbers the Indian economy and markets both did much better than the global markets. That has definitely happened. The only worry has been on the political side, which again is very difficult to predict.
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On the global level do you see QE3 coming? And what kind of support do you see the governments extending?
SM: I dont think liquidity will dry up. I think policy makers across the world are very clearly making sure ample liquidity is available whether its keeping interest rates very low or whatever way. I think the issue is how bad it gets. We are forecasting a 1.8 per cent GDP growth for US and 3.3 per cent global growth. How much more downside is to that. I think sentiment and liquidity are global things and however much we can say India is a consumption driven economy the reality is we need capital. I think that global sentiment will impact flows.
You mentioned about the interest rates peaking out and global commodity prices are coming down. How do you see things shaping up from there?
SM: What is very clear to us is inflation is a real problem here. I do think its something that the RBI is quite committed to bringing it down to more reasonable numbers. Maybe its not a sub 5 per cent levels because of structural reasons like supply side constraints. I think it needs to come a lot lower than current levels to around 6 per cent level. Global commodities are related to that in the sense that petrol is almost market linked and diesel price hikes are being passed on. So to that extent, if global commodity prices do soften, then I think RBI maybe more inclined to pause. Our own estimate is 7-7.5% inflation by March 2012. I also think come Jan 2012 the base effect will start working favorably.
How does India compare with other Emerging markets in terms of growth rates and valuations?
SM: India has always commanded a higher multiple partly because we have a higher ROE and higher earnings growth. So clearly we will be on the higher side when it comes to valuations. But, I think India as opposed to some of the other countries which are either dependent on one sector or have more state owned companies, India is a story of private entrepreneurship across well diversified sectors. A higher entrepreneurship component leads to higher returns, thus boosting valuations. The most pessimist investor on India will agree that we will grow at 6 per cent in real terms for the next decade or 2 decades which is a level of compounding you wont get in many markets. Perhaps, Africa, Indonesia maybe China. But China the demographic dividend is shifting the other way now. So from that perspective India remains one of the few bright spots globally.
So in this scenario, how are you advising investors to position themselves in terms of equities?
SM: We are saying India is all about bottom up stock picking. We did a study recently where we looked at 2008 peak where stocks were till now. Which are the stocks that have done well and the ones which have done poorly. The results were quite eye opening. First thing is even within the same sector, some stocks did so well and some stocks did so poorly like TCS vs. Wipro or Hero Honda vs. Maruti. The outperformance is over 100 per cent in some of these sectors. Which means that you even if you pick the right sector it is not going to help. So that is how we have decided its time to focus on stocks. We have a list of 10 companies which we really think are very attractive – Bharti, Idea, Dr Reddy's, M&M, Axis Bank, Federal Bank, Mannapuram, ITC, Power Grid & BHEL.
Gautam: In the midcap the names which have done very well are Coromandel, Havells, VIP, Exide.
After the US downgrade and fears of double dip recession the IT sector has been hit. What is your view on the sector?
SM: In IT we have to relook at some of the numbers in the wake of the downgrade and more importantly the reasons for the downgrade. My own sense is luckily that sector has fairly high quality of governance, those companies are large, liquid, so to that extent I think there will always be investor interest in this sector which is a double edged thing because they might exit also. Infosys has not revised guidance which I think is a good thing. But maybe the lower end of the guidance now becomes the base case. This will mean that there is a bit of negative momentum there. But these are high quality companies. In the worst case scenario, Infosys can trade at 12-13 one year forward p/e multiple that is around Rs 1800-1900. Further, when times are tough companies still have to be competitive. I think off-shoring is an inherent part of the competitiveness of a company. The overall demand pie may come down resulting in lower growth. But Indian companies will get their business. A lot of people don’t realize that in US the problem is on government debt but the corporate sector is in much better shape than last time.
When do you see stability returning to markets?
SM: I think by November-December things should pick up as people will start focusing on FY13 numbers and then Indian stock markets will look very attractive.
What is your take on the Banking sector?
SM: I think credit growth will be around 18 per cent for this fiscal. There could be pressure from past restructured assets on the NPLs. If we see slowdown then the Banks' asset quality could be under stress. We think, 40 per cent of the overall power exposure is at risk (3.2 per cent of total bank loans) of restructuring or NPL by FY13. Gross NPL will go up by 80 per cent in the next two years. We have lowered earnings estimates by around 10 per cent. Our top picks in this space are Axis, SBI, HDFC Bank and Federal Bank.