 "Surendra Goyal")
Surendra Goyal, Head of India Equity Research at Citi India, part of the multinational financial services group, feels earnings growth will be crucial to sustain the market momentum and explains why stocks in private banks, four-wheelers, cement and pharmaceutical sectors emerge as defensives, in a conversation with Hamsini Karthik. Edited excerpts:
How comfortable are you with the recent run-up in the markets?
If you compare some of the macro indicators with what was the case at the same time two years earlier, things seem better at the margin. Recovery has been uneven but largely along expected lines. From an earnings perspective, we are expecting 13–14 per cent growth, as against flattish growth in the past two years. These factors make the Indian market attractive on a relative basis. Liquidity has helped the markets.
From a global perspective there are challenges and I don’t think one should ignore these. You have the Chinese currency devaluation. US Federal Reserve rate hikes spooked the market earlier this year. While Citi does not have a view of this happening (again) anytime soon, the event is not off the table. The US election is another unknown variable. While the market seems to have digested Brexit in the short term, there will be a lingering impact in the UK and Europe. These are challenges that can’t be ignored but there are things in favour of India and if these play out, we still have decent relative positives.
What more, apart from (a good) monsoon and seventh pay commission (implementation), do we need to keep the momentum on?
While the monsoon and pay commission have helped the market, inflows into emerging markets have also been strong. That’s also helped the Indian market, post (Union) Budget. But, the key thing to watch for is earnings. In the past two years, we started the earnings season with the growth expectation in teens and ended up with flattish to low-single digit growth. So, now, there is a lot of scepticism on earnings forecasts. If earnings come through, the markets will do fairly well.
Do you expect major upsides from GST (the proposed national goods and services tax)?
GST has been talked about for a while. A part of it has been priced in. But, there are still some elements of GST we don’t know about. There should be longer term benefits in terms of implications for the indirect tax code and significant supply chain benefits from the reduction in interstate trade barriers. We will only know the quantum of the upside once we see the details.
How optimistic are you about this earnings season?
From a growth perspective, we expect the earnings growth to be flat on a year-on-year basis in the first quarter of FY17. The earnings in the third and fourth quarters of FY16 were relatively weak and, so, the base will become favourable towards the second half of FY17. Second, from the 13–14 per cent earnings growth we expect this year, around four per cent or so will come from metals and financials, as the base was weak last year. Continued momentum in sectors like automobiles, pharmaceuticals, industrials, etc, should help.
However, there are risks. In metals and mining, we are cognizant of the volatile commodity prices and we monitor these closely. But, at this point, we are comfortable with our earnings growth target.
Which sectors would contribute to this growth?
We remain overweight on financials. Cement is a sector we have liked for a while. We recently increased our exposure in the pharmaceuticals sector, as we see the regulatory overhangs of the sector easing. Earnings growth in the sector has been okay and we are expecting 20-plus per cent earnings growth for the pharma pack, way ahead of market growth. Likewise, we are overweight on four-wheelers in the automobiles space.
We are largely underweight on information technology (IT) services and consumers (goods).
We published a report more than a year back, pointing to the challenges for profitable growth in IT. Revenue growth has started to slow in the past few quarters and operating profit growth is even slower. We expect things to be challenging in the near to medium term. For consumer goods, when you see the valuations of consumer stocks in the context of muted volume growth, it is difficult to be constructive on the sector.
From a defensive perspective, what sectors would you recommend?
We are going with sectors where earnings visibility is high. In this context, we like private sector banks, four-wheelers in the automobiles sector, cement and pharma. Consumer goods has traditionally been considered defensive but the valuations (here) are high, considering the growth outlook.
