 "Sanjay Mookim")
Even as headwinds persist, Sanjay Mookim, India equity strategist at Bank of America Merrill Lynch, says there are quite a few reasons to be positive on India. In an interview with Vishal Chhabria, he speaks on the earnings and market outlook and related issues. Edited excerpts:
China is slowing down, and ECB and Japan are infusing liquidity. Isn’t that clearly pointing to significant growth issues around the world? Are we heading for another global crisis?
There are no reasons to believe that significant concerns exist around growth. The Fed will increase rates at least twice this year, if not thrice, as we had thought earlier. Of course, there are head winds, but still, we see quite a few reasons for being positive on India – primarily because India is generally a beneficiary of the current environment of low commodity prices.
There are clear signs that the Indian consumer is still alive and kicking. While most of the discretionary categories continue to deliver stronger volume and top line growth, margin expansion is also happening due to lower commodity prices. This suggests that the weaker global commodity prices are helping India to stand out. Are there signals of a global crisis coming around? I don’t think.
With oil and other commodity producers in a bad shape and risk-off trade leading to withdrawals from India, it is going to hurt India and would this kind of a trend continue?
There is no reason to believe that the withdrawals should hurt India. To put it in a rather crude way, India has been paying the oil producers, who have been eventually investing that money to buy Indian equity. With the oil prices falling, the oil exporters are drawing less cash from India. Therefore, instead of buying Indian equity, they are now selling their historical holdings. Conceptually, it is better for India to save money and put it in equity and this is evident from the fact that Indian flows in mutual funds have significantly gone up. Therefore, structurally, India is in a better situation today.
How do you see global events pan out, especially the growth part as well as with respect to China?
Although China may continue to muddle along on fiscal parameters, I do not expect a severe action from the country in the near future. India, in many ways, is de-coupled from China and hence it should not lose out on growth even if worries in China continue. If there is a global crisis, of course everybody will get affected, including India.
As of now, the global markets are hoping for some sort of an action from central banks. The general consensus is that the Fed should start to ease in some form or the other - either pause the rate hike or start easing the rates -- which is what the global equity markets are praying for.
But if fed actually does ease, will it not send a wrong signal to the world given its sudden U-turn?
If Fed eases, then it might send a wrong signal, especially in the current complicated economic scenario. There are signs that the US economy is still doing okay but some recent US data pointers have raised concerns, leading to a conundrum around growth. Worries are that the strengthening of the US dollar is hurting US economy and its companies, building expectations that the central bank might do something to control the appreciation of its currency. That is why, predicting a near-term action has become very tricky in this complicated scenario.
Your house view is that oil prices have bottomed out. What is the outlook for the next one year?
Our forecast for average oil prices is $51 for FY17. The demand-supply scenario would remain balanced over the next six-nine months. There is currently an excess of inventory, which should be flushed out of the system also helped by production discipline.
How will the price rise hurt India’s macro and Indian companies?
If oil prices rise from here, India’s import bill would obviously increase and factors such as balance of payments etc. would deteriorate. Also, prices of other commodities are linked to oil and hence they will also start to track up, pushing up the WPI back to around 4 per cent (currently at minus one). There isn’t a one-to-one correlation (of higher oil prices) with corporate margins. However, some companies would still experience margin contraction.
The gains from reduction in commodity prices cannot continue for long and there are demand issues as well. How do you see earnings panning out?
While the wider consensus for earnings growth is 18% FY17, our top-down estimates are somewhere around 12-13%. About a month before, we did some detailed work on the impact of dis-inflation on corporate earnings. The premise initially was - When the nominal GDP growth is at 6%, it would be difficult for earnings to grow 17-18%. The work suggests that if oil prices remain low and consumer price increase does not happen, then there is a loss of about 3-4% on earnings for these companies. There are certain sectors and companies at risk if pricing power does not come back and we argue that this has not happened in the last 30 years. We estimate that earnings of Sensex companies would grow somewhere around 5-6% to Rs 1,360 in FY16.
Which are the areas you think will be outliers on the earnings front?
In the short-term, banking will continue to remain under severe stress because of the acceleration of the booking of the NPAs. While the December quarter has been particularly bad for all the banks, March quarter doesn’t seem to be any different. There is still no clarity around the June and September quarters. Does the stress booked by banks continues in FY17 or would there be some sort of relief? We don’t know the answers yet.
The consumer discretionary sector, however, continues to deliver growth supported by the underlying demand and other catalysts. Lending rate cuts together with the Pay Commission will further drive the discretionary demand.
The defensive basket of IT and pharma continues to look good due to a steady demand, earnings trajectory and the recent depreciation of the rupee adding to their earnings. The concerns are around the capex-heavy sectors such as industrials and materials, where demand is linked to global factors and is expected to remain under stress.
Your take on, when would the capex cycle revive?
The key driver for capex cycle is the aggregate industry utilisation, which as of today is extremely low in case of heavy industries, cement, steel and power. The government can do very little to catalyse further investments in steel, as it is linked to the global demand. Some degree of power capex is happening, but the utilisations are sub 70%, which means it will take years before India needs to build many more power plants. That is why I think, there will not be a pick up in the corporate side industrial capex in the next visible quarters. The government, in its desire to cut deficits and transfer money to the Pay Commission, has little left to spend.
A lot of focus has been laid on railways, roads, etc. What is your outlook for infra sector?
Roads sector, which has been doing better, will continue to be a focus of expenditure. Railways, despite a lot of discussions around capex, has been well behind the FY16 budget targets. Hopefully, this will get corrected next year supported by the availability of third-party funding.
Beyond roads and railways, the market is hoping for some big ticket investment push coming from the central government.
In comparison, the state governments are way bigger in aggregate numbers, spending 60% more than the central government next year -- to build roads, houses, irrigation and power capacity in rural India. Cement sector will benefit out of this.
In banking, will the NPA reporting issues be done away with by September quarter?
Majority of the banks have said that the incremental stress levels in March quarter would be in-line with that in the December quarter. Interestingly, the classification of a corporate as an NPA is not homogenous across banks. Therefore, the re-alignment of this may continue till September quarter and its magnitude is tough to assess as of today. Also, going forward, the NPAs booked by banks today will age, thus needing more provisioning – adding to further stress.
The second problem arises from a bunch of corporates, the so-called over-leveraged groups, who are still not classified as NPA by any of the banks. The risk is - if any of these large corporates also tip over, then there could well be another hit on the banks.
Would you be buying PSU or private banks at these levels?
Most of the large corporate facing banks, both PSUs and private, are starting to discount a very large amount of potential stress. And that is why we have an ‘outperform’ rating on the big banks because of comfortable valuations. Therefore, for investors with having a long-term view, the prices are right.
How do you see the ‘Bad loan bank’ proposal?
I haven’t tracked the details of this proposal carefully, but conceptually speaking, the only way it would work is if, enough capital is made available to whichever entity is booking the bad loans - whether individual PSU banks or a bad loan bank. Still, I do not see the capital forthcoming in a very big way in the short term. So the problem remains as it is.
What is your outlook for the Indian market for 2016?
Our Sensex target is 26,000, premised on an earnings growth of about 12%. However, we are underweight on India in the regional context and EMs (emerging markets) globally. Investors in India should focus on consumption stocks instead of trying to time the global recovery. These companies along with IT and pharma should push index earnings up by 12-13% next year, translating into an upside for the index.
When do you expect the trend in FII selling to bottom or reverse?
There are two aspects to it - withdrawal by sovereign funds and general withdrawal from the EM funds. India is an overweight for the EM funds and until you see the withdrawals reversing, I don’t think FII inflows into India will come back meaningfully. When does the appetite for EM improve globally? There is no answer, but some sort of central bank catalyst could help.
Now the Modi magic seems to have faded off. What are your views on that?
In one of our research notes, we have tried to establish that the market and economic cycles in India have been coincident. So, unlike in theory, where you can argue that the market should trend up anticipating a turn in the economy, the Indian market and economic cycle have instead been correlated, coincident. There are market oscillations seen around the economic cycle in India. What perhaps the 2014 elections did was to create an oscillation around the economic trend, which is now correcting.
As the Indian economy improves, the market should also track up with it. Whichever government is in power, turning an economy of the size of India does take time.
What are your expectations from the budget and how would you position yourself in its run up?
The top down argument is that the government doesn’t have too much fiscal room, especially if it sticks to the fiscal deficit target of 3.5% in FY17. It may eventually have to bust that target a little bit and our expectation is of 3.8%. The other important aspect for the government is to support rural India. There is significant stress in the rural economy after two bad monsoons and agri prices are just not growing.
Historically, the big growth in rural India has always been led by prices, which is not seen happening. So, even if the volumes grow 2-3% but prices are flat, there could be only 2% of agri growth. That is why the government needs to use all its energy to support the bottom of the pyramid, which again supports the argument of buying cement as a play on infrastructure and spending in rural India.
The government will draw something more from tax optimisation but otherwise I don’t see a big catalyst for the market from the Budget.
Bonds yields have remained quite elevated despite the rate cuts. How do you see the trend going ahead?
Bond yields have remained tight because the RBI’s liquidity policies have been tighter. Even though the policy rate has been cut, RBI was not infusing permanent liquidity, until end-December. As liquidity improves, there could be a 10-15 basis points reduction in the 10-year bond yields. We have a forecast of 7.5% for 10-year G-secs.
