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After hitting new highs, the market has seen a correction in the last few days. Vikas Khemani, President and CEO, Edelweiss Securities speaks with Vishal Chhabria on the recent trends in market, economy and earnings, sectors that will do well and the IPO market among other things. Edited excerpts:
The markets, which were nervous in the last few days over the possibility of AAP's victory in Delhi elections, have actually rebounded on Tuesday even as AAP has won more seats than anticipated. What is your take on the market's reaction?
Delhi results were factored in post exit poll surveys. Market correction was underway post recent steep rally, not only due to Delhi election. There were other factors also at play such as poor quarterly earnings and global factors. Now markets will look forward to the budget session.
Will AAP's landslide victory have an impact on the working of the Central government, say for instance more populist measures in the forthcoming Budget or delay in hard decisions, etc?
I do not think AAP victory will have any major impact on Central government as Centre has clear majority. Also Delhi election was not won on populist promises by AAP. It was clear case of 3 way fights converting into 2 way, congress being absent and congress votes tilted in favour of AAP. So BJP will surely have to rethink on their election strategies for forthcoming state elections. We have seen in recent times, Populist promises and attitude do not win elections.
The BJP government has made many announcements but the macro data like low credit off-take and IPP numbers, are still subdued. Are you seeing any kind of changes happening at the ground level or it's too early?
It is unreasonable to expect a credit off-take and IPP numbers to start improving immediately. The Government took charge post a long period of policy paralysis and right now they are forming, correcting and implementing policies. The impact of these policies on the numbers will be seen with a lag of 6-12 months, albeit you should see marginal improvement because of change in sentiment and low base.
One thing I am enthused about is the government's approach to address issues structurally even though it is taking time rather than resorting to quick fix solutions. While this is currently under appreciated it will set a foundation for super growth in long term.
When do you think the investment cycle will begin and credit growth start picking up?
In the first phase you will see utilisation level picking up and thereafter entrepreneurs will go for expansion which will lead to capex. Meanwhile, I think Government or PSUs will have to lead the capex cycle especially in Infrastructure (Rail, Road, Power etc).
In my opinion, credit growth will start picking up meaningfully only in FY16-17 as entrepreneurs start capex. Initially, you will see financial closures taking place, companies inviting bids, but ground level numbers will change only once capex actually starts which in my opinion is still 12-18 months away.
The early earnings' numbers are pretty disappointing. What is your reading?
We have been saying that this quarterly earnings will be very poor, because of a base effect. In the last four quarters, the earnings impact was largely because of the currency effect, wherein topline was muted while bottomline trend was healthy. There was little volume growth and growth was largely in export-focused companies like IT and pharma. Now that base effect is over.
This quarter and maybe to some extent next quarter earnings will be muted. After next quarter, some benefits of rate cut would reflect in bottom line. We look for volume growth which has multiplier effect where operating leverage also kicks in. Volume growth will start picking up in second half of the next financial year. So, I am very positive from 2016-17 and 2017-18.
Next year, we should see 17-18% earnings growth. But the real quality of volume led topline growth will happen only in 2016-17. However, I do not see downside risk to 17-18% growth in 2015-16 because the rate cut cycle has begun and that will provide good amount of expansion in margins.
The markets, however, are at new all-time highs. Is it a case of the market going up too fast on hopes of earnings recovery or is it time to be cautious?
Many people would be worried about this. There are about five stages in any market cycle. First, where there is extreme pessimism about future when markets are significantly under-valued, which we have come out of. Second phase is when a bit of optimism starts building, which is what happened once elections happened. So, from pessimism we came to a normal situation - where Nifty moved from 5,500-5,800 to 7,300, which I call the fair value zone. Third stage is when expectation of growth starts building and market moves in anticipation. We are currently in this third phase.
The fourth stage is when the actual growth takes place and sustains for few years. I think that will be probably FY16-17 & FY17-18. Obviously the assumption is that the Government will deliver on growth and no extraneous risk factors derail economy. Finally at some point we will see a euphoria getting built. From pessimism to euphoria is a normal market cycle. We are currently in the third stage, where there is a fair value expecting growth to pick up. When the numbers come, market will keep going up, and I do feel that 2016-17 and 2017-18 would be great growth years with GDP growth in 2017-18 of around 8%. If we can get that GDP growth, corporate earnings can grow easily by 25-30%.
We are in a very early stage of a structural bull market. So, worrying too much about valuation in early stage can be very harmful because then you will end up missing the rally. Now, even the global terms of trades are positive for India, low commodity prices, exports, U.S. growth etc.
What about the weak points namely, Europe, Japan and China?
The current readjustment in China is good for India as it makes Indian export more competitive and poor growth keeps commodity prices under check. India can save easily $80-$90 billion of forex every year, which can have a big impact. Europe slowing down is a concern but US makes up for it. As long as our export growth is slightly above average we are okay.
Recent Monetary easing by ECB and Japan helps counter balance the impact of expected tightening by US. I believe we are in sweet spot as far as Global terms of trades are concerned. In a few years India will be most sought after economy.
What are the potential downside risks external as well as domestic?
I think major risks will be from the unknown-unknown. Today, the world is in a very peculiar situation. Two opposite monetary policies are being implemented by two major parts of the globe which accounts for approximately 2/3rd of world GDP. (Japan and Europe are easing, whereas US is tightening). This kind of situation is unprecedented. Also, several oil and commodity dependent countries will have to re-align their economies. See what happened with Swiss Franc or in Russia. These events are unknown unknowns and are unpredictable. When such transitions happen, readjustments happen mainly through currencies. Every economy, country, corporate is exposed to the currency risk but you do not know when and how such events will come.
Secondly, if the Prime Minister were not to lead this government, that's a key man risk we have.
Thirdly, geopolitical risk. Here we have an unstable neighbour and any development on that front can create problem. But more importantly, with India ushering its place in the world, some countries will try to create disturbance for India, directly or indirectly.
Given this background what kind of sectors or themes or stocks would do well?
You have to play the market where the growth is likely to come. Infrastructure, EPC and capital goods companies, BFSI space could easily report 20-30% earnings growth and should do well. Themes linked to economic recovery and more urban in nature like consumer durables, paints will also do well in first 2-3 years.
Export-related sectors like auto components and textiles can also do well. Suddenly, India has become a lot more competitive by about 20-25% over China based on the labour as well as the currency cost, which are very meaningful for India.
I think this bull market will see a diversified bull run and will not be led by one or two sectors. In this you will also see new opportunities such as digital, including online.
The IPO market is still pretty weak. What is your reading about the situation?
The pipeline with SEBI was very limited. It takes time to file a document, get approval and then come out with IPO. Whatever was in the pipeline has more or less been exhausted. Once SEBI clearances come, companies will hit the market. April onwards there should be a good momentum in the IPO and QIP markets.
What is your IPO pipeline?
We are doing fine. In the first stage we have done three out of five IPOs that hit the market. We have also done six QIPs and have a good pipeline and the activity will pick up next year. We are a bankers to several large IPOs like Cafe Coffee Day, DM Healthcare, Inox Wind and HCG and have about 15-20 transactions that we are working on right now.
What is your target for SENSEX?
Looking at a target has no meaning, because when you are putting money into equity you are not putting money in terms of just making 10% and getting away. Structurally, India will give anywhere between 18-20% return per annum over next 4-5 years. This year probably debt might do better but otherwise once the rate cycle is behind, from a five year perspective equity will outperform all other asset classes including gold, real estate, fixed income.
What do you expect from the Budget?
The government has pretty much said what they are likely to do. But what investors might watch out is how they are allocating the capital to some of their flagship projects and secondly, collection targets. I do not think Budget will be a great event, except the fact that some quality of numbers might be looked at.
