The escalating load of NPAs, bond yields and decline in credit growth rate are major issues faced by state run banks.
Vinod Nair, Head of Research at Geojit Financial Services, continues to have a conservative view on the market. His one-year forward view on the Nifty is 10,450 which is based on 15 percent earnings growth compared to the street’s 20 percent.
Edited excerpts from the exclusive interview with Moneycontrol’s Kshitij Anand:
Q) The crude price shock has taken equity markets by surprise. If crude stays above $73 per barrel, would it spell trouble for the economy as well as OMCs?
A) Crude is currently trading at a four-year price high of above USD 71 a barrel, which may trigger a rise in inflation. But given the election period, oil marketing companies (OMCs) may have to absorb the hike in cost, impacting their profitability.
March CPI inflation has eased to 4.28 percent from 4.4 percent in February due to reduction in food prices. However, any further rise in oil prices and monsoon outlook will adversely impact its trajectory.
The recent spike in crude oil prices is largely due to a sudden spurt in West Asian geopolitical tensions. A spike in oil prices above current levels can attract higher US supplies (shale oil). Considering this, oil prices are likely to be in the USD 60-70 a barrel range in the medium-term.
Q) Mutual fund flows have slowed down considerably in March thanks to global volatility. What role would the reduction in DII flows play in charting direction for our markets?
A) Average monthly inflows in mutual funds was Rs 20,000 crore till February. This has reduced to Rs 11,000 crore in March due to negative equity returns since February in global and domestic markets.Additionally, introduction of long-term capital gains (LTCG) from April, led to marginal redemption in the last two months of FY18. There is a possibility that this reduction in inflows can be sustained in the medium-term due to higher volatility in the global and domestic markets.
The trend is likely to be positive as financialisation of assets will be key to household holding in India for a long time.
Q) Any stock/sector which can emerge as a dark horse in 2018 or FY19?
A) The pharma sector could emerge as a dark horse in FY19. The sector has been facing adverse conditions in both the domestic and global markets since 2016. All major Indian pharma giants were impacted due to stricter norms of the US Food and Drugs Association (USFDA) leading to subdued earnings and underperformance by the sector.
During the last couple of months, we have slowly shifted our view on the pharma sector from neutral to constructive. Their valuations are so attractive that it is impossible to avoid such businesses for the long-term as these are likely to stabilise over the next one to two years. It is especially true for companies which have shown positive regulatory approvals from the USFDA.
Q) There were many quality stocks which have corrected in the last 2-3 months thanks to global volatility. Any top contrarian stocks which investors can buy at current levels and why?
(D’Mart):D’Mart has a strong track record of high growth and profitability. Revenue/PAT has grown at 37/51 percent in the past five years. EBITDA margin is higher among peers due to better asset turnover and lean cost structure. The recent strategy revamp to include leased stores along with owned ones will accelerate its pace of growth. We expect high growth to continue aided by store additions, change in strategy, e-commerce, debt reduction and tailwinds from the Goods & Services Tax (GST). As a result, we expect the high premium to be maintained in the medium-term.
(BEL):At present, BEL’s valuation looks attractive post the recent 20% correction in the last two months due to lower-than-expected allocation to defence from the Union Budget and stake dilution by the government. However, we continue to maintain our positive view on the stock given the strong order backlog of Rs 40,000 crore (5x FY17 sales) which provides a strong earnings outlook. Further, BEL has limited competition due to its niche capabilities, strong technological tie-ups, strategic nature of projects, capital-intensive nature and high gestation period. Going forward, BEL will emerge as a key beneficiary from the on-going defence modernisation programmes and the government’s focus on indigenisation.
Natco Pharma:Natco Pharma is a vertically integrated pharmaceutical company with a presence across multiple speciality therapeutic segments. Focus on R&D and complex molecules will drive growth and stability in the business. The company is strategically placed in terms of backward integration for critical active pharmaceutical ingredients (APIs), which equips it to enjoy corresponding gains in terms of cost, quality, and logistics. EBITDA margin is expected to remain stable at 40% over FY18-20e, led by new launches in the US and India and improvement in operational efficiencies.
Tata Consultancy Services (TCS):We remain positive that TCS will deliver better earnings growth under its new leadership. Despite external headwinds, revenue from its digital business stood at 22.1 percent in Q4 FY18, a growth of 40 percent YoY. The management is confident that one-third revenue will accrue from the new digital business by FY20. We are factoring in 7 percent revenue CAGR over FY17-20e given the strong deal pipeline in the non-BFSI sector, coupled with traction in the digital business and recovery in the retail vertical. At present, TCS is trading at a valuation of 19x FY20 P/E, which is acceptable considering its three-year historical average.
Q) Do you think March quarter earnings could be as strong as consensus estimates? What are your estimates for FY19?
A) The consensus is estimating over 15 percent YoY PAT growth for the Nifty in Q4 FY18. In Q3, the expectation was of a similar range but actual results were below par due to the poor performance of finance, pharma and telecom stocks. For Q4, the market is hoping for a favourable base effect, global tailwinds, revival in the domestic economy and increased government spending to push earnings growth. But few sectors like IT, pharma, telecom and finance could come in as a laggard impacting overall performance. For FY19, we are currently estimating EPS growth of 15% to Rs 560 for the Nifty as compared to consensus’ 20% on a YoY basis.
Q) Most foreign brokerage firms such as Citigroup and CLSA have trimmed their 2018 estimates for the Sensex/Nifty. Have your also trimmed your December-end Sensex or Nifty target?
A) We continue to adopt a conservative view on the market. Our one-year forward target for the Nifty is 10,450. This is based on 15% earnings growth in FY19 as compared to 20% by the market and also reduction in valuation to 16x P/E as risk aversion is inching up. The main risk is a slowdown in the global economy due to globalisation, a reversal in funds, increase in interest rate, high crude prices and domestic political risk.
Q) What is your assessment of the banking situation? It looks like new skeletons are emerging out of the closet every day. Do you see state-run banks as a potential long-term buy at current levels or should investors stick to private sector banks and NBFCs?
A) The escalating load of NPAs, bond yields and decline in credit growth rate are major issues faced by state run banks. 21 public sector banks (PSBs) continue to record net losses of Rs 18,097crore, whereas 17 private banks reported a net profit of Rs 1,1195 crore in Q3 FY18.
Bad loans of PSBs stood at Rs 7.34 lakh crore at the end of Q2 FY18 and the street is expecting the same to touch 10 lakh crore by FY18 end. NPAs of private banks are considerably low at Rs 1.03 lakh crore as at the end of Q2 FY18.
Huge losses during Q3 FY18 and rising bond yields are likely to partially negate the recapitalisation program of the government. Credit growth has been declining continuously to 7.8% till 2017.
Q3 FY18 earnings for private sector banks have been good, but the recent unpleasant newsflow cautions us while selecting private sector stocks. Our outlook on NBFCs is positive on account of higher margins and earnings.
Q) Midcaps are trading at over 70% premium (in terms of P/E) to the Nifty. Do you think this premium could actually narrow in 2018 and possibly in 2019?
A) On a trailing basis, valuation looks as high as 70-80 percent, but if you look at a one-year forwards basis, it is in the 20-25 percent range. This premium narrows during bear or consolidation phases. Given our conservative view, we prefer stock-specific defensives and largecaps.
Q) Any secular story which you are tracking? Are there any businesses which are trading at a fair price – great businesses at a good price are seldom seen?
A) Our focus in FY19 will be to move towards sectors or stocks which will be able to maintain a fair outlook in their business in spite of a slowdown in the economy or market. We are looking at rural focussed, infrastructure and defence plays.
One can also look at fair valuation plays in pharma, IT and telecom space which are showing an edge in their business model. Export-oriented companies with stable cash-flow and competitive edge in spaces like chemical or food are also looking good.