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Gautam Chhaochharia , executive director and head of India research at UBS, believes consensus earnings estimates for FY16 are too optimistic, leaving scope for further earnings cuts. He shares his views on the road ahead for the market with Sheetal Agarwal. Edited excerpts:
How has the earnings season been panning out so far? Do you anticipate further downgrades?
So far, the numbers are broadly below our estimates. We expect FY16 earnings to grow 10 per cent and hence may not trim them much. The Street, though, is factoring in 16-17 per cent earnings growth for FY16. To achieve that, and assuming Q1 Street estimates are real, the nine months implied earnings growth would be 25-30 per cent, which is a tall task. So there will be more cuts. However, we expect some pickup in FY17 and peg earnings growth at 18 per cent.
Is there any uptick in corporate order books?
We’re seeing selective upticks in the roads sector. But we are not expecting any major boom in economic activity in the next one year or two. We had written an interesting report some time ago. Recently, there were two sources of excitement for the markets — one was the CMIE data that stalled projects is coming down and then some numbers floating around how approvals had picked up pace. We went through some 500 projects. There were very simple statistics from there. About 75 per cent of the projects in that project monitoring group report are either not viable or promoters will not commit because of funding issues or money has already been spent.
So it is actually irrelevant from the capex cycle perspective. Then, if one adds back and calculates the amount which will actually be spent over the next two or three years, that amount is insignificant from a capex cycle perspective. It will act as a feel-good factor, but will not be a boom. Similarly, for CMIE’s data that stalled projects is coming down, our analysis indicates bulk of it is projects are abandoned rather than being revived. So net revival is nothing significant.
What is your view on Indian markets?
After the rally this year, the risk-reward is less favourable from a near-term perspective. So we have kept our Nifty target for year-end at 8,000-8,600. Directionally, longer term, we are still constructive on India. On a relative basis, we are still ‘overweight’ on India both from an EM (emerging markets) perspective and APAC (Asia-Pacific) perspective.
Which sectors would you bet on in the current scenario?
We believe the pace of growth recovery in India to be very slow and grinding. So it will keep on disappointing investors who are optimistic. In the past 12-18 months, we have seen hopes rising after the elections, festive season and so on. Again we see that happening in the next two-three months given that most companies are saying demand will come back in the second half of this financial year. The other part of macro framework that we are following is that inflation and interest rates will keep on surprising investors. Inflation has come off sharply in India and it will keep coming down.
Therefore, we believe interest rates will keep surprising markets positively. We are still looking at 75 basis points more rate cuts in FY16. And another 50 basis points in FY17. So we make our portfolio within this framework. Banks should do well because lower rates will be positive for banks and they will more than compensate for slower credit growth etc. On the other hand, some consumption-led sectors such as discretionary, staples, durables, TTK, Havells, etc are pricing sudden recovery. We will be under weight on these sectors. We remain overweight on telecom, oil and gas. Among global sectors, we remain overweight on pharma and underweight on IT. Then we have selective bets in auto, where the only stock we like from a strategy perspective is Maruti.
How much of the Fed rate hike is already factored in the current markets?
Our house view is that it should not be a big deal for global markets or for India. It is not just the first rate hike, but the overall sense that market gets on whether it is the first of a series of rate hikes or there will be one, two, or three hikes. If we see a series of hikes, which no one is factoring in or forecasting, that would need a serious recovery in economic activity in the US. We are less worried for India from that perspective because the macro stability factors such as CAD (current account deficit) etc have improved a lot. India’s dependence and therefore vulnerability to debt market flows is far lesser versus other emerging markets.
You have a bearish view on the Indian IT sector. What are the reasons?
We are cautious on IT because we believe the digital transformation that these companies are talking about, can actually be deflationary and will hurt them. That’s because they will not be the leaders in this transformation. Ten to 15 years ago when the IT sector was going through its transformation towards offshoring, Indian companies were the innovators and they were herding the incumbents in the US and took away the market from them. Now the sector is more about digital, cloud, etc where companies based in the US are the innovators and Indian companies are the incumbents. The digital model will hurt the classical labour arbitrage offshore model. In our view, the market is not reflecting the risk from this transformation. The market is giving them the benefit of doubt that they will be able to do the transformation.
How has the earnings season been panning out so far? Do you anticipate further downgrades?
So far, the numbers are broadly below our estimates. We expect FY16 earnings to grow 10 per cent and hence may not trim them much. The Street, though, is factoring in 16-17 per cent earnings growth for FY16. To achieve that, and assuming Q1 Street estimates are real, the nine months implied earnings growth would be 25-30 per cent, which is a tall task. So there will be more cuts. However, we expect some pickup in FY17 and peg earnings growth at 18 per cent.
Is there any uptick in corporate order books?
We’re seeing selective upticks in the roads sector. But we are not expecting any major boom in economic activity in the next one year or two. We had written an interesting report some time ago. Recently, there were two sources of excitement for the markets — one was the CMIE data that stalled projects is coming down and then some numbers floating around how approvals had picked up pace. We went through some 500 projects. There were very simple statistics from there. About 75 per cent of the projects in that project monitoring group report are either not viable or promoters will not commit because of funding issues or money has already been spent.
So it is actually irrelevant from the capex cycle perspective. Then, if one adds back and calculates the amount which will actually be spent over the next two or three years, that amount is insignificant from a capex cycle perspective. It will act as a feel-good factor, but will not be a boom. Similarly, for CMIE’s data that stalled projects is coming down, our analysis indicates bulk of it is projects are abandoned rather than being revived. So net revival is nothing significant.
What is your view on Indian markets?
After the rally this year, the risk-reward is less favourable from a near-term perspective. So we have kept our Nifty target for year-end at 8,000-8,600. Directionally, longer term, we are still constructive on India. On a relative basis, we are still ‘overweight’ on India both from an EM (emerging markets) perspective and APAC (Asia-Pacific) perspective.
Which sectors would you bet on in the current scenario?
We believe the pace of growth recovery in India to be very slow and grinding. So it will keep on disappointing investors who are optimistic. In the past 12-18 months, we have seen hopes rising after the elections, festive season and so on. Again we see that happening in the next two-three months given that most companies are saying demand will come back in the second half of this financial year. The other part of macro framework that we are following is that inflation and interest rates will keep on surprising investors. Inflation has come off sharply in India and it will keep coming down.
Therefore, we believe interest rates will keep surprising markets positively. We are still looking at 75 basis points more rate cuts in FY16. And another 50 basis points in FY17. So we make our portfolio within this framework. Banks should do well because lower rates will be positive for banks and they will more than compensate for slower credit growth etc. On the other hand, some consumption-led sectors such as discretionary, staples, durables, TTK, Havells, etc are pricing sudden recovery. We will be under weight on these sectors. We remain overweight on telecom, oil and gas. Among global sectors, we remain overweight on pharma and underweight on IT. Then we have selective bets in auto, where the only stock we like from a strategy perspective is Maruti.
How much of the Fed rate hike is already factored in the current markets?
Our house view is that it should not be a big deal for global markets or for India. It is not just the first rate hike, but the overall sense that market gets on whether it is the first of a series of rate hikes or there will be one, two, or three hikes. If we see a series of hikes, which no one is factoring in or forecasting, that would need a serious recovery in economic activity in the US. We are less worried for India from that perspective because the macro stability factors such as CAD (current account deficit) etc have improved a lot. India’s dependence and therefore vulnerability to debt market flows is far lesser versus other emerging markets.
You have a bearish view on the Indian IT sector. What are the reasons?
We are cautious on IT because we believe the digital transformation that these companies are talking about, can actually be deflationary and will hurt them. That’s because they will not be the leaders in this transformation. Ten to 15 years ago when the IT sector was going through its transformation towards offshoring, Indian companies were the innovators and they were herding the incumbents in the US and took away the market from them. Now the sector is more about digital, cloud, etc where companies based in the US are the innovators and Indian companies are the incumbents. The digital model will hurt the classical labour arbitrage offshore model. In our view, the market is not reflecting the risk from this transformation. The market is giving them the benefit of doubt that they will be able to do the transformation.
