 "Market valuation appears stretched: Dhananjay Sinha")
Ahead of the earnings season and Bihar elections, Dhananjay Sinha, Head of Research and Strategist, Emkay Global Financial Services, speaks about what the markets expect. He also tells Purva Chitnis, how Indian markets cannot completely insulate themselves from the global events. Edited Excerpts:
The recent 50 bps rate-cut by the Reserve Bank of India (RBI) has taken everyone by surprise. How do you see the significance of this rate-cut from the market and economy viewpoint?
The expectation on the rate-cut was only 25 basis points (bps). It appears that the RBI has front loaded with additional 25 bps deduction in rate.
From the fundamental standpoint, the lower inflation rate was creating more elbow room for the RBI as inflation trajectory was lesser than the RBI had expected. Also, the US Fed’s decision to not hike the interest rate has also helped the RBI. If you are front-loaded it does mean that for some time RBI might pause. We will have to see how the policy rates transmits to lending rates.
What we have already seen is that prior to this 50 bps, RBI had done a 75 bps rate-cut and the transmission was partial. That was the area of concern for the RBI. It is likely that with the change in base rate calculation on marginal cost basis, the transmission of rate easing will be more efficient. We expect lower lending rates can support urban consumption, while still pulling down margins for banks due to lower yields. This may neutralise benefit from trading profits.
The RBI might pause for a couple of meetings, as it has said the inflation rate might start inching up after October. At this juncture, they have done a front-loading and further action will be based on incremental data points.
On global front, events such as Grexit fears, China’s economic slowdown and the always imminent Fed rate hike have dominated the equity markets across the world. Do you think the Indian markets will be able to outperform their emerging peers in the backdrop?
If you look at India’s real GDP growth with respect to major economies and also cutting across developed and developing economies, the correlation and sensitivity of the economy with respect to these economies has increased. The correlation with China is fairly high. The elasticity with China is as high as 0.8, which means a 100 bps decline in China’s real GDP growth would mean 80 bps decline in India’s growth. There does seem to be a significant influence on what is happening in China.
There are multiple channels for this influence and what is happening to emerging markets in general would be relevant to India as well. Our analysis shows since 2012, developed markets have fared better and contributed to world GDP growth more than what emerging markets are contributing.
After 2011 especially, for the developed world the negative gap is narrowing sharply so effectively to the overall global GDP growth the developed markets are contributing incrementally. So from that point, I don’t think India, given the context of correlation and elasticity, will be able to evade that.
A lot has been said about how China’s bane is India’s boon. Your thoughts?
There is a transformation happening in China. It has significant excess capacity across multiple industries, especially the manufacturing sector. Also, China has depreciated the currency to benefit the exporters. Given the context of excess capacity and depreciation of currency, it is likely that the competition for Indian manufacturers would increase.
From the corporate performance stand point, topline of the companies has actually been contracting for the past 3three quarters. This is partly because of deflation in commodity prices, contraction in exports and weak domestic demand. In this scenario, it is difficult to expect Indian manufacturing to pick up. So, it is quite likely that the revival in industrial investment could still take time.
How significant is the ‘Make in India’ campaign and how will it benefit the economy?
The ‘Make in India’ is a good slogan but there already are companies typically in Auto and Pharma sectors that are making goods here and exporting. A lot of investment and Foreign Direct Investment (FDI) has already gone into this and it is not a matter of one year or so. This process has been happening for quite some time.
In the past 18-24 months, while the FDI flows have increased in sectors such as automobiles, e-commerce and cash & carry, the common factor is that they are all aimed at gaining market share in the domestic consumption. There is little evidence of these FDI flows aiding the purpose of “Make in India”, on the contrary many of these sectors funnel imported manufacture goods.
Demonstration of success of the ‘Make in India’ campaign can be established only if we first ensure that we manufacture things for ourselves. At this juncture, significant components of manufacturing products are imported and sold. Make in India is happening where technology and research & development is high, like Auto and Pharma and this has been happening for last 10 odd years.
How do you see the September quarter would pan out for India Inc?
Lead indicators suggest that the sales growth is likely to be weak. Profit growth, too, will be modest. Both domestic and external demand scenario has been weak during the quarter. The critical thing to watch out for is whether corporates are able to retain the benefit of decline in commodity prices in their operative margins.
On the positive side, rupee has weakened during Q2 which can translate into some earnings expansion. Also, government has front loaded spending over the past two quarters which may have improved demand at the margin.
What is your outlook for markets in this backdrop?
I expect them to trade sideways. From a fundamental standpoint, if the market is currently at 8,000 plus, P/E will be at least 22x trailing, and assuming a modest growth in earnings for FY16 about 10%, forward multiple will be in the region of 18 times.
The valuations are far stretched and with exuberance nearly twice the level seen in 2007. So if the flows are not too strong, (FIIs, DIIs) then vulnerability can re-emerge and then possibly there might be some realignment to the underline context of modest earnings growth for the past six years. Hence, with market valuations being stretched, it can be exposed to any adverse of the global and domestic factors.
Which sectors and stocks would you recommend your clients to investment at the current level?
Before considering the investments, it is important to look at companies that are consistent with respect to earnings. Also, the companies that can benefit and retain the rupee depreciation going forward.
Among the companies that are most commoditised such as metals, the benefit will be a pass through unlike in pharma. We are overweight on urban consumption, especially the non-discretionary. However, I don’t think there will be wider level of income generation unless the investment cycle picks up, which I don’t think will happen in one or two years.
Our top picks from IT space would be TCS, HCL Technologies. Lupin and Aurobindo Pharma are our picks in the healthcare sector.
In the urban consumption space, we recommend Britannia Industries and GSK Consumer. From the banking sector, we will go with Axis Bank, IndusInd Bank, and HDFC Bank. From the Mid-cap basket, we will go with Ahluwalia Contractors, J Kumar, Adani Ports, Havells and Jubilant Foodworks. We would also recommend Asian Paints. We are currently underweight on capital goods, PSU banks, real estate and Cement.
How do you see the impact of Bihar elections on markets?
Bihar election will be a crucial test for the political capital of the BJP. Hence, if BJP comes to power in Bihar, it might trigger a rally, but significance of the rally will be muted than what it was following the general elections 2014.
The reason why market is closely looking at it is because the government is weak in Rajya Sabha and in case of a positive mandate, it will be extrapolated in other states. If BJP doesn’t come to power, contrasting the Delhi debacle, the markets may react adversely this time as the sentiment has already weak. If you look at the bias, the downside from a defeat in Bihar election is going to be higher than the upside from victory. Having said this, I think this Bihar election result will be relevant only temporarily; eventually it will have to realign to the earnings growth and global liquidity which will be dominant factors.
