 "Head-Research, IndiaNivesh Securities")
In the midst of markets consolidating after hitting fresh record highs Daljeet Kohli, Head-Research, IndiaNivesh Securities tells Tulemino Antao that corporate earnings have to catch up a very fast pace to justify current stock prices and as of now most of the market is moving on hopes of sharp revival.
After hitting fresh record highs the market seem to taking a pause. How do you see the markets panning out till the run-up to the Union Budget?
We believe markets may remain range bound with increased volatility. On the domestic front the markets will take cues from any reform oriented action/announcement by central government while on international front US Fed’s take on increasing interest rates in US, Chinese authorities taking action to revive growth, Euro Zone slippages etc will keep markets nervous.
In terms of valuation, we believe our markets have run much ahead of fundamentals. Corporate earnings have to catch up at a very fast pace to justify current stock prices. As of now, most of the market is moving on hopes of a sharp revival. However ground reality has not changed too much. On top of this, in our opinion all Emerging Markets will have to deal with much greater uncertainty arising out of diversionary monetary policy expected from US Fed and other big economies like European Union or Japan.
What are your expectations from the third quarter for the Sensex group companies in terms of top line and bottom-line?
We have not increased any earnings estimates for Q3FY15 as we do not see any real change happening. Demand in almost all sectors appears to be muted. We have not seen any strong growth in top line even in the festive season. Hence consumer sectors should remain benign.
Car volumes growth has been erratic in the last 2 months. Major part of growth in auto has come due to taking advantage benefits of excise going away & not from real demand pick up. Similarly cement/steel off take has also not picked up in any meaningful manner. Taking cues from credit off take of meagre 8% in banking sector we believe the growth across the entire manufacturing sector will remain on lower side. Trade data of last 2 months too does not suggest any significant growth in exports.
Overall we believe the top line growth in Q3 may mirror the growth in previous quarters. As regards bottom line again we do not expect any major surprise as we have not witnessed meaningful reduction in raw material or other costs. According to us most of the corporates have minimized expenses and reached cost optimization levels hence not much can be improved from here-on.
According to us, any increase in margins can come only from top line growth (operating leverage) and not from cost cutting. Finance costs have remained elevated since interest rates have not come down in last quarter. Year-on-Year there would be increase in depreciation for some companies due to change in companies act. Hence on net profit level we expect muted growth.
The Bank Nifty is trading near its all-time highs. Meanwhile, non-performing assets continue to haunt state-owned banks. With the economy showing signs of pick-up and inflation easing what is your take on the banking sector and which would be your top picks among state-owned banks for 2-3 year horizon?
We agree with street view that macro -economic indicators have become favourable for rate cut. It is only a matter of time when we should start witnessing reduction in interest rates. This coupled with some meaningful action by the government on removing execution bottlenecks especially on stalled/new infra projects should be extremely helpful for all the financial services sector and banking sector in particular. However the benefits to sector will accrue only when some concrete action is taken and things start moving on ground. As of now everything is in the realm of hopes/expectations.
We believe asset quality pain for banks is likely to remain for some more quarters. Government/RBI will have to take some strict /stern actions on defaulters, removing administrative bottlenecks and only then can the asset quality of banks improve. We are estimating capex cycle to revive only some time in FY16. Hence while long term view is positive on banks but near term the pain persists, therefore we are selectively positive on certain banks but overall we feel this sector is overpriced.
For 2-3 year time period we like SBI & BOB. Both these banks have taken certain steps on managing asset quality, both of them are enough capitalized to take advantage of upcoming revival in investment cycle and valuation wise still have some space.
Will IT majors reap the benefits of a weakening rupee during the third quarter? Further, are there any mid-cap IT stocks that are attractively priced at current levels?
Yes we believe IT sector is well placed for growth. Our call is on demand revival from major markets (US and Europe) for most of the Indian companies. We believe visible signs of macro improving in US will lead to many US companies to re-start spending in a big way on IT which they had stopped in last 5 years. Increased spend on technology will lead to strong growth for many Indian companies.
We expect Rupee to remain above Rs 62 levels arising out of impending USFED action leading to strength in dollar against all currencies of the world. Any doubts on funds outflow from emerging markets (including India) will also put pressure on Rupee.
Twin benefits of revival in global demand and weak Rupee will result in good fortunes for all IT companies. Amongst the mid cap IT companies we like OnMobile Global (turnaround story), Thinksoft Global (potential to scale up immensely), KPIT ( strong dollar revenue growth), Mastek (value unlocking post de-merger of insurance and other business).
Among the defensive sectors pharma companies seem to be on a roll. You have won the Best Analyst award for pharmaceuticals from Starmine. What is your all on the sector and which would be your top two picks among the large-cap and small-cap pharma stocks?
Most of Indian pharma companies have grown on back of timely launches of generic products in US and other regulated markets. However due to patent cliff coming off and long delays in getting approvals for new products from USFDA, the process to launch new products in US has substantially slowed down. Meanwhile, the base business of many India companies has grown very large.
Hence base effect will play adverse to the growth numbers for these companies. Third, major change in US/regulated markets will come from the fact that now the launches are happening for those products where many Indian players are competitors. This means that now Indian players have to compete against other whose costs are similar v/s in previous scenario wherein there used to be pharma companies from other parts of the world.
This effectively means that earlier price erosion at the time of genericisation used to be much lower than what is happening now. Telemisartan is one good example of that product. In view of the aforesaid discussion we expect a gentle pause in strong growth of Indian pharma companies (especially those targeting US) for next few quarters. However in our opinion next growth trigger will come from biosimilars and highly differentiated limited competition products. Many Indian players are already working in this regard. Dr. Reddy’s, Cadila, Lupin, Biocon etc are all working towards these segments.
Most of the pharma stocks are trading at high multiples in present times hence leave limited upside scope. However, we continue to like the sector. We are selective on stocks where valuations are still justifiable and pipeline of products is visible. We like Cadila and Shilpa Medicare even at current levels.
Cadila has a large products pipeline waiting approvals from USFDA. The hard work that they have done in last 2-3 years is likely to help them now. We expect US business to grow very strongly. On the domestic front Cadila was showing muted growth due to issues related to pricing policy. Now that those issues are settled, we expect Cadila to come back to industry level growth of 15-16% pa. Thus both US and domestic business are poised for strong growth in future. Cadila also has pipeline of 20 biosimilar products and intend to launch 2 of them by 2020 besides the one that they have recently launched.
Shilpa Medicare: This company is involved in high level of R&D on many oncology products. We like the co’s capability to identify the products and build the capacities around that. It is already a very strong and established player for certain oncology related APIs. The company is now in process of building base for a very strong growth in FY17-18 when patents of many of the molecules, that it is working on, will get over. FY14 was exceptionally good year in terms of financials for the company thus optically growth in FY15 may look muted because of high base effect.
We expect FY16 to be normal year and then FY17 or FY18 to be another block buster year for the company. Near term trigger for the stock would be long pending inspection of one of its facility by the USFDA.
Tyre and paint companies have surged in the previous sessions on the back of declining crude oil prices. What are your views on their valuations at current levels? Which would be your top two picks in the tyre and paint segment?
Both these sectors we do not cover. While there will be savings for both the sectors but I think stock prices are factoring in much more than what would be actual saving. Hence almost all the stocks are overpriced in both sectors.
Disclosure: I have no personal holdings in the stocks mentioned. However, the directors of IndiaNivesh Securities as well clients may have positions in the stocks recommended.
