The markets may be closer to the bottom of their earnings down-cycle feels Mr Harendra Kumar, MD and Head – Institutional Equities and Global Research at Elara Securities. Explaining why it could still take another two quarters before markets start moving ahead decisively, Mr Kumar also speaks about the perception of FIIs in scam-hit stocks. Excerpts:

Did the fourth quarter earnings disappoint you?

We were as a house very conservative and hence did not have to cut earnings. But if you take the street, I think earnings have been cut by 7 per cent. For the full (current) year, there could be another 3-4 per cent going into the next two quarters. But that will pretty much be the bottom of the earnings down-cycle. So the next two quarters could see some sideways movement in the market.

Aren't you worried about commodity costs biting into the margins of companies?

We believe that crude beyond $130 would start affecting demand. The impact of slowing demand will play out in two-three quarters. We believe that is already playing up and crude has topped out. So we expect crude to be in the range of $90-$100, which is a realistic level unless there are external shocks. So, till such time there is visibility on QE3 (quantitative easing), commodities would move sideways and that should help us.

Talking of QE3, it is perceived that it would have a negative impact on our markets. What is your view?

I want you to recollect that QE2 did not have a favourable impact on the markets. We underperformed. To assess whether QE would benefit or hit us we have to look at the following: if growth is inherent in the economy and a QE happens, which also results in a cost push, it is a positive because money flow will come into the country.

But what prima facie happened in QE2 was that growth was under question for India's economy, money flowed to some other commodities or some other regions and did not come to India; but it inflated cost and was, therefore, detrimental. So, if QE3 comes in and India is in a position to grow — if we are at the bottom of the cycle and looking at robust GDP growth and the capex cycle picking up — the cost push factor will not be such a great variable and will probably lead to a P/E re-rating. So, growth will itself ensure that money flows into equities. In terms of valuations we are cheap now.

So, much would depend on the growth outlook. How do you look at it?

We feel that the economy may be in a dicey state over the next four-five months. There is lack of confidence. It is not that there is no demand. There is enough demand as we operate at high capacities in industries such as auto or refineries and we are an infrastructure-deficient country. So what is stopping us is private expenditure — capex.

There should be conviction that the interest rate is going to turn and that everything is stable for companies to go out and invest. We expect this situation to come about after 1.5-2 quarters. This is because consumption in the country has been elevated for the last five quarters. That will also trigger off a revival in capex. It may start off slowly but pick up. And such a revival will flow through.

How about sectors such as banking which have been beaten by markets for their performance?

Private banks have done pretty okay. It is the public banks that had provisioning issues. Such issues come to the fore only when growth is in question or there is exposure to segments that are in distress. Those are the segments that public sector banks get to lend. But then, they (public banks) have the biggest delta if you have a revival in the economy.

The private sector banks more or less move in tandem with business performance. But if you forecast that the economy is looking to bottom and has a good future, then public sector banks may be a good bet. But yes, we have not arrived there yet.

Some NBFCs have undergone a sharp re-rating, are backed by a hike in FII stakes and are trading at demanding valuations. Would this make them a risky bet?

While a good number of them were backed by strong growth, what you said may not be a secular trend as some have witnessed a correction.

If you ask me, I feel that the sector will see a lot of mergers and acquisitions. If you see the policy makers' comments in terms of who should hold banking licenses, the NBFCs are right on top of the pecking order because of their experience and history in running this business compared with corporates from other sectors.

So they will be in the forefront of reforms in the banking sector. And because they have a franchise which could have been undervalued earlier on, they will probably get re-priced and even get a premium on the franchise they have built over many years. Once you get a license, even corporates (with no financial business background) would want to acquire the franchise rather than build it over a period of time. So valuations of well-managed NBFCs will remain elevated.

Is the beating received by scam-hit stocks a short-term reaction?

Everybody feels investors have learnt to live with corruption. But if you see the reaction from the FDI side, it is not the case. FDI flows provide a clear indication of the confidence of foreign investors looking at sustainable investment in India. If that is coming down, it does affect growth. We should not look at it from the lens of FII flows alone.

Two, in the markets too, there is enough documentation to show that high corporate governance is equal to a high price earnings (PE) ratio. And allegations of corruption do impact the PEs of stocks. So it is wrong to say that FIIs do not look at these aspects. Now, look at the shock that an investor receives in some such stocks. You lose 15-20 per cent because there are no circuits. If you have large positions, you are destroying wealth. So volatility is itself a reason why you will get a low P/E.

Our understanding from talking with FIIs is that corporate governance and good promotership are high on their agenda. So it does significantly impact sentiment in specific stocks.

Related Topics
comment COMMENT NOW