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There's greater comfort in owning pvt banks: Deepak Jasani, HDFC Securities

Deepak Jasani - HDFC Securities
If recovery under IBC cases improves in terms of proportion and timeline, then a lot of troubled banks (including PSUs) could do well. However, within banks, the emerging scenario of competition, technology changes, subdued credit growth for extended periods and possibility of fresh slippages from new segments need to be considered for taking a long term view on individual stocks, says Deepak Jasani, Head of Retail Research at HDFC securities in an interaction with Swati Verma. Excerpts -

There is a sharp contradiction between the performance of benchmark indices and macro-economic scenario. What's your view?

Markets perform based on expectations. Although the macro situation is not too rosy at this moment, expectations of further measures by the government to push the momentum in the economy by stimulating demand and encouraging investments are keeping the markets in a buoyant mode. This apart the flows from the domestic investors (steady SIP investment of Rs 8,000 crore per month over the last several months and no large redemptions) and foreign investors (large inflows into emerging markets - the rotation out of US equity funds to the rest of the world continues, hitting $123 billion year to mid-November and emerging markets seeing the largest inflows in 41 weeks at $3.3 billion in the week ended Nov 13) are also helping.

Given this gush of flows, valuations continue to rise hoping for a turnaround in corporate earnings trajectory. A large global negative or continued disappointment over earnings could puncture this hope and result in some reversals in valuations, though it’s happening and timing is uncertain at this point. In the absence of this happening soon, valuations could get even more stretched before they start to fall.

How do you rate September quarter results? Estimates for FY20 and 21? Which sectors can surprise positively and negatively?

While the recent cut in corporate tax rates led to better-than-expected profit and restrained the pace of earnings downgrades, businesses continued to reel under pressure in the three months ended September. The quarterly results show resilient double-digit growth in aggregate net profit aided by the recent corporate tax cut, lower commodity prices and cost cutting initiatives.

However, lacklustre revenue growth reveals lower demand both at the business and consumer levels. Destocking across the board also contributed to the sluggish topline growth. Lower commodity prices resulted in lower topline growth for a whole host of companies including metals. Telecom sector continued to suffer due to cut throat competition and pressure on average revenue per users (ARPUs). Also in the base quarter i.e. Q2FY19, sales of listed corporates jumped more than 23 per cent creating a large base for Q2FY20. Absence of pricing power across the board also did not help matters.

In Q2FY20, although corporates had lower base of profits, lower operating leverage in Q2FY20 meant that margins did not show commensurate rise and disappointed in most cases. Interest costs either remained flat or rose despite the cut in repo rates by the RBI suggesting delayed transmission of benefits to corporates.

Going by the poor macro numbers (which are not turning up so far), GDP growth and corporate revenue growth is unlikely to show a significant rise in H2FY20; however, companies could improve margins by cutting costs, improving working capital use, postponing capex/commissioning of projects and benefitting from tax rate cuts (for companies that had to write off deferred tax assets). Q2FY21 could be the quarter to watch out for in terms of a sharper turnaround.

So far in FY20, broader market has continued to underperform headline indices. How long will this underperformance continue?

The disparity in valuations across market has some key reasons behind them including SEBI reclassification exercise conducted w.e.f. July 2017 which led to buying getting concentrated upwards resulting in P/E and P/BV expansion for these stocks and the reverse for the lower capitalisation stocks. One other reason was disruption (whether due to technology, regulations, GST, competition, liquidity squeeze or otherwise) that has affected a lot of smallcap and midcap companies.

Some small and midcap companies have thrown up corporate governance issues and hence investors are doubly cautious before investing in them. For the situation to improve, we need faster and hassle-free takeover process, faster judicial delivery, lesser protection to existing managements and better capital allocation decisions (including higher payouts - dividend or buyback) by small and midcap companies.

What advice would you like to give investors for the current market scenario? How comfortable are you with the valuations at this stage? Have the markets run ahead of fundamentals?

Optically, the markets do not look cheap. However technical factors (liquidity, no alternative asset class etc) means that equities could continue to do well for some more time. However, investors have to be alert for sentiments changing down. They need to review/rebalance their portfolio continuously to weed out the non-performers and be prepared to reduce the weight of equities at the first signs of a large definite negative change in sentiments. In the meanwhile, they could do some trading in happening stocks. However, if we witness a recovery in corporate earnings growth soon, then investors can afford to be a little less cautious/alert.

Banks and telecom have been in news recently. What's your view on the measures announced and how should investors play these two? Given the likely hike in tariffs from December 1 by some incumbents, is the worst over for the telecom sector? 

As far as banks are concerned, if recovery under IBC cases improves in terms of proportion and timeline, then a lot of troubled banks (including PSUs) could do well. However, within banks, the emerging scenario of competition, technology changes, subdued credit growth for extended periods and possibility of fresh slippages from new segments need to be considered for taking a long term view on individual stocks. Private banks have been doing well and there is a greater comfort in owning them.

Telecom stocks have bounced up well in anticipation of tariffs starting to rise soon. The pace of rise in tariffs will be important to monitor as well as the drop in usage post that resulting in overall impact on ARPU. This will decide whether the companies will be in a position to service the large debt and other payments due from them over the next few years. 

Are PSU stocks good investment ideas? Why/Why not?

PSU stocks in a lot of sectors have deep embedded value. However, their market valuation does not reflect this due to issues of governance, freedom to management, capital allocation decisions and socialistic tinge to running quite a few PSUs. Given the fiscal situation it is imperative for the government to go for one or two large divestment by way of privatisation, an announcement of list of such companies has already been made. Bidders have to get excited by the whole process and the conditionality attached. This will help unlock value and help government to fund its spend in Infra and other areas. One or two large privatisation at good valuation will trigger another round of more sustainable rerating of the PSU sector. 

Your overweight and underweight sectors?

We like Consumer stocks, BFSI space, Pharma and new age internet-enabled stocks, though the entry levels in these need to be fine-tuned. We are underweight Metals, Capital Goods and Power.

What are the biggest global headwinds and tailwinds for the Indian market?

India could face headwinds arising out of risk-off sentiments across global and/or emerging markets which can happen due to shocks like geopolitical development, US China trade tiff worsening, end of monetary easing and rate cutting cycle, and global growth going into longish slowdown. On the other hand, if global economy starts to recover soon and the sentiments towards emerging markets improves Indian market could benefit out of it.

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