The S&P BSE Sensex breached 41,000-mark, an all-time high, this week. In stark contrast, the Indian economy seems to be limping with gross domestic product (GDP) growth, which is predicted to hit a new low in the second quarter. The economy is at its worst which is largely factored in the market, says Vinod Nair, Head of Research, Geojit Financial Services Ltd. In the last two years, the equity market was skewed and it started to do well about 2-3 quarters before an improvement in the economy was visible. The economy is expected to do better in the coming year led by stability and support from the government, Nair tells Kumar Shankar Roy in this week's Finapolis Conversation. Read on to know more.
What is the effect of the interest rate cut on corporate earnings? The RBI has cut the repo rate significantly. What has been the effect so far on corporate earnings in Nifty and Sensex?
Broadly, savings from interest costs are not visible as on H1FY20 since the cost of the funds and debt are still high on a company-wise basis. NPA (non-performing assets) issue and drop in cash flow due to slowdown in the economy is impacting the confidence and availability of funds in the system. But, we have seen some benefits for high-quality companies. A recent fall in bond yield led by a reduction in systematic risk will benefit corporates in the coming quarters.
The GDP growth is slowing down. However, markets are gaining pace. What explains the disconnect?
It is largely due to the jump in earnings growth of about ~10%, due to cut in corporate tax and other reforms announced by the government post-budget. Additionally, reduction in raw material cost, better than expected results from midcaps and sectors like banks, NBFCs (non-banking financial companies), cement & FMCGs (fast moving consumer goods) in Q2 is extending the rally.
Structurally, risk-taking ability and investment environment for equities has improved in India and abroad. Lower interest rates have created arbitrage opportunities and shift to equities. The economy is at its worst which is largely factored in the market. In the last two years, the equity market was skewed and it started to do well about 2-3 quarters before an improvement in the economy was visible. The economy is expected to do better in the coming year led by stability and support from the government.
One section of market participants is saying premium quality stocks deserve higher valuations. This is being said in the backdrop of certain corporate misgovernance events. What is your opinion?
This was also due to decent amount of liquidity floating in the equity market with limited opportunities to invest, leading to premiumization. They chased for stable businesses in spite of enough demand and earnings growth. The losing stocks and sectors were cyclical, indebted, pledged and mid-small caps. This trend will reverse as the broad economy improves. Super-premium is unlikely to stay for a long time.
Mid-cap and small-caps have corrected quite a bit from January 2018 highs. How do they look today in terms of potential earnings growth and valuations?
In recent times, we see that the top-100 stocks are underperforming to the mid-caps. This is because mid-caps are available at a discounted valuation, while the strength of the balance sheet has improved with better cash flow as per Q2 result. This outperformance is expected to be continued in the long-term as the environment for equities has improved. Nifty-500 indices PAT grew by more than 20 per cent in Q2FY20 on a YoY (year on year) basis, and 10 per cent on QoQ (quarter on quarter) basis.
Out of the Nifty, only half of the stocks have pulled the index forward. The other continues to decline. Nifty comprises blue-chip stocks. Why is the market treating Nifty stocks as two separate baskets?
The other half of the companies impacted by downfall in the economy are like metals, auto, port, infrastructure, and industrials. There are also sectors that are under disruption due to changes in the global and industry norms like pharma and telecom. There are also stocks with promoter issues, pledging and NPA problems like media, finance and so on. Such stocks do not attract investment, indices may reconstruct its portfolio in the future.
The corporate tax rate reduction event is done. Have you done any objective assessment of the impact on companies? Will all the companies benefit?
Based on Q2 results, we understand that the majority of companies under our coverage are seeing the benefits of taxation in a range of 5-10 per cent. Few stocks are not availing the benefits of new tax policy due to better gains in the future due to deferred tax assets and exemptions benefits.
What are the next triggers that can help the Indian stock market reach newer highs?
Reformist agenda of the government, cut in corporate tax rate to 25 per cent for old companies and 15 per cent for new capex. The corrective actions/reforms undertaken by the government post-budget are good initiatives to speed up the economy and to take the Indian stock market to the next levels. We expect the government to come with more supportive measures and strengthen its fiscal position. Business spirit is improving and NPA resolution led by IBC (Insolvency and Bankruptcy Code) will bring credit growth to drive the market. Attractive valuation of mid-caps and cyclicals and lower cost of funds with drive inflows in the country will be supported by a drop in risk averseness of FIIs in the global market.
How do you view PSU and NBFC stocks? What is your outlook?
With most of the PSU banks in the midst of a mega-merger, we remain selective in this segment, with a positive outlook towards SBI & BoB, and prefer to stay away from the banks involved in the merger for short to medium term. NBFCs were in double-digit business growth due to slow down in the banking business owing to asset quality and capital constraints. Most of the issues are still continuing but at a reduced intensity backed by various government interventions. We foresee moderate business growth in the NBFC space in the next 3 to 4 quarters. Hence, we prefer to remain selective on few stocks with a robust business model, lower asset-liability issues, and attractive valuation.
Is the worst over for automobile OEM stocks? Explain why?
Apart from the financing and economic slowdown, the auto industry is also impacted by structural changes in technology and consumer preferences. However, we believe that this sluggishness will improve with the government's intervention and supportive policies for the auto sector and economy in the last three months. We also expect a scrappage policy to be introduced in the future providing further respite for CVs (commercial vehicles). The current inventory level will reduce in H2FY20 as de-growth gets stabilized by pre-buying before the launch of BS-VI model from April FY21. We expect the auto sector to underperform in the medium-term, as valuation continues to be at a premium of 20 per cent to its 3-year average on a one-year forward P/E (price/earnings) basis.