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5 sectors that may see earnings recovery in 2018: Harish Krishnan, Kotak MF

Talking with ET Now, Harish Krishnan , Senior VP & Fund Mana..

Talking with ET Now, Harish Krishnan , Senior VP & Fund Manager-Equity, Kotak MF , says he is bullish about earnings recovery in corporate banks, gas utilities, media, infra pack including cement and capital goods and food companies.

Edited excerpts:

Market has been climbing lot of walls of worries on geopolitical tensions, GST implementation and interest rates moving higher, Further developments that may dent the macro scenario is the tax collection which is the lowest since the rollout of GST and crude oil prices moving much over $67 per barrel. If the news flow from Middle East is to be believed, then any situation can take it much higher than $70 per barrel. What is your take on the broader picture?
You are right. The macro does start to look a bit worrisome. If you go back over the last three years, we had a great macro trade with no micro which is earnings support coming through. We possibly are looking at the inverse relationship in possibly the next two years wherein the macro may not be getting better for sure but may be either stagnant at best or deteriorating at the margin due to all of these factors. Crude oil is on the boil and India is a big importer. You have got overall commodities doing well again. India is a big importer out there. Then you have got inflation which after being significantly lower, has started moving up. Interest rates are starting to move up. But if you go back to the cycles in the past, it is not necessary that the interest rate cycles and the equity cycles map each other in toto at any point of time.

Typically, we have seen that when interest rates bottom out, that is the signal for equity markets to take off. So steepening yield curve in India is in fact suggestive of strong growth ahead for Indian economy as a whole and to some extent, there should be some benefit for the equities as a whole. In a ,nutshell macro does look worrisome for all of these reasons but we would think that for equity market to continue to perform earnings has to be delivered and we are seeming to sense a bit more optimism than we have in the past few quarters.

You believe that earnings will really recover. Which are the sectors and if at all any companies that you like to talk about which are poised to deliver better numbers in the coming quarter or so?
Corporate earnings as an aggregate profit pool has been about Rs 4 lakh crore for almost three years now. We give or take about Rs 5000 crore here and there. Essentially, we would start from 4 lakh crore move it up to Rs 480000 crore and Rs 480000 going to Rs 550000 or 580000 crore. This has been the typical analyst peak at the start of every year over the last three years and this delta of Rs 150,000 crore is what has failed to come through in the last three years. Effectively, if you are taking two years or a two-and-a-half years kind of a view, there are about four or five different sectors or themes where the delta of about Rs 150000 crore can come through.

The first and foremost is corporate banks. At the peak of their profit pool in 2014, all these corporate banks had a cumulative profit of about close to about Rs 50,000 crore that went to losses last year and this year they are barely profitable This will be one area where there can be a swing may not be in the near interim because there will be provision related hits on to the P&L but as the resolution picks up pace, this will be to an extent of anywhere between a delta of about Rs 40000 and 50000 crore over a two and two and a half year cycle that can come through, That is one segment that we are positive on where we see incremental profit pool starting to emerge out there.

The second space where we see profits or profit pool increased quite substantially is on the gas utility space. Cumulatively, the profit pool of the gas utility companies only about Rs 6000 crore. To put it in context, the three OMCs put together have about Rs 30000 crore. Our sense is with all the reforms that is being talked about, we now have a regulator which is going to determine the tariff for gas and all said and done we also have to comply with the clean energy protocols that we are signatories on. We sense that gas could be in for a structural upturn from a three to five years perspective.

The third segment that we are positive on is of course media channels. Primarily there are about two or three tailwinds. Clearly you had both GST and demonetisation having an impact on advertisers, namely FMCG companies which curtail their discretionary spending which was media. Now that being on their base line as well as the fact that GST rates for lot of advertisers have come down from 28 to 18%, that will again add a fillip to the overall spending on media.

The fourth space that we are positive on is in the infra pack cement and capital goods, it has been almost 8 to 10 year kind of stagnation of profit pool in this space as an aggregate and we are now seeing sense of some amount of government capex clearly and at the margin even private capex starting to come through so that is the fourth area.

The fifth area that we are positive on is a bit tactical which is on the food companies. If you look at various agro commodities globally — wheat, sugar — they have come down quite materially.

These are the five broad sectors or themes that we are positive on.

If all these mergers let us say an HPCL with an ONGC, BPCL wanting to merge with GAIL take place, will that also redefine this entire pack?
It is a combination of all of these factors I mean from a very top down perspective the fact is that gas globally is abundant, pricing is very favourable for India. The second positive is that India already has a lot of infrastructure that gas companies have built up. It is just that the utilisations levels were very low. Third the government is proactively setting up quite a few fertiliser plants which would be a big zone of under investment for decades. We are now going to start seeing about three or four big fertiliser plans which are going to consume gas. If you add all these dots together — the fact that we have got abundant supplies, a ready infrastructure and demand coming through over the medium term, you have got the makings of capacity utilisations which are running anywhere between 30% and 40% will move up quite significantly.

Add to that the fact that pollution is a big worry especially in Delhi, where every winter we have these issues of smog etc. and gas, it will become one of the favoured fuels out there and more importantly we have got the regulator PNGRB with its forum for members to decide on tariff increases. Last and not the least, is the possibility of gas coming into the GST again make it much more lucrative for industries to start consuming gas over other fuels. So you add all of these put together I think it has got a making for a multi-year story in our view.

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