Why are you optimistic even for 2018? There has already been a 27% rally in 2017.
Two-three things. Over the next two-three months, focus is going to be on how the fiscal deficit number pans out and how much spending the government is going to do. So, two parts of the economy — what the government is doing, what the private sector is doing. We have already seen some patchy data but improvement in high frequency data in auto sales, commercial vehicles and we have seen some credit growth number also picking up.
So the private part is picking up. What is interesting is what the government is going to do. We feel the government has the ability, the room. They have practiced fiscal discipline over the last three years and that gives them some room to spend more money. In the first half of FY18, we have already seen fiscal deficit numbers go to about 96% of the budgeted numbers. This is an accounting entry but in the second half, the government would be a little tied up if they do not free up space to spend extra.
We believe that there could be a 0.5% spending which will come in through the government state and centre put together and that 0.5% extra as a percentage of GDP could push growth forward. There are two key factors that we are looking at. One, fiscal discipline which has been maintained. Second, the government has the room and ability because inflation is very stable. There is no runaway inflation in the key matrices that we look out. There is a rebound which was more or less expected and the currency market is very stable. Once this setup is present, it gives the government some ammunition to spend and that spending could translate to a faster economic growth and we believe that that 0.5% will play out in FY19 and FY20 so there is room and we believe that this could be a trigger for the market for next three to six months.
What is your outlook on the kind of valuations the market is commanding right now? Does it look slightly on the expensive side?
We look at valuations in two matrices. First, we have not seen the kind of EPS growth that market would have liked but there has largely been a PE expansion. if you look at the numbers on face value. But if you compare on a like to like basis, in March 2015, Nifty hit about 9150 and we are at 10,500 today. So, we have had about 12-13% rally from top to top. What is interesting is in March 2015, Nifty EPS was close to 435-450, today the number is very similar. I think there is a 10% to 12% of PE premium that we have seen from top to top. But the market leaders were IT and pharma and the laggards were the cyclicals.
When cyclicals underperform, a big market cap erosion takes place and valuations appear cheaper. Right now, if you look at the market leaders, they are the cyclicals. Underperformers are the defensives like IT and pharma. Although they have not contributed anything to incremental earnings growth, they have not really fallen in market cap so much as to take away a chunk from the Nifty. That gives you an optical over valuation on the face but I think this PE of about 17 to 19 will continue for the next two-three years. So we are not really concerned with this number for now.
What we feel is that EPS growth that is earnings growth is going to be the key, going forward because we already had a round of PE expansion. Secondly, there has been an interesting data in terms of pickup in commercial vehicle sales. Thirdly, if you look at the weekly data that RBI gives on the non-food credit, it has moved from about sub-5% in June to about 10.3% as of 8th December. This tells that even before PSU bank recap has come in, some amount of pickup has already happened. This gives a clear indication that EPS growth will pick up and that could be the basis of the market rally going forward.
I want your opinion on two areas of the market. One, banks because they have a lot of exposure in the telecom space and that is becoming a big an issue and also telecom as a pack. Reliance's big outperformance this year has got to do with Jio. Bharti has got back to eight-year high. What are your thoughts there, these two areas?
For banks, overall it has been private banks and NBFCs in the BFSI space and it will continue to be that way. One area where we see changes are happening is corporate lending. If the initial signs of pickup in investment demand are true, that area will also pick up and that is an interesting fact because if you look at investments, almost 40% to 45% of it comes from the housing market which is more or less private and individual driven market and is a big part of how capex recoveries began.
Historically they have begun like that some times. So that could be a part which will get a push through because housing is going to do well going forward. That is one part which could play out in banks through corporate lending. Second, in telecom space, consolidation has already happened and in next two-three years, markets are going in to be really focussed on how the profitability profile of these players change. That will be the key differentiator for the players who are still in the sector because post consolidation. profitability is going to be rewarded the most.
What about your top stock recommendations?
We are largely playing the building material theme. Housing is a very large theme. It is going to play out over the next five to seven years. The basic premise is that as soon as we reach FY21, FY22, we are going to be clocking about a crore houses a year which is a very large number and housing expenditure most likely is going to grow at about 8.5% to 9.5% CAGR over this period. That gives you a big space in building materials and within the building materials, various areas which could benefit from – A) this shift towards housing and B) GST led plays from unorganised towards organised.
For example, tiles is a play which we feel is going to play out over the next few years and we have picked Asian Granito which is a Morbi-based player which could very well get a lot of benefit from market moving from unorganised to organised sector.
Other plays that we are looking at is Everest Industries, Birla Corp as a cement play because cement is almost one-third of the whole cost. It has big growth potential going ahead and another one is housing finance, again we are playing through plays like Can Fin Homes, GIC and PNB.
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