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Expect double digit earnings growth at index level for first time in 4 years: Pramod Gubbi, Ambit Capital

Talking to ET Now, Pramod Gubbi, Ambit Capital , says growth should be much better in next 12 months and that should also help earnings growth which is desperately required to justify the sort of valuations.

Edited excerpts:

This is not really the best of the years considering the macro landscape which clearly the bond markets are worried about. It is a little bit neutral for the currency but the equity market continues to be nonchalant about despite the current account deficit (CAD), crude prices, industrial production, inflation or the latest GDP estimates. Are we going to continue to track global strength as opposed to our own domestic macros for some more time to come?
The markets over the last 12 to 15 months, have been largely led a by flows and especially domestic flows. Foreign funds have been participating in the primary market but in the secondary markets, it has been pretty much the domestic fund flows which have held up the markets. Of course, the global support has helped as well and is likely to continue to help. But even through these last 15 months, we did not particularly enjoy great fundamentals, particularly in terms of the economic and earnings growth.

We had a fairly comfortable situation as far as inflation, the current account deficit and the currency was concerned. But all that is changing now. Indeed, at the margin, even the CSO estimate suggests that actually the GDP growth is likely to accelerate if you consider H1 to H2. Given that H1 came in below 6%, even if you were to end the year at 6.5%, you are looking for an acceleration and FY19 is likely to be accelerating even from there.

At some stage, given that we have not seen any sort of earnings growth in the country for the last four years, this sort of pickup in the economic growth should also trickle down to corporate profitability and we should see a double digit earnings growth at the index level for the first time in four years.

Having said that, a lot of this growth is coming from the stimulus that the government has unravelled either in the form of GST rate cuts or the pullback in some of these norms or the farm loan waivers. We are likely to see a slew of such measures as we run into the election season over the next 12 to 15 months. This means that the economic growth is likely to remain fairly positive.

While some of the other issues on fiscal deficit and CAD, CAD of course is beyond control, fiscal deficit clearly is set to expand and that has its own implications. The bond market is clearly seeing through it with the bond yields going up 100 bps. But the bottom line growth should be much better looking in next 12 months at least and that should also help earnings growth which is desperately required to justify the sort of valuations we are seeing in the market.

Has Ambit Capital changed its view because for the longest part of 2017, your house view was that market fundamentals were stretched and only liquidity is driving markets higher?
Yes indeed. We have become more constructive as far as growth is concerned. We have highlighted our higher estimates on GDP. We are looking at 7% sort of GDP growth for FY19 as well. Our estimate for FY18 was 5.8% and similarly in earnings growth, for the first time we starting off the year with double digit earnings growth closer to about 15% for the index level. So, from our perspective, both economic growth and earnings growth are likely to accelerate through FY19.

So let us talk about what we could see from individual sectors in the earnings this quarter and let us pick up alphabetically, autos first of all. We have seen how strong the volume performance has been in the monthly data and this on a low base. Do you think this could be coupled by margin improvement and we could see some strong numbers from autos as such?
Yes, autos tend to do well in an environment where there is stimulus across the board and clearly the money is in hands of the consumers. Economic growth, income generation and job creation which will be the focus of the government should all augur well for consumer discretionary in general and within that, autos will be right up there. Particularly two-wheelers, the sort of emphasis that the government will put on the rural economy, the need for reviving the rural economy — that message seems to have sunk in post the Gujarat elections.

The two-wheelers are likely to benefit from any sort of stimulus programme towards the rural economy. In any case, we are seeing improvement in the rural economy thanks to couple of decent monsoons, the farm loan waivers and finally we are seeing some sort of an MSP increase and that should be the norm at least until the next general election.

The other key talking point that we have been highlighting for the last couple of sessions is what happening with commodities and whether the rally can last. Do you think that the move is structural in nature and as an extension, it is not just about commodities. This earnings quarter, you are going to be very closely watching out for the turn in cyclicals, some of the investment led themes as well ahead of what the budget may lay in terms of increased infrastructure spending. construction, capital goods, metals, commodities are the sectors largely where one would spot revival.
Yes indeed. I think it is pretty much sort of given that any sort of improvement in the economic cycle will bring the cyclical sectors into play and more so because we have had a long period of time where the market is generally focussed on the tried and tested sectors of financials and consumer and which has moved these sectors into valuation territory which is becoming hard to justify and thereby as you see the economic cycle move.

You will see fund managers and investors moving out of some of these sectors which have done well into the cyclical areas of metals, construction and so on. Metals particularly I think there is still has more legs to go. So far, we have seen the improvement in commodity prices globally because of supply contraction rather than any sort of pickup in demand. It is about time that demand also starts picking up given the sort of improvement in the global economy. Add to it, the sort of tax breaks that you are getting in the US and even in India as the economic cycle picks up, demand catches up with supply and perhaps you will have some more legs to the commodity price rally which should augur well for commodities stocks in general.

A lot of these investment themes would largely be a play on credit growth also picking up and that working with the loan growth numbers for some of the key banks there as also some of the NBFCs, what do you look for in the financial sector in this earnings report?
The corporate lender should do well from this point in time because so far retail banks and retail NBFCs have done particularly well. While retail from a growth perspective should continue to do well, the one area in financials that we are concerned about is because of the effect of the bond yields, we expect the cost of borrowing for some of these NBFCs who were reliant on the whole-sale market to go up. As the PSU bank recapitalisation gets done, you can expect some sort of a competition from these banks in those areas where these NBFCs were operating in particularly in segments like housing finance.

If you see a double whammy in the form of cost of funds going up and increased competitive pressure from the PSU banks, that is one area where it is worth taking profits. Those sectors have done phenomenally well until now and stay out and look to increase exposure to corporate lenders which tend to do well at this point in the cycle when the economic cycle picks up and hopefully at some stage, the private capex cycle also picks up. So, corporate lenders — some of the large PSU banks and large private sector banks — which are exposed to corporate credit, is one area to look at because the valuations are perhaps slightly more attractive than the rest of the sector.

It is very easy to write an obituary of IT and pharma. I can give you three, you can give me five, but how much of the bad news is in the price because when you are investing in market, you also need to consider the scenario. How much of the bad news is in the price?
Absolutely, I think everything has a price. Pretty much everybody knows what went wrong with both these sectors and at some stage at a certain price both these sectors become attractive. The only difference I would make is given the sort of challenges these sectors are facing, you would rather take a selective approach into these sectors as we play the next leg of this rally rather than paint them all with the same brush. The concerns have been very specific and it also depends on the sort of capabilities the geographical exposures particularly in the case of pharma.

We know the issue are on the pricing pressure in the US. We know the issues around the FDA regulatory issues but the FDA regulatory issues also come with a sort of positive fact in the sense that you will get faster approvals, the number of drug approvals should pick up. It is in some ways double-edged but based on a bottom up analysis, if you carefully choose stocks with the right geographical exposures and the right drug pipeline, you should do better given the valuations they are trading at.

It is the same with IT. Given the sort of structural changes in the way of consumption of IT in the western world. A lot of the Indian IT services companies have invested in catering to those changes. You need to pick a couple of them ahead of the curve and explain who will benefit. You may not go back to the levels of say 15% to 20% growth but even if you move from the 6% to 8% that we are seeing to about 10% to 12%, add to it any sort of benefits you will see from the tax cuts that the US is given which should again drive demand for IT services and finally any possibility of the dollar appreciating as a result of the stimulus programme in the US could become an icing on the cake for both these sectors.

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