Home Market Expect muted returns, sectoral rotation this year: Surendra Goyal, Citi

Expect muted returns, sectoral rotation this year: Surendra Goyal, Citi


There are not that many sectors where earnings could surprise meaningfully compared to the 23% aggregate which people are pencilling in, Surendra Goyal, Head- India Research, Citi, tells Nikunj Dalmia of ET Now.

Edited excerpts:
In one of the reports you have mentioned that there is a rotation at play and the underweight stocks are coming back. In beginning of the year, the underweight was IT, Reliance and maybe a little bit of corporate banks. Now that the markets are rotating and underperformers will start coming back, will the leaders get into a timewise or pricewise correction?

That is what we have seen in play through the course of this year. Since the start of the year, IT has been a big performer.

Corporate banks have come back.

Yes, corporate banks have really come back in the last month. Pharma has seen a nice bounce. So, in between, they had done well for a month and now in the last month again, they are doing well. Cement has actually made quite a nice comeback over last 30-45 days. Before that, you really saw quality in play.

That was not really a sectoral play but you could see that people were betting on the largecaps. This year, we expect returns to be relatively muted, particularly if you are looking at dollar term returns.

In that situation, there are still flows but dollar term returns are not excellent. You will see a lot more rotations. That will continue and some of the sectors we would like to go into next year are corporate banks and cement. While cement has moved up over last month-and-a-half, there is more room to catch up.

What is the best way to judge corporate banks? Markets are obsessed with NPAs but is that the only way we should look at corporate banks?

That is obviously important because in the last three years there has been a huge focus on that and that trending in the right direction really helped these stocks. So, it is important. But it is also important to look at how the rest of the business is shaping up because some of these banks actually have huge retail presence.

If you see retail as a proportion of overall revenue, it is a very significant amount and that part of the business is doing well. At one point, when the noise over NPA related news flow was too high, people were just ignoring that part. You will have to look at a combination of both things – how the core business is doing and how companies ate providing for the NPA issue and how things are easing out.

A combination of that and valuations in some of these names are still quite attractive, particularly when you compare it to the private bank space. That is the reason why you have seen some bit of outperformance or absolute return last month and some of that could continue.

When clients ask you tough questions about leadership issues with some of these corporate banks, how do you address them?

There are a couple of things to keep in mind. Firstly, these are all large banks and generally with large organisations, you will see a very good second tier or second level management team. In certain cases, some of the industries that I have like tracked for a long time, but still not known the second and third level of management that well because they have not really been exposed to analysts or media.

They were not the face of the company.

They were not the face of the company but that does not mean that they do not have a great second line or third line of management. And large companies will generally have that. It is a question of how the board is going about looking at things and making some of those changes. So, that is one.

Secondly, valuations have become very important. If you are getting a good bank with a decent mix of businesses and things bottoming out on the NPA side at a multiple which is less than half of what a good quality private bank trades at, then a lot of risks are in the price. In some ways, it is always a risk reward call for us and that is a risk which given the valuation cushion we are okay to take.

Let us understand hospitals before we understand pharma. Hospital is where you are getting a sense that the government is intervening from stent to knee cap operations. Everything is getting under control. AAP has announced a series of price control measures which are applicable in Delhi. How does one deal with that?

I will start with hospitals. In hospitals, we have a bottom-up, stock-focused call and I cannot name a stock. So, maybe I will restrict it to the sector. Over last two-three years, because of something or the other, the business was getting disrupted. It could be demonetisation, GST, floods in some part of the country, etc and then again as you rightly pointed out, the whole issue around capping of prices in certain areas played out and because of that, this space has been a big under-performer.

In fact, in absolute terms, some of the stocks could be down meaningfully from the highs. Maybe early in the year, there was a lot of these concerns which people have priced in. Also, new hospitals are coming up, impacting profitability in a big way till last year.

Our view was as this new business scales up, the utilisation on the new capacity goes up. You will start seeing EBITDA growth being very strong and return ratios also moving up. This is generally when hospitals really do well. Our view was we are getting into that cycle and June quarter results suggest that things are trending in that direction which is the reason why we went overweight.

You do not think they are asset heavy businesses?

They were always asset heavy businesses. Either you say you dont want to be in them at all or you say that this is the time when the return ratios will go up because capacity utilisation is picking up and things are normalising and this is the time to buy those stocks. You can take a call. Our view is that things are improving. These stocks have underperformed, the risk reward looks favourable and so this is the time to be in the sector.

Corporate banks is one space where things could be at an inflexion point. But what about the other pockets where there is a lot of confusion — metals. There is a demand push and there is a trade war fear. They both are co-existing currently. I do not know whether trade war is real or demand is real. It is lot of confusion there.

It is going to be a difficult sector in my view because firstly, the amount of news flow which comes out of China is quite significant and on the other side, the whole trade war issue has something which we monitor on a daily basis. There is too much news flow coming out all the time and this is the reason why the sector could be volatile.

On one hand, there are huge winter cuts expected in China from a supply point of view, which should be supportive for price, but on the other side, nobody knows how demand can get impacted. Given the kind of volatility and risk that we expect, we have a small underweight position on the sector but we are monitoring it closely.

I do not think it is going to be an easy call because a lot of these things will move very fast and frequently over next three months. One will need to monitor it more closely.

But if I have to connect the dots here, the sense I am getting is that barring corporate banks, you do not see too many pockets, groups or sectors where there could be an earning surprise. Markets, even if earnings come through, are price to perfection because there is no room for surprise left now?

In some ways, that is what I started by saying that 23-24% is not really a small number. Corporate banks have disappointed over last three years. I really do not know if this year or at some point, things will normalise. You could always be positively surprised, particularly if the base is as low as last year, particularly the fourth quarter of last year.

One needs to be a bit careful for those earnings to normalise because a lot of it is just a reversal of what happened last year. In other sectors, there could be pockets where numbers could be better, like cement. That is something we like and here earnings have generally disappointed. But it does look like things are bottoming out and starting to pick up. But, yes, overall, I would agree with that there are not that many sectors where you feel very comfortable that earnings could surprise meaningfully compared to the 23% aggregate which people are already pencilling in.

Where do you see a mismatch of valuations and earnings and we could be in for a hard landing?

Again, a lot of that kind of discussion is stock specific. We have concerns about specific names. I would not really say that it would apply to a sector as a whole but say a sector like consumer staples where everybody is optimistic that consumption is recovering in a big way and multiples are whatever they are.

This quarter was particularly strong but then one has to keep in mind that last year, the base was obviously very bad. Restocking happened in the second quarter last year. If the second quarter does not look great it could be purely because of base.

10-12% volume growths will not sustain.

Yes, and if that moderates and multiples are 50 times, that might cause some kind of realty check. In IT services, if you see the earnings upgrade this year, it is all currency led, maybe barring one odd company. Those kind of earnings can always be volatile. For whatever reasons, currency reverses, IT earnings come down and the fact that the sector has been a big beneficiary of this flight to safety. But that could also reverse and in fact these are the two sectors where we are underweight in our model portfolio as well.

Are clients now engaging with conversations centred around 2019 mandate? We are still six-seven-nine months away.

Before that, we have the state elections which are also crucial. When I meet clients, there is always discussion around that but at this point people are worried about bigger EM issues.

That is why I do not think the market is showing any kind of nervousness or uncertainty. We put out a note after we met a lot of investors in Singapore and Hong Kong where our view was that even if people are talking about it, at this point the focus is on the global issues and India clearly looks a safe place to be in. At this point, that is the focus. If that gets resolved, then we can move toward some of the other issues. At this point, it is not top of the mind for EM investors.

When you talk to seasoned investors who have seen cycles in India, do you see some whose positions are not based on who is going to be the next chief minister or administrator? They are here for a long haul. They like earnings and even through events that are large in nature, they do not change their view. Are there seasoned investors like this in India?

There are obviously a lot of very old hand seasoned investors in India. People like the market. People like a bunch of stocks which are good quality, good governance, good return ratios and have decent earnings visibility.

That part of the market will always be in vogue. Three months back, I was in Europe where people are more valuation sensitive. They have struggled with the Indian market but the appetite for those 40-50-60 names never comes down. People always want to know what is happening here and is this a good time.

The appetite will remain. I do not think that is an issue. It is always about incremental flow. Whatever I said, applies to foreign institutional investors because domestics are getting inflows, they have to buy. They really do not have a choice at this point with the kind of inflow momentum we have seen.

Original Article


Please enter your comment!
Please enter your name here