Indian Market Still Expensive Despite Correction, Says Sanjeev Prasad Of Kotak

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Indian equity market still seems expensive despite the recent correction, says Sanjeev Prasad of Kotak Institutional Equities.

“China delivered something like 50 percent over the same period, so people are looking at other markets more favourably in the emerging markets space,” Prasad told BloombergQuint in an interview. Foreign investors, he said, are more cautious on India, due to problems in the banking sector.

Indian equity markets have given returns of 20 percent in dollar terms over the last 12-15 months compared to 30 percent by the MSCI Emerging Market Index and 50 percent by China. Prasad said stocks that investors would like to own are still expensive and the correction has happened in areas where the interest is somewhat limited.

Here’s the full conversation:

Lots happening within the political circles and giving cues to the market. Yesterday Urijit Patel giving out a very passionate plea about how it’s very difficult for the regulator to go out and plug all holes within the PSU banking system unless some moves are taken. How is sentiment looking like for investing within India and within the emerging market universe currently?

You need to break it into how domestic investors are looking into India and how foreign investors are looking into India. I guess most people still like India but I guess they would like India to be somewhat cheaper, especially for the good quality consumption story, including the private retail banks which are trading at fairly high valuations. So, if you look at foreign investors, they have been somewhat cautious on India for the last seven-eight months given the fact that there are better opportunities available from a valuation perspective and the other markets have been far better performers over the last 12-15 months. If you look at the MSCI Emerging Market Index in dollar terms, that 30 percent return over the last 12 months, India has done decently, 20 percent, nothing to be sneezed at, but obviously it’s much lower than the returns for the emerging market. China delivered something like 50 percent over the same period, so people are looking at other markets more favorably in the emerging market space.

If you come to domestic investors, they can only invest in India at this point of time. so their positive stance is vindicated by the fact that they can only invest in India and they still seem to be getting fair inflows. at the same time, a lot of noises in the background with respect to the macro, it had deteriorated pretty significantly for the last 6 months. Bond yields have gone up sharply and of course the political environment is starting to look at a little more uncertain compared to where we were a few months back. So all that put together is making investors slightly more cautious, when I say investors, I mean the foreign investors are more cautious on India at this point of time.

If I distill the news and I try to pick out the greenshoots, while the by-polls may have had getting the ruling party jitters, in the larger elections they are able to hold their fort well and if i just look at the recent releases on the macro front have been and please correct me if I am not wrong here, but the CPI, IIP numbers, the last 2 releases in a row seem to be in favor of a more benign core inflation and industrial activity is showing visible signs of a pick up ?

I would agree with that. Clearly, over the last 2-3 months, we are seeing some positive signs in the economy and that is something we have been highlighting also. the confidence seems to be coming back among the companies, we are starting to see some investment on the private side also with some investments picking up in cement, refining and steel, so that’s a good sign. On inflation, we are not anyways looking at any rate increase by the RBI. So anyways, if the numbers are coming on the lower side, I don’t think that’s sufficient for a rate cut anyway, if anything, that takes away possible change of a rate increase. we will have to anyway watch the next few months to see what happens to inflation and we also have to keep in mind that we are headed into a season of some amount of uncertainty given the fact that we will have some idea of monsoons as to how they will play out over the next kharif season and more importantly, how does the government approach the whole situation in the rural economy, do we see a reasonable amount of increase on kharif MSP prices, we will have to wait and see, we will have to see how the situation is with inflation going forward. So our stance has been pretty clear on this part, one that we do not see any rate increase by RBI at least in the first half of calendar year 2018, after that it will all depend on how inflation pans out, that’s the positive sign.

The problems still remain, I guess in the sense, that if you look at the broader macro picture, GST revenues are still looking somewhat subdued, the hope is that over the next few months, post implementation of the e-way bill system, revenues will start picking up. but as of now we are running well short of the requirement for GST revenues for fiscal 2019. Also, oil prices at $65/barrel is not very comfortable I would say, so the hope is that eventually things will pan out better in terms of the macro with inflation generally staying benign or undershooting the expectations of the market, GST revenues picking up and oil prices cooling off somewhat to close to 60s or high 50s. if that situation plays out, from a macro standpoint, that’s a lot of positive news for the market, but these are macro variables, very hard to get a good handle on, things could go the other way also. So let’s see how this situation evolves over the next few months before we can start feeling more comfortable on the macro front.

You had come out with a note in late February in terms of valuations, you found them expensive despite the correction. Since that time, there has been a much more deepened correction that has come in. Are valuations fair according to you now or still do you find them expensive for India?

When you talk about valuations, there is no point looking at broad market valuations, ultimately you at the bottom of valuations across sectors and stocks, so for whatever it is worth, if you look at the Nifty 50 index on a top-down basis and I never recommend looking at the market as a whole, it’s about 17.5 times on a March 19 basis and that is after assuming 25% earnings growth for the Nifty 50 index which is what we are projecting for March 19. So, the market is exactly not cheap, on March 20 basis, assuming we see another 15 or 16 percent growth in March 20, then it’s trading at about 15 times, so maybe looks okay. But whether we will see the kind of earnings growth that we are projecting, that remains to be seen, especially after the developments in the banking sector where we do expect the earning numbers to be cut on the back of higher provisions for some of the banks. So that’s on a more top- down basis.

If you look on a bottom-up basis, then that’s where the real challenge has come. the stocks which have fallen are anyways stocks which had little amount of interest, some of the PSU banks, the so-called private corporate banks, the metal mining names etc., some of these are based on developments which happened with respect to the US imposing tariffs on certain products, so nothing to do with India in that sense and whereas if you look at the good quality consumption stories, whether they are consumer staples, whether they are consumer discretionary names and the private retail banks, better quality NBFCs, they have not really corrected, they are still trading at very high valuations, and maybe there is a reason for them to trade where they are trading, and that is where the problem is at this point of time.

What investor would like to own more of, at this time they are really expensive, and you are seeing correction in areas where the interest is somewhat limited at this point of time and unfortunately the bad news keeps coming in the sectors where valuations look okay and we start getting excited about those stocks and then some more bad news comes. this is what we have been seeing in some of the corporate banks and public-sector banks over the last several years. so, it looked like we were coming to the end of the NPL cycle, with most of the large NPLs being recognized by the banking system, we had started to see a lot of good news with regards to resolution of NPLs also, especially the large assets but suddenly you have a situation where the whole sentiment has soured because of the scams that that have come out off late and also the announcement by the RBI to remove some of the special dispensations that were available for the banking system.

You had a conference recently. what was the broad feedback that you got, both from the client side as well as the company side on the macro as well as micro of the country?

Pretty much what we discussed. So, everybody was of the view that there seems to be some recovery as far as the micro is concerned. Companies were reasonably confident about recovery and they were also seeing the third quarter numbers decent on a year-on-year basis. You had started to see some signs of companies becoming more confident about investing looking at the demand environment. From the micro side, there seems to be some amount of optimism, investors generally seem to be fairly comfortable with the earnings scenario, earnings numbers were disappointing for the last 3-4 years but this time around there seems to be a lot more confidence in earnings numbers but this was before some of the banking related issues really started coming to the forefront and now there are some question marks about earnings of the banking sector, especially for the first half of FY19.

On the macro, these are concerns which everybody recognizes but I don’t think at this point of time investors are really pricing the macro risk to the full extent and you can see that in the big divergence between bond yields and earning yields. It’s now as if earning yields have moved a lot in the sense PEs have more or less held up and the bond yields have gone up sharply over the past few months, something like 120 basis points increase. So the bond market is clearly worried about the macro and the equity markets is somewhat relaxed about the macro, probably under the assumption that things will improve going forward with GST revenues picking up, oil prices cooling off etc. So, let’s see, I would say the mood was you know, using a term which has been beaten to death, was cautiously optimistic.