A bronze bull statue stands at the entrance to the Bombay Stock Exchange (BSE) building in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

Urbanisation, Retail Private Banks Will Drive Earnings Growth, Says JPMorgan

JPMorgan feels urbanisation and retail private-sector banking will drive earnings growth in the next couple of years.

“Urban consumption seems to be fairly robust and healthy. This is a play on demographics and urbanisation. It continues, and the momentum remains very strong,” Bharat Iyer, head of India equity research at JPMorgan, told BloombergQuint in an interaction. “Retail private-sector banks… continue to fare very well and take market share from the state-owned banking system and benefit from strong growth in consumption, particularly at the urban level.”

JPMorgan also estimates an earnings growth of 15 percent for Indian companies over the next two years from the 7-8 percent growth in the year ended March 2018. “There could be little bit of lull in terms of activity levels as we’ve national elections next year,” he said. “So, two months before and after (the elections) you could see a bit of slowdown, but I don’t see why we can’t sustain 15 percent for the next two years.”

Iyer said the outlook on the India investment theme depends on what you look at. “If you’re fixated with what’s happening to oil and the cost of capital, then India tends to fare a little poorly,” he said, adding: “…if trade wars dominate investors’ attention... then India stacks up relatively well... we’re a very small part of global supply value chain which could make the case for investing in India more dominant.”

Watch the full conversation here:

Here are the edited excerpts of the conversation:

Does your Asia Pacific team believe that on a relative basis, as well over the next six months, global money should flow into other economies and stocks as opposed to India?

It depends on which part of the problems you are looking at. If you are fixated with what is happening to oil and cost of capital, then Indian tends to fare a little poorly. But on the other hand, if trade wars dominate investors’ attention over the next six months, then India stacks up relatively well. Because we’re a very small part of global supply value chain which could potentially make the case for investing in India more dominant, if this were to be the overriding theme for the next six months. The jury is out there, we don’t have a great deal of clarity and what we are seeing so far is war of words. We need to see how it pans out in terms of action. But if these were to take center stage, on a relative basis India will fare better.

Do you believe that clients will be happy to put fresh money to work? Would the money come back in a meaningful way if the trade war would take center-stage over the next six months?

It depends. It’s a relative argument rather than an absolute argument. If you were to have full-fledged trade wars going on, it’s a moot point if money flows into emerging markets at all. But on a relative basis, India would stand out vis-à-vis some of the other peer group countries. The other thing which can go in India’s favor is that we have a great pipeline of very high-quality companies waiting to hit the market in terms of IPOs. That always gets incremental money. Never mind where the investors are positioned vis-à-vis the benchmark. So, that is another dynamic which you need to watch out for.

Also read: India Better Placed Than Peers Amid Trade War, Says JPMorgan’s Bharat Iyer

How does what you have seen thus far for India Inc. in FY19 places up for the entire year? The much anticipated recovery in earnings growth and not necessarily just the topline growth...could the rising cost of funds and slightly higher commodity prices dent that optimism?

It is fair to say that in FY19, we can grow earnings by 15 percent. We ended FY18 with earnings growth of about 7-8 percent. The exit rate in the last quarter was 10 percent despite the aggressive provisioning by banks for the new NPA recognition norms. This year you have couple of things going for you like the relatively low base effect, particularly in first and fourth quarters because these were badly impacted by demonetisation and teething troubles associated with GST implementation. On top of it, you are seeing a recovery in select areas and there is the structural component which goes along. I don’t know why we should not be growing earnings at 15 percent. That could be true for the year after as well. There could be a little bit of lull in terms of activity levels as we have a national election in May next year. So, two months before and after you could see a bit of slowdown there in activity levels, but I don’t see why we can’t sustain 15 percent for the next two years.

In terms of higher commodity prices, that is something which could be passed on. I could say that corporates should take that kind of price increase. That’s embedded in most forecasts. The street at large is looking at inflation being anchored somewhere around the 5 percent mark for the next 12 months. That’s something which is par for the course.

In terms of how macro starts impacting the micro, it's early to say. Deteriorating macro typically takes 2-3 quarters to start impacting the micros. We have seen volatility as oil was at $80, today it is at $70 and who knows where it goes. So, I guess there are a fair number of moving parts. The base case which we are working is that we get 15 percent growth in the next couple of years. But we have to review the situation in the fourth quarter of this year as by the time we will have clarity on some of the key factors that we are watching out for.

Would that be a positive surprise that we clock in 15 percent at the start of the year itself as that reduces the ask rate in third and fourth quarters?

We are in that camp. We believe that earnings will grow by 20 percent in the first quarter. You have the best base effect advantage in Q1 and Q4. And these were the quarters where last year earnings dipped. So, we saw a decline. We believe we will see 20 percent in Q1 and some kind of normalisation in Q2 and Q3 and then pick up in Q4 again.

What themes will drive the earnings growth this time?

Urban consumption seems to be fairly robust and healthy. This is a play on demographics and urbanisation. It continues, and the momentum remains very strong. The other area which looks relatively good is retail private sector banks. They continue to fare very well and take market share from state-owned banking system and continue to benefit from strong growth in consumption particularly at the urban level.

The third thing which is playing is government investment in priority infrastructure areas. To be fair to the government, I don’t think they have spread themselves thin. They have been focusing on four-five areas like highways, railways, power transmission in renewables and affordable housing. Here, the data points have been trading in the right direction for some time now. Even if you saw the budgetary outlays, it was up 15 percent in all these areas. Project implementation is going on very well. It is reflected in the first derivative which supplies into these areas. So, you see cement sales clocking 10 percent for some time now. Tractors, commercial vehicles, you name it and all the segments catering to these four-five prioritised areas are faring very well and they should continue to do very well.

Where all can you find value right now and where is the value worth buying into? Where did you find value good enough to make an investment in?

It depends on the time frame. If you are looking at eight-nine months, I still think growth will continue to outperform value as an investment style which is going to be the paradigm because of the way the event calendar is stacked. If you want to see value in conventional terms, then you need to take a view beyond a year. If you are willing to take a view beyond a year, then there is value in tobacco, oil marketing company, cement, wholesale banks, corporate banks or state-owned banks. So, there are pockets where there is value. This polarisation has resulted in that outcome where the broad market is trading at standard deviation higher than mean but there are pockets which are relatively below mean. All of these categories mentioned will fall in it. Investment horizon should be over one years.

What is the red flag for you? Would it be trade war, political risk which would come to force after six months, crude which seems to be contained or something different?

I would say crude. The market starts pricing in any kind of political risk only six months down the line, and December is the time to take stock of the political situation. It is too early right now. There is just too much noise, but we don’t know which way the numbers will go. Again, on trade war, it is a small part of the global supply value chain. So, we have relative argument rather than absolute argument. Crude is something which we should watch as it will mess our macros. It is red flag otherwise we will stay constructive.