Housing Sector Recovery To Aid Cement Makers: CLSA’s Mahesh Nandurkar

We believe that election outcome is a big sentimental booster for foreign and domestic investors. This means that flows should continue to be in a positive territory. India is looking like an attractive bet. as compared with the other Asian markets or emerging markets in general. That is a point of attraction from foreign investors’ point of view. We have seen some foreign inflows in over the last one month and broadly over the last thee to four months in general. But there is clearly a scope for more to come.

It’s heartening to see that despite the recently concluded Morgan Stanley Capital International rebalance, which was supposed to take out more than a billion dollars from the passive fund out of the Indian market, was more than compensated by the inflows from the active fund managers. That event is reassuring.

We continue to stay optimistic on the market. Although, the returns will be capped because valuations are at the higher levels as compared to India’s own history and other emerging markets. At the same time, the economic reality is not as buoyant as the market sentiments be like. We should be expecting single digit market returns. So, we are still in a positive territory, given where the sentiments are.

We’re going through a phase of consumption slowdown. Thankfully, some of the more investment linked indicators like cement demand growth, steel demand growth or foreign capital flows are in a positive territory.

Consumption indicators aren’t looking up. That is the big change that we will look forward to in the next three to five years, compared to previous five years. If we are expecting the investment cycle to improve, then it has to come at the cost of something.

My personal belief is that the private consumption expenditure as a share of GDP has peaked out. If we expect savings to improve and the investment cycle to kickstart, then it has to come at the cost of consumption trend slowing down. We are looking forward to it in the next three to five years. Consumption parameters will not remain as strong as they have been in the last five years.

In my view, cement is attractive. After a long period of time, we have seen cement pricing improving. Volume growth has been robust for the past six to seven quarters. Our house view is that we will be looking for a housing market recovery going forward and clearly cement is key input for that, as nearly 60 percent plus of the overall cement demand goes into housing. I’m optimistic about cement.

On the steel side, it is more of a global cyclical. If you are looking at a slower trend in demand growth globally, and also the U.S.-China trade war possibly impacting the growth outlook in China as well. The benefit of capacity closures in China has played out to some extent. So, metals is a global variable and where the demand supply dynamic is not looking optimistic, that part is something we’ll be underweight on.

Indian markets will also be linked with what happens globally. If the foreign flows are going to be a big factor going forward, then what happens globally becomes even more important.

One of the factors which tempers our enthusiasm is what’s happening globally. The near-term worry is the possible escalation of the U.S.-China trade war. Also, there have been some growth concerns in the U.S. and European markets, too, although recent data shows Europe’s showing some signs of improvement. If we continue to see the risk appetite of global investors reducing because of trade war related concerns, then India will be impacted for sure.

Staggered manner is always the right approach. These days Systematic Investment Plan is the right way to go. We need to take sectoral bets. What has worked in the last five years will not necessarily work in the next five years. In terms of portfolio allocation, financial sector looks good to me. More than that the corporate banking space where non-performing loans have peaked out and provisioning is also peaked out. In the next couple of years, we will see blockbuster earnings growth in financial space, especially the corporate oriented banks. So, that space looks attractive.

The valuations don’t appear all that stretched. On NBFC as a category, I will remain cautious and limit myself to top one to two housing finance companies, which could be beneficiaries on ongoing concerns on the NBFC liquidity front.

We like cement, property developers. We also like capital goods, infrastructure, engineering, procurement and construction companies. Some of the public-sector undertaking names on oil side look attractive. Telecom sector has battered down a lot. So, some names over there are also beginning to offer value, in my view. So, this are the sectors that we like.

We will be owning these as against staples, autos, NBFC, metals. I will also go underweight on Information Technology and pharmaceuticals. It is time we choose sectors. The broader market may not give strong returns, but some of the sectors and stocks could give double digit returns.

The primary reason is a large amount of industry consolidation which has happened. We have seen new entrant come in and gain large amounts of market share. Possibly, the competitive pricing wars end sooner rather later. In some of the sectors, we have seen companies deleverage through rights issuances. We have also seen recently that some of the low-priced plans have been discontinued. Average revenue per user in the sector have bottomed out and when it starts moving up, remains to be seen and can be debated. But my feeling is that the worst is behind us and that primarily is the logic.

There will be a broader impact because the global investor sentiments towards the emerging markets is greatly determined by what is happening in China. For any of these, if Chinese market remains weak then India will bear the brunt of it as a collateral damage. There could be some of the sectors which will be the beneficiaries of this trend. While India is not big in manufactured product exports, there are some of the smaller segments like agro-chemicals and chemicals, in which certain players can potentially benefit on the ongoing U.S.-China war. That is a small sector that can be looked at.

Some of the leading banks, whether in corporate or retail side are not looking as expensive. Banks are not looking expensive relative to its own history and definitely not the corporate banks for sure. We continue to believe that market share gain story will continue to be in the favor of private banks. Historically, in falling rate environment, NBFCs have posed a great competition for credit growth for the banks, but NBFCs are on weak footing as an industry. In that, banks and private banks still appears to be an attractive bet. In corporate banking side, you will get very strong earnings growth by the financial year 2020 and 2021 because of the low base effect. The large part of earnings impact in the last couple of years was because of higher non-performing loans and higher cost of provisioning. Both of which have peaked out in our assessment. Corporate banks, to my mind, is a no brainer.

Mid-caps, as a category, is looking more attractive today than what it was a few months back, because valuations have moderated and many of these are domestic oriented companies and in cyclical space, which is where we continue to remain optimistic. For example, property developers and mid-cap cement names look attractive to us. But rather than going mid-cap as a general category, I would look at the industry verticals that they are operating in. Some of the expensive consumer-oriented mid-cap is also something that I will look with caution, because of same reason that high valuation and slow consumption trend don’t look optimistic. Beyond some of these expensive names in discretionary consumption space within the mid-cap in some of the property developers, cement looks attractive.

Two arguments there. We believe that the affordability is strong. Secondly, over the period of the last couple of years, we have seen unsold inventory has come down from around 8 lakh units to close to 6 lakh units. The pace of new purchases by customers is more. My sense is within the current unsold inventory of 6 lakh units, many of the projects will not see the light of the day or get delayed, because some of the developers are facing issues. The real inventory is not as much as 6 lakh units. There are developers who still are financially strong and will be able to go and complete projects. I don’t think it will be a massive supply. The NBFC crises will bring down the new supply, which will mean that the attractiveness of some of the quality developers will be delivering on time--the value of those projects will go up.

While we continue to be optimistic on the broader housing market, but to be bullish on the listed property names one doesn’t have to take a broader market call. These companies are gaining market share from the other smaller developers. Even if you take a bearish view on property markets in general, then some of these companies will do far better than the market and that is the key call.