GST Will Cause Only A Short-Term Disruption, If At All: Prabhat Awasthi
GST won’t change the fundamentals of the economy like GDP and demand, Awasthi says.
Like the government’s demonetisation exercise, the impact of the Goods and Services Tax (GST) on the economy will be short-lived, says Prabhat Awasthi, managing director and head of equities at Nomura India.
The implementation of the new indirect tax regime will not fundamentally change GDP or demand, and earnings, therefore, will not be significantly impacted, Awasthi said on BloombergQuint’s weekly series, Thank God It’s Friday. He expects a 15-16 percent earnings growth in the next three quarters.
Where do benchmark indices go from here and what are the triggers that will lead us there?
Markets are driven by earnings and multiple expansion. The market has seen a re-rating but earnings don’t change that quickly. Ultimately, earnings will have to show up. We are at that stage where there is a pickup in earnings on a structural basis. The last quarter was marred by two months of demonetisation. We may see slow growth this quarter too. Structurally, there doesn’t seem to be too much damage. We think the economy will come back to that growth path. We will start seeing improved earnings growth and that’s what will drive markets. The other factor is (price to earnings) multiples. Multiples are a tad expensive compared on a historical basis. Markets are trading at price-to earning multiples of 17.1 to 17.2 times. The historical average is 16.5 to 16.8 times – that’s 3 to 4 percent more expensive. Remember, we have had a big correction in interest rates in India compared to global rates. This means that there will be some uptick in multiples because the cost of ‘risk-free’ has gone down. Markets may have rallied very quickly but I am not too worried at this point in time.
Fund Flows In 2017
Foreign portfolio investors (FPIs) have been net buyers of Indian equities every day in March. Is this trend here to stay for the rest of 2017?
Very tough question to answer. In the last quarter last year, there was fair amount of selling but the market refused to fall. I think the risks from the perspective of global funds will always be largely global and not really local. When we talk to foreign investors, they are very comfortable with India’s story per se. So if you see outflows, it will be largely be because of global events. Or it could be driven by a correction in the U.S. markets because of what’s going on on the policy side - if you start getting concerned that the Trump agenda is not moving forward. There could be a variety of things that could cause a short-term reaction as far as markets are concerned.
From a 5-month point of view, foreigners have not been buyers and they have not been the drivers of markets this year or in the last six months. That could very well be the case going forward because there is definitely structural upturn in the amount of money that is coming through into the Indian equity market.
Pick-Up In Earnings
Third quarter earnings was as bad as expected but the fourth quarter should be a better gauge of the return to normalisation after the currency ban. Your thoughts?
There will be a month or so of demonetisation impact. If we talk to companies across sectors, by and large, no company is saying that they are worse off than the last three months. They are saying there has been a recovery compared to the first two months after demonetisation. I don’t think things have decelerated from the last quarter but the pick-up is going to be relatively slow compared to what would have been the case had demonetisation not happened. We are probably in a recovery phase but the impact of demonetisation may linger on for another month.
GST: Short-Lived Impact?
Earnings for financial year 2017-18 will be, to a great extent, be determined by the monsoons. There is also the fear that it may take longer than just couple of quarters for industries to adapt to GST. Based on that, when can we see robust earnings growth come back?
GST is essentially a change of tax regime. The fundamental underlying growth in earnings is not going to be affected by a taxation change unless it causes large scale change in the amount of taxes collected by the government. For example, if the government is talking about a neutral tax change, if they charge manufacturing less and services more, but on net basis, the overall net charge in terms of taxation is the same, then it’s not hitting the consumers’ pockets. Will a consumer stop buying a car or soap because of GST? I am very sceptical about that notion. There could be some short-term changes in terms of how inventories are kept by the retailers. So it will be a short-term disruption. It doesn’t change the fundamentals like GDP or demand. From the earnings perspective, we are seeing a very slow recovery. In three quarters, we may start to see 15-16 percent earnings growth. That, in the current global context, is not a bad number.
Betting On Consumer Sector
There are a lot of FMCG companies that are trading at premium valuations and above their historical averages. How would you approach the sector?
They have given pretty decent returns. The multiples in the sector expanded quite a bit. And there is good reason for it. For a set of stocks where earnings is protected, and growth elsewhere is falling off, which is making overall cost of capital much lower. Essentially when growth rises, the capital consumption rises. And when growth falls, less capital is consumed and capital becomes cheaper. And in that environment if your growth is the same, the stock gets priced up because cost of capital has fallen irrespective of growth. In India, growth has started to pick up so you could make a long-term case that there is some risk to their multiples if global growth, for example, continues to pick up. Globally, consumer stocks have gone up everywhere and not only in India. With respect to the cyclical sector, there is a good likelihood over the next 3-5 years these stocks will not perform. When you are building a portfolio and you have three sectors – technology, pharmaceuticals and consumer – which one will you pick? Our pick this year has been consumer. We have been underweight consumer for a while but this year our view is that the challenges in other sectors are bigger so we had become overweight simply in that defensive space. In consumers, there is protection of earnings and the multiples seem to be in no imminent danger of collapse.
‘Credit Growth To Lag’
On Thursday, the finance minister spoke about bringing in some proposal to address the issue of non-performing loans. Previous measures like SDR, S4A, 5/25 don’t seem to have helped much, and credit growth continues to be at multi-year lows. What is the road ahead for PSU banks and is consolidation is really a solution?
There have been continuing challenges in the resolution of NPAs. For example, in the the last two years, the metal sector faced difficulties as the global metal cycle went down; it’s recovered somewhat now. A lot of projects which are getting built are now coming into production stage and are nor able to repay debt. There was such a big capex cycle and the impact of that, in terms of NPAs, has come through in a phased manner. I think we are probably done with that sort of fresh NPA creation. Now, the problem is resolving the existing bad loans. That’s especially true of PSU banks because their ability to take haircuts has probably been limited and therefore consensus around resolving some of these thorny issues have been tougher. If the government can step in and either resolve that or take it off their books at a fair price, that’ll be solution that we talked about, that is, making a committee or getting a bad bank in place. The problem is one of decision-making in the context of Indian supervisory system of banks. So, if the government, fresh from its victory in Uttar Pradesh, is in a position to do something bold, that’ll be very very helpful.
On the question of growth and credit, if the banks are lending in abundance, you will see some pick-up in credit growth, but at the end of the end there is a cycle which depends on the external environment – if more projects are undertaken, credit growth will take off. My own view is that credit growth will take longer. In the last 5 years so many assets have been put up in telecom, power and steel and these sectors are going to be in repayment mode for a very long time. A large part of the credit cycle which is related to steel, metals and power sector is not necessarily going to be in a position to build fresh capacity. And the new sectors which are coming up are not large enough to offset the repayment mode. Even if growth picks up, credit growth will lag – that’s always the case in this kind of cycle in which we see huge capex and then a meltdown. In such a scenario, credit growth will always lag.
IT Sector: Compelling Buy?
Is the information technology sector a compelling buy right now? If not, what are the factors that you will like to see changed before it becomes a compelling one?
Our concerns are fundamental. Two things have happened – the industry has realised that the traditional business model is not working the way that it used to. There is automation, cloud etc. Global growth has picked up but volume growth is declining. That trend may continue. Management commentary is not changing. Even global players are saying that the environment is still quite weak. The link between growth globally and growth in IT players seems to have been broken. Secondly, we think multinationals have copied the model of Indian IT well. So Indian companies are losing market share. Thirdly, the rupee is turning out to be a bigger headwind than people thought. Between 2007 and 2014, rupee appreciated by 50 percent. Did earnings rise in conjunction? No. Now we are in a situation where rupee is not helping. Stocks, if they are not dirt cheap, will turn only if the fundamentals turn but we don’t see signs of that just yet.