Next 3-5 years, stay away from these 3 sectors: Pratik Gupta, Deutsche Bank India

Though there are more risks in the short-term, Pratik Gupta, MD, Deutsche Bank India, says one should stay away from telecom, PSU banks and US generic pharma players for next 3-5 years.

Edited excerpts:

India is outperforming at a time when there is gloom and doom in the world. Is this outperformance here to stay and if not, do you think Indian markets will correct and by how much?

India’s outperformance is likely to sustain given the weak outlook from some of the other emerging markets, especially China. In the short term, the noise around the trade wars will worsen. Deutsche’s China team has just put out a note saying that they expect the Trump tariffs to come through later this month and in that scenario, the Renminbi will weaken all the way to 7.5 next year. So, there will be more pressure on the emerging market currencies, the trade war noise will worsen and the EM outflows will continue.

India will outperform in relative terms although on absolute terms, the market could still come off. If you turn that around, three-four months down the road, some of this trade war noises will cool off. India in absolute terms may do well, but in relative terms, we may underperform the other markets such as China or Taiwan or Korea, which have come off a lot more versus India this year.

Those markets have come off and the valuations are cheaper over there. They could also bounce back a lot more strongly. A lot depends on how the trade wars pan out over the next few months. We think the market will continue to outperform in the EM selloff environment, partly driven by relatively strong earnings growth outlook and also given the fact that domestic flows are helping the local equity markets.

In the last couple of trading sessions, the crowded groups are witnessing profit booking. Names like HDFC Bank and Kotak Bank, HUL and Britannia have started correcting. Bajaj Finance has taken it on the chin. Are you getting a sense from some of your global investors that they are a bit weary of investing in some of the safe havens? Is it time to bet on rotation, on the other end of the spectrum which is metals, corporate banks and cyclicals?

I would say it is a mixed view. I do not think that is the overall view. From our perspective, we are recommending clients to take profits in consumer staples. We were overweight on consumer staples at the start of the year, but of late, we have turned negative or underweight. We are recommending an underweight stance, given the expensive valuations despite somewhat better growth prospects.

On the retail oriented banks, the outlook is still good. Our view is that the liquidity environment in India will worsen in the next six to nine months. This time, the government borrowing programme is heavy in the second half. Credit growth is picking up, the rupee is under pressure and if the RBI intervenes further, it will suck out even more rupee liquidity. In such an environment, you do want to be with high CASA banks.

But you are right, within the banks in particular, there is some amount of rotation underway. I would not say everybody is convinced globally. A lot of them are still sticking with the tried and tested retail banks which have performed well in the past and are not yet willing to jump the gun. They want to see a couple of more quarters of results from the corporate lenders to make sure that the provisioning pain is really behind them and there are no further negative surprises. So, there is some rotation happening there.

In staples in general, we are seeing very little fresh buying. We recommend folks to take profits over there.

There is a lot of chatter around the Sebi circular on FPI KYC disclosures. It was being said that it would lead to $75 billion worth of outflows. This contention was rubbished by Sebi in a statement yesterday. Is that spooking the market because what kind of outflows you are going to see is not clear and I do not think anyone can calculate that.

That is a good point. Personally, I do not think the Sebi circular in itself caused that kind of selling. India was impacted by what is going on with the overall EM environment. But as far as the circular is concerned, this is not so much a Sebi-specific issue. It is related to the Prevention of Money Laundering Act (PMLA).

One of my colleagues at Deutsche is part of the Khan Committee. We should wait till we see regulatory response to this sort of the outcry over this circular. There is still three, four months left. I do not think we will see any changes in the circular. You could see some dilutions to begin with. So, that is point number one. Second point is I do not think you will see that much of an outflow. Most of these foreign clients say that in the worst-case scenario, they will have to restructure their FPI vehicles and appoint someone else. There will be some sort of restructuring done and they will find a way around.
But it does increase the hassles for them and that is why you are seeing all these folks protesting in quite a big way. But in the end, we will get to that stage eventually. Let us give it some more time.

As an investor, what do you do in the market? Brokerages seem to be voicing same concerns. This morning too some of the notes are already calling FMCG stocks – Britannia, Unilever extremely expensive. They are already cutting their price targets and their ratings on some of these names. Do you go out and buy this decline or do you just profit take from here? Private banks like HDFC Bank, Kotak Mahindra Bank, FMCG as a cluster and other consumption names have made some stupendous returns in the past one year.

Our view is that in this environment, given that globally interest rates are going up – be it by the US Fed or ECB which will start hiking rates further and BOJ will follow. In India, we expect at least another rate hike if not two. The liquidity environment is tightening. In general, our preference is; a) Stick with the largecaps versus the small and midcaps. b), You are right that where valuations are very expensive, it is very difficult to expect a further re-rating. If anything, we should be prepared for a de-rating for the next 12 to 18 months.

The focus should really be on earnings growth. Companies with strong earnings growth prospects. Even if the PE multiple comes off a little bit, you could still see positive returns from stock investments. So, focus on companies where you see strong earnings growth. We are looking at IT services. The rupee is a strong tailwind. The US economy is doing really well especially the BFSI focussed IT outsourcing companies. Second, high CASA, high growth banks which are mainly the retail banks should do quite well. The third sector that we like is the industrial sector. In India, for seven-eight years, we have not really seen strong industrial growth.

We are beginning to see green shoots of an industrial revival in India. When that happens, some of these capital goods companies from a longer term horizon, will do very well over the next couple of years and earnings surprises could come through starting in FY20 onwards. The market will start discounting that a little bit in advance. We actually like the industrial goods companies. Also some of the cement manufacturers, again those who have relatively better balance sheets in particular, and that is how we are looking at this space.

We are underweight on some of the more expensive FMCG companies or even pharma. We think valuations over there have not come off enough. The US FDA problems persist. There might be a temporary tailwind because of the rupee, but structurally we are a bit cautious on the US generic space. Over there, we prefer some of the Indian pharma companies or the India focussed pharma companies instead.

If interest rates are likely to go higher, macro is a concern. Earnings recovery may be solid but a lot of good news is in the price and in the context of the political event which is going to be market moving in nature, why should one not go for 15-20% cash in the portfolio given the valuations levels we are at. Even if we get an earnings recovery, this market will not run up in a hurry. The downside could be large and open if anything backfires.

You are right that the risks are right now more in the short-term or if you take a 3-6 month investment time horizon. You should be raising cash and from these levels it is tough to make too much upside. In fact, the Sensex target is already breached. It was 37,000. We are at 38,000 odd something. If your investment time horizon is just about the next three to six months, then you should be raising cash right now. But again, it depends on whether you have a slightly longer term investment horizon of three to five years. We think equities could still outperform fixed income and the main driver is really the earnings growth expectation.

In India, in the last four-five years, the index earnings have hardly grown in single digits. For the first time, after man, many years, we are seeing an earnings growth revival. In the June quarter for example, if you strip out the financials, the Nifty index earnings were up 28% YoY in the June quarter.

That rate will moderate given the high base effect but nonetheless you will still see relatively strong earnings growth in rest of FY19. Our discussions with corporates on the ground suggest that overall corporate commentary is getting better. The corporates are feeling a lot more positive. The demand environment is improving. The economy is picking up. Earnings surprises or strong earnings growth can be expected in the next couple of years.

Even if you see a little bit of PE derating from a one-two years perspective, you could still make money as the earnings continue to deliver. But yes, if you have a three-month odd investment horizon, then you should be raising cash.

What will you not buy for next three to five years?

In general, I would stay away from companies which have weak balance sheets where there are corporate governance issues. There are structural issues in some sectors. I would be very careful in telecom. Unless these stocks come off a lot more, we would stay away from telecom. In PSU banks, a lot more needs to be done. So, stay away from PSU banks by and large. One or two the larger PSU banks might still be alright though.

In pharma, we need to see valuations come off a lot more before we get excited about it. We would stay away from the US generic pharma players. There are obviously pockets of opportunities here and there but it is better to stay away from there.