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Corporate profits have only got deferred, not cancelled

Sunil Singhania, CIO - Equity, Reliance Nippon AMC

24th November 2016

In a nutshell

While acknowledging the near term pain from demonetization, Sunil asks us to remember that corporate profits have only got deferred, not cancelled, due to this disruptive reform. Looking ahead, a fall in interest rates will benefit rate sensitives. It is time to be even more bottom up focused in the banking and NBFC space, as a gradual shift to a "cashless" society will mean different things to different players in this space. Sunil remains confident that FY18 earnings estimates still hold good and is looking forward to the Union Budget in early Feb 2017, which he believes will be a significant near term market driver.

WF: We know that consumption oriented stocks are significantly affected by the near term deflationary impact of demonetization. But from a bottom-up point of view, how will listed companies in the consumption space derive any long term benefits from this move? They were not really suffering due to the black economy; they are not large consumers of capital for whom a fall in interest rates will bring relief. So, is it a case of short term pain for no gain for the consumption theme?

Sunil: Staples and Consumer non-discretionary will have no impact except in the very near future. There will be medium term impact on consumer discretionary space. However, as the cash in circulation improves, the impact should reduce significantly. On the other hand, a move towards organized sector driven by a combination GST and demonetization, can lead to lot of benefits for the organized players.

WF: Is demonetization a game changer for PSU banks that should merit a significant upward re-rating of these stocks? In what ways do you see demonetization impacting the medium and long term outlook for PSU banks, private sector banks and NBFCs?

Sunil: In the absolute near term both Private and PSU Banks should benefit significantly due to the higher deposits leading to cost savings on the liability side. Further the sharp fall in G-sec yields should result in significant treasury gains for the banks. However, there can be some near term impact specially with reference to SME and working capital loans. Technologically advanced banks should benefit from the move towards 'cashless 'or 'digital' lifestyle. Select NBFCs with exposures to real estate developers can be impacted over the medium term.

Thus while on an overall basis, the banking space should benefit; it's too early to have a one-sided view.

WF: What are your broad market earnings expectations for FY 17 and FY 18 after factoring in the likely impact of demonetization? How do our market valuations now look, post correction and post any earnings downgrades?

Sunil: Near term revenues estimates for some sectors have fallen significantly post the demonetization and for these sectors/stocks the next two quarters (Dec'16 & March'17) will be challenging. We are constantly analysing the situation at the ground level & engaged in meeting companies to have a better sense of the actual impact. We should be in a position to have a systematic analysis in a couple of weeks.

However, our view is that profits have only got deferred and not cancelled. We believe FY 18 earnings should be in line with our earlier estimates.

WF: Many observers are gung-ho about the long term structural positives from GST and demonetization. Can you help us understand from a bottom up view, how these will impact key sectors that make up a large part of our broad market indices?

Sunil: Indian stock market is very well diversified with representation ranging from consumption, domestic Consumption, Capex, utilities, exports and global cyclicals. There are many sectors which are "largely unaffected" by demonetisation. Sectors which could be meaningfully impacted are mainly the domestic consumption oriented sectors like real estate, hospitality and luxury goods & services. Due to cash crunch, there could be a temporary blip in other sectors like autos, select NBFCs as well. On a positive note these sectors which are impacted have small share in our broad indices.

Moreover, beyond 2-3 months, there isn't much impact on most sectors due to this move. In fact, post demonetization decline in interest rates will eventually be helpful to most rate sensitive sectors like financials, autos, industrials, etc where demand recovery should also take place by next quarter.

WF: "Trumpflation" led rise in US yields is causing a huge reversal of flows away from EMs. As inflation expectations take root in the US, could there be a case for a de-rating of Indian markets along with other EMs, as they adjust to potentially lower global liquidity?

Sunil: US yields have moved up post the victory of Donald Trump and the difference between US 10 year yields and Indian 10-year benchmark have narrowed to approximately 4% (from a high of 7%). Thus there is case for lower FII interest in Indian Bonds for some time especially as the US dollar has been strengthening against major currencies. However, after the initial sell off in Emerging Market equities, things have stabilized and there has been a smart up move in the last few days. India has been an exception, given the demonetization uncertainty.

WF: What is your overall call on equity markets over the next 12-24 months and what do you expect the medium term drivers to be?

Sunil: In the near term markets should be range bound. However, Government revenues should benefit from a combination of one-time windfall because of the expected currency calculations and a medium to long term jump in tax collections due to better compliance & GST impact. We expect the Government to use this additional inflow to boost the economy by spending on its already announced infrastructure initiatives. The Union Budget which is likely to be presented in Feb 2017, is the biggest near term driver.

WF: In what ways have you asked your equity team to fine tune strategy to align with recent global and domestic developments?

Sunil: We at RNLAM Equity Fund management team are constantly analysing the situation. However, demonetization is an unprecedented event and hence require more intense tracking. Markets have reacted very aggressively especially in stocks/ sectors perceived to be impacted more by the demonetization. As mentioned previously we are focused on more on-ground research in our attempt to take more informed decisions. Small portfolio changes have already been undertaken and will continue as a constant feature.

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