The international situation has turned grimmer | Value Research Aseem Dhru of HDFC Securitie tells us why he is bullish on banking

The international situation has turned grimmer

Aseem Dhru of HDFC Securitie tells us why he is bullish on banking

In the second part of this three part interview; Aseem Dhru, managing director and chief executive officer, HDFC Securities speak to Sanjay Kumar Singh on a wide range of issues ranging from European sovereign debt concerns to the Q2 corporate results

What is your assessment of Q2 FY11 corporate results?
The Q2FY11 numbers have come in quite strong, with earnings up about 31 per cent y-o-y for the Sensex ex-oil. However, more companies have surprised on the downside. Of the 81 companies we track, the performance of 52 companies was on the downside of our expectations; only 32 came up with an upside performance.

There was a skew towards the energy sector. Foreign subsidiaries of companies — whether Corus or JLR — also made large contributions to Sensex earnings.

Revenue growth has been quite strong and broad based, reflecting demand momentum. It was up about 19 per cent or so for the second quarter running. Margins, however, have come under pressure. There have been five interest rate increases by RBI over the last one year. Their impact on corporate bottom lines can be seen clearly.

However, strong demand remains the key driver of corporate earnings and of investor confidence. Overall, we are quite happy with the results.

Among sectors, pharma has been a consistent performer; banking and financials continue to grow robustly; cement and telecom have disappointed even on our low expectations. Cyclical energy and metal spaces have seen strong growth.

We are looking at a 27 per cent earnings growth this financial year for the companies we cover. They are on track for that kind of earnings growth.

A four-quarter acceleration in earnings has definitely taken a pause this quarter. The skews have got larger and the subsequent two quarters do call for a close watch.

With so much liquidity flowing around, do you see a danger of a spike in commodity prices that could raise input prices and affect the India growth story?
Three forces affect commodity prices. One is demand. We are seeing quite anaemic world growth and a slowing China which doesn't augur well for a build up of demand. If you look at crude, inventories in the US are at an all-time high already. Demand has grown by only about 0.4 per cent. Second is positions which are driven by expectations. Liquidity pools are chasing and taking positions in commodities in a world where printing of currency is making money lose its value. The third factor is the dollar linkage. As commodity prices are quoted and traded in the dollar, movements in dollar rates have an impact on the landed cost of commodities in various countries.

So QE1 and 2 in the US and QE in Europe and Japan are nice names for the fact that governments have been printing notes. More the number of notes in circulation, the less is their purchasing power. So in the effort to reflate the American economy, the Fed believes rising stock and housing prices are the key for the American people to get a feeling of wealth regeneration. Commodity price increases and likely formation of asset bubbles are the collateral damage of this strategy. One needs to watch the speculative build up.

In the matter of stock picking today, do you favour a particular market cap category or sector? Or do you believe that one should go for bottom-up picks today?
Domestic consumption is the current theme in the Indian market — FMCG, auto, etc. But these stocks are now fully valued. The consumer sector, both staples and discretionary, could underperform in the coming months. We are seeing the return of the capex cycle. Investors should look at financials; infrastructure and its backward linkages such as cement, capital goods, etc; and agriculture, including fertilisers, nutrients, pesticides, seeds and implements. In the matter of stock picking, a bottoms-up approach is always the sensible way to pick stocks.

Why are you positive on financials?
Banking is essentially a play on the economy. If somebody wants to bet on the Indian economy, he should invest in banking. In 1990 India had a GDP of $312 billion. In 2010 we are at $1.37 trillion. A recent Standard Chartered Bank report sees India's GDP at $30 trillion by 2030 — at third position after China and the US. It takes our share of global GDP from 2.2 per cent to 10 per cent and per capita income from $1,164 to $7,380.

If GDP grows at 8 per cent, apply a multiplier of three: bank credit will grow at somewhere between 20 to 24 per cent. Clearly bank balance sheets will expand. Besides, currently the banking sector is in a phase where the capex cycle is growing with corporates setting up more plants and enhancing their manufacturing capacity. Moreover, when interest rates are rising, the banking sector tends to do well.

But what about valuations? Are valuations still attractive within banking?
Tell me, which bank in the world is increasing its earnings at 20-40 per cent every year? Indian banks have been growing quarter on quarter between 20 to 40 per cent in a sustained manner. Even the high level of non-performing assets (NPAs) that come in from time to time get addressed because the banking system is healthy and profitable. As a $1 trillion economy grows and becomes, if not $30 trillion then at least a $15 trillion economy, bank balance sheets are likely to expand at least 20 times over the next 20 years. If you are looking to capitalise on the longer-term growth story, the current valuations should not be an issue.

In any case, PE is not a very good way to look at the Indian market. Instead you should pay more attention to price-earnings to growth (PEG) ratio. The growth rates in India are very different from the rate at which advanced markets are growing or have grown in the recent past. What appears expensive today may actually be cheap if you take at least a three-year view. Any bank whose earnings are growing at 30 per cent every year will virtually double its earnings in three years or less.

To read the first part of this interview click here

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