How do you assess the current macro picture characterised by sustained slow-down in growth, weakening rupee and possibility of lower rate cuts
The current round of down-cycle that we are looking at is very different from those observed in the last 20 years. In the last two decades, such cycles were either led by some global event or a specific domestic event that didnt really impact every sector.
But the current down-cycle is very deep since in the last five years there is been no real investment in the country to increase adequate capabilities on the supply side. Investments that took place in this period were funded by debt which companies are struggling to replenish. Clearly, the balance sheet structure of corporate India is out of whack with 20% to 22% of corporate Indias debt in foreign currency. Till six months back, all of us would have thought that these are book losses that would turn track. However, severe currency depreciation is a reality now, which means that the book losses are turning into actual losses.
If you look at the top ten largest corporates in India today, their debt is grown by 35% in the last five years while their revenues have grown by close to 15%. There is a clear strain in their balance sheets which also that there will be ripple effect on the financial system with a larger NPA cycle lurking.
My fear is that if the environment remain uncertain over the next six months then urban Indias consumption pattern may change significantly. The premium end of the market which was growing steadily and where the companies made greater chunk of profits would start to disappoint.
In an economic slowdown the first thing to get impacted is discretionary purchases. You will never see staples being affected so much as personal care products. Auto, two-wheelers and aviation would continue to see the impact of slowdown. Categories which would remain stable is the staples part of the business, including all consumer names.
Are the equity markets in an uncharted territory
The equity market is not reflecting the downtrend effectively. While the benchmark Sensex is around 20,000, the broader market is possibly around 14,000 15,000, because of the skewed behaviour of stocks. For example, * Hindustan Unilever and * ITC are quoting at valuations they demanded 20 years back.
What is holding up the market now is the strong liquidity. Though the global environment for the developed market is better now, the emerging market theme has weakened out.
There is a lot of passive money which is coming to India, because those investors have to invest in various markets. These investors are picking up not bottoms-up stock but are going top down. Such passive money is lot more dangerous than active funds. This is sticky money. What we need to worry about today is that there is a total absence of the retail participation in India. For the first time in 20 years, the actual numbers of demat portfolios have shrunk.
Does the Indian market need to be de-rated
I clearly think that India deserves a de-rating. None of the parameters that test the strength of the market are met currently, in terms of corporate health, government policies, cost of capital or rate expectations. There is no rationale for this market to be where it is now. Consumption businesses are quoting at their life-time highs whereas the fact is that the deceleration in consumption is a given. The propensity to buy discretionary items would decline and there will be stronger slow-down that we would start to notice. The de-rating is already in play at least for 50% of market, beginning with with infrastructure and financials.
Valuations of most defensive stocks have soared. Is this a sustainable trend
The broader environment is extremely challenging which ideally means that even these businesses should see a fall in their valuations. We are getting in a scenario where interest rates are not going down in a hurry. So if one has to live with the current level of capital costs, defensive would continue to remain in favour since they are by default negative working capital businesses. Right now we are in a situation where volume growth is falling but are not cracking down totally since rural consumption remains strong. However, if the situations prevail for the next six months, I think we may see fair bit of margin correction that you may see in consumption businesses.
What direct and indirect impact a weakening rupee could have on the markets
More than its weakness, the volatility of the rupee is a bigger challenge for corporates as the former is easier for them to accept. The volatility weighs on companies because the cost of hedging increases disproportionately. Currency uncertainty prevents them from making large capex plans. One-fifth of corporate Indias debt is dollar denominated and is a huge risk for India.
As far as input cost pressures are concerned there is going to be obvious hit on the margins given that India is a net importer. Lot of crude derivatives which are inputs for most commodities get marked up, posing a risk to margin expansion. This year if we look at about 5.5% top-line growth for corporate India, mapping the GDP growth expectations, there is less likelihood of margin expansions as profit growth would also be somewhere close to revenue growth.
How do you see the June quarter result season panning out What are your expectations on the FY14 earnings growth
Excluding a handful of stocks which may surprise on the positive side, the broader market results would turn out to be disappointing. A year back the earnings growth expectations for FY14 have been pinned down from 15-16%. We may possibly end up with a 6% to 7% earnings growth in the financial year. Margins would be under pressure and corporate India would be more than happy to sacrifice growth to protect their balance sheet, and so growth would take the backseat.