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S Krishna Kumar on why 2020 is going to be better than 2019

Long-term, we are short of houses and infra & as glitches clear, the demand side would perk up.

ET Now|
Updated: Dec 09, 2019, 04.42 PM IST
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ETMarkets.com
S Krishna Kuma2r-Sundaram AMC-1200
We are sticking to our conviction that there will be an improvement in the next three-four months and being investors in the broader market would give you far better returns, says S Krishna Kumar, CIO - Equity & Executive Vice President, Sundaram AMC. Excerpts from an interview with ETNOW.

Everybody in the market is reaching that stage where even if you start banging your head against the wall and make a case for revival of midcap and smallcap stocks, they are ignoring it.
We have been maintaining that going into third and fourth quarter of the year, you would see the markets getting broader in terms of rally and that would percolate into the mid and smallcaps. The reality is that in the last three years, the largecap indices are up about 50% to 60% whereas the mid and smallcap indices are just about 10% to 15% up or lower. In the current year, a similar underperformance continued. However, valuations being reasonable, there is a case.

Of course, economic growth has been stuttering and we have seen that the data that the market currently is looking at is most of the second quarter numbers and you are probably seeing that the improvement that we experienced in the third quarter is not as sharp as one expected it to be. However, there is a lot of improvement on the inventory destocking at the channel level across various products, including consumers. We do believe that the factory orders, the manufacturing engine is starting to do better at this point in time.

The Maruti YoY manufacturing numbers have got better after about a year’s time. Similarly, in case of a lot of other auto and auto ancillaries, we hear at the ground level that the schedules are getting better. So, we are sticking to our conviction that there will be an improvement in the next three-four months and being investors in the broader market would give you far better returns. One cannot look at equity from three or six months’ perspective. All of us are in the game for long terms.

On the macro front, the picture has deteriorated. RBI has said inflation has come back, global markets are indicating that trade war is back and the spike in the crude will dilute a lot of assumptions. While bad was supposed to become better, it actually has become ugly.
I disagree here because the extent of the slowdown is definitely getting reversed. I am sure that the third quarter numbers are going to be around 5%, compared to 4.5% in the second quarter. The jury is still out on whether the 5% could go up to 5.5% and then 6% in the fourth quarter. You would probably end the year closer to 5.5% on the fourth quarter exit, rather than a 6% that one would have expected earlier.

Having said that, it is a little too early to say that the scenario is turning from bad to ugly. One could argue that the pace of improvement is a little slower than expected. Having said that, once we are through with this BS-VI transition, a larger story could pan out on the auto, the auto ancillaries and that has a significant impact in terms of how the demand percolates across sectors to metals and plastic. We need to wait for the next three-four months to see how the economy is moving. As for inflation, it is more on vegetables and that is not core inflation. Core inflation is still dropping to 3.5%. There is no major upthrust in core inflation. Globally, the inflation levels are low. The industries are well supplied. Crude moved up to $64-65 led in knee-jerk reaction to OPEC plus production cut. In next one week, we expect it to settle down, given that the US is already the largest supplier of oil and we expect crude price to normalise over the next one to two weeks.

I do not think these are all going to feed through at this point in time, in terms of the inflation metric. Of course, RBI has a constraint in terms of the inflation dynamics and what it looks at. While one would at the ground believe that inflation would peak out in the next two months more arithmetically on the CPI, core inflation will continue to trend down. Also, people are a little worried about the fiscal.

The bond markets are telling you that it is going to slip and that is why the 10-year remain stubborn at 6.5% and above. All those risks are well in the market and people are looking at that. We should look at it constructively in terms of medium-term outlook on equities.

Though people have been calling it a flash in the pan, there has been a bit of production uptick coming in after nine worried months of a cut or halt in Maruti. Finally, a production uptick of about 4% coming in. Is the worst over for autos?
I would think that FY21 would be a far better year for automobiles. 2019 has been a year of constraints, starting off with the liquidity issues in NBFCs. There used to be 12 guys financing you at the showrooms and that went down to two-three guys at most. But that is getting better to maybe six guys now. So the liquidity situation is getting a lot better than what it was one year back.

Second, BS-VI transition and the increase in cost are also confusing customers. Companies have had to do a little bit of inventory sell down. There is a hard stop on 31st March, 2020, unlike last time around where the sales of older cars went on till April. The industry is working on a week-to-week basis and that is making it sound like an 11 month-year.

We believe that next year is going to be a normalised year when you will have to build up BS VI stocks by April. The year will start quite robustly and the next year would definitely see a double digit growth in autos over 2019.

Telecom could turn out to be a spot of bother, especially in the wake of the comments coming in from Kumar Mangalam Birla on a public platform, saying that they will have to shut shop if they do not get any relief from the government. Also, there is the issue of banks’ exposure in telecom sector.
Every stakeholder has to make its point and try to get the maximum benefit from the other stakeholders. In this case, industry incumbents are gunning for more sops and benefits and easing of moratoriums and timelines on payments. However, the government is also quite considerate in terms of the pressure on the industry and on the banks as well as its own fiscal. So, it is balancing out all the needs of the government, the banks and the players at large.

The rural market also is going to be better next year, given the improved rains that we have seen. so that is also going to add a leg up in CY20.

-S Krishna Kumar


However, it is a free economy and the players have to learn to live with it or look to exit the business if it is not conducive. So I do agree at this point in time that the incumbents are trying to get the best from the government and the government we believe will take a considerate approach. We do not believe that the telecom issue will snowball further into any significant event. There will be a good resolution in terms of payouts and cash flows and matching it.

Let me look at the bright side and then the ugly side. The bright side is that for a lot of sectors, the base effect has kicked in and so natural economic recovery would be strong. But the ugly part is that top line has been sluggish. Also, if crude prices stay where they are, we would be importing inflation out. What would you magnify? The real recovery is not there; we are betting on the base effect.
Definitely there is a base effect that will help us over the next four quarters. That is going to play out differently. More importantly, we should focus on the consumer in terms of the actions and the on the ground purchases and numbers would actually give you the story. I am not going to be too much concerned about the crude pricing and the import in inflation, the reason being that when there is a lot of softness in terms of the capacity in different industries, there will be some amount of absorption the value chain.

Further, we do not believe that the crude is going to stay higher for a longer period. This is a very transient spike that of about 5-6%. It should get normalised over the next one month. Also, we should focus on . More banks are lending to the NBFCs and the consumer segment. We are seeing that a lot of banks are putting a lot of money into the call money at this point in time. The rebuild of confidence into the financial systems has to accelerate and that is where the government and RBI’s efforts are focussed on. We have also seen that some of the schemes being launched on the housing side are starting to move on the ground with about Rs 10,000 crore AIF fund. A lot of confidence would be built in the financial sector, bringing in real liquidity to the user industry. That is what we should look at as that would have a big effect in terms of the consumer being able to leverage himself and participate in the growth.


One pocket that you do like and we have touched upon is cyclicals and cement in particular. What kind of potential are you looking at when it comes to the cement space?
Cement is a domestic commodity. It does not have links to global prices on the output side and not much import happens. So, you are in a protected industry for the competition is at the local level. Also, being a very freight intensive industry, the circle of operation of every company is also determined, given the plant locations etc. That builds in a case for a lot of companies which have strength in different regions.
Overall, I think, if you axe out the south Indian companies and the capacities there, the rest of India operates at a good capacity utilisation on average of about 80-85% and that is a very good number to have because the rest of the 10-15% is never going to be used fully because of the operations constraints etc that generally comes into operations. It is quite a tight market, compared to monsoons where there is weakness, the industry should do well the rest of the year. The energy costs are definitely under control and that is also helping the companies to expand margins in spite of the realisations not doing as well.

Further, we also believe that there is a lot of operational inefficiency on the supply chain, which every company is trying to address and also able to start saving some on that front. We think that given the very low capacity addition that we will have in the rest of India, over the next two years, when the demand improves a little better and the supply tightens, the pricing power of these companies could get a lot better and help play out on the prices of the companies.

It would be a little different in south India, where there is a lot of price discipline. At 50-60% capacity utilisation, a lot of companies could bleed if there is a price war. That is a disciplined industry and at most points of the year, it gives them one of the highest EBITDA margins in the industry even though it is a surplus space in the south. These are the positives.

The long-term story in India is that we are short of houses and infra and as things pick up and some of these glitches around policy, regulation and government change, the demand side would perk up a lot more. The rural market also is going to be better next year, given the improved rains that we have seen. so that is also going to add a leg up in CY20.

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