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We remain underweight on auto and neutral on consumer stocks: Gautam Chhaochharia, UBS

Lower tax rate for foreign investments coming into manufacturing is where the delta would be.

ET Now|
Updated: Sep 23, 2019, 10.16 AM IST
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Friday’s development has brought the hope element back amongst global and local investors, says Gautam Chhaochharia, Head of India Research, UBS. Excerpts from interview with ETNOW.

Are you confident now that things will improve and that too, very radically?
Absolutely. Even last time, we discussed how we are not panicking about the growth slowdown which we are seeing because this kind of growth slowdown is neither structural, nor cyclical, but was largely a negative feedback of over three to four months. Therefore, it also meant that policy response was around the corner.

But, obviously, no one expected such a big step. In our view, the most important thing is the lower tax rate for foreign investments coming into manufacturing because that is where the delta would be. You would have been hearing from different commentators that near-term demand boost may not happen, but the government has not taken up policy step to look at the next 1-2 quarters of growth. In a way, this is a much bigger step to attract foreign investment into manufacturing in India. We said four-five months back that India has a golden opportunity to benefit from the manufacturing shift from China and this is clearly the biggest step to realise that opportunity. It does make us a lot more hopeful and optimistic in the medium term for India.

Have you already missed the bus or do you think there is still scope to jump in and buy one of those stocks that you had already been eyeing.
Our fair value for Nifty for June 2020 with the revised tax rate would come to around 12,300 and upside-downside scenario makes the risk reward quite attractive. Our stance would be that it is not like missing the bus; the government has taken a big bold step and it is still not a given that the step will fructify in terms of higher growth over the next two-three years. But this, dramatically increases the probability of that happening. So we would advocate that it is still a good level to buy.

Are you getting a sense that foreign institutional investors are now looking at allocating a disproportionate amount of money to India? Could the outflows seen in August, September and July reverse?
Foreign investors in aggregate have remained overweight. Their overweight has not been at peak levels but they have remained overweight. The outflows which you saw over August or over the last few months is peanuts in the scheme of things, in terms of their investment in India or even in terms of YTD flows.

So they are already invested. Question is will they allocate more? Our sense is that they are looking at India more constructively. They remained overweight in the last few months because in the context of the global developments, India was still looking okay. There were worries around growth over the last three-four months but the Friday’s measures have given them confidence. Over the last few years, investors kept on investing in India despite disappointing local growth because the medium-term story looked compelling. The Friday development has brought that hope element back amongst investors globally and in India.

Everybody is focussing on the bright side, a glass half full approach. But even the best of the markets always have risk. What would you not do in this market?
It is again a question of timeframe. If you are looking at a 6-month, 12-month timeframe, we have to live with the reality that in the near term, markets look at data points beyond the medium term and that is what drives relative performance, rather than just medium-term absolute performance.

In that context, we remain underweight on autos and neutral on consumer stocks because beyond the mechanics of tax rate driven earnings improvement, these measures are at this stage not going to spark a consumption recovery in a strong way. What we saw over the last three-four months in autos would stabilise, but we would not see a sharp recovery in hurry.

In a portfolio construct perspective, I advise underweight autos and neutral consumers. The capex cycle hopes will definitely rise but you have to break it up into two parts – capex cycle driven by the local corporates driving a capex cycle that will still take time because of the local demand environment. Roughly 60% of private capex is happening in sectors where the bottom up drivers does not give us visibility of capex like power, infra, telecom, etc. The big private capex surge will come linked to the big manufacturing shift in India. These things take time. For us, the biggest delta for the macro would come if the government is able to use this corporate tax rate cut to attract meaningful manufacturing FDI over the next few quarters.

Besides being underweight on autos, would IT be also under that pack?
We have moved IT to underweight because our IT analyst thinks that the demand outlook in the US for IT services will likely surprise negatively not for FY20 but for FY21. There would be earning surprises next year and while the stocks are trading at peak valuations and even positioning is quite in higher end. IT is a clear underweight call for us also.

What about the positioning in autos? While we are talking about tax cuts, we are also talking about this big reboot which will happen at the cash flow level. At the GST meet, there was no tax cut for auto. Will that disappoint the market because the sensible investors never thought a cut was coming?
It will disappoint for sure. In the short term, the positioning will work against autos and even through the last few months and a year of slowdown, we have not seen foreign institutional investors stake coming down in the leading names because a lot of the investors kept on, buying the dips with the hope that things will turn around and valuations improve.

If we look at the leading players, we have not seen material de-rating despite the sharp earnings cuts. We have seen stock prices react more to earnings cut rather than multiples getting de-rated at levels where we will find risk reward attractive. So, from fundamental, technical perspective, it is easy for us to argue for an underweight autos call.

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