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RBI policy, FOMC meet to be key drivers for market: Mahesh Patil, Birla Sunlife

"On the RBI policy front, clearly there is expectation of a 25 bps kind of a rate hike, looking at the inflation numbers."

ET Now|
Updated: Dec 17, 2013, 03.57 PM IST
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'Expect mild recovery in economy in 2014'

In an interview with ET Now, Mahesh Patil, Co-CIO, Birla Sunlife MF, shares his views on the markets and certain sectors. Excerpts:

ET Now: Seems like the market is pretty cautious ahead of the two big events -- the Fed, as well as the RBI policy?

Mahesh Patil: Yes, that is true. We have seen the market actually rise up in expectation of the election results and now these two events really would be the key. On the RBI policy front, clearly there is expectation of a 25 bps kind of a rate hike, looking at the inflation numbers.

However, if you really dissect the inflation numbers, they have largely been on account of food prices and more specifically, vegetable prices, and we have actually seen signs of that moderating. Therefore, that should not really be read too much into.

On the Fed policy and the fears about tapering, our belief is that we should not expect any large tapering this month and probably it should happen somewhere in the first week of the next calendar year, but this time we would be well prepared for it, because we have seen a lot of easing on the current account deficit front. Our balance of payments situation is also pretty comfortable. Hence the reaction this time to such an event would be less muted than what we saw last time.

ET Now: If that is indeed the case, how would you position yourself for equities?

Mahesh Patil: Well, it is very difficult to really position for any such event, but by and large, our view has been that we are at somewhat of a cyclical bottom in terms of economy and we should see a mild recovery going forward. Even from the rate perspective, we feel that the rates are at peak levels with the 10-year bond close to around 9% and inflation should ease off somewhere by March next year and then, you should see a moderation in interest rates.

Hence we have been positively inclined on the market, from a medium-term perspective, and also with a slight bias towards some of the cyclical stocks. Though they have rallied recently, with any correction, one would like to increase exposure to cyclicals, especially in sectors like banking and financials.

ET Now: Both the Fed tapering and what the RBI does would have an impact on banking. How would you advice investors to look at banking from hereon?

Mahesh Patil: In the banking sector currently the liquidity situation is pretty okay and the borrowing in the MSF window is actually zero. So even if the RBI were to increase the repo rate, it would not have too much of an impact on the borrowing cost of the banks. More importantly, for the banking and financial services sector, there are two concerns which have been there.

The first is the increase in NPAs and because of the slowdown in the economy, that is what has hurt some of the banks, especially the PSU banks. There again, while we have seen some signs of easing, it still remains a challenge going forward. The good thing is that on a lot of large accounts, which were potentially likely to become NPAs, we have seen some pressure by banks to do asset sales and deleveraging. That is good for some of the banks, especially banks which have lending to the large corporate side.

So going forward, if we believe that the economy would start to recover and we have seen the bottom, then the stress on the asset quality should start to ease off, though it would not happen in the next immediate quarter, but over the next two or three quarters.

The fact that interest rates also kind of have peaked out, I do not think it will really lead to further increase in borrowing costs. Given these two factors and also the fact that the valuations are pretty reasonable, the outlook, as we move forward, looks to be favourable for the banking and financial services sector and we have seen decent correction in the banking stocks over the last one year.

Uptil now, we have seen that the retail private sector banks have done much better because the retail part of the credit cycle has been pretty well, but even some of the large banks focused on the corporate side, where the valuations are at significantly lower levels, should also start to do well going forward as we see some ease off in terms of asset quality pressures.

 

ET Now: What have you made of the tyre space and does that interest you, or does it seem like this is just a temporary blip up?

Mahesh Patil: Well, the auto ancillary space, especially the tyre companies, has seen a significant improvement in their profitability in the last quarter numbers and essentially, it was driven by the lowering of raw material costs, especially of rubber. So we have seen a margin expansion and to some extent, while the OEM demand has been weak, we have seen the replacement demand to be pretty okay. So with the change in mix -- OEM typically is a low margin kind of a business and replacement a higher margin one -- we have seen better numbers coming in.

Therefore, with good numbers and margin improvement we have seen some re-rating happening in all the tyre company names, but the key question here is how sustainable the margin expansion is, because the benefit accruing from lower commodity prices, sooner or later, would have to be passed on to the end consumer. So looking at the run up that we have seen in some of these stocks, one should be a bit cautious. But overall, the outlook for the sector looks to be pretty good.


ET Now: Is that corroborated by your view on the auto space as well, because leaving aside the CV cycle, most of the other auto companies are trading pretty well and the sell side seems to be bullish out here too?

Mahesh Patil: Yes, if you look at the auto space, especially the two wheelers and the four wheelers, on the consumer side, we have seen in the last one year things have been pretty tepid. We have seen a flattish kind of growth. So going forward, as we see some recovery happening next year, one can again look for numbers returning to somewhere in the low double digits or so.

Also, a lot of auto companies, even in this downturn, have been able to protect their margins pretty well. They have been able to reduce costs and other expenses. So they have been able to actually increase margins.

Hence as volume growth picks up, operating leverage should also come into play and should lead to higher earnings growth. Therefore, while the current scenario looks pretty depressing in terms of volume growth, but taking a slightly one-year or forward view, as we see a cyclical recovery, there will be a volume growth rebound and typically when we see a volume growth rebound from a bottom of the cycle, they tend to actually overshoot on the other side. They are never near the long-term average, which is 12-13%. With that view, it is a sector which holds promise from the next two-year perspective.

 
ET Now: Talk about two defensives -- FMCGs and IT. In FMCGs, an average PE multiple for the large stocks is trending northwards of 30 and in IT the average PE multiple for the large ones is sub-20. These are expensive stocks, but do they have room to move up further, because everybody right now seems to be liking IT. Is that a faith justified and can the stocks give superior returns, even after the rally that they have seen in the last 12 months?

Mahesh Patil: If you look at it, IT is not exactly a defensive. We have seen some cyclicality in IT, depending on the growth in the developed markets. FMCG is a classic defensive. The valuation overshoot on the upside in the FMCG sector is at an all-time high. It is close to two sigma standard deviations above the long-term average and in FMCG, we are seeing this on the backdrop of some slowdown in consumption and the last quarterly number volumes have tended to be lower than what we have seen in the last one year. So clearly there, the risk reward does not seem to be favourable if you look at the sector as a whole.

On the IT side, the valuations have moved up a bit in the last one year or so and growth outlook for the next year looks to be better than what we had seen last year. In fact, IT budgets for the next year are getting finalised and the indication is that IT spends -- which were negative last year – will probably see an increase of around 1% to 3%. That bodes well for the IT stocks in terms of volume growth for the next calendar year and obviously, companies have been also able to benefit from the rupee depreciation.

Therefore, IT is a sector where we are actually seeing the earnings trajectory to be much stronger than what we have seen in the last couple of years and to that extent, I would say that the valuation re-rating which has happened is justified and one could continue to see outperformance in the sector in the medium term.

ET Now: What according to you is the market pricing in from the RBI this time around, because the IIP data and the inflation figures yesterday do not really give you a comforting feeling and it seems that it could be a rate hike anywhere between 25 and 50 basis points?

Mahesh Patil: Yes, from a market standpoint, a 25 basis point kind of rate hike looks to have been discounted for and I do not think it will make a material difference in terms of market outlook, because as I said earlier, the liquidity situation is pretty easy at this point in time with money coming in from FCNR (B) deposits. That has improved the liquidity situation in the banking system as a whole.

Therefore, even the kind of repo rate hike that we are expecting would not lead to any significant increase in the costs for the banking system and it would not lead to any significant change in our view on the market at this point in time.

ET Now: Leave us with one pocket. It need not be in the large cap space, but could well be a set of stocks in the midcap space, which you are confident about outperforming the markets over the next 12 months.

Mahesh Patil: I would not like to comment on specific stocks, but there are sectors, especially the capital goods sector, where we expect recovery next year, if at all, particularly with a stable government at the Centre. In that sector companies which have enough capacity and where the balance sheet is strong are the ones which will be able to bounce back and do well over the next two to three years. Hence that is the sector opportunity which one should be looking at closely to play the recovery next year.

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