Unmesh Kulkarni, Managing Director-Senior Advisor, Julius Baer India.
Unmesh Kulkarni, Managing Director-Senior Advisor, Julius Baer India, says the Budget 2021 is a break from the past as it deviates from the fiscal target while making a concerted effort to revive growth and, more importantly, the investment cycle.
The government’s intent to put the economy on the growth path is good news for investors but given the sharp run-up in valuations, they should befaith prepared for some intermittent pullbacks.
Disappointment on the vaccine front, a strong dollar or rising US and domestic bond yields can set the stage for some profit-booking. The pullbacks would be an opportunity to build up the portfolio, but do not get left out in case the market rally extends further, Kulkarni says in an interview to Moneycontrol’s Sunil Shankar Matkar. Edited excerpts:
Edited excerpts:
Q: How do you view the December quarter earnings? Do you expect upgrades in earnings to continue?
The December quarter has witnessed very robust earnings, with several companies beating expectations. Among the companies that have reported so far, while top lines (revenues) have been flat and in line with expectations, earnings have been very strong, both in terms of PAT and EBIDTA. For the Nifty companies that have reported so far, earnings are up about 22 percent.
The earnings trajectory has improved across the spectrum—autos, banks, cement, metals, consumer durables, technology—to name a few. As we have been expecting, domestic cyclicals have led the way, beating consensus expectations by a huge margin.
We expect the momentum to continue to gather pace and towards this, we are already seeing earnings upgrades by analysts across the board. We started the year with an expectation of a small YoY decline in earnings (around 5 percent) for FY21, this saw an upward revision post the Q2 results to an expected growth of around 5 percent. However, the way the results are panning out, there is a high likelihood of further upgrades and we could possibly move closer to a double-digit growth trajectory for the year.
A continuous improvement in demand, coupled with aggressive cost rationalisation initiatives undertaken by the companies during the pandemic year, is leading to an overall improvement in the bottomline of companies. We are seeing a number of companies reporting record operating margins and we believe some part of cost savings is structural. The recent sharp increase in input costs, however, remains a monitorable.
Besides, the fiscal boost provided by the government in the Union Budget and the special thrust on infrastructure and capex should kick-start the investment cycle in due course. The improvement in business sentiment is leading to a pickup in the lending business for banks and NBFCs (which was much awaited). Besides, for banks, the deposit growth continues to be strong and the asset quality has also been better than what was expected due to the pandemic-led lockdowns. We expect a strong rebound in the earnings of banks, especially the stronger banks. Many NBFCs have also managed to weather the COVID-19 crisis and been able to protect their asset quality (including a robust improvement in collection efficiency), besides benefiting from the lower cost of funds.
While rural demand continues to be strong, aided by a favourable monsoon, healthy crop production, higher MSPs and support from various government initiatives, the urban demand has also started witnessing a good recovery. Besides the latent demand and some cheer from festive demand, the overall improvement in consumer sentiment (thanks to the continuous un-locking of the economy and people gradually returning to work) is leading to an improvement in discretionary spend as well.
Q: What would want to add to the portfolio, in terms of sectors, after the Budget and why?
Although there were not too many measures directly impacting sectors, the ‘cyclicals’ clearly emerged as the biggest beneficiary of the Budget, with its focus on the revival of the investment cycle and supporting the economic environment. These would include sectors such as banking & financials, industrials, building material (cement + metals), auto, real estate, etc and then there would be a second-round impact on domestic consumption as well.
Sector-wise, the Union Budget had some positives for the auto sector, including the policy for scrapping old vehicles, enhancing public transport, capex allocation for the railways (positive for ancillaries), etc. The PSU bank recapitalisation and the proposal to set up ARC/AMC for cleaning up banks’ balance sheet should augur well for corporate-focused banks and PSU banks. The increase in FDI in the insurance sector is marginally positive for the sector, though the ULIP-heavy companies would face some set back owing to the taxation of ULIP policies.
There were various degrees of positives for companies engaged in the infrastructure space, particularly EPC and capital goods companies catering to the roads and railways sectors, water management and ports. Cement, building materials, pipes and companies catering to the infrastructure space should benefit overall from the increased capex. The allocation towards healthcare infrastructure and wellness is likely to drive greater demand for pharmaceuticals, healthcare services and consumables. Additionally, the allocation for COVID-19 vaccine should benefit pharma companies.
To sum up, the Budget, being growth-oriented, should turn out to be beneficial for most sectors. However, the domestic cyclicals could benefit a bit more (and especially with the space coming out of a painful period of the past few years) and hence one can look at increasing the allocation there.
Q: Which are the sectors you will leave out of the portfolio after the Budget and why?
We think that the Budget has provided the necessary growth impetus to the economy, which should result in demand creation and benefit the broader market. While the Budget may be neutral or marginally negative for some sectors (such as steel) in the near term, we would ideally look at the medium-to-long term prospects for companies and sectors in the backdrop of the recovery in demand and growth and consequently, how the earnings recovery plays out rather than focusing too much on any near-term negatives from the Budget.
Q: What is your reading of the Budget fine print? How will you score the Budget out of 10?
Over the past few years, the Budget had actually lost its relevance from policy-making perspective, as most important policy decisions were being announced outside of the Budget. Moreover, given the fiscal prudence path that was adopted under the FRBM framework, there was very little leeway for the finance minister to provide any significant stimulus to the economy, unlike in the western countries.
However, this year’s Budget has been quite different, as there has been a conscious decision to deviate from the fiscal targets and make a concerted effort towards the revival of growth, and more importantly, the investment cycle. The Budget, therefore, definitely scores high on this count, as it has addressed some of the key and fundamental areas of the economy that need attention—education, healthcare and infrastructure, besides being supportive of local manufacturing.
The enhanced allocation to capex, expanding the coverage of the National Infrastructure Pipeline, setting up of a DFI are all steps towards kick-starting the investment cycle again. Besides, the announcements around privatisation and asset monetisation through InvITs, if backed by timely execution, could change gears for the government’s long-term disinvestment agenda.
Another area where the Budget scores high is the transparency that it has attempted to bring into the fiscal math—getting several of the usual ‘off-Budget’ items included in the Budgetary allocation, even though this transparency has resulted in the fiscal deficit number shooting up further.
Overall, the Budget was sensitive to the needs of the economy (growth focus), the social needs of people (rural, healthcare, education) as well as financial needs of savers (no changes in tax structure). The good part was that the government finally loosened its purse strings, even at the cost of a fiscal relaxation and putting the resources to more productive use rather than taking a populist bend.
The one place that needs careful attention is the impact that this expansionary Budget might have on inflation as well as interest rates. The high duties (plus the agri cess) on the already high fuel prices along with increase in duties on various items could potentially create cost-push inflation for the economy, especially at a time when a number of commodities have already seen a sharp surge.
Besides, the fiscal expansion could also create inflationary pressures and the higher consequent government borrowing is likely to put upward pressure on interest rates, despite RBI’s intermittent intervention. That said, the need of the hour is clearly a focus on revival of growth, demand, employment and investment, which the Budget seems to have addressed, even if it means sacrificing a bit on the cost side.
Q: Do you think the Budget gives a boost to the banking & financial sector? Will the creation of a bad bank solve the NPA problem?
The Budget has been most favourable for the cyclicals and the banking & financials sector remains one of the best plays to benefit from the cyclical recovery. Apart from some of the direct measures such as PSU bank recapitalisation and the proposal to set up ARC/AMC for absorbing the stress on the banks’ balance sheets, the bigger story for the sector would be in the form of a pick-up in the investment cycle and an improvement in the economic environment, leading to better consumer sentiment. This has a dual impact on revival in the credit growth and improvement in asset quality. In fact, what has also supported the buoyancy in the BFSI sector has been the positive results by a couple of banking majors such as ICICI Bank and SBI, which came up around the time of the Budget. The healthy stock performance of these heavyweights (both the stocks gained 10-15 percent post results) also provided a leg up to the BFSI rally.
Regarding bad bank, though it may not be a permanent solution for all future problems, it definitely provides a breathing space to some of the ailing banks and an opportunity to rejuvenate. It also provides a strong signaling mechanism that the government is willing to support the BFSI sector, which is the lifeline of the economy.
Q: What should be the investment strategy post-Budget? Should investors continue with the buy-on-dip strategy to rejig their portfolios?
The Budget has certainly created a positive market sentiment given the special thrust on revival of growth, demand creation and investment cycle. Since Budget Day, the Nifty has rallied more than 11 percent on the back of this positive sentiment, while being supported by the buoyancy in global equities (S&P up about 5.4 percent during the period).
Our investment strategy for 2021 revolves around four key themes: (1) Earnings recovery (2) Rotation trade (3) Midcaps / Smallcaps to outperform and (4) Revival of the private capex cycle. The Union Budget has further reinforced our conviction in these themes. We have a constructive outlook for equities over the medium-term, given the expected rebound in earnings, the impetus provided by the Budget and a benign outlook for global equities as well.
The vaccination drive is picking pace across the globe as well as in India and this should provide the necessary support for economies to get back to normal. Besides, the dollar is likely to continue its weak trend this year, which augurs well for flows into emerging markets.
In the near-term, given the sharp run-up in valuations, investors should be prepared for some intermittent pullbacks. Any disappointment on the vaccine front, or a possible strengthening of the dollar (contrary to expectations) or the rising US yields and a similar possible rise in domestic yields could set the stage for some profit-booking in the equity markets. However, any such pullbacks would present an opportunity for investors to build up their equity portfolios. A mix of lumpsum investing, staggered investing and buying on dips could be a prudent strategy to ensure that investors ride out any possible volatility in the markets but at the same time, do not get left out in case the market rally extends further from here.
Q: Do you think the divestment target set by the government is achievable in the current scenario?
Divestment has been one sore area for the government over the last few years, as they have been consistently missing their targets. There have been no big-ticket divestments and the regular supply of paper through the CPSE ETF route has in fact been detrimental to the valuation of the PSU companies. However, this time around, it seems that the government has a more concrete and a better plan on the divestment front.
Firstly, they have indicated that there will be no supply overhang through the ETF route. Secondly, they have clearly identified the PSU companies where they want to push for the divestment (with some target valuation in mind) and accordingly, they are taking steps to improve the valuations of these companies.
For instance, the recent announcements on the sale of Numaligarh refinery in case of BPCL or the approval for land lease policy in case of Container Corporation. Besides, the target set of Rs 1.75 lakh crore seems achievable. Finally, the trump card available with the government is LIC, wherein a 10 percent stake sale can help it generate close to Rs 1 lakh crore, of which they have already made a mention in the Budget.
Hence, the prevalent positive sentiment in the market (with abundant liquidity) coupled with a more structured approach by the government should help in meeting the target. In fact, one successful big-ticket divestment can set the ball rolling and lead to better valuations for the entire PSU pack.
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