Banking sector continues to drag; consumer stocks may do well if commodity prices correct: Dhananjay Sinha

Dhananjay Sinha, Co-Head of Equities & Head of Research, Systematix Group, says the consumer market may improve if commodity prices correct, as HUL noted rising input costs. Better results could follow, depending on the year's developments. While passenger vehicle and truck sales are down in the auto sector, the tractor and two-wheeler markets remain strong. A drop in steel prices from issues in China and excess supply could also boost growth. He remains concerned about government infrastructure spending and its effects on the industrial sector that depends on it.

Are you convinced by the argument in favour of staples and FMCG companies? Should one start buying the defensives?
Dhananjay Sinha: We saw the results from HUL yesterday and also the management commentary. The stress as far as the demand scenario is concerned is continuing. The demand scenario remains lacklustre. The guidance they are talking about is that it would still take about a couple of quarters to get reasonable recovery. But what is important is they are trying to look at their strategy with respect to premium, premiumisation and all.

They are trying to look at the D2C business that they have acquired, how they can actually move, ramp that up and all. Basically, the attempt should be, for most of the consumer companies to ramp up realisation through better product mix and all. Overall, the demand scenario for the rural which was supposed to do better, but has not really panned out as robustly as it was hoped.


So that is a drag as far as the ongoing season is concerned in the consumer space. The hope is that in the upcoming Budget, there will be a certain amount of allocation in the rural space. There will be more spending on the revenue side which can enhance the consumer spending power, possibly they are expecting some tax move as well on the direct tax.

But indirect taxes would be more helpful because that is outside the Budget. So, the market is trying to build in a hope trade or a hope situation where the disposable income spending power for the household improves. I would say some of these companies are good companies. They have corrected a lot in terms of valuations. If we look at 12 months down the line, they should improve as far as the business traction is concerned.

We need to really look at what their product strategy and pricing strategy are. But with the kind of correction that has happened, it is possible that this year they can actually give a reasonable return with the context that the market might actually remain mostly flat, I would say, because on an average we are looking at earnings growth which might continue to see downgradation and we may possibly end up with an average growth of about 4% to 5% over the next couple of years. We will need to look at where the tractions are. In that context, with the correction that has happened in the consumer space, some performance can be seen.

Largely it has been the IT pack where Q3 earnings are out. What has been your takeaway? Where are you seeing both growth visibility as well as some amount of valuation comfort after the recent correction?
Dhananjay Sinha: The IT space has been an overweight area for us. The results for the December quarter did not show much excitement because this was a lean quarter and there was an election. So, the lean quarter was leaner than expected. Going forward you might see some traction going up. Traction might be visible and some of the indicators that we are looking at, point to an increase in margins; possibly the revenue mix is favourable.

Currency depreciation has been there and that is contributing to the margins. Also, if you look at the hiring cycle, the attrition ratio, how it has moved and incremental hiring that IT companies have been making, I would say it is bottoming out after a correction in the past one-and-a-half years. There does seem to be some stability and the commentary from the companies is also that there can be some improvement, especially in the US markets, where there has been some traction as far as the BFSI space is concerned.

Certain segments like media are still seeing some amount of stress but the bulk of it is basically BFSI, healthcare, etc, where we see some positive traction. I would say that is where we can see earnings support coming up. But by and large, if you look at other segments such as the banking sector, that segment will see correction. We are seeing margin pressure that has been there and we will see credit costs also ramping up. We are seeing that in the banking sector and the BFSI sector in general so that is about 33% of the weight in the Nifty.

The consumer space can do better if there is a commodity price correction. HUL talked about the input costs and stuff. If there is a correction in the commodity prices, there can be improvement but that will be a function of how things pan out during the year. Likewise, I would say in the auto space, while the volume growth for passenger vehicles and even trucks, commercial vehicles has been contracting, there is some resilience in the tractor and the two-wheeler segment. If steel prices come off because of the pressure in China and the dumping that is happening there, there can be some expansion there as well.

What I am circumspect about is the infrastructure spending that the government has been doing and the industrial sector that is dependent on that. Those are the broad thoughts I have at this juncture.

What according to you explains this weakness in the private banking names? Is it just the FII sell-off or is there more to it, reading into the numbers of Axis, HDFC Bank, and Kotak, and now we have got ICICI Bank over the weekend too?
Dhananjay Sinha: If you look at the banking sector, it is very difficult for them to really grow in the context that you have a peak level of credit deposit ratio. Many of these private banks are at above 90% credit deposit ratio and it is very difficult for them to really ramp up their deposit franchise, especially in the context that the rupee has actually depreciated and that has actually tightened the systemic liquidity and that essentially means that the money market rates have remained high.

I think that sort of adds up to the margin pressure and the cost of funds would entail in the context of the monetary conditions that are there. The hope that the market had was of rate cuts by the RBI sooner than later. That is getting postponed in the context of rupee depreciation. So, this whole growth context and also the margin context is actually weighing on the banking sector. I would say the other thing is, of course, that we are gradually seeing the pervasiveness of the credit cost emerging from the retail lending that had been fairly exuberant in the past, I think that is sort of coming home to roost.

That is also weighing on the fundamentals of the banking sector. I would say PSU banks had done phenomenally well earlier on, but a considerable de-rating has happened in the PSU banks. The price to book for the PSU bank index was 1.8 times eight months back, today it is 1.1. The de-rating in PSU banks could continue.

So, overall, I would say that banks that can do relatively better are banks with better ALM, and low credit deposit ratio. There are multiple filters that need to be looked at in the case of banking sector investments. I would say the cycle would be still about one, one-and-a-half years out before it reaches convincing equilibrium. So, the banking sector will continue to see a drag as far as valuations and the business cycle is concerned.