Banking, PSU oil & gas space will outperform: Motilal Oswal Securities

Rajat Rajgarhia, Director, Research, Motilal Oswal Securities, in an interview with ET Now discusses their India Strategy Report and preview to the earnings season

Going through your report, you seem to have mentioned that the global markets are one of the main triggers for the direction of the markets that we will take. However we have seen that in terms of the domestic factors that the Indian markets have thrown up in terms of IIP numbers, even the advanced tax numbers or the auto sales numbers we clocked in were fairly good. Do you think that the markets are possibly discounting this and global factors are taking precedence?

In the short term, you will always see global markets taking centre stage to drive the Indian markets. But if you look at the outperformance that the Indian markets have done in this calendar year, that is largely because the domestic factors are still holding up quite well.

Actually it is a reflection of what happened last year June. Also when because of the election results, you saw a big outperformance coming in the Indian markets and this year because you have normal monsoon expectations, you have a government which is now all set out to carry some long awaited reforms and the domestic economic retaining its momentum, all these things are just helping us to hold on while the rest of the world has tanked down by anything from 8-15%.

If you have to pick two sectors, which you think will outperform in the next 13 months both in terms of earnings? And perhaps their prices have not factored in that kind of earnings growth, which would those two sectors be and if you can walk us through the reasoning?

The first would be financials because we will get surprised by the kind of loan growth, which will happen in the system. If you talk to most of the banks, they are still talking about disbursement growth being just okay and you have a YoY growth, which has already touched 20%.

One would not be surprised if by the end of the year, you see this number inching up 23-25% and today the P&L account of the banks are earning lower than what they typically earn in an average cycle. So you will see a lot of good numbers coming over the next 4-6 quarters from the PSU banks. For a 20% average RoE, they still trade at 1.5 times price to book. Some stocks are at 1.7-1.8, but large part of the sector is still between 1.2-1.5. So they can still offer you in excess of 25% return.

The second sector, which should offer very good returns from here will be the entire PSU oil and gas space. We have seen a big run-up in the last one month or so, but these stocks have done almost nothing in the last five years. Stocks like ONGC, the oil marketing companies, their real earnings are way above what they are reporting right now and if oil prices remain in a band of $65-75 and the government just carries on with what they have announced, you have still a lot more returns to be made in these stocks from here. So these are the two sectors, one is financials and second is the domestic oil and gas space, which we will be overweight upon.

We have seen a pretty significant fall in input costs whether it’s steel, iron ore, copper or aluminium. If you could pick one sector where we would see an immediate uptick in margins and in the bottomline because of this, what would it be at the moment?

Actually because of the fall in the commodity prices, the impact on the margins will only play out in the second half. In fact, this June quarter when companies will report, we will see margin dropping for most of the sectors in our universe, but if you were to pick up one beneficiary, which will benefit because of this fall in the raw material prices, autos will be the key one where it’s a complete pass through and its also a question of operating leverage. So if the second half volumes were to remain good and the raw material prices were to turn lower, we will see earnings upgrade and surprises coming in the sector.

We have earnings season, which will be kicking in less than a week from now. So if you could just highlight the kind of sectors that you think will show outperformance and underperformance in terms of earnings?

This time it would not be a sectoral behaviour, it will be a more stock-specific behaviour, which will be a key driver of earnings. Before that, I would like to point that when we released our final aggregate, we were surprised by the lower amount of growth that we are seeing in our aggregate.

We would have thought that this quarter earnings growth will be in excess of 25%, but the actual compiled number just came to 17-18%, which means that the system has seen a much more margin compression than what we have seen, whether it is cement, FMCG, IT or telecom. Most of the sectors are going to see margin contraction. So if you want to be positive, you have to be a lot more stock specific, whether you have a Bajaj Auto in autos, whether you have a BHEL in engineering or whether you have someone like an HDFC Bank or a Yes Bank in private banks. These are the ones which will still report a very strong YoY growth.

Otherwise in terms of major driver, PSU banks will have on an average a pretty good quarter to report by and very selective picking in oil and gas space and metals, which will do well. Otherwise on an average, the rest of the sectors will have a very muted growth. That’s why our aggregate growth number for this quarter is just 17% YoY.