Pointing out the macro data in the months of November and December may contain demonetisation “one-offs”, Neelkanth Mishra of Credit Suisse said the impact of the currency recall exercise will extend beyond the March quarter. It will be take about 12-18 months to assess the complete impact of demonetisation, he said.



Mishra pegged corporate earnings growth in FY18 at 10-12 percent, while saying the FY17 earnings growth may be hit due to demonetisation.

Sharing his outlook on the IT sector which has seen slowdown in the recent quarters, Mishra said it is possible that IT sector revenues will grow in the next few quarters. If corporate spending in the US increases on account of factors like taxes, Indian IT companies will benefit, he added.



Below is the verbatim transcript of Neelkanth Mishra's interview to Latha Venkatesh, Sonia Shenoy & Anuj Singhal.

Anuj: Your thoughts on what a couple of bank numbers have thrown up. It looks like almost demonetisation was not a problem at all. Would it be too early to take that call or would you go with that argument?

A: It's too early to take a call. There are significant distortions in the data that we have seen, all the high frequency indicators - one, too narrow; they do not reflect what happened in the informal economy and the kind of disruption that we saw there as against the trade number an second, also look at what is happening to inflation, while my view is that a lot of food inflation was bound to come down anyway but they have been significant anecdotal evidence of disruptions in the perishable supply chain.

There are also indicators that we will never get on what happened on reverse migration, a large number of informal industries like paint brushes or shoes or stainless steel utensils - these are very cash based supply chains and I do not think we will get data on them plus the numbers in November and December are definitely distorted meaning some people have attempted to launder their cash through backdated invoices, some have tried to launder it through paying service tax and therefore service tax collections were up 44 percent in November and there have been other distortions like November sales for cars were weak but December sales were very strong and people are saying things have normalised. I think it is too early to say that.



Latha: Therefore what would you prepare us for? What are the indicators you will look at to gauge the impact of demonetisation on earnings. Is it that the January-March quarter will show us the pain or lack of it or would it be even longer?

A: I think it has to be longer. We have been advising investors to look through, and this is from day one of demonetisation, that let us look through this period of currency shortage because it is an abnormal situation. Humans by nature are very creative and especially with abstract notions like money, so at places credit has replaced cash and in other places people have used creative mechanisms and therefore the sales numbers, the volume numbers sometimes can also be much distorted. So let's look through this and from an investment perspective let's look at what could happen from 12-18 months perspective and those implications will start becoming visible, maybe even after March. So the high frequency indicators that I think are going to be far more trustworthy than Index of Industrial Production (IIP) would be cement volumes on steady state basis, of course December was weak but that was because November was abnormally strong compared to what is happening.

I would also look at oil demand, which has been surprisingly robust or steady in November and December. I would look at credit growth because that affects almost 30 percent of our stock market. So these are relatively high frequency broad based indicators that I would look at to assess the impact for the market.



Sonia: Let's talk about some sectors now because the one call that Credit Suisse got bang on was the metal space and it is almost legendary, the comment that we got from Sakthi Siva last year on Hindalco Industries and the way Hindalco surged, became a triple bagger since then. What is the view now? Is it still a viable option to invest into metal names or do you think investors have missed that bus?

A: I think there is still room to run. What you see from China is that they are now investing in infrastructure whether that is sustainable and advisable over the medium-term or not, the point is the 19th plenary is coming up later this year where the leadership will get re-elected and till then they need to support the market, so credit is surprising on the upside, infrastructure spending is surprising on the upside and even more hearteningly there seems to be some supply discipline which is starting to emerge on steel. So we have seen very meaningful capacity cuts which have already happened and there are some more ambitious numbers for 2017. So there is still some life in that trade though I would be very watchful because I do not think lasts beyond August-September for now. It is a bit early to take a call, maybe it lasts longer but for now I would stay watchful but there is still room for it to run, we are still overweight that sector.

Anuj: What is the portfolio approach from here on? In the last bull market that we had or a sort of mini bull market, it was all about banks and consumption and then we saw both of these sectors take a big hit post demonetisation. Do you get a sense that it is back to banks to consumption for market leadership?

A: I guess you meant the non banking financial companies (NBFCs) as well because you meant financials in general. The first big direction that we have given to our portfolio is that let's prefer the non-India stories because there is significant uncertainty that has emerged in the Indian economy, there is a lot of transition that we are going to go through. So there is an impact of demonetisation and mostly likely in the middle of the year we see goods and services tax (GST) start then we see a lot of uncertainty globally. We do not know what the US administration policies are going to be, what Brexit does to us. So investment demand is likely to be very weak, you will need to be a very bold entrepreneur to put on heavy bet sometime this year - that affects the banking system. We have seen rate cut starting to happen and while people think it is because of the government arm-twisting. I think there is a fair bit of competitive element here as well because if your corporate loan growth, which is already quite weak is going to stay weak for another year then you need to take the battle out to the retail lending market and there some of the banks can only compete on price and that means that interest margins for the whole of banking system comes down and that is not good for the overall market, that's not good for the economy as well. There will be new stresses that will emerge from the micro, small and medium enterprises (MSMEs) front and we will see evidence of that. This is too early, maybe in the next two-three months we can see some commentary on that as well.

The second aspect is to do with real estate. It is by now consensus, almost everyone expects that real estate prices will come down and that by itself - whether that eventually happens or not - time will tell but puts a bias strike in place and that means construction demand comes down. Real estate is a large part of the gross domestic product (GDP). It is about 13 percent of India GDP and therefore that slowdown affects cement demand, construction labour, steel demand, downstream effects. If prices do come down there is a significant wealth effect. So these are drivers of potential slowdown in the Indian economy which makes us prefer the non-India stories more than the India stories.

However, within the Indian aspect of the market we would look at beneficiaries of lower interest rates. So we continue to like construction, we would also like housing finance companies like mortgage providers, we also like private sector banks but that is more like a share gain story. As I said earnings will be very unexciting in the coming year for banks but this is as clear a share gain story as you can find anywhere in the world of a sector which has three-five year outlook, the private sector banks.



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Latha: Your note speaks and as you just did that there will be some beneficiaries of low interest rates and yet in the list that you have put out there is only LIC Housing Finance. Is there any other way to play this low interest rate game?

A: Companies that have very high interest costs are going to be the beneficiaries. One of the things, one of the constraints when we put out our reports is that you have to give a list of top picks, so by definition we need to be selective and we give the highest conviction ideas there but there will be many beneficiaries of lower interest rates.

Latha: Metal stocks - they have a bit of global tailwind as well as high leverage?

A: Yes, that's another reason, so this is a call we have had even before demonetisation and this only supports what has happened in the last two months, it supports that call and in that we had highlighted that there is a whole screen we put out on the list of stocks where interest cost to EBITDA ratio is very high and the metal names feature very highly up there.

Sonia: You also mentioned that you like a lot of the global linked stocks. In that context we have seen the way pound has fallen - that will benefit a lot of the companies like Tata Motors and I see it in your top conviction list as well. How do you play this apart from stocks like Tata Motors? Who are the companies that would be beneficiaries of a falling pound?

A: I can think of only one steel name which is an immediate beneficiary but I would say that if you look at it from a sectoral perspective, I cannot discuss stock here but the last three-four years were all about focusing on India and a period of weak global growth, for whatever reasons and however sustainable or unsustainable, we have 2017 outlook for global growth which is the best since 2011. Therefore, we should start to look at more globally exposed sectors and these are sectors which have been forgotten, some of them have been badly derated, so refiners, metal companies, I would even say IT companies and this maybe too early, people are still digesting quarterly results and looking at quarterly outlook which is not the call to make here. What you have to look through and see 12 months down the line will we see slightly more earnings growth and better growth outlook for some of these companies even though the longer term stresses of cloud computing and less manpower intensive IT services etc, all those things will continue but is it possible that financial services, energy, metals and mining which were very large end consumer segments for IT services companies, can they surprise on the upside given that the global markets in the last three months - those are the sectors that have done the best. So it is quite possible that a few quarters down the line we see the revenue growth outlook for this sector being much better than it is currently.

Anuj: What has gone wrong with Indian IT over the last one decade? The story is now different than it was in 2003 or 2004?

A: The larger you grow the more difficult it becomes. Growing from 5,000 to 20,000 to 80,000 to 150,000 is perhaps you can maintain a certain growth rate; you cannot keep growing at 30 percent. Once you become 200,000 people there is a certain inertia that creeps in. It is maybe the law of large organisations; you cannot keep growing at that pace forever. There is also the market share impact meaning that you now become much larger, you had competitions. So when I used to look at IT services and analysts about ten years back, there was reluctance among the global IT services companies to start operations here and there was a very natural reluctance because they would have to fire people in their home basis; in the US and Europe and then hire people here but soon enough the writing was on the wall and it was clearly visible to them and now some of them are perhaps as big as many of the Indian IT companies in terms of their operations here. So there has been a much sustained competitive response. I think IT services has become less manpower intensive, the organisations have become much bigger. I would also say that as the leadership has transitioned out perhaps the new leadership has not been able to come to grasp, come to terms with how to keep the growth rate sustainably high. So it's a combination of all of these factors but there is also the end demand aspect - till 2008 the developed world was growing rapidly and since then there has been a slowdown and that slowdown has lead to lower discretionary spending by corporate - that is the call that has to be made from here - that if corporate spending for whatever tax reasons etc, starts to pickup in the US then IT companies would be beneficiaries.

Latha: Since you said that the demonetisation effects will be known perhaps 12-18 months down the line, FY18 is a time where it is, as well you are saying that nevertheless global growth is going to be better for 2017. What are your earnings numbers for FY17 and FY18?

A: FY17 is too volatile. It is now 8 percent or so but I would say that FY18 is a tricky one where we are about 4 percent below consensus when we do bottom up numbers and some of our numbers also need to be brought down. So I would say maybe settle at 10-12 percent growth because we have to understand that the headline indices may not do that badly while the Indian economy may do worse than what the market currently expects. The headline indices are also - there is a global growth angel there - so 10-12 percent growth for now.