Manish Sonthalia expects the taxation to return to equity given the lower GST collections along with economic scenario.

the market returning 27-28 percent for calendar year 2017 the focus shifts on whether the Street will be able to repeat the show next year.

"This will be a challenge. Valuations are a concern in mid and smallcaps. Fiscal situation, current account deficit and inflation are a problem," Manish Sonthalia, Head Equities- PMS, Motilal Oswal AMC told CNBC-TV18 in an interview.

Talk of reintroduction of long-term capital gains tax in Budget 2018 could weigh on the market, he said, adding, this could in fact hit the market in a very negative way.

But, if this taxation is not introduced in the Budget, he expected a steady show from the Street, with the Nifty hitting 12,000 by March 2019. "Crude also could be a problem for the market. All hell will break loose if it touches USD 70 (per barrel)," he added.

Sonthalia preferred select stocks in private banks and consumer names. Industrials are interesting, but better to avoid PSU banks on the back of asset quality concerns, he said.

Among stocks, he was bullish on AU Small Finance Bank and Gabriel India. A 40 percent growth potential is visible in the former, while the latter is a market leader in shock absorber space, he said.

Below is the verbatim transcript of the interview.

Anuj: What a remarkably strong market it has been and fund managers’ delight, right? The midcap index has been up 46 percent this year. The Sensex also up 28 percent. But, the challenge is for 2018. How do you repeat this kind of performance of 2017?    

A: That is the big challenge. As long as the party is going, everything seems fine. But, valuations are definitely a concern, particularly so in the midcap and the smallcap space. There are no two doubts about it. One is sure about the earnings coming through, but fisc is a problem, current account deficit (CAD) is a problem, inflation is a problem, all these will weigh on valuations. And on top that, now long-term capital gains tax, because of short-fall of revenue, even that is going to weigh on the markets till February 1 when it gets out of the way or not.

So on a broader market, since it is not very expensive, 17-18 times one year forward, one can still expect if long-term capital gains tax etc. are not coming then maybe 10-15 percent return on the indices which is Nifty or the Sensex is still possible from a one year’s perspective. Cannot be that sure about the midcap and the smallcap.

Latha: You are so strongly expecting the long-term capital gains?

A: We know that fisc is going to be a bigger problem in FY19, so no doubt about it given the revenue collections on goods and services tax (GST) and December is going to be a bigger problem. We just saw the numbers yesterday on November.

Latha: Be that as it may, you are being flooded, I assume, month after month with either systematic investment plans (SIP) or fresh inflows. Where do you put them?

A: We have a select set of stocks and we are buying them only. But, it is the same private sector banks, it is the same consumer names and slightly on the industrial side as well, we believe that the capex cycle may be just on its way up. So, maybe industrial as a space is also looking somewhat interesting. So these are new areas where we are deploying some capital.

Sonia: I was going through your funds and one of your big bets this year has been AU Small Finance Bank. I want to understand from you what the growth potential looks like for the sector, maybe if you do not want to talk stocks, but maybe as a sector as a whole.

A: The private sector banks have been doing much better than the public sector banks. Of course, valuations are much more comfortable for public sector banks, but the basic problems of the public sector banks are not yet fully solved. Non-performing assets (NPA) are still going to be a worry, so we are staying out of public sector banks.

Coming to AU Small Finance Bank, since this is a bank in the portfolio, we believe that the bank can grow at 40 percent between now and 2020. Just take this example and look at HDFC Bank when it just was coming out of its IPO. Its profit was Rs 40 crore, its market cap was Rs 1,000 crore. At any point in time, HDFC Bank always looked expensive. But today, HDFC Bank is having a profit of Rs 15,000 crore and market cap in lakhs of crore.

So you have just got to be sure about how long that growth is going to last and whether that bank and the people running that bank have that DNA to maintain growth without NPAs and that is the bet we are taking on AU Small Finance Bank. The bank has executed very well and it will execute well over a period of time.

Anuj: One stock which has done remarkably well for you and your portfolio is Page Industries, but it is about the most expensive stock in the market. So, what do you think the market is betting on?

A: The markets have always got the longevity of the growth wrong. Bank has grown at something like 32 percent over the last decade, 12 years or so, so we have always believed that either the growth is going to come down due to competition and we know the competition, what the players are like and what their strengths are and how long this growth is going to last. I think the aspiration for Indian people to earn and spend and up-trading, moving up the value chain is underestimated.

We are only looking at the pie growing and within the pie growing, this Page Industry is a leading player. And he is also expanding the market category, entering into various newer segments. The size of the market has become very big and he is a dominant player. I think the competitive advantage is much more structural than what people can estimate.

Latha: What about the oil and gas stocks? You have Hindustan Petroleum Corporation (HPCL) in one of your portfolios. Would you want to now either replace it or at least add Oil and Natural Gas Corporation (ONGC) going by the way crude is charged up?

A: We have truncated allocation in HPCL since capital allocation, debt, how much of a super-cycle these gross refining margins (GRM) can continue into, these are some of the reasons why we actually reduced allocation on HPCL, but given the valuations of below 10 price-earnings, we still think that a 5 percent allocation is good for this sort of a name, this sort of a return on equity (ROE). Having said that, within the oil gas space, we are far more bullish on the city gas distribution names than maybe the likes of upstream companies.

Sonia: Generally, you guys at Motilal Oswal like to pick up companies that are market leaders in their segment and one stock that you have identified is Gabriel India which is a market leader in the shock absorber space. This is a stock that not too many people talk about but it has done very well in your portfolio. Is there still a lot more scope here?

A: They are leaders in the shock absorber space and within the two-wheeler space. And if you believe that the two-wheeler space still has a long way to go in terms of the number of vehicles that are sold in this country, this company is only known to either maintain its market share or increase its market share. At the same time, operating leverage playing out quite well for the company. Over the last 2-3 years, if you see, the margins have expanded. If you look at the operating ratios of the company, they are fabulous given the valuations at which they were trading. So it was an undiscovered name. We liked it, we still continue to hold it and I think the journey is still a long way to go from these levels.

Latha: Would you say the downside of this market would be protected considering the flows that are coming into mutual funds?

A: If the capital gains tax comes then market will fall like a stone. Everything said on the table, economy, fundamentals, earnings, if the capital gains tax gets introduced, we have a serious problem in the market. Other than that, markets should be fine.

Anuj: That bogey has been there for the last two Budgets as well and with this bit of a fear, but it does not materialise. Do you think this time there are strong enough reasons for you to believe that we could be having long-term capital gains tax back?

A: The fisc is in a problem. We had the fisc in our favour in the last two years. Now the fisc is going the other way. Oil prices are approaching USD 65 per barrel. If we see USD 70 per barrel, all hell breaks loose. And then, the GST collections are not up to the mark, it is going to be a bigger problem in 2019. If this is what the trend is, how are we going to brace the fisc? It is Rs 50,000 crore, capital gains collections, that is surely a possibility.

Latha: But barring that, do you think the market, let us assume that does not happen for whatever reason. There are calculations that the GST short-fall is actually only Rs 27,000 crore as of now. That is not a whole lot. It is just because already the government does not have dividend from RBI and spectrum and all that that the hole is worrisome. Otherwise, on GST, if you do the calculation, yesterday about the average I got from economists is about Rs 25,000-27,000 crore short-fall and these are still young months for GST. As you perhaps mature in terms of the system, it may not be. Anyway, only for argument’s sake, if there is no capital gains, then what is the view on the market?

A: There is no problem with the market. The headline indices which is the Nifty or the Sensex still has and in all probability will deliver something like a 15 percent returns even from these levels. So we are looking at closer to 12,000 on Nifty maybe by March, 2019.

Latha: What about the midcaps? That is where there has been a near 50 percent rally in 2018. So how would you approach the non-Nifty stocks?

A: Problem is valuations. Earnings is where some sort of surety remains, but valuations are simply out of the bag. So it is all going to depend on which of these midcaps are there in your portfolio and how sure you are about the earnings and how long those earnings are going to last. There is no one statement for the midcap as a whole. In all probability this 50 percent sort of a return, 47 percent for midcap and 58 percent for smallcaps, in all likelihood is not going to get repeated in 2018.

Sonia: You said 12,000 on the Nifty by 2019 right?

A: March, yes.

Sonia: I know you guys are not big fans of metal stocks, but recently, we have seen names like JSPL do exceptionally well. A lot of commissioning of new plants, higher volumes, etc. would you look to increase allocation or put fresh money to work here?

A: Typically not great fans of metal companies, but the fact remains that the outlook on steel remains good. We have seen iron ore prices hit USD 75 yesterday. The interesting names would be in the midcap space. Guys which are there in the NCLT, if there is some resolution, you can have a great runaway from these prices. These NCLT cases, I do not want to take names, but NCLT cases offer great scope.

Latha: Are you already buying some of them because now they are at throw away prices.

A: No, not yet. We are doing some more work on them and we have got to be sure about these managements, etc. but this space looks interesting.

Anuj: In the past, we have had Motilal Oswal, some of the funds having interesting midcap pharmaceutical names. Ajanta Pharma is a case in point, Granules India as well. Anything that you are bullish on right now in the midcap pharma space?

A: Pharma, as a space, I am quite bullish on. There are problems with global generic pharma companies and I do not want to take names, but you can understand which name I am referring to. If these were to go some sort of into chapter 11, or you could have seen the bottom of pharma companies as far as India is concerned because a lot of market share will be taken by our Indian pharma companies like the Suns and Lupins of the world. And plus, it could also signal some sort of a price erosion stalling in the US, the generic price erosion.

So, I am a great fan of pharma companies at these prices, whether it be domestic pharma companies or whether it be generic players who are exporting outside India. So this is classic value play. In the domestic pharma space, we like Ipca Laboratories, we like Alkem Laboratories. In the global generic Indian pharma companies, we like Sun Pharmaceutical Industries.

 30 Dec 2017, 05:57 AM