Larger banks to gain once economic slowdown bottoms out: Siddhartha Khemka

It is a problem for banks now. There is a correlation between the economy slowing down, NPAs rising and delinquencies, but the way the selloff is happening in the banks' names, it is a little alarming.
The banks have been under pressure for quite some time and they are bearing the brunt of the heavy FII sellings. One sector has the maximum exposure of FIIs investment and that is the banking and financial stocks. There has been sharp FII outflows and most of it has been from the banking and financial space. That apart, if we were to expect a recessionary environment and economic slowdown, banks would be the first to get impacted.

Low credit offtakes had been apparent even before the Coronavirus crisis started. The crisis only adds to the overall business slowdown. With higher exposure towards the SME segment, smaller banks were already under some asset quality stress. Banks like IndusInd or RBL have exposure to some of the stressed industries. NBFCs specifically are again not getting bulk of the benefit that RBI has given to the banks and are also under a lot of selling pressure.

Overall, a few larger banks like SBI, HDFC Bank, ICICI Bank, Kotak Mahindra Bank would gain market share, but that would happen once the economic slowdown bottoms out and we see some recovery in the economy. Till that time, the heavy FII selling would continue.

What about pharma? Not only pure play pharma but even healthcare names which are the preferred picks ones and the only sone standing in the green? Stocks like Lupin, Sun Pharma, Cipla, Apollo Hospitals are the only saving graces?
In the current environment, there are a few sectors which have acted as pure defensives and unlike the last few years, pharma has now started behaving like defensives and investors’ interest also has increased because of the healthcare concerns that we are currently witnessing.

Since the supply of low cost raw materials has started from China again, these are adding to the margins and being an essential service, the business continues. There is a lot of demand, especially if you look at some of the domestic focused companies. There are some issues with the lockdown with some plants getting impacted because workers are not turning up and some issues with transportation but, overall because of the lockdown there is an expectation that there would be no fresh USFDA observations.

Whatever observations we are seeing are from the earlier ones and so that a big overhang of fresh site visits and observations has gone away. Then there is an expectation that because of the constraint in the supply chain, some of these plants may get some relaxation in terms of supplying products to the global markets.

Having said that, when it is a global healthcare issue, the demand for pharmaceuticals is consistent and that should help the sector and that is what we are witnessing. Over and above that, the sector was under pressure for the last few years. Valuations are comfortable and that is also aiding the sector in the current environment.

Define comfortable valuations because Sun Pharma is 17-18 times, Glenmark Pharma is also expensive, Lupin is trading still in late teens. Why are such valuations comfortable?
If we look at our overall aggregate valuation on a one year forward PE, our healthcare aggregate PE has come down from a peak of 28 to currently about 17. So that kind of a peak correction has already happened.

In terms of price to book on a one year forward from a peak of say about six times price to book, they are now trading at about 2.5 times price to book. So that kind of comfort has come in. Yes there are specific stocks where the earnings are not there and the valuations looks higher. As you said, Sun Pharma, Lupin are where the concerns could be. Some of the other stocks which have consistently done well like Divi’s, continues to trade at a higher valuation and even in this market, has not seen much of a correction. The business model continues to remain strong. So some of these names will be there in the overall pack which keeps the valuation higher.

How are you approaching autos? The volumes have come off quite sharply in March and now expectations are that April is going to be even worse than that! Are you bottom fishing here?
Before the current pandemic started, the auto companies were under severe pressure and volume offtake was not happening. To add to it, the transition from BS-IV to BS-VI were to take place and companies were expecting some kind of pre buying in March. But March ended in lockdown. So auto companies are now stuck with the BS-IV inventory for which the Supreme Court has given a partial relief.

Overall, auto is one of the sectors which has been deeply impacted. Production has been shut almost and a lot of labour have one back to their respective villages. It will take a lot of time to convince them to come back. The volumes that we saw for March and April are likely to be even weaker with the bulk of the lockdown being in the month of April. Plus the shift from BS-IV to BS-VI would also move the prices higher.

If economic growth does not come back fast and if the pandemic does not stop soon, auto will remain under pressure. Apart from the domestic companies, a lot of these companies like Tata Motors which are more global and cyclical with exposure towards markets in the US, Europe and China, have been largely impacted by the coronavirus.

Overall, we would stay away from autos for some more time, It is not the time to start bottom fishing in autos, you will get a lot of opportunities going down one to two quarters. It is best to stay away from the auto sector right now.

How are you navigating through the metals sector?
We believe the overall commodity space would underperform till the global scenario improves or the visibility on that improves. Overall, we are underweight on metals. We are not recommending them at this stage, given the kind of damage that is going to happen or is happening to the global economy and the resultant slowdown in demand for metals.

We are seeing already metal prices correcting and you have the double whammy of demand as well as prices coming down. Overall, metals would continue to remain under pressure and one should stay away from global cyclicals now.