Cautious on cap goods and engineering: StanChart MF

Q: How would you play the upstream side right now, Cairn has gone up quite a bit, ONGC has been bogged down by these subsidy sharing problems. As a fund manager how would you approach that end of the market?

A: I think one clearly will have to delineate between the government-owned upstream companies and the private sector owned companies, which do get import-linked prices. I would say that in case of the government-owned upstream companies, one will have to wait whether they would be made to share more than one-third of the total burden because I think they are extremely tempting cash cows and I do not think that the government can resist increasing that percentage, which these upstream companies are made to share. So from that perspective, the upside is limited for government owned upstream oil companies.

I think the other point that I would like to point out is that all of us are totally focused today on the oil sector and rightly so. But all of us are tending to forget an equally large problem that could come to fore very soon which is the fertilizer sector. There is a sharp divergence of opinion between the Fertilizer Ministry and the Finance Ministry about the quantum of subsidy or the quantum of fertilizer bonds that one needs to issue. In fact if you look at the numbers, then in last financial year, the Fertilizer Ministry said that the total fertilizer bonds that needed to be issued were for Rs 40,000 crore whereas the Finance Minister had made provision for only Rs 22,000 crore in the Budget. For the current year, he had made a provision for only Rs 30,000 crore and the Fertilizer Ministry has said that it should be Rs 90,000 crore and at current fertilizer prices it could balloon to Rs 1.5 lakh crore which is again 3% of India’s GDP.

So I think once the noise on the oil sector dies down, one will have to start refocusing on the fertilizer sector and look at how that-because a third of urea is imported by India and urea prices have moved up very sharply in the global markets. So one will have to also focus on that sector.

Q: How do you see the equity market performing in an environment like that - do we get away with the rangebound performance or do you think now things are actually getting more gloomy than strong?

A: I think as you move forward in next few quarters, one will have to be very cautious. I think one will have to brace ourselves for tough times because I see inevitably interest rates moving up as you move in Q3 and Q4. India Inc is in the moods of capital expenditure, they will have to be content with the higher price for credit and I think that is inevitably going to eat into the margins profitability of the companies on the return ratios and in this scenario, I think it will be tough to argue for a higher discounting. So discounting will have to narrow.

Today at 15% expected growth in earnings, you are looking at Rs 970 of earnings per Sensex and we are still trading at 17-17.5 times ’08-’09 earnings. So I think going forward, I see the market to be under pressure.

Q: Give us a quick word on the capital goods space where you have seen quite a few earnings and more are coming over the next few days, are you becoming more circumspect looking at the operating margin picture of these results?

A: I certainly am. The concerns as you have pointed out is on the operating margins front being impacted by the relentless rise in raw materials, increase in interest rates impinging on their net profit margins and what is more worrying is the fact that orderbook inflows are decelerating. Capital goods sector is seeing a drop in order inflows and this is a trend that one is seeing across the board in different subsectors in capital goods where clearly the rising interest rates have started to impact and the high inflationary expectations have started to impact the rollout. So I think I will be very circumspect in case of capital goods and engineering sector

Disclosures:

It is safe to assume that my clients & I may have an interest in the stocks/sectors discussed.

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