Diesel price hike is in the offing once again. According to Sanjeev Prasad of Kotak Institutional Equities, the government will go ahead with its plan to raise diesel prices every month, and the second tranche of it may come on February 17-18. On January 17, oil firms had hiked diesel price by 45 paise.
Earlier, this month, Oil Minister M Veerappa Moily had announced that diesel prices will be hiked by 40-50 paise per litre every month till losses on the nation's most used fuel are completely wiped out.
The move is set to benfit companies like ONGC, points out Prasad. An important data point to take away from results is the recovery in domestic production that was declining for the last four quarters, he said in an interview to CNBC-TV18. "This is the first time after four quarters we have seen an improvement in production from the company's own field as far as crude is concerned." (ONGC Q3 net down 17.5% to Rs 5,563cr, but beats forecast)
Talking specifically about the market, Prasad feels that it is important for the Union Budget to send out positive signs to increase investments in India. He finds both global market sentiment and liquidity stable at the moment and sees foreign institutional investors (FIIs) focussing on select large cap stocks.
At the same time, he is worried that investment cycle is unlikely to pick up in next 18-24 months.
Below is a verbatim transcript of the interview:
Q: Let us start by talking about National Mineral Development Corporation Ltd (NMDC), which reports results today. The stock has come back to that issue price or the offer price because of some recent developments, is there any disappointment among institutional investors who bought into that issue?
A: There are two issues, which need to be resolved in case of NMDC. One is this entire pricing mechanism for iron ore in India. There is a fair amount of contribution and NMDC is saying they have appointed a consultant to advice on the right pricing system. However, the January pricing was disappointing because at a time when iron ore prices went up globally, suddenly you had a decline in NMDC’s realization at least as per the pricing formula, it seems like a decline. So that is one concern as to what is the pricing system for iron ore in India.
The second and bigger issue, which has coming up now is the use of cash in NMDC. This company is sitting on Rs 20,000 crore of cash and we are hearing that NMDC may asked to put money in some steel entity whether a new steel plant or it could be a joint venture (JV) with any other government owned steel company.
Q: Oil and Natural Gas Corporation (ONGC) is the one which has done quite well post its results, deserved reaction you would say?
A: I would think so because there was some amount of correction, which had happened in the stock before the results. Results were quite good. It was about roughly a percentage point higher than our expectations and about 2-3 percentage point higher than the street expectations.
The more important data point to takeaway from results is a recovery in domestic production because you were seeing a decline in quarterly production going quarter-on-quarter (QoQ) for the last four quarters. This is the first time after four quarters we have seen an improvement in production from the company’s own field as far as crude is concerned. So to some extent, it looks like the company has been able to stabilise crude production. I think that is positive.
There are a lot of other triggers for the stock. First one is, on February 17-18 you see a price increase on diesel as per the government’s plan of raising diesel prices by small amount over a period of time. Hopefully, the cabinet will take up this issue of gas price formula at some point in time in the next few weeks.
All these things will probably keep the market positive on the stock because upside from some of the developments can be quite positive just to give you few numbers on ONGC as of now -- broadly one is looking around Rs 30 earnings per share (EPS) for 2013. Let us say the companies can manage to raise diesel prices by Rs 4 per liter during the course of the year. That results in subsidies on diesel declining by something like Rs 30,000 crore, which means if the government plays fair and subsidy arrangement is 60:40 for government and upstream companies, it could save about Rs 1,000 crore for the upstream companies and looking at ONGC's portion at about 80-82 percent that could result in additional Rs 7.50 EPS for ONGC.
So there are a lot of triggers for the stock. How this plays out in the next few weeks, we will have to wait and see. Of course we still have an overhang of an uncertain subsidy arrangement for 2013 and beyond but as long as the government plays fair, I think there is a lot of upside in the stock.
A: Nothing, we have had a pretty underweight position on these names for a fairly long time. Looking at all the data points, it does not look like we are seeing a recovery in the industrial construction space for other 18-24 months because unfortunately it is not just the case of about few things, which India needs to do. There are a lot of things, which needs to be done to revive the investment cycle.
If you look at the data points which are coming out – as of now everything is slowing down rather dramatically whether in terms of approvals or sanctions of banks, you look at the Reserve Bank of India (RBI) data, the first half sanctioned by banks for projects is somewhere about Rs 1,00,000 crore that is lower compared to what we have seen historically. So that itself is a matter of concern. You are not seeing too many new projects awarded, you do not have any clarity on land acquisition issue, on allocation resources, on the whole approval process for the environmental issues for power projects. So unless and until you put these basic building blocks in place for the sector, I am not sure you are going to see any revival as far as the investment cycle is concerned.
Unfortunately, whatever you can do, you have to do in the next six-eight months before we start getting into an election mode as India has a lot of state elections in the month of October-November, four major state elections. So then you will basically get into the general election mode for somewhere in the middle of the year assuming election do not get advanced earlier.
If that is a case, I am not too sure how much the government can deliver in the next six-eight months, which can result in some improvement in the investment cycle. So as of now at least I am not looking at any recovery in the investment cycle for the next 18-24 months.
Q: There is also Coal India reporting today, a stock you track. That will probably be hitting the market in a month or so to raise capital. Any thoughts on that and whether there is any regulatory relief expected from there?
A: It is quite an undervalued stock even if you assume no major change in the pricing system in India as of now. Anyway Coal India makes about 50 percent of whatever should be its realization into global prices even if you adjust on a calorific value basis -- not that the government of India suddenly going to increase coal prices in India dramatically.
However, if you look at a broad math of 6-7 percent volume growth -- which Coal India should be hopefully in a position to deliver -- at least this year as of now if you look at the April to December data we hear that production growth is about 5.8 percent but dispatches have grown faster. The railways have given more wagons and dispatches have grown 8.5 percent for January, the number is 9.3 percent. So clearly, there seems to be some recovery as far as coal production and dispatches are concerned based on the inventory which is available.
So if Coal India can grow somewhere about 6-7 percent volume growth in the medium-term and get even small price increases of 4-5 percent per annum, this company can quite easily give you 15 percent earnings growth for the next several years. As of now, if you adjust for the overburden, cash, other income, the stock is available at about 9 times, so it is not a very expensive stock anyway with the upside of volume growth and price increase. So Coal India looks pretty good at current levels.
Q: The next big event is the Budget. Do you think it will be a big event for the market with the ability to swing it either side or do you think it will be like the monetary policy which comes and goes without moving the market beyond a day or two?
A: It is going to be important from a sentiment perspective whether you are going to see the promised fiscal consolidation in Budget and how that is going to be the more important thing. So the Finance Minister already committed to a 4.8 percent fiscal deficit to gross domestic product (GDP) for 2014. How he goes about that route is going to be an interesting one and that would have lot of implications for individual sectors and stocks.
My sense is, at this point in time, it is going to be difficult for the government to implement across-the-board tax increase as it could do last year. Last year excise and services price both went up by 2 percent from 10 percent to 12 percent. This year looking at the fact that the economy is slowing down dramatically, consumption is slowing down, I am not sure the government can increase the rates of taxes itself but then you will have to look at selective taxes whether it is on cigarettes, crude oil, rich people -- I do not know whether it will be some combination of selective taxes on certain sectors and segments of populations.
On the expenditure side, again there is not that much of leeway but as far as oil sector is concerned anyway you have an option of not showing the subsidy amount for 2014. There will be some balance amount of 2013 that will be carried forward in 2014 may be somewhere about Rs 40000 crore. So 4.8 percent the government can show that number. I do not think that is the issue. The issue is how you are going to get to that figure and what implication it has for various sectors etc.
The other important part is going to be non-tax related message in terms of what the government can and will do to revive the investment cycle because that is the other thing which I am getting very worried about. What the government is going to do about the current account deficit (CAD) which is going up dramatically and what measures, if any, the government can take to curb the consumption of gold.
Anyway the government has increased import duty on gold to 6 percent now but the smartest strategy there would be to put in some sort of domestic tax in gold which will bring gold consumption in the tax bracket that can bring down the amount of gold consumed for the purpose of storing black money. So it is still going to be interesting Budget despite the fact that you are not going to see a lot of tinkering off taxes.
Finally, you will have to look at what are the incentives or benefits coming for the capital market segment because as far as India is concerned given the huge CAD we have to make sure that we are getting the right amount of portfolio flows. So I would not be very surprised if you see some incentives for capital market whether it is some reduction in securities transaction tax (STT), removal of STT completely or some incentives for savings or additional savings. So it is still going to be an interesting one I would think.
Q: What are you hearing about money though, do you expect to see the money remain this strong in terms of inflows?
A: Looks like for the time being because clearly there is a lot of global liquidity everywhere in the world whether it is US Fed or Bank of Japan, European Central Bank (ECB), everybody is following a rather loose monetary policy. Some of the economy may be trying for some amount of fiscal consolidation but as far as monetary side is concerned just about every global bank is following a very loose one, so I would assume global liquidity continues to be reasonably good.
At the same time, India has to start doing the right things. There has been some progress on reforms but clearly we will have to deliver a lot more which links back to the problem of current account that I was talking about earlier. You are running a huge current account deficit, the last number is 5.4 percent for Q2, on a structural basis earning about USD 20 billion current account deficit per quarter. So, somewhere you require USD 12-14 billion support for your flows. Whether it comes in the form of equity portfolio flows or debt portfolio flows, banking capital, NRI deposits, which is a large component banking capital or borrowings, they all depend on sentiments to a large extent.
As of now, global sentiment is good, US is showing some recovery, China is looking okay, Euro Zone is not falling apart so at least a global sentiment is good. At the same time, you have to ensure that we are also giving the right signal to investors. So, from that perspective, the Budget is going to be important. The next set of reforms including a price increase on diesel in the next three-four days is going to be important.
So, as long as global liquidity is good, we continue to do the right things and make the right noises, money will continue to come in. It will still probably go into largecaps. That is what my sense would be. Looking at the fact that you are not seeing too much of pick up in economic recovery, in fact, I think it is slowing down, investment cycle is not picking up. So it is basically going to be restricted in the top few names I suspect, so it is still going to be a top-down market.
Thankfully, a lot of opportunities are opening up in terms of the oil sector becoming investable, Power Grid Corporation, National Thermal Power Corporation (NTPC), both are looking interesting. So, you have a lot of government-owned large companies which can attract some amount of foreign capital.
Somehow these sectors had become virtually uninvestable earlier because of a lot of uncertainty etc. So, I think the largercap names can still absorb some amount of money and even the government of India as a big government of India divestment plan as next year you will see big ones like Coal India, Indian Oil Corporation coming to the market which can absorb some amount of these foreign flows.
Q: Within the frontliners, the conundrum is Tata Motors, the stock took a nasty cut after the earnings warning of sorts that they put out but they have been building out some pretty strong numbers in terms of sales still?
A: It is ultimately going to be a little bit of a volume versus margin trade-off over there. I would say volume versus price/margin trade-off. Volumes will continue to be good because the company is launching a lot of new and exciting products. So the product pipeline is pretty strong in the next two-three years.
The issue is that what margins and how much of capex is going to sustain that kind of volume. I would not be too much worried about the increase in capex guidance, which happened recently because ultimately that reflects reasonably strong demand and hopefully the company is reading the tea leaves quite okay and there is demand. So obviously they need to build in some additional capex. So that is fine.
The challenge is going to be what is the pricing at which some of this volume growth is coming through, how competitive is the market and whether Tata Motors has to compromise on pricing and margins to get its additional volumes. So this is going to be pretty much a first quarter where you see some guidance on the margins.
Anyway you have got a margin guidance, hopefully that will give you some more colour as to what is the volume price equation out there. As long as it is not a big disaster in terms of margins, I think the stock should be okay in that case.