Jul 26, 2013 03:49 PM IST | Source:

HUL may fall 15-20%; RBI unlikely to ease in a hurry: Kotak

According to Sanjeev Prasad of Kotak Institutional Equities HUL was a `sell' for most people until Unilever came out with Open Offer. Valuations ran amok since then.

Sanjeev Prasad of Kotak Institutional Equities expressed dismay at the bizarre valuations of top FMCG stock Hindustan Unilever (HUL) and expects it to correct 15-20 percent.  There is no point owning this stock at current levels, he says.  According to him most investors had a sell on HUL until it came out with the open offer.  From then on the stock zoomed and the valuations now belie any justifications, he said adding there is not much to recommend in these market. 

Below is the verbatim transcript of Sanjeev Prasad’s interview on CNBC-TV18

Q: Lot of the discussion this morning has hinged around Fast Moving Consumer Goods (FMCG). What do you do with Hindustan Unilever (HUL) now at these kind of valuations running into its results?

A: Sell it. It is trading at rather bizarre valuations, 40 times on 2015 numbers, low 30s on 2017 earnings, so I do not know how you are going to make money on this stock. It is going to correct maybe about 15-20 percent and then we can start looking at it, but at these valuations honestly owning any FMCG stock is asking for disaster. Either you are not going to make money for a few years or you are going to have a severe price correction over here. So there is no point owning these stocks at current levels.

Q: Many of your brokerage community friends do not seem to agree. Every dip is considered an opportunity to buy. The valuation outlook for Hindustan Unilever (HUL) is justified at any level. What is going on over there?

A: It is up to them to justify the valuations. What is happening these days is you do not have much to recommend anyway in the market, so if the top stocks in the sectors that are doing very well, that automatically becomes a benchmark for just about every other stock in the sector and the classic case is HUL, about Rs 450-500 before the transaction got announced, most people had probably a sell or a reduce or whatever. It was pretty fairly valued then.

Then suddenly HUL comes with an open offer at Rs 600, then Rs 600 becomes a benchmark, then because of the short squeeze it goes to Rs 700, which then becomes a benchmark for the stock. Obviously the valuations have got inflated by about 50 percent between Rs 450 and Rs 700 and on that basis everything else gets rerated by 50 percent.

That is what is happening in the market. That is pretty much a joke the kind of argument made out by the market in terms of relative valuations. The company is great, but the kind of valuations and the arguments being made to justify the valuations does not make any sense.

Q: The big problem over the last one month has been the banks with reference to what the Reserve Bank of India (RBI) has also done of late. What do you do with that space now and how have you read the measures from RBI?

A: We have been pretty underweight on the banking sector for sometime. Most of our concerns stem from the Non-Performing Loan (NPL) side and I honestly do not think we have seen the worst of it. In fact NPL problem is going to be far bigger than what the market expects it to be. Many of the larger companies are in serious trouble and they are alive primarily because they have been kept alive by the banking system. As far as the economic recovery goes it is not happening for sometime, so I am pretty confident that a lot of these companies will eventually get restructured or classified as NPLs as the case maybe. So that was our primary source of concern.

The other area which has emerged of late is India should have prepared for much higher interest rates. All these measures which the market is expecting is going to be temporary from the RBI's side. I do not think you are going to see the RBI tapering this off in a big hurry. Do keep in mind the fact that India is running a structurally large Current Account Deficit (CAD), it requires large amount of capital flows to come in and actually needs to prevent capital flows from going out.


The only way you can do that is you need to have much higher interest rates in this economy compared to any other economy. Just look at interest rate differential between, let us say the India and US. The US 10-year treasury is somewhere about 2.6 percent, India is about 8.1-8.2 percent, so that is about 5.5-5.6 percent which is not even enough to cover the hedging cost.

So I do not think these measures are temporary in the sense maybe the Liquidity Adjustment Facility (LAF) measures maybe removed eventually, but I think they would be replaced by higher repo rate. I think India has to have a much higher interest rate regime to tackle the current account issue and if you want capital flows that is the only way you are going to get it, particularly from the debt side. So I think we should be prepared for it and not be under any illusion or delusion that interest rates are going to come down in the economy anytime soon.

Q: Within that banking universe the market has been quite targeted at some of the names like Yes Bank for instance which has traditionally been quite a favourite. How would you approach some of these high valuation private sector names that have corrected so sharply?

A: The big worry for some of these private banks is they are very over-owned. Keep in mind the fact that banking itself is a pretty large portion of any index, Nifty, MSCI whatever it may be. Generally people have been very overweight on private banks compared to public banks. The worry now is with the kind of environment you are seeing in the economy in general, interest rates are going to be on the higher side, you are starting to see NPL problems, even in areas where things were quite okay.

Commercial Vehicles (CV) cycle for example is definitely showing signs of stress, so people are going to be become more and more concerned about the kind of valuations they have been paying for these companies, the credit growth is going to be lot lower and clearly the NPL number is going to be higher than what people have budgeted, so in that context it is pretty hard to argue for very high valuations for the private banks.

An HDFC Bank is still trading at 3.7, it has corrected little bit, but 3.7 times on quoting book is actually still a very high valuation number. So unless and until you start seeing some recovery in the economy, credit growth picking up and NPL cycle coming under control I am not very sure even after the correction you can justify the valuations of many of these private banks.

Q: How is money approaching India at this point, especially given those macro points you just made? What would the approach to a market like India be where earnings performance has been so poor, added to which there is probably some kind of rate pressure looming?

A: Honestly as far as Foreign Institutional Investor (FII) investors are concerned India is not a market that is in focus anymore. It is one more emerging market (EM) which is struggling with a pretty large CAD. So effectively look at what has happened in India in the last 8-9 years. From a special place in the hearts and minds of foreign investors, it was an asset class by itself, we moved to a favoured EM and now we have moved to a situation where honestly investors really do not care that much about India given its macro problems.

So the interest is confined to a narrow band of maybe 50 stocks. You have a very peculiar situation in the Indian market. You have effectively a three tier market. You have the top tier where you have your consumer staples, pharma and some other top names in a few sectors. Those companies are trading at rather ridiculous valuations, not pretty expensive I would say. Long-term these are great companies, but how much do you want to pay for them in the next 2-3 years.


Then you have a middle of the road stocks in the auto, energy, maybe telecoms and regulatory utilities which are trading at more fair valuations and then you have the rest of the market which honestly nobody cares about. It is a pretty peculiar market and if you look at this composition where would money go in that case.

Are you willing to buy HUL at 40 PE, the answer is no. Are you looking to put money in the middle of the road names where things are looking reasonably fairly valued and a lot of growth issues over there and in the third lot they are all priced to bankruptcy at this point and probably some of them will go bankrupt looking at the situation over there.

I do not think you can see money coming into this kind of a market unless and until you start seeing some clarity emerging in some of the sectors for example, energy can absorb a lot of money, but then the government has to give some clarity on the subsidy sharing etc. They have some reforms done, but nobody knows what the net benefit to the companies will be because of deregulation on diesel pricing or higher gas prices etc.

Same view on the telecom side, again the sector can absorb a large amount of money, but there is a lot of uncertainty on the regulatory framework in terms of spectrum pricing etc. So if you start giving some clarity I think you can see some amount of money moving from the traditional favourites to more broad based bunch of stocks and that can really help this market because in this kind of a weird market I do not think you will see money coming in.

Q: When the dust settles on the currency even if that gets pulled back into a bit of a range for the moment what happens to growth? Do you think the next 3-4 months as we wait deeper into the year people may suddenly realise that we may have another year of 5 percent GDP growth, not this 6-6.5 percent that the government is talking about?

A: I think if we get to 5 percent we should consider ourselves lucky. I think economists are generally smoking dope as far as GDP numbers are concerned. Every year you start with high numbers and then cut it back to some lower number. I do not know where this optimism is honestly coming from, because you have a dead investment or capex cycle. You are seeing negative numbers as far as the consumer discretionary sector is concerned. I am not too sure where this growth is going to come from.

Yes, maybe monsoons are good, so that will result in maybe agriculture GDP growth being slightly higher than what we have seen last year, maybe lower 2 percent odd over there and you will get some stimulus to the economy once you are headed closer to elections whether it is official spending or unofficial political related spending. But that is about it. Beyond that I am not too sure what is the driver for this economy at this point of time.

My bigger worry is actually 2015. There is a lot of hope that we will get to 7 percent then. We would be lucky if we are managing 5.5 percent in 2015. The simple point is if you do not fix the capex cycle now, 2015 capex numbers are going to be even worse than what we are going to see in 2014 and given the fact that we still do not have any clarity on many of the sectors in terms of the regulatory environment I am not too sure why investment will flow in over there. No new projects are being launched, so whatever capex we are seeing currently is basically coming from projects they have started earlier and which are now getting complete.

So I think 2015 is also going to be washout unless and until they start fixing problems ASAP. One of the things we need to definitely implement is the Goods and Services Tax (GST) from 1st April, 2014, otherwise even the next month is actually going to look pretty dire.

Q: Have you guys translated all this into a market target, because that is the weird part of it. Everyone can see what the problems are and the problems are large, but the market has not corrected in conjunction with that.

A: There is still some hope. The arguments which I get from investors are somewhat fallacious, but you can see some merit over there. Number one argument is India looks better among EMs and especially the larger EMs. On one side you have Brazil, China, Russia which look worse than we do and even South Africa and Turkey are also running pretty large CADs, so India in that context among the larger markets looks okay. Versus Southeast Asian countries we may look cheaper, but those countries are doing better in terms of GDP growth, but they are much more expensive now. So India in that way stands out among the EMs for whatever it is worth.

The second argument I get is India is a great long-term story, so even if you are overpaying for some stocks, that is fine we will continue to stay invested. The big worry is at some point in time a lot of investors are going to start wondering whether this whole EM thing makes any sense for them and whether they start pulling out money from EMs as a pack, which we witnessed in June because developed markets (DM) have done far better in the last five years compared to most EMs especially on currency adjusted terms and then people will start questioning what are we into these markets for?

Does it make sense to take so much of currency risk etc.? With EMs now effectively adjusting to much lower growth profile whether it makes sense to be invested that much in EM space? So that is a much bigger worry with EMs and within that India will have to contend with. Also keep in mind the fact that at some point in time you will start seeing the US Fed starting its tapering of the bond buyback programme. What does it mean for capital flows to EMs and particularly EMs who run very large CAD; that is going to be a big pressure point.

What happens to the currencies then is a big question mark and we should be prepared for a fair amount of volatility whenever that process starts, maybe towards the end of this year if things start picking up in the US economy it could even happen earlier as far as India is concerned.

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