Gems and jewellery shares are unlikely to regain their record high levels anytime soon, feels Gautam Chhaochharia of UBS. Jewellery shares have taken a beating over the last couple of months ever since the Reserve Bank of India started putting curbs on gold imports.
In an interview to CNBC-TV18, Chhaochharia said Titan’s underlying business fundamentals were weak and advised investors to sell the stock.
Chhaochharia is not too impressed by the rebound in second line shares over the last week. He attributes it to covering up of short positions more than fresh buying.
He says investors have become cautious on emerging markets in general, though India is now better placed compared to its peers in this space.
Chhaochharia says the Nifty may get past 6400 only if there is credible macro-economic data to support. He is not hopeful of a recovery in earnings growth in the June quarter, but expects bottoming out of demand to start in September. On consumption, he feels the tailwinds could continue near term. He is positive on oil and gas shares, and United Spirits.
Below is the verbatim transcript of his interview to CNBC-TV18
Q: First a word on what you are hearing anecdotally about whether or not the mood is changing a little bit in the near term towards emerging market (EM) like ours and whether some of this pressure we have been seeing by way of outflows is alleviating now?
A: It is still too early to say on that. The mood on the emerging markets as a broad asset class has still not changed completely. In fact that has definitely taken a beating from the last few weeks of nervousness. India’s positioning worries related to other emerging markets is gradually dissipating.
Two clear reasons which we have been highlighting to investors I think which is gradually getting appreciated.
1) One is that India’s dependency on the carry trade sensitive bond flows is far lesser than other high current account deficit (CAD) countries. It has gone up compared to India’s own history. Therefore has caused the short term volatility but in absolute amounts as well as a percentage of CAD funding. It is far lesser than a lot of other high current account deficit countries. Therefore, this entire emerging market bond linked volatility could be far lesser for India going forward than what we have seen.
2) The entire hedge towards commodity prices, long term, medium term and short term, we have seen very strong correlation between strong dollar and commodity prices including Brent as well as gold. We have already seen part of that play out and that kind of alleviates the pressure on India’s CAD. Also other macro parameters like fiscal and inflation if these commodity pressures move in line with dollar.
If we assume gold at even USD 1,300 per ounce and Brent at USD 100 per barrel, even at 60 INR, you are looking at CAD broadly improving almost 50 basis points as a percentage of gross domestic products (GDP) in FY14 versus FY13. So, it depends on how the commodities move versus the dollar. That is also kind of unique for India specifically compared to a lot of other high CAD countries.
So these two factors do mitigate the nervousness about the volatility from the global emerging market worries for India specifically.
Q: Do you expect to see a trading range for the market from between 5500-6400 and we came off from the lower end of that range. What do you expect to see through the course of earnings season and do you think that range will get challenged on either end because of what earnings quality may show through?
A: Not really. This is the third time we are seeing that trading range holding on broadly. That will still hold on. For it to really breakout on either side will need factors beyond what we have been seeing for last few months.
For Nifty to breakout beyond 6400 levels what we need is a more credible economic data locally beyond just hope. We are also in the camp of hoping for a cyclical economic recovery even though a mild one, but still early days.
The direction of the government has definitely changed versus last year. They are on the same path of trying to get the economy back on track. However, it is still very early days. And it takes time.
Once we start seeing that happening maybe in next 2-3 quarters then possibly you could look at a more reasonable case of market breaking out beyond current range.
Q: In that sense there has been some genuine effort by the government to step up reform in the oil and gas space either in the form of the gas price hike or consistent diesel price hikes as well. How would you approach the oil and gas space now?
A: We have just upgraded the Oil Marketing Companies (OMC) today morning. That was because the stocks had corrected and this trend is likely to continue from hereon in terms of government continuing the diesel price hike.
The big challenge there obviously is the currency, which we think is overdone. However, beyond that the space does look attractive. Both the marketing companies including players like Reliance Industries and Oil and Natural Gas Corporation (ONGC) look to be well placed to benefit from this entire thing.
Q: What is your expectation from earnings season this time? In general how are you approaching the earnings season?
A: This quarter will not be a recovery quarter. However, the key trend to watch out for is if it unexpectedly deteriorates beyond fourth quarter. If it maintains the broad parameters which we saw in the really weak fourth quarter in terms of macro also then that will be a positive signal in our view.
If it deteriorates from fourth quarter parameters then it will be a big negative. Sector specific; trends will be different. Autos will still likely to be weak given the trends which we have seen and given those broad consumption tailwinds which we continue to see.
What will drive IT services stocks also will be the outlook. The US outlook still remains the biggest driver and Immigration Bill has been a recent overhang. So, the commentary we hear on these two will also be the key factor beyond just the quarterly number. The biggest trend for us would be if we see improvement bottoming out or worsening compared to fourth quarter in terms of operating parameters.
Q: Are you feeling more confident or less in terms of whether or not the pace of overall growth is recovering the way it was supposed to? Are you seeing those growth parameters that need to crop up to be more confident about the second half?
A: Not really. If you look at the broad problems in the current economy, we need correction of the economic imbalance away from consumption towards more investment. Over-consumption had manifested itself in both high fiscal deficit as well as in high Current Account Deficit (CAD). One can debate about the causality, but basically the high consumption was being driven by that and that also led to high CAD.
So, we are kind of in the course correction mode where the government is doing fiscal consolidation. The immediate impact of that is always dampening of economic activity and more specifically consumption. Consumption tailwind is likely to continue for a bit.
The second step is when enough space has been created for the private sector, to feel for them to come in. Government providing some support or some incentive structure to revive the investment cycle, which is still in the early days. If you try to create a roadmap in terms of the economic trajectory around September-October is when one will start seeing the first rounds of demand bottoming out or picking up specifically on the investment side.
But what the pain we are going through for last couple of quarters including this quarter is a basic necessity for the economic imbalance to be corrected. Therefore, to create a more sustainable growth trajectory ahead.
Q: Oil and gas is balancing out what has been a pretty poor trend for the banking space. How are you guys approaching some of these banking names now?
A: Banking is a good proxy and more recently even a high-beta proxy for the overall market and the biggest sector clearly. For us when we talk about the Nifty trading range of 5500-6400, we also tell investors that towards the lower end is a good level so start positioning for the economic cyclical recovery for the next couple of years or next three years.
The tenure of the recovery is always uncertain, hopefully towards the end of the year. However, the lower end of the market trading range is when you start positioning for the cyclical recovery. The best way to position for that is definitely the banking sector. So, when the market approaches 5500-5600-5700, that is the time when you start being more bullish on the banking space and bite into them in terms of positioning for the cyclical recovery.
The risk reward is definitely attractive in the banking space, both in terms of valuations as well as in terms of reasonably conservative earnings estimates. If we see any mild recovery also you will see becoming better and earnings upgrades as well as valuation re-rating.
Q: The UB Group stocks saw a big bump up yesterday and you track United Spirits. There has been some fund buying into that particular counter. How would you approach it now?
A: We were quite positive earlier, but the thing is at these valuations a lot of the near-term upside etc. looks like priced in. The long-term story is intact.
The long-term opportunity is obviously meaningful. However, it will take time for them to show up in terms of numbers when they implement the strategy. So, at this point I am not really very bullish on the stock.
Q: What about Hindustan Unilever (HUL)? A lot of your peers have started to get slightly bearish on the stock stating that it is only the open offer price which is supporting HUL for now. How would you map the trajectory post the open offer closing and what kind of a target price would you have?
A: We are actually positive on HUL. Technically the open offer is definitely supporting the price. It is still not yet clear in terms of how much actually gets tendered in the open offer. If the open offer is very successful and a lot of the existing holders tender their shares then obviously this kind of level is more technical rather than fundamental.
However, if there is not much of tendering offering which is what we have said in the press also then that is not necessarily a technical support at these level. Beyond that fundamentally the big question is Unilever do take up majority stake in HUL, what they do with HUL and what the outlook is.
If they are looking to making it a much more dominant player in terms of broadening their product portfolio and therefore looking at higher growth rates. Then definitely this is not a great level to sell out, but more a level to get in and that is what our analyst is betting on.
Q: In the last couple of days we have seen the midcaps pick up quite a bit of pace. Is this just the exuberance that comes with a short covering rally or have you been able to identify any genuine buying opportunities in the midcap end of trade?
A: Top down, not really. We think that this is more a short covering rally rather than any genuine buying in a big way in the midcaps. Top down technically midcaps are still at a disadvantage from lack of support of genuine buying. Simply because of the fact that the big flows which have been happening in India over last two quarters is more from the Global Emerging Markets (GEM). Global funds rather than specialist funds which are looking at bottom-up midcap ideas and also the locals who have been traditionally very big buyers of midcaps, they have been facing redemptions.
Technically they do not really have had any big support from liquidity and that continues to be the case right now. We still are yet to see in terms of big buying coming into the midcaps anytime in a hurry. There are still lot of small cap focused funds and still some India specialist funds. We still continue to look at these midcaps. Individual stocks can still do well like they have in the last couple of years, but as a broader basket I do not really see this trend changing in a hurry.
Q: You guys track some of these Non-Banking Financial Companies (NBFC) like Shriram Transport etc. What did you make of the big rush to apply for banking licenses and have you changed your call on any of them because of that?
A: No, not really. Banking license is a more near term market fascination, but for these guys to get a license that is first big call to make whether they will get or not.
Secondly, the entire details around the banking license in terms of how it will pan out, what are the commitments they have to make and therefore how value additive it will be from the next 3-5 years for the stock price is still really uncertain as of now. Beyond technical factors and markets getting excited about it, purely from a fundamental point of view that is still an open field.
Q: The big collapse has come in the gems and jewellery sector including some of the front-line faces like Titan Industries. Is this a good time to go in and buy into any of these stories or do you think the run is done on some of these gems and jewellery or gold related stocks?
A: Titan is different from a lot of these gems and jewellery companies in a general way. Titan is the only large organised player which has a fully hedged model unlike these companies. However, we still have a sell on Titan despite stock having corrected. That is because the underlying business model is getting inferior in terms of Return On Capital Employed (ROCE).
Earnings impact is still debatable as to how big it is from moving from a hedged lease model to doing the hedging in-house. The bigger issue is that we have to realise that government is definitely trying to dampen the gold consumption in the jewellery form or in the pure gold speculative form. That measure is very difficult to say whether it is largely done and that can continue to be an overhang for a lot of these stocks.
Therefore these stocks may not re-rate or go back to their early days in a hurry. So, Titan does standout against a lot of these stocks in terms of its brand positioning as well as business model. However, in terms of the near-term outlook for the next couple of quarters we do not think the stock had become cheap enough for us to get really bullish on.