Trading in ONGC and Oil India over gas price hike may be over for now and Reliance would be a clean bet, believes Dipen Sheth of HDFC Securities. He added that the capital flows will continue to be volatile this week.
Dipen Sheth, head of institutional research at HDFC Securities expects foreign capital inflows in India to remain volatile. India's over dependence on overseas funds to finance its current account deficit (CAD) is a concern, he told CNBC-TV18 in an interview.
"Every time there is a rush towards exit by foreign investors, markets crack and when there is a bit of mending of quantitative easing (QE) not going away substantially, the money rushes back. I am afraid, we are at the mercy of the volatile capital flows and to much more than what we should ideally be," he elaborated.
Meanwhile, he is positive on the oil and gas sector on the back of recent natural gas price hike. He advised investors to trade in Reliance now. One should not bet on PSU players Oil and Natural Gas Corporation (ONGC) and Oil India based on gas price hike because gains from price hike will be offset by subsidy issues.
From the IT pack, he is cautious on Infosys. According to him, valuations of TCS are expensive, but one can bet on HCL Tech from the large cap names. After Tech Mahindra's merger with Satyam, the stock warrants attention.
He is underweight on auto stocks and public sector banks.
Below is the edited transcript of his interview to CNBC-TV18.
Q: We had a fairly sharp pullback for the market come Friday. The worst in terms of price damage maybe behind us at least in the short-term?
A: Not really. There is no volatility and that is all which is evident. Every time there is a rush towards the exit by foreign investors, markets crack. And every time, there is mending or increased prospects of quantitative easing (QE) not going away; the money rushes back.
We are at the mercy of volatile capital flows and too much more than what we should ideally be.
Q: What do you think is tilting things this way and that? Is it up due to a a couple of domestic developments? Or is it still centrally a global problem as also linked with the rupee? Is that is going to determine how the next few weeks shape up?
A: India amongst the emerging market (EM) economies or EM pack; we are excessively dependent on capital inflows to fund our CAD as it were. Many of the better EM economies have current account surpluses.
So yes, they do have volatility when money rushes into their markets and out. But for us, there is a structural problem that we are plugging with these capital inflows. I really do not know whether we will ever get less dependent on global mood swings.
As for internal initiatives, a lot could have been done in the last few years. I see them as lost years for the Indian economy, quite frankly. You might call me a cynic, but that is how I see it right now.
Q: What does all this amount to in terms of an equity market movement? Do you think we had seen the worse at that 5500 level for the Nifty or because of the reasons you alluded to we could breach that as well?
A: There is going to be more volatility because of our dependence on foreign inflows and outflows. There is going to be sharper mood swings every time money rushes in and out.
If you think 5500 is a good enough level for the markets to stabilise at or find a bottom, I could tell you that it should be 5200 or something. So headline valuations will not make sense.
The Nifty itself is a composite of many different kinds of companies and sectors. Valuations across the Nifty are completely skewed too. So, there are parts of Nifty which look very costly at 25 times and more, and very cheap at 7 times and less.
So, on a blended basis, quite a few market gurus have been saying that 13-14 times looks like a good number to be invested in. I am not so sure about that. The skew is only increasing in the Nifty. It is not going away. That again is attributable to the kind of money that is coming into the country.
Q: The oil and gas stocks were in focus last week because of the gas price hike. You have been slightly sceptical about the formula that has been put into place. Can you just take us through why and how you would approach the oil and gas names now?
A: This formula that has been suggested and implemented in the form of a gas price hike now to USD 8.5/mmbtu. It is all wrong. Globally the gas market is a distorted and deficient market in terms of efficiency. You have Henry Hub prices in the US which had gone up and now have crashed because of huge domestic finds in the US.
European prices are reflective of what is happening in Russia and the North Sea. Asian prices are again distorted by the excessive demand from India and base demand from Japan.
Natural gas is actually not a fungible market and a freely tradable commodity, because it poses tremendous challenges for storage and transportation. So you will find completely different prices in different parts of the world.
And for this, Rangarajan Committee to take a call that we are going to average out all these prices in some complex manner and then say that is the price that we should pay Oil and Natural Gas Corporation (ONGC) or Reliance at the wellhead looks not so logical to me.
So I am not sure whether this is a very feasible and sensible formula. That said the price that they have arrived at is a substantially higher price than what is in vogue right now. Hence, a lot of extra money will accrue to the upstream sector, whether it is ONGC, Oil India (OIL) or Reliance at the margin.
Q: On a relative basis, who might stand to benefit the most? What would you buy from there?
A: There is some more cynicism left in this argument if you will allow me. Naturally the OILs and ONGCs of the world make more money like Reliance does. But what the Rangarajan Committee is going to give them by way of extra accruals, the Finance Minister is going to snatch away in the form of extra sharing in the oil pool subsidy to finance under-recoveries in the Oil Marketing Companies (OMC).
So, the trade is over as far as ONGC and OIL are concerned. On the other hand there is clean accrual for Reliance starting April 2014 and arguably even earlier. So yes, there is more net money going to be leftover with Reliance; not withstanding profit share from its extra proceeds.
Q: What seems like a more likely outcome; do we remain in a trading range where the market just bandies depending on global news flow or because of the events of the last month or so and the damage to the currency; there is a real risk that market breaks its range? Are we are headed for much lower price points at some point this year?
A: We more vulnerable to a breakdown. It is simply because of the increased reliance on external flows which affect both asset markets such as bonds and stocks as well as affect our CAD. So yes, we are in vulnerable territory. Valuations do not look too bad, but it is very easy to slip in asset markets just because money is flowing out.
For a more sustained and steady uptick in asset markets, the underlying economy should do well. We have got it all wrong there whether it is the macro indicators like inflation or CAD or whether the government is going to get a manageable fix on its fiscal deficit now that extra spending is called for after the price hike in gas.
The capex cycle is simply not taking off owing to a bad mix of poor governance and ill advised policies. So unless we get the macro stuff right we should not go anywhere as a market. Increased vulnerability to global liquidity flows will only make it worse.
Q: What has the experience been with the domestic crowd this time? Usually, the retail crowd and mutual funds have been quite savvy. They have been laying low in this period of turbulence and consistently redeeming when the market moves higher around 6000. What have they done through the month of June?
A: At the risk of possibly offending a few friends in the domestic money management space, they have been savvy. They have been wise and stayed away from volatility. It is fine.
If they are redeeming with every uptick, I do not think it is they who have been redeeming. It is the much more savvy Indian retail saver and investor which has been redeeming his or her mutual funds regularly on every uptick.
I do extend my sympathies to all domestic money managers. Assets Under Management (AUM) accruals are simply not happening in the equity slices. Lot of money has come into debt. Some money trickles in and out of equities.
But with every rise in the equity market, people have been pulling money out. For that to change, the domestic saver needs to be given a lot more faith in the economic well being and the future of this country. I am afraid that has not been given right now.
Q: How much do you see the rupee weakness to moderate earnings gains? Which are the companies that could be worst hit by the depreciation?
A: Large borrower in rupees, importer of commodities, overseas currencies with a domestic revenue stream is going to be very badly hit. So the infra stocks, large borrowers, leveraged plays, guys who are going recklessly after acquisitions abroad with leveraged money are going to be hit.
On the other hand, the clean, less capital intensive guys who are exposed to a falling rupee and dollar revenues will gain the most. So our portfolio stance is positive on IT not withstanding the Immigration Bill.
It is positive on pharma not withstanding the Drugs Price Control Order (DPCO) which is for the domestic slice of the pharma business. Our stance is extremely underweight on all the interest rate sensitives, infra stocks, consumer discretionary given high inflation data.
Although wholesale inflation is fallen, consumer inflation is still very high.
So the auto pack, the PSU banks' pack would be natural underweights in this situation.
Q: You are positive on IT space. Certain brokerages believe that Infosys could scale down their FY14 revenue guidance. Within the space itself, what are the stocks that you would be bullish on?
A: We have had a lot of hope on Infosys for sometime now. Quite frankly, the recent developments did not inspire us too much; the return of Narayana Murthy and with his son in tow. We have great regard for the man. He has done fantastic service for the company in his past avatar.
He is going to be very severely challenged this time and our best wishes are with the gentleman. But, I do not think, Infosys is getting it quite right. I hope they prove me wrong. We have a lot of regard for the company. I do not think they are getting it right this time around. We have changed our view on Infosys. We prefer to be cautious at this point of time.
On Tata Consultancy Services (TCS), we are concerned about the valuations. What that leaves on the table in terms of the front-lines is HCL Technologies with its heavy focus on the infrastructure management services (IMS).
So, I would put my money behind HCL Tech and a little more in Tech Mahindra. Post its merger with Satyam, it is going to become a USD 3 billion company and invites a rerating at this point of time.
Q: Today is the deadline to submit the applications for new banking licenses. In the last couple of days, so many companies have thrown their hat in the ring. Which are the prime candidates? Which are the companies that you would put your money on?
A: We have also seen a couple of more gifted and clear thinking companies withdraw their hats from the ring. Mahindra Finance was very clear that they did not want to be in this business and I admire them for this stance. A lot of people who are throwing their money in the ring may regret it later on.
Banks are still very strongly controlled. It is not that there are huge gaps or opportunities available for new entrants to come into the banking space. But there are several interesting business cases for the existing aspirants to set up large and sustainable banks over a period of time.
So Infrastructure Development Finance Company (IDFC), Tata Capital comes to mind. The Kumar Birla group has thrown its hat in the ring and there are going to be some concerns about them being a large industrial house already.
They have a substantially evolved financial services business and they should qualify. So, a lot of interesting competition is going to brew in this space. Many of the new aspirants are going to have some capabilities which will challenge the incumbents.