The market is cheering up government's move to bail out State Electricity Boards debt. Analysts feel that the package is a positive sentiment upmove for the capital goods sector.
So, to make the best use of the rallying power and banking stocks, here are some of the best picks of Rahul Singh, Head of Equity Research, Standard Chartered Securities.
Below is the edited transcript of the interview
Q: How do you look at the power distribution companies loan restructuring package? On the back of this, would you get positive on the PSU banks or on the power generation companies or do you think they have already run up?
A: I think it’s definitely a positive move especially because it’s now linked to some kind of a stronger quid pro quo than what was there last time when the central power sector utilities were bailed out in 2002. While it does change the credit worthiness of state electricity boards (SEBs), and that particular issue gets resolved to some extent, some of the issues surrounding the fuel risk and the individual assets, which are standard for utilities, do not go away with this. We would be a little cautious in extrapolating the positive from this to the utilities although the capital goods companies could benefit a bit more than the individual utilities if the projects pickup.
Undoubtedly, we definitely see it as a positive on banks. We like the PSU banks. We thought that they would lead the rally and they are leading the rally and this could also provide further fuel to that rally. We like Bank of Baroda (BoB) and Punjab National Bank (PNB) amongst the public sector undertaking (PSU) banks.
Q: Why would you be more positive about the capital goods companies in the power generators? The power generators are little hopeful that their buyers, the SEBs, will now be solvent enough to buy a little more power. But does that mean that anytime soon these will go into expansions? Does any of this indicate that capital goods players will find orders coming their way?
A: Right now, the improvement will be mainly on account of sentiment. The immediate project flow may not improve but the outlook or the expectations of projects picking up might go up on the basis of this. Also, I am looking at it more as a package so I am not looking at power in isolation.
If you look at what is happening on the national investment board and the NIB setup and the thrust on the infrastructure projects apart from what has happened yesterday, those things, as a package, look better rounded for the capital goods companies. This might be lead to a sentiment improvement for capital goods companies rather than for the utilities, which have their own issues. Each company is struggling with its own set of standard assets or fuel related issues or both. There is little bit of a subjective difference between both.
Q: Based on these administrative reforms, how much of an incremental upside do you hope to see in the market beyond 5,700 levels now?
A: If you look at the overall index PE, it’s about 14-14.5 times already. We could probably go to 15 times but I have my reservations on whether it can breach that kind of multiple because what we have to understand is that the cost of equity in India is still very high. We do not see the 10-year government securities (G-Sec) going down soon below 8 percent.
As long as that is the case and till the time we go back to 6-6.5-7 percent kind of 10-year bond yields, which is the risk free rate in the economy, I do not see the major rerating over the market as a whole. But does it mean the individual sectors cannot do well? That is not the case. We will see certain sectors going up 10-15 percent even from here even while the index might remain static and we have seen that.
One would have thought that the index would probably be higher than what it is today. But for the decline in the FMCG, pharmaceutical and the IT stocks, one has to understand that some of the valuations in the FMCG, pharma and IT might have been higher than what they deserve because of the scarcity premium which is also going to go away. I am not very finicky on the market levels and it is treacherous to project a market level because it’s a sum total of so many diverse movements happening today across sectors and stocks.
Q: Your overall macro view on the economy doesn’t seem to be positive unless the 10-year yield falls, you are not looking at market rerating. How are you looking at the consumption theme then? Do you think that we will continue to see subdued consumption, and therefore, cyclicals are not yet on your buy list?
A: Autos are not in my buy list because discretionary spending is slowing down, and it’s for everyone to see, I do not need to give examples. Real estate is different because the valuations were beaten down. We like DLF and it has done well, not because we saw a pickup in retail demand for real estate but we saw definite visibility on their asset disposals and they have continued to deliver.
Consumption wise, we will have to go apart from autos, which is more of a basket where I am not very positive on. If you look at the FMCG space, you have to go company by company and take a call, for example, we are negative on Nestle and Asian Paints where we see issues in terms of a slowdown rising before the slowdown hits Hindustan Unilever. There has to be a pecking order there. I think, sooner or later, some kind of a slowdown would impact each of these FMCG companies. We just have to rank it and play it accordingly stock by stock.
Q: How high is the possibility of a trip up in the global markets because of weak economic data impending fiscal cliff and that would, perhaps, result in our market peaking out for the year?
A: We have a few events which could trip but my guess is as good as yours on what specifically is likely to happen in Europe is very difficult to guess. But what I would say in defence of the Indian market is that we started underperforming late 2010 much before Europe problem became a big problem.
Subjectively speaking, at least 50 percent of the market derating was because of the domestic issues. Even within those domestic issues, the issues of government policy were lacking. We have addressed that problem. So if there is any global event, which is negative, I would tend to think that India will still outperform in that downfall, which could happen globally. We seem to have formed a firm inflection; we seem to have crossed that inflection point on the policy front definitely.
Q: Would you get into an earnings upgrade scenario? If yes, which companies or sectors in the Nifty would you consider?
A: Not yet. I do not see it happening in the next quarter or so because if you look at the earnings, the earnings cuts have been reducing. We have seen very moderate cuts in the last couple of months on an aggregate basis. But I still do not see a major uptick happening anytime soon because some of the largecap companies have long-term issues where the earnings are likely to get an uptick firmly into FY14 or even FY15. So my guess is we might have to wait for some of the earning upgrades to start happening. I do not see it happening in this quarter at least.
Q: Are there any nuggets in the midcap space that catch your eye?
A: We like Yes Bank and Prestige in the midcap space. We have liked Apollo where we continue to be positive. So these are the names I would go for among the stocks we cover.