Sep 17, 2012 01:45 PM IST | Source: CNBC-TV18

Be cautious! Valuation no longer cheap says Sanjeev Prasad

Indian market is basking in the moment of glory, already touching 2012 high as it opened to trade on Monday. Riding high on the pending reforms, investors are seen betting on the market. However there are still some experts who are approaching the market with a bit of salt.

Indian market is basking in the moment of glory, already touching 2012 high as it opened to trade on Monday. Riding high on the pending reforms, investors are seen betting on the market. However there are still some experts who are approaching the market with a bit of salt.

Not so much impressed by the government’s move, Sanjeev Prasad of Kotak Institutional Equities feels that modest diesel price hike will not alter fiscal situation much and neither stake sale in PSUs will meet deficit target as it is not a reform.

In an interview to CNBC-TV18 he said, "Selling in 5-10% stake in companies periodically just to meet some budget targets do not classify as reforms."

Advising caution, Prasad says that valuations are no longer cheap. According to him, most stocks are fairly valued but good quality look expensive. At the same time, he argues that liquidity argument is not sustainable driver of market. Prasad also adds that many positives are already priced in the market now.

Below is the edited transcript of the interview

Q: Would you still be cautious on the market or do you think what you have seen over the last 72 hours is enough to change one’s fundamental view on equities?

A: Not at all. I think the media should cut out the hyperbole around the reforms announcement and focus on real reforms. What has been announced is not going to aggress the structural or macroeconomic challenges of the country. Look at the state of reforms; two of them I would hardly classify as reforms; something like raising prices after 15 months, and that too, by a small amount as far as fuel prices are concerned can hardly be termed as reforms.

If there is a deregulation, I would be much happier. If you look at the total subsidy numbers for 2013, we are looking at Rs 1.6 trillion of under recoveries on oil. That is higher by 10% compared to last year’s level. I doubt the government is in a position to raise prices beyond whatever we have seen so far. Over the next 6-9 months, it could be extremely difficult in the current political environment. Coming to the second bit, which is on divestment announcements, selling 5-10% stake in companies periodically just to meet some budget targets do not classify reforms.

If they do privatization whether it is outright sale to private companies or through bringing down government share below 49% then that’s classified as reforms, not selling 5-10% stake in government owned companies.

Increase in FDI is positive but it’s a modest one. If you want to revise the investment sentiment then you have to bring in whole host of reforms whether it is deregulation or deregulation of all the factor markets, land reforms, labour reforms, electoral reforms. There are so many reforms which have been pending for a fairly long time. So let’s not get carried away. This is a good beginning but we will have to wait and see whether the government in position to implement more serious reforms. Given the political climate, this is probably the best the government could have done under the circumstances.

Q: So would you still sell into any rally on sentiment in the market right now?

A: I think stocks have become fairly expensive; the broad Indian market is now trading at somewhere about 15 times plus 2013 basis and almost 14 times on 2014 basis. Many of the high quality names are really expensive now. Most of the consumer names are trading at 25 times 2014 basis; domestic ones like Hindustan Unilever, etc would be above 32-33 times 2014 basis. So it is really expensive unless you want to own them in 2015, which is two years away from a discounting perspective.

If you look at the good quality private banks, HDFC is in the range of around 4 times 2014 book and HDFC Bank 3.5 times, so again, both are very expensive. Valulations of pharma companies are okay, but it is not extremely cheap. Other sectors have a whole host of problems. There are stocks which are definitely not cheap in the context of all the regulatory issues, which need to be resolved or the policy risks.

The operating sentiment and the environment in many of the sectors are still bad. Given the fact that valuations have become fairly expensive for good quality names or fairly valued in most of the other stocks in the market, I would be a seller in the market now.

Q: How high is the probability that the incremental global liquidity gets moved into sectors like infrastructure, power etc; that have been bogged down because of government apathy. Do you think money could flow into them or would you still be cautious?

A: This liquidity argument is somewhat self deluding. Keep in mind the fact that you have seen something like USD 42 billion of money coming into India between January 2010 and now. The market has gone up about 5% since then. In dollar terms, it has gone down 10%. I do not think liquidity alone will make the market float up. If that was the case then all the central banks in the world should just be printing currency and everything will be taken care of.

Ultimately, what matters are fundamentals and earnings. As far as those are concerned, I think we have a long way to go in terms of addressing the fundamental structural issues in India. In terms of valuations, many stocks are now between fairly valued to richly valued. I would be fairly cautious on the market now.


Q: On the subject of the two reforms that have come out over the weekend, which is FDI in aviation and FDI in multi-brand retail, are there any stocks that you would look at or you would avoid completely?

A: There are not too many listed players to play on these names anyway to start with. Obviously, there will be excitement about Pantaloon, Trent, to some extent keeping in mind that there is lot of conditionality involved with both these recommendations. So let us see how the investment really takes off in these two areas.

In multi-brand retailing, there are geographical limits to start with and approvals of states, which are required. So, the whole process will take some time to really take off. Many of the partnership arrangements will have to be figured out. Because if you allow the foreign company to own 51%, it means it has to find a partner, which is compatible with its long-term plans etc.

Similarly for aviation, the FDI limit is only 49%. So the foreign partner does not get control as far as operations are concerned. There are lot of restrictions on the ownership and on the directors. Therefore, it is a positive but it will not change the mood in these two sectors dramatically. Also keep in mind the fact that economics in these sectors are really bad.

If you look at aviation, there are a lot of problems on high prices of fuel in India, high sales taxes and high airport tariffs so the economic is nothing more to write home about. Just because there is an increase in FDI, it doesn’t mean that you will see lot of money coming in unless the more fundamental problems get addressed. This also applies to retailing.

There are very large Indian companies, which are present in multi-brand retailing but none of them are making any money primarily because we have very poor infrastructure logistics, real estate prices are very high in India, you have a cap on what prices you can sell at. It’s not issues, which will be resolved just because there is FDI in those sectors. I think all these things will take some time.

Q: Given the formation of a national investment board and the speedy clearances that the FM has been speaking about, and purely in terms of sentiment and animal spirits, do you think it could restock at least partly the investment cycle, which has been dead for the last three years?

A: I think it’s a positive. Whatever the government is trying to do is positive. But keep in mind that there is a huge legacy of negative factors there. You have still a lot of witch-hunt in telecom, power, coal blocks. So until those issues are addressed, I do not think the animal spirits will be unleashed so quickly. The government is trying to do a few things. But at the same time, you will have to address a whole host of factors and reform measures, which has more of a fundamental nature and which are more deeply entrenched, hurt a lot of vested interest in the country. It is not as if industrialists would be queuing up to put money into India where you are still seeing a lot of operating problems and a lot of policy issues. On the infrastructure side, various sectors are still in a big mess.

On the power side, there has been some movement on coal etc but given this scam around coal block allocation issue, that’s a big dampener. So till the time that is resolved, you have a proper policy for allocation of coal blocks through whatever auction process etc, I do not think you will see a big movement over there.

On the distribution side of the power sector, serious reforms are needed. The state electricity boards are raising prices periodically but what you require is a complete freedom for them to raise prices as and when required. Probably, the government should look at privatization of some of the state owned distribution entities. Road sector is doing fine; clearances have been pretty much on an automatic mode over there. Given the whole host of problems, it is still some time away before you see a big amount of investment coming in. Things are turning but a lot of this is already in the price of many of the stocks, and that’s what worries me, and if the stocks are expensive, let’s not get away from it.

Q: Within the Nifty, which are the stocks that may provide alpha in the market like this?

A: I think it’s cash at this point of time. Our biggest overweight position in the model portfolio is cash and then, we are overweight in pharma and power. Among power stocks, we are invested in regulatory businesses like Power Grid Corporation of India (PGCIL), NTPC and Tata Power. We were overweight on consumer stocks earlier but now, we got them down to underweight, given the fact that valuations have become fairly expensive. Other than that auto is okay, it is more of a neutral position. We are neutral on energy but other than that, everything else is actually an underweight at this point of time.

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