Market can go down 20% more; surprised by Re slide: UBS

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"The rupee free fall has caught market by surprise," said Suresh Mahadevan, managing director and head of Indian equities at UBS Securities. As the rupee stands at its all-time dollar low, with the currency vulnerability adding to the fears over the global volatility, Mahadevan says the instability in the market is most likely to stay for over the next few months.

"The Indian market is the worst performing, globally. The market is moving towards a final leg of capitulation and on a worst case scenario there could be a 20% downside from current levels," Mahadevan cautioned.

In an interview to CNBC-TV18, he held that the negative earnings momentum and the weak sentiment are likely to be an overhang.

Meanwhile, he also said that he expects telecom as a sector to outperform. "I like both Bharti and Idea for long term view," he added. On the other sector picks, Mahadevan prefers M&M and Hero Motocorp from autos, Godrej Consumers among the FMCG counters at current levels and Mannapuram Finance from the gold finance companies. " Coal India too looks attractive at these levels," he further added.

However, he sees a downside risk in HUL , although said that it is priced to perfection at this point in time. Also, he picks Titan as a good long term bet, although not at the current levels.

Below is an edited transcript of Suresh Mahadevan's interview to CNBC-TV18. Also watch the accompanying video.

Q: Generally, you have been on the bullish side but after the data points of the last one month, have you too scaled down your bullishness?

A: Certainly, the rupee move has caught everybody by surprise. There are few short term and medium term implications. It has an implication on inflation and probably prolongs the tightening a little bit more; hence, I think the sentiment is weak.

We are yet to see big FII outflows. The last few days we have seen some selling but if that selling were to intensify, in the short term the market could go down further. I think our bullish view is more on the medium to longer term. So, there this might be an opportunity because we are not on a cyclical slowdown, which is probably further worsened by the rupee. However, it might typically signal the last stage we have before things come back together. In the next few months, the market is going to be quite volatile and wobbly but there is some opportunity in it.

Q: What are you hearing about flows?

A: The last few days we have seen some selling but it is not to an extent where it is worrying. However, given the way the rupee is behaving, you might see a little bit of capitulation because the reality is that last year, we had over 29 billion dollars of flows and this year we are more or less flat.

The market has been one of the worst performing in the world. Clearly, with the rupee now giving away it could lead to a little bit of capitulation. However, this is simple liquidity sentiment driven, and fundamentally rupee is the last straw. We haven't seen any worrying flows yet but we have seen selling at the margin.

However, if the market continues to slide we might see a day where things can go wrong and that might actually provide some buying opportunity. At this stage the sentiment and liquidity, everything seems to be weak.

Q: Would you say there is a high probability the market closes at or below the lows we have seen for the year by the time we are done with 2011?

A: Yes, it is quite possible. Given the rupee move, it is quite possible that the risk has moved to the downside because a fair amount of bad news was in the price whether it is high inflation, slowing economic growth or negative earnings momentum but the rupee has come as a bit of a shock to a lot of investors.

It will also have some repercussions towards our economic growth as well as inflation as we look at FY13, depending on where the rupee ends up in. I think that development could put us at risk for the rest of the year. The market is already trading very close to the recent lows which we have seen in August or October, hence, it is quite possible that we go below that. If I look at earnings numbers we are looking at an EPS of 400-380 for the Nifty. Even at 380, the market may not be trading very far from 12-12.5 times. In worst case, we can go to 10 times, hence, in a worst case scenario we could be down 20% from these levels.

Q: How much earnings damage could happen in FY13? How worried are you about both earnings and balance sheet issues cropping up or extending into the next fiscal year?

A: Currently, we are looking at around 12.5% for FY12, which may become 10% looking at the rupee situation. For, FY13 I think the Street is looking around 14% growth which again could be 10%. I don't really see our growth falling much below 10% because even in the earlier financial crisis if you adjust some of the exceptions, we still grew at around 9% and liquidity was much tighter at that time.

There are two issues here - the earnings momentum will be negative and the sentiment too stays negative. Hence, you rather don't recover very quickly and continue to stay at low levels which can be quite worrying. In the next few months, are going to be quite nervous and volatile for investors.

Q: You track telecom quite closely. Apparently the DoT has also accepted recommendations of the TRAI on spectrum allocation and pricing. Is today's weakness on account of that or the controversy on 3G allocations and how is that panning out?

A: There has been positive and negative news flow in the sector and off late more negative, with this 3G roaming packs etc. However, this sector which has done relatively very well, and has been a big outperformer this year. Maybe it is venerable where people are booking profits, but the underlying pricing power has come in plus potential change in M&A rules, as and when the TRAI recommendations get accepted, those two are very powerful inflexion points for the sector.

The sector should continue to outperform because it will be a sector where growth is still going to be quite strong, provided pricing power stays and also when regulations change around M&A where you will see a market which is consolidating. We continue to like both Bharti and Idea. There is some short term weakness in these names but net-net for the year, they are still big outperformers. I think pullback might be actually a good buying opportunity in these names.

Q: Post earning season, what is your list of top 3-4 large cap companies that you are overweight on right now?

A: As sectors, telecom and pharma should do well. Some of the stocks have corrected too much and hence, something like Coal India looks very attractive at these levels. Power Grid still could do quite well. We continue to like some of the selective banks like Federal Bank . There has been some foreign selling in that name but it is very attractive at these levels. We continue to like the gold finance companies both Muthoot and Manappuram , where there is growth.

Q: Which sectors would you look to buy now - autos and FMCG?

A: FMCG has relatively done quite well and probably it is over ruled at the margin. I think within FMCG, we still have ITC which has done relatively well and maybe Godrej Consumers. FMCG as a whole seems to be at a good valuation at around 17-18 times FY13. Within FMCG I like Godrej Consumer Products.

In autos I prefer Mahindra and Hero Motocorp. Mahindra's results were a little bit disappointing particularly on the raw material supplies. However, I still think Mahindra should do well because it is more position towards rural demand which still stays strong. I would still prefer Mahindra & Mahindra and the portfolio. Hero Motocorp has done well and may continue to do well.

Q: HUL had done the best of the lot and there are a lot of concerns creeping up now on the rupee's deprecation on what it could do to its margin, because of its import content. Would you be underweight on HUL?

A: Yes, currently we do not have it in our portfolio and our analysts are negative. It has about 42% of raw material cross dominated in Forex, which is certainly a risk. The stock has done exceedingly well, I do think it gets hit pretty badly but we like Godrej Consumer and ITC more in that space, and not necessarily HUL at this point.

Q: Consumer facing names have also done very well and are trading at premium valuations, like Titan, which has now started correcting. Do you think there is lot of room on the downside there?

A: I think any stock which trades close to 13 times FY13, any small news flow, runs a risk for the stock to go down. And, that is what we are seeing in Titan and some of the other consumer names which are very pricey, like Jubilant Foodworks, which has corrected.

One has to keep questioning what is already priced in and any small accident can hit the stocks. I do not have Titan in my portfolio though we like the name from a long term perspective, at current levels I wouldn't look at it.

Q: Do you track aviation because after Kingfisher there were concerns raised on Jet yesterday from their auditors?

A: We do not track the airline space though we hope to do that in the future. However, they have been hit by crude prices and their effects now. Airline industry around the globe do not make a lot of money, so there are a very few profitable airlines. The industry dynamics of very low entry barriers and high exit barrier does not really help.

 

Q: What do you hear from your global peers, in terms of where risk levels are at right now and how globally people are positioned for the tail end of the year because that will have ramifications and our own market as well aside from our internal issues?

 

A: Investors are quite concerned about global growth per se because we have some really serious problems in Europe. US relatively is slightly getting much better than Europe. When you put all this together while emerging markets may be seen as higher beta or more risk, but eventually money will flow into the growth markets.

 

In the short term, there seems to be some headwinds, it is not just the rupee which added to the issues, rupee has been one of the worst performing currencies but I am sure a lot of emerging market currencies are facing the same problem. It is primarily due to inflation and the general US dollar strength.

 

People are becoming a little bit more risk averse but I do not think we saw a lot of buying after November. Investors are interested in India but they are looking for better levels and maybe local catalysts to emerge - whether it is lower inflation, RBI loosening rate hike cycle or government progressing on reforms, etc and these may all happen in March-April-May, hence, the next few months are going to be quite challenging.

Q: You have been quite circumspect on IT. Have recent comments from the large cap companies made you even more cautious despite rupee's depreciation?

A: The fundamental trend in IT is very clear - growth rates are going to come down but in times like these, rupee is a short term tailwind for these companies. Some of these companies are vey good in corporate governance; hence the flight to quality during these times helps the companies to outperform on a relative basis.

As long as rupee continues to be under pressure and as long as we don't come out of deflation mode, I do think this is a sector that may generally do well on a relative basis. Apart from Infosys , we have a negative rating on all the other names. Infosys we still think is somewhat defensive where we are neutral. In these uncertain times given the premium on quality and also the rupee, I do think this sector has the potential to outperform in the next 3-4 months.