UBS sees FY12 earnings growth at 10-11%, bearish on IT

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Though Indian market has eroded wealth of many investors, some experts still find India attractive now. Suresh Mahadevan, MD and Head of Indian Equities, UBS Securities feels that valuations in India are reasonably attractive at the moment.

In an interview to CNBC-TV18, Mahadevan said, "Clearly 2012, is not beginning on a very optimistic note, so to that extent we are fine because the only risk I see is still foreign outflows. So anything that triggers that whether it is something global or something local is the only worry but otherwise I think we are at a level where valuations are beginning to look attractive."

However, it comes with a warning that the market may slip to 10-11x FY13e in case of high volatility.

Mahadevan is expecting FY12 earnings growth to be at 10-11%. He remains underweight on banks due to asset quality concerns but recommends HDFC , HDFC Bank and Federal Bank among the financials. Meanwhile, he is bearish on IT as growth is expected to decline in that sector and may underperform too once the market starts recovering.

Mahadevan is bullish on Coal India .

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

Q: What is your Sensex target for end 2012? Will you put out a firm target for the end of the year?

A: We haven't yet put out a target for end 2012 but valuations clearly are reasonably attractive. We don't really find any clear catalysts emerging but it may emerge in the next three months with either inflation coming down, followed by the central bank's action or some amount of progress in terms of various policies from the government.

The market needs some catalyst at this point because 2011 has not been very good and that is partly because the news flow getting worse and in the end, we got hit by the rupee depreciation.

Clearly 2012, is not beginning on a very optimistic note, so to that extent we are fine because the only risk I see is still foreign outflows, which haven't happened in a big way in 2011. Anything that triggers that whether it is something global or local is the only worry, otherwise I think we are at a level where valuations are beginning to look attractive.

Q: Part of the UBS call for 2012 suggests that you see earnings growth slowing down to as low as 10% and market falling about 20%. Can you walk us through how you expect that to pan out through the course of this calendar year, in terms of the which quarter will be worst on the earnings parameter?

A: What we prepared is a worst case scenario and it was also put out at time when rupee was looking very volatile. We said there could be some knee-jerk reaction selling from foreigners, and if that happens market could to go to 10-11 times earnings in a worst case scenario. However, our base case doesn't look at a 20% downside.

If one looks at earnings momentum, it has been weak for the last 9-12 months and it will continue to be negative for few more months. However, most of the earnings revisions have happened. In FY13 we are looking at 12% earnings growth but there is further downside, so maybe, 10% number is a safer number given earnings momentum it is still negative.

Our base case scenario in FY13 is slightly better than FY12 from an economic growth perspective because FY12 we are looking at slightly below 7% growth around 6.9% and FY13 we are looking at 7.3% growth. We expect FY13 to be a better year which will start getting discounted once things start bottoming out. Things can only get worse due to foreign flows, otherwise our base case scenario is stable once inflation comes down, RBI starts easing interest rates, growth starts picking up, investment cycle starts picking up and then we are back to normal.

Q: On the point about this fear of outflows in 2012, what do you hear from your sales desk? One of the mystifying things of 2011 was that everybody overseas seems to be quite bearish about India but they did not press the sell figure. We did not see many meaningful outflows, do you think we could see some capitulation from the global investors this year or are they just sinking their heels and saying we will not abandon this market at this kind of price levels?

A: There are two things here - with the markets performing the way they have been in 2011, and with the currency there are no doubts that the Indian market has become relatively more attractive and if you look at the last decade or so, about foreign flows, except for 2008, we haven't really seen massive foreign outflows because structurally this is a market where foreign investors want to be long because its one of the few growth spots left.

In a worst case scenario, we are still looking at a sub 7% real GDP growth which is not really bad from a regional global context. The only time we saw heavy foreign selling was in 2008 and that is primarily because there is totally risk off kind of climate where firms like Baer Sterns and Lehman Brother were going under and things were really bad and the knee-jerk reaction.

It is not in our base case but it's good to have that sensitivity in the back of the mind. So, we go down by 15-20% and that is it. The reason foreigners haven't really sold because we haven't had a totally risk off yet. Also, it is a market where people want to be structurally long and hence it is a market where we haven't seen much selling yet.

Q: How nasty do you think this particular earnings season will be? Most of the damage we saw in the rupee actually happened in the narrow December quarter that is why this earnings season may throw up some ugly surprises on individual companies?

A: Clearly, earning season is not going to be very positive but the market knows that and hence, it is trading at sub 12 times FY13 earning. So, I don't think it can take down the market a lot further, unless we see huge negative surprises. I haven't really looked at the number but FY12 earnings growth may come down to close to 10-11%, which is what we are thinking though I have seen some numbers in the Street which are even sub 10%, though it is a bit extreme. We will wait and see, we haven't looked at the preview but we will do so in the next few weeks.

Q: The big call for a lot of people is what the banks will do because they took it on the chin through 2011, do you see banks making a price bottom this year and recovering meaningfully?

A: Our base case scenario for the market is to trough out this year and banks being 25% plus weighting, the indices will have to play a big role in that. However, we are still underweight on banks as because NPAs are going to increase and with credit growth slowing down it is not the best time to own banks as yet.

Some of the high quality names should do well like HDFC, HDFC Bank, Federal Bank is something we like, we like the gold financial companies. We like Federal Bank for specific reasons which are more specific to those kinds of companies. We have been negative on banks, particularly the PSUs. So that trend is going to continue into the next 3-4 months before we things reversing from inflation rates perspective.

Q: The IT index also lost quite a bit of ground although individual stocks should be closed up flat and perception wise people seemed more comfortable with IT as a sector, how do you think earnings season will be for that pack and what is your top buy there right now?

A: We have been cautious on IT and then negative. It is not a call that has worked very well partly because of the rupee partly. I am neutral on IT at this point primarily because of the currency weakness. Though our analysts are negative on all of them except Infosys where expectations are reality or are probably closer, whereas in others experts see further downside to the expectations because reality is going to be worse.

If you keep the rupee aspect away, the growth rates are coming down and with global economy not doing that well, we can argue that growth rates are unlikely to recover in the near-term. So IT sector which should probably do well till the market start performing then it may start under performing until the market is in a correction mode or downward trend or lower. Hence, IT should out perform.

Q: One of your most preferred stock ideas for this year is Coal India and it has had a very difficult 2011, what is the call you are taking on that stock and what kind of price potential do you see for it?

A: We were negative for most of the year on Coal India but at Rs 300 levels we thought it was good time to put a buy on the name. We are bullish on coal globally and though it is selling at a price which is lot lower, I do think Coal India is a good kind of coal play and given its size, it becomes a core holding for some of the India investors.

It is also kind of related to crude, India gets affected if crude prices go up but coal is also kind of substitutes, so that is the other way we like it. But the more interesting thing is from a valuation perspective, early teens kind of PE, one year forward PE, we think Coal India maybe quite attractive here. Though I have heard a lot of push backs from investors both domestic and foreign that it's probably a government company and they have missed their volume targets but given that it is large owner of coal, it is a stock where you can be structurally bullish. Hence, at Rs 300 we definitely like the stock.