Earnings growth estimate down to 13% for FY09: Kotak Sec

Q: What is your sense of what has happened with the price damage? Are we anyway close to the end with that?

A: That depends on how much more selling is to go from the Foreign Institutional Investor (FII) side. We assume it is probably near the bottom as far as the market valuations are concerned. If one looks at FY09 basis, then the market is below 10 times. If one looks at FY10 basis, it is about 8.5-times given the numbers sold out as far as earnings are concerned. So from a valuation standpoint, the markets are pretty cheap. They are trading at its lowest ever at 8-9 years' historic lows. So from valuation standpoint things look okay but the problem is how more selling is still out there as far as FIIs are concerned.

Our sense is one could see potentially another maybe USD 5-6 billion for selling coming in and remember they have sold above USD 11 billion as calendar year to date. So that's the big issue of how much of that can be made up by buying for domestic funds--remember the domestic funds are sitting on a pretty large amount of cash above USD 5 billion. I assume some of that can be deployed once there is some gradual easing off of FII outflows and also the insurance companies will reasonably get a fair amount of money in the second half--our assumption is about USD 5-6 billion.

Hence, the domestic money comes into the market then we can balance out the outflows from the FII side but the problem is it is relentless with pressure from FIIs which is happening at one-time. Thus, there is no way the market can absorb the selling and one can see the stocks which are going down and these are the blue chips now effectively are selling their core positions. So with such signals, may be, we are probably at the bottom as far as the market is concerned.

Q: You spoke about the market being around 10 times. You think that will hold given the kind of earnings picture we are expecting to see over the next two-four quarters, or are you beginning to scale down your earnings expectations quite significantly now this year and next year?

A: We have already brought down our earnings numbers quite significantly. If one excludes the energy sector then they down only 13% for the current year and about 11.5% for the next year. As far as the broad market is concerned, the big issue is what's happening to the energy sector numbers because numbers for Reliance and ONGC are big and they can swing the overall numbers quite dramatically. However, I do not think the energy sector will get the same kind of valuations as other sectors and if one looks at numbers for next year about 50% of the incremental profits are coming from Reliance as well as ONGC. So, what happens in energy sector becomes quite important.

Q: How much have you had reason to scale down earnings estimates for these two names--Reliance and ONGC?

A: With respect to Reliance Industries, keeping in mind the fact that it is ultimately a global cyclical commodity play and what's happening in the metal space, the cues as far as refining and chemical sector is concerned are not good. Moreover, refining utilisation are quite low in the US, the demand is coming off similarly in the chemical sides. Plants are reducing offering rate quite significantly. So, there is a whole problem of demand and at the same time both chemical and refining supply is coming on stream. Over the next three years, effectively, there will be incremental capacity which is double the incremental demand and this is assuming the demand stays at a reasonably good levels. Hence, margins will be under pressure as far as both chemicals and refining are concerned and one would see downgrades as far as Reliance's earnings are concerned.

We have already built in some but who knows what the turf would be and these are cyclical plays so the margins can decline quite significantly from whatever people assuming. With respect to ONGC, a lot will depend on what the government does eventually, but I do not see too much of pressure on ONGC's earnings because overall its losses have come off and even next year the losses could be on the lower side just because where crude prices are. So ONGC's number will stand up, hopefully.

Q: What are your thoughts on whole infrastructure space that lead to the big fall in the market on Friday? Are you revising all your estimates down for companies such as BHEL, ABB, NTPC, etc.?

A: There are two offsetting factors there. First, Q1 and Q2 had margin pressures because of high commodity prices, particularly steel prices, so that's reflecting in the Q2 disappointment as far as margins are concerned. Where Larsen & Toubro reported a weaker than expected margins, I presume BHEL will also go through a similar situation. But having said that, the commodity prices have come off significantly so that pressure is gone now.

The bigger challenge these companies will face now is what's happening to order booking going forward and BHEL seems to be in a good situation and they have about three more years of visibility as far as order book is concerned. Thus, they should be quite okay and even L&T seems to be in a reasonable position and at least for Q2 they reported good order booking.

So, as of now I am not sure how this situation pans out. On one side there is commodity pressure, margin pressure easing off and on the other side we still have a lot of question marks as to how the order booking will pan out just because of the slowdown in the economy. I hope the government starts reducing all the orders which are there with the big backlog there as far as road projects are concerned and they can probably improve the statement quite significantly if they start releasing orders now.         

Q: The pressure on individual stocks is also quite intense. You track telecom. What have you made of what's been happening with Reliance Communications?

A: I guess the big issue there is that people are still to reconcile the balance sheet with whatever they are reading in the press. There are some discrepancy in the numbers between what they report to the TRAI (Telecom Regulatory Authority of India) and what they report to the shareholders. People are not being able to get a grasp of that. So, at this point of time people want to stay away from any companies where there are any sort of financial issues--the issues may or may not be there but whatever perceived issues are there people just want to stay away from those stocks.  Whenever one sees selling in stock and no real buyer out there, the stock comes off significantly, and the whole problem there is just no buying there.