HUL downgrade doesn't indicate a moldy FMCG basket: UBS

ALSO READ See what other experts are saying about markets See what FIIs are saying about the markets See what Udayan Mukherjee is saying about the markets HUL BSE | NSE 30/05/12 Are Mutual Funds betting on HUL? Other Stocks in this news ITC | United Spirits | Godrej Consumer Products | Emami | State Bank of India | Power Finance Corporation | PTC India Financial Services | Rural Electrification Corporation | Hero Motocorp | Maruti Suzuki India | Mahindra and Mahindra | Tata Consultancy Services | Wipro | HCL Technologies | Coal India | Sesa Goa | Tata Steel | Sterlite Industries (India) | Exide Industries | Petronet LNG Ltd | LIC Housing Finance | Crompton Greaves | Oil and Natural Gas Corporation | Bharat Heavy Electricals | Oil India | NTPC | SKS Microfinance | Manappuram Finance |

UBS has a sell call on Hindustan Unilever. Suresh Mahadevan, Managing Director and Head of India Equities at UBS Securities tells CNBC-TV18 in an exclusive that the company has been downgraded because of the pressures it is likely face from competitors in an inflationary environment. ITC and United Spirits are a great buy for an ideal portfolio, he says.

Below is the verbatim transcript. Also watch the accompanying video

Q: The downgrade on HUL that UBS has put out, what was that predicated on because that stock has been on a bit of a tear?

A: We think some of the consumer names have done quite well. Hindustan Unilever (HUL) is just one of them where we have a negative view. It's not a downgrade per se; we had downgraded it earlier because we did some work on how companies perform in high inflation, and found companies like ITC probably doing very well. HUL didn't come out that well in the stuffy environment. So we downgraded it a while ago. This is just probably a note today, reiterating that, because the stock has moved up.

Q: So is it a concern you extend to the rest of the FMCG basket as well?

A: Selectively, the FMCG sector has done very well, probably because in these uncertain times, these stocks act as good defensives. We still like ITC, United Spirits and Godrej Consumer . W also like some of the midcaps like Emami . My sense is, a fair amount of good news maybe priced in on the consumer side, but given there is no clear direction in the markets right now, these stocks may continue to do well. What worries me is, some of the midcaps sometimes do way too well and then, you are left wondering whether some of these stocks are priced pretty much for perfection. To that extent, ITC and United Spirits are what I have in my model portfolio because I still find value in them.

Q: How are you positioned on the public sector banking universe? As someone was pointing out last earning season, SBI spoiled the mood towards the end, are you expecting bad numbers from the public sector banks once again this time?

A: I don't have any exposure to public sector banks, but having said that, some of these prices have come down to good levels. Actually, public sector banks may not be as bad because again, its one of expectations. SBI was a big negative surprise last quarter and my sense is, now, people's expectations have toned down. In fact, SBI now seems like they are looking at a fairly large NIM expansion of close to 25-30 bps points, which I don't think is in the price yet. Even though I don't have it in the portfolio, if the results bear out, then definitely, a positive surprise for the banking sector. As such, this quarter may not be very good for obvious reasons; it typically happens during the later part of the rate cycle when you have not only deposits getting re-priced, but also your credit growth slowing which is not a good combination for the banks. The question we need to ask is what is priced in, and my sense is the public sector banks obviously have underperformed over the last couple of quarters. Maybe, most of that negatives is priced in now, but results are not going to be very good with the exception of SBI where there maybe a positive surprise.

Also read: Single-stock ideas spurting; bodes well for mid-caps: UBS

Q: What is your expectation for the market now as we end this earning season and also probably take in one more rate hike? Do you think the market still grinding in a range or are you expecting a significant outperformance or breakout over the next few weeks?

A: There are a lot of negative news in the price. Everybody knows about high inflation, even rate hike maybe priced in pretty much. Obviously, earnings momentum is negative because analysts still look at data points and then downgrade their numbers. There is still a bit of that left to go. I think, the only risk to the market is significant outflow for which you need an external catalyst. I don't think anything in India is going to cost so much of an outflow, going as we are in a huge negative news flow environment. So any external event could take the market lower because we haven't had outflows after Rs 30 billion came in last year, and even this year, net FII numbers are more or less positive to a couple of billion dollars. The second thing, on the positive side, we may need some catalyst. I am not sure what it is going to be, it may well be the combination of perhaps RBI signaling that the rate cycle is peaked, to a normal monsoon, to the inflation numbers coming down etc and obviously, some government action I am hoping with the monsoon session. Policy inaction has been worrying investors quite a bit and I am hoping from August 1, the monsoon session does produce some momentum there. So it could be a combination of these things that could take the market higher, and in my observation of the Indian market, come October-November, we also tend to focus on the next fiscal year which is FY13 numbers which automatically gives some valuation support to the markets. In the absence of real positive cataclysm in the near-term, the market could be range-bound till we get to Q4. That is quite a possibility, but we are overall positive and suggesting that people pick stocks as opposed to just take a market view.

Q: What is it that you are picking up about liquidity or money interest though, because we started off with the bang and by Friday, we were down to some Rs 40-70 crore kind of action from the FIIs. Have they lost interest along with the market's momentum or is money interest still there?

A: I was quite surprise by the amount of inflows we saw because I have been, at some point, expecting there maybe some outflows given at least that the Europe and US situation is not very encouraging. However, quite positive flows have come in, so that itself tells you how difficult it is to predict. Most of the investors are realising that India is a bottom-up market and I am quite surprised that not many people are very negative on India. Actually, people are quite open to single stock ideas and there is a good audience for a good bottom-up stock idea which ticks the governance and other disclosure boxes. People are quite keen to look into that, and that also boils down to even some of the midcaps where people are quite happy to look at some of the high quality companies there, which is very encouraging. So that trend is going to continue and that's again the reason why we are saying, let's focus on specific stocks whereas markets can be influenced by whole host of factors which may not be totally in India's control or anybody's control.

Q: Last week there was some excitement in some of these PSU power related companies like PFC , PTC and REC , on the back of expected SEB reforms. How do you guys approach some of these largecap names?

A: I think we still have a positive view on some of them, but I am not putting them on the model portfolio yet. Primarily, there are better bets than them, but clearly, some of these stocks have corrected quite a bit. I am sure at some point, they are very attractive and when stocks correct a lot, there is always a good bounce when some positive news emerges at the margin. Out of the 145 stocks we cover, roughly 25 make it to the model portfolio. So definitely, it is not in that list yet, but we keep reevaluating this every five-six weeks. Analysts are still positive on these names, fair to say that.

Q: Autos have also corrected quite a bit, have you used the correction to include any of them in your model portfolio?

A: Yes. I have been quite positive on Hero Honda which luckily has done well. My logic has been that it is a good play on rural consumption with monsoons looking normal, plus the company is showing good amount of pricing power. So, we continue to be positive. The other stock which is at the other extreme, which is not loved at all, is Maruti . I am quite positive on this name because I find that a lot of the negative news maybe in the price already. Understandably, the first half of fiscal is not going to be great for this company, but if you look beyond that, there are quite a bit of things to cheer about like the expansion of their Manesar plant wherein some of the diesel models could get sorted out. That could lead to some volume growth there. Also, the most significant competition is going to be a Hyundai small car launch. Other than that, we don't see anything very significantly on the negative side, though competition has been hogging the limelight. That is why the stock is where it is. At this level, at 13-14 times one year forward or FY12 earnings, we think Maruti could be quite a good stock. I am overweight on that in my model portfolio. Therefore, Hero Honda and Maruti are the only stocks I have currently though we are positive on M&M as well.

Q: We have seen two earnings call from the technology majors, TCS and Infosys , both of which of course have had polar opposite reactions. What is your top pick from technology now?

A: Currently I am positioned as a little bit more overweight Infosys though I think we are still trying to figure out. The last two-three quarters have been a little bit disappointing with this company, but listening to the management calls etc, the feeling I get is that maybe in the second half things may come back. But TCS has been doing an outstanding job. It is in my model portfolio as well. So both Infosys and TCS make it, but I am slightly more overweight on Infosys. So I think we are re-looking at that at this point, but clearly with all the leadership issues sorted out etc, I do think that Infosys at this level may also offer an interesting opportunity, unless we keep assuming the next few quarters are also going to be disappointing, which we don't have that view yet. So I think we are kind of neutral on the sector, but kind of overweight on Infosys and neutral on TCS as well. So that is a way we are positioned in the model portfolio. We don't have any of the other stocks like Wipro or HCL .

Q: Have you guys had the opportunity to go through the impact of this draft mining bill, especially for stocks like Coal India , Sesa Goa ; have you been able to assess the impact?

A: Yes, I think we did look at that and our conclusion is that obviously as and when it will get implemented, it will be quite negative for Coal India and Sesa Goa as well. But it is a lot benign for someone like Tata Steel or maybe even Sterlite . In that space, the only stock we are clearly pitching is Tata Steel, where we think the risk-reward is quite attractive right now, particularly with the domestic capacity coming in. So Tata Steel is the only stock which is there in my portfolio and we will continue to push it as a top pick. At this level, I think it is quite a good stock to buy.

Q: Quite a few interesting midcap results this week from names like Exide , Petronet , LIC Housing and even Crompton Greaves . Any of these in your research basket you have a take on what to expect and how to approach these stocks?

A: I am not sure about the results. Interestingly, we cover all these four names in fact I think we are quite positive on Exide because I think the stock has done well. The thesis there is more related to the two-wheeler push start, I think that could open up an entirely new market for Exide. So clearly we are positive on that. Petronet LNG, we are not too positive, I think we have recently downgraded them after their good run. Crompton, we have been negative for a while and we continue to stay negative. LIC, maybe, neutral. Therefore, Exide seems to be the top pick out of these and the analysts' conviction is reasonably high. Exide is in my model portfolio as well.

Q: The FPO candidates, what do your reports suggest of names like ONGC , BHEL maybe even Oil India ?

A: We have been reasonably positive on these names and particularly, I like BHEL the most. That is in my portfolio primarily because, again, it is very similar to Maruti. The stock has got derated quite a bit, but I think the concerns are pretty straight forward. It is related to foreign competition, sustainability of margins, the whole SEB issue of viability and also coal availability. So the concerns are pretty much in the price and our analysts believe that possibly the company will come up with good results to start with and there is also talk around import duty being imposed on some of these foreign equipment particularly Chinese equipment. That could be a trigger and of course, some clarity on the NTPC bulk tendering will also help BHEL. So BHEL at 13 times FY12 earnings, it quite reflects and it is again a very interesting risk reward and the governance is good; the company is well managed.

Q: Do you have a view on SKS Microfinance , where do you stand on that one?

A: We unfortunately don't cover that name, though we cover one of the gold loan company, Manappuram , there we are structurally very positive on them. So unfortunately I don't have a view on SKS.