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Telecom cos to see sharp margin erosion: Raamdeo Agarwal
In an interview with CNBC-TV18, Raamdeo Agarwal, Director and Co-Founder of Motilal Oswal, spoke about his reading on the earning seasons and his future expectations.
In an interview with CNBC-TV18, Raamdeo Agarwal, Director and Co-Founder of Motilal Oswal, spoke about his reading on the earning seasons and his future expectations.
Below is a verbatim transcript of an exclusive interview with Raamdeo Agarwal on CNBC-TV18. Also watch the accompanying video.
Q: Was the earnings season above your estimate or did it just fall in line or disappoint? A: According to me, it was broadly in line. When you look at the aggregate, it looks almost in line. However, clearly there were some disappointments and big positive surprises particularly from auto pack. For auto pack, we were expecting large numbers, but the numbers turned out to be much better particularly in Hero Honda , Mahindra and Bajaj Auto . They really excelled in terms of quarter performance. Fast moving consumer goods (FMCG) was good. Pharma also did well. One of the biggest surprises was PSU banks which were led by Bank of Baroda , Punjab National Bank (PNB) and State Bank of India (SBI). So, on the whole you had four-five sectors which were doing well- purely Indian play and more on the consumer side of businesses. Then we had real estate, metals, telecom- which was a very big disappointment. So there was a mix of it but on the whole aggregates were more or less in line.
Q: Telecom numbers were weak but they did not account for the kind of price erosion or tariff erosion which happened in the current quarter. Do you think numbers will only get worse over the next couple of quarters? A: Without a doubt, the next quarter will be quite interesting because more than the revenue erosion, there will be margin erosion since it is largely a fixed cost business and any decline in the revenues straight tells on to your margins and margins of various players are very different. The largest one would have about 20 paise EBITDA and if your revenue falls by 15 paise then you lose about 60-70% of EBITDA. However, if you think of the guys whose EBITDA is 10 paise and decline is 15 paise, we are going to see some horrifying numbers next quarter from the telecom sector.
Q: Many stocks like Punj Llyod , Jaiprakash Associates etc, in the largecap space corrected significantly after earnings. Were you disappointed with some of the numbers there? A: I don't track a lot of the companies in this sector except Larsen and Toubro (L&T) which I look at closely. L&T had better margins with strong order inflows. They have been getting quality orders, but otherwise the new issuance and the fluctuation in the margins are quite unpredictable.
Q: You recommended an overweight going into earnings season on both infrastructure and telecom. How would you recalibrate your portfolio now? A: In telecom, my optimism clearly turned out to be a disappointment in the short run atleast. I am still in the thinking mode. Maybe my inaction of selling out has already cost me a lot. I am still thinking on how things are going to evolve but it was a big disappointment at the pace at which the tariff war has started. So all 3G and things which were to be expected although, are coming through and the longer story is good but we are going to go through pain for sure.
Q: This market has fallen 12% in the last fortnight or so, much more than many of its peers. What do you think has led to that under performance, is it earnings disappointment or is it something else? A: I think it was the sustained bull-run. So much of optimism got build into four-five months of foreign institutional investors (FII) and domestic purchases. There were not many corrections and valuations which really got stretched. Secondly, even the oil price went up to as high as USD 80 per barrel. The biggest damage is from the new issuances. Due to the pipeline of qualified institutional placements (QIPs) and change of regulation, we saw very aggressive mopping up money by corporate. There was not much left on the table for fund managers to put in the secondary market. So on one side there was short-term over valuation and on other side lack of purchases in the market, these two things made the market correct. I think it's a very healthy thing but it was just uncomfortable because there was nothing you could recommend at some point of time.
Q: Do you get the conviction that earnings will surprise on the way up in fiscal year 2010-2011 in a very meaningful way because at the start of this earnings season people were talking about significant earnings upgrades and how earnings will surprise so much that current stock prices may well be justified in a year's time? Do you still have that confidence or has it turned a little bit more ambiguous or uncertain after this current earnings season? A; I think earnings season is more or less in line. Except for telecom sector, everything else is intact, broadly in line. Cement was very good despite the talk of glut and decline in prices. As far as September quarter was concerned, it was very good. This quarter was year on year flat or maybe 3-4% lower in terms of Sensex earnings but next four quarters we will see big base effect of last year's low earnings. So the numbers will look very good and valuations will also be up. So as far as earnings are concerned, except for telecom, I don't see any challenging kind of environment for earnings in next four quarters. I think it's going to be issuance of new shares. The kind of appetite there among foreigners to put money into India, right now seems to be very positive.
Q: What is the right way to look at earnings because the base effect catches up in three-four quarters and once again neutralizes itself? Would you rather be monitoring whether their businesses are recovering quarter on quarter? You are actually seeing good revenue and earnings momentum picking up every quarter. Would you rather look at year on year comparisons on a very low base and feel happy about it? A: According to me, how one looks at earnings is a function of going into every company. Taking Asian Paints as an example- their margins expanded extraordinarily this year because the commodity prices are very low. All the petro based raw materials are down significantly. With stimulus package, you got the excise cut also. Hence, one is reversal of stimulus which will happen. Secondly, all the raw material prices are already catching up as oil price has gone to USD 70-80 per barrel. So clearly the margins that had gone up the EBITDA expanded from 14-15% to 18-20%. They will come back to 14-15% in years ahead though the topline will keep growing at 15-17%. Therefore, one has to look at this year's margin expansion in lot of these branded companies which are not going to sustain. However, next year on this base, we will see earnings growth on these kinds of companies. One has to be very careful on what PE multiple is paying to the current years earnings. If you look at tyre companies, they never saw double-digit EBITDA. However, this year they went to as high as 15-17%. So these margins are not sustainable. One has to go from company to company to figure out what is the source of margin expansion and how those margins are going to be sustainable.
Q: Even so as we stand at half way point in this year, are you confident of holding that Rs 1,100 EPS target for FY11? A: A lot depends on what happens in foreign subsidiaries of Indian companies like Tata Steel's Corus, Tata Motors's JLR, Novalis and Hindalco. A lot of these are part of Sensex or Nifty and they do add or subscribe to overall forecast that imparts a lot of volatility. Then you have the oil sector and what government has to do about that and you have the gross refining margins (GRMs) for Reliance's earnings growth. There are lots of things which are not solidly predictable. However, we are going to see significant ramp up in the earrings between 2009 and 2010, which we are talking about as Rs 900. The year 2010-11 has to be upwards of Rs 1,050.
