CAD will improve from Q4; oil & gas attractive: Kotak

Even as current account deficit (CAD) for the third quarter of FY13 is expected at close to 6 percent, higher than the 5.4 percent registered in the previous quarter and 4.2 percent in year-ago period, Sanjeev Prasad, senior executive director and co-head at Kotak Institutional Equities expects it to improve from next quarter onwards. Third quarter CAD figures are slated to release on Thursday.  

Speaking to CNBC-TV18, Prasad said one should tread the banking sector with extreme caution. He finds agriculture and aviation sector account for most of the NPLs faced by the banks. Although private sector banks claim to have resolved most of the NPL concerns, similar assurance has not come from public sector banks.
At this point of time, oil and gas sector has gained from improved policy framework. Within IT, Prasad finds the valuations of TCS may not be good but that of Infosys and Wipro are not too bad. Below is the verbatim transcript of Sanjeev Prasad's interview on CNBC-TV18

Q: The current account deficit (CAD) figure will be coming later this evening. What are your expectations and how do you think markets will react to something that is overtly negative?
A: This quarter is likely to have worst numbers that have been seen for a fairly long time. Last quarter was also bad at 5.4 percent and is going to exceed that looking at the trade deficit numbers that came out for October-November. The good thing is, at least in February you had a slight decline and the trade deficit figure were at about USD 15 billion compared to the previous months that were around USD 20-22 billion. Hopefully this will be the last, as far as bad numbers on current account is concerned and we see some improvement going forward. Q: While the market has been banking at current levels, the big run has come on the banks through this month, the private sector banks in specific. How are you approaching that space? Do you think there is more in terms of a valuation reset or this was a kneejerk reaction and banks should perform from here?
A: We have been fairly cautious on the banks ever since reforms started. We were never in the camp that you would see as a quick turnaround in the economy, a big recovery and all the non-performing loan (NPL) problems would get addressed. We were not very confident about the monetary policy loosening that people were expecting at this point in time that would result in inflation in bond portfolio and some amount of support for the banks. It has played out reasonably well as far as our views are concerned.
Going forward, I am still not sure whether we have seen the worst for NPL cycle. Even for the December quarter, you had fairly bad numbers for the PSU banks. So far, the private banks are somewhat immune to whatever we are seeing in terms of NPLs across the board. The worry is, so far you have not seen any of the big boys getting into trouble.
Other than Suzlon Energy the usual suspects in the power infrastructure space so far seem to be somehow staying afloat. Most of the NPLs in the banking space have come from agricultural sector which is more of a PSU bank problem, aviation and small and medium enterprise (SME) across a whole host of industries such as chemicals, pharma, iron, steel, textiles. I do not know whether we have resolved the problems in the power infra space. If any of those big boys get into trouble, the impact on the banks will be pretty large. You can have a few smaller companies getting into trouble to Rs 2,000 crore each, but if you have one big entity of Rs 20,000 crore of borrowings from the bank it will continue to trouble and will impact NPLs quite significantly for the banking sector as a whole.
I am still not convinced that the banking sector has resolved its NPL problems. Valuations are quite okay, but for PSU banks, I do not know what the book is like, given the amount of restructured loans and net NPLs that some of those banks are sitting on. Average PSU banks have almost 9 percent restructured loans plus net NPLs, private banks at least on paper seemed to be doing better. When I look at their portfolio compared to a public sector bank, I do not see much of a difference there, except for some of the retail oriented banks like Housing Development Finance Corporation (HDFC) and IndusInd. The other banks are in pretty similar position when it comes to the lending profile. So if anything goes wrong with the bigger entities, private banks are going to be equally hit later on.
_PAGEBREAK_ Q: What is your advice to investors with respect to the overall market momentum and how one should be placed right now? Is it better to stay in cash or cut positions in some of the high-beta rate sensitives, because there is just no turnaround in the economy?
A: Right now valuations are quite okay across most of the sectors. Barring the consumer, pharma and maybe IT to some extent, you have seen a fair amount of correction in most of the other names, so you can still build a portfolio. You will have to be careful, because I do not think you are going to see any greater recovery in the economic cycle at least in next 12-18 months.
As of now, we are not recommending any of the India stories, consumption story looks very weak and the stocks are still very expensive, investment demand is just not picking up and we have discussed the issues in the banking sectors. So our position of portfolio currently is more on the export oriented sectors like IT, pharma, where we have large weights. Pharma is a very big overweight for us.
We look at some of the specific companies where the revenues or the profits are in dollars, so at least we have some protection against any rupee depreciation that we could see because of the balance of payments (BoP) issues. Then you build a portfolio where the earning numbers are somewhat agnostic to whatever is happening in the economy, some of the oil and gas companies such as Coal India, National Mineral Development Corporation (NMDC), National Thermal Power Corporation (NTPC), Power Grid whose earnings are more dependent on regulations or Government of India policies.
In some cases, we are seeing improvement in the policy framework, particularly in oil and gas sector. You can make a reasonably good portfolio based on pharma, IT and some of the regulator/government owned companies where you have reasonable valuations, some amount of earnings comfort and an improving policy framework. Q: What are your thoughts on Reliance Industries? It is sitting below Rs 800 mark and is at the lowest level since November. What is plaguing that stock currently and how do you see it move from here?
A: This stock looks fairly valued. It can bounce back a little from here, but there is no real trigger for the stock. Gas production from KG-D6 field continues to decline. The production numbers had come down to about 17.3 cubic meters per day which is quite disappointing. I do not know where this will stabilise, but it continues to decline.
On the core business, refining was doing well up to a month back, refining margins were shot up significantly, but again over the last three-four weeks they have come off quite a lot. They are down about USD 3 a barrel from their peak level, so that maybe one of the reasons why that stock has come off over the last one-two weeks.
If you look at the medium-term, one or two year timeframe, there is no real catalyst for the stock apart from a price increase that will happen over the next few months. But everybody knows that and is presumably factored in terms of the earnings and cash flows of the exploration and production (E&P) segment.
The government-owned PSUs are broadly better positioned to participate in a gas price increase whenever that takes place. So I do not know the catalyst for the stock for people to get excited. This company will do about Rs 70 EPS in 2014-15. The stock is trading at about Rs 770-780, so it is already at 11 times from March 2014/15 earnings with no real triggers in medium-term.
The next leg of earnings for this company will come only in fiscal 2017 when new projects will come on-stream whether it is expansion of the D6 production satellite fields coming on-stream or coal gasification or the new petrochemical project and is sometime away. So, there is no point buying the stock in anticipation of a big increase in earnings in fiscal 2017 and 2018. Q: Do you have any concerns from IT space on what comes through in the next quarter’s earnings or if earnings are disparate across some of these names?
A: We will have to wait as to what comes out in the quarter, but so far the guidance seems to be okay from Infosys Technologies, Tata Consultancy Services (TCS) as they seem to be talking the right language. If you look at Cognizant numbers, they are still talking about 17 percent growth which is not bad as far as the global slowdown or some of the issues in India are concerned. This is more of a space where people are hiding as of now and my strategy is similar as far as my model portfolio is concerned. Overall, valuations may not be that great as far as TCS is concerned, but if you look at Wipro or Infosys the valuations are not too bad.
Wipro is sitting at about 14 odd times in March 2014 earnings, Infosys about 16-17 times. So from valuation standpoint, not looking too bad with respect to some amount of confidence in the volume growth numbers and the fact that you get a pretty good hedge as far as rupee is concerned. If something goes wrong on the BoP/current account you will get some upside in the stock based on the earnings upside coming because of rupee depreciation.