Monetary Policy: 25 bps cut along with reforms will revive mkt, says Kotak

The much awaited Reserve Bank of India (RBI) policy will be announced today. A 25 basis points repo rate cut is unanimously expected by most market experts and economists.

Sanjeev Prasad, executive director and co-head, Kotak Institutional Equities is hopeful that the central bank will oblige the market with a 25 basis points repo rate cut, but believes that only a rate cut would not be enough to reverse market sentiment to a great extent. Also read: Rate-cuts take 6 months to boost earnings: StanChart “Indian economy and consumption demand are slowing down. There is virtually no investment demand at this point in time. A 25 basis point is not going to reverse that,” he said in an interview to CNBC-TV18. The government needs to continue with its reform measures to boost sentiment. A revival in the economic cycle is likely after another 12-18 months, he added. Below is the verbatim transcript of his interview on CNBC-TV18 Q: What is it looking like? Do you think the RBI can change sentiment around or do you think it will come and go and the market will remain in a rut? A: A 25 basis point cut is not going to change the sentiment too much. There are lots of issues, which I don’t think a 25 basis point cut is going to resolve. You have a situation where the economy is clearly slowing down and a 25 basis point cut is not going to reverse that. Consumption demand is slowing down significantly given the fact that you had an extended period of inflation and prices of many of these non discretionary items have been going up. There is virtually no investment demand at this point in time. Given all that, I don’t think a 25 basis point cut is going to reverse sentiment so quickly. This is going to be a pretty long drawn affair of 12-18 months before we start seeing some revival in the economic cycle. Q: What’s the problem with Coal India? That stock is now sub Rs 300. Do you expect the Offer for Sale (OFS) to be priced a whole lot lower than the current market price and what’s been plaguing this stock? A: I guess two things. One is clearly the OFS, ever since news came out; the stock has been drifting down. It used to go Rs 350 when the first speculation of a divestment by the government started coming out about two-three months back. Then based on yesterday’s news where there was some sort of confirmation that this is going to be one of the divestment candidates for next year and given the target is Rs 40,000 crore, clearly Coal India will probably be there, that has affected the stock performance. Other thing has been the fact that this company has been delaying a price increase for some time. There have been a lot of debates and discussions and newspaper reports that there is a price increase in the offering but nothing has happened. There have been two-three items whose costs have gone up, particularly bulk diesel prices have gone up, so that would impact the profits by somewhere about Rs 20 billion. Freight costs also went up in the Railway Budget and also some labour cost, particularly contract labour has gone up. So, all that would impact the EPS by about Rs 3.50 unless and until the company can take a price increase to offset that. That is creating some amount of worries in the minds of investors’ on whether this company really has the freedom to take price increases as to offset some of these cost increases. Q: What is your prognosis for this market over the next couple of months given the point you were making about rate cuts not making too much of an impact? Are we stuck in a bit of a trading func you think or do you hear from the sales desk that money is still strong and in that the market could continue to perform despite our reservations? A: Money flows are imperative for India. From a current account perspective, if you look at the amount of deficits one is staring at, roughly at about USD 20 billion per quarter, India requires inflows jsut to make sure that we don’t have a problem as far as the Balance of Payment (BoP) is concerned. So, assuming that inflows come in, let us look at what can change the mood domestically. I don’t see much on the anvil. A lot of this will have to eventually come from the government, whether it is some sort of reforms, correct pricing in various sectors, and the right signal to investors, so on and so forth. Otherwise, if you look at the earning numbers, we are clearly not seeing any signs of upgrades. For 2013, our earning numbers is down to five percent that is for the BSE 30 year on year (Y-o-Y) growth for 2014. As of now it is stuck in a 12 percent band for the last several months. Clearly, we are seeing consumption demand slowing down. If you look at auto numbers, they are pretty horrible. If you look at consumer staple volume numbers, there is a declining trend and the investment demand is just not picking up. As far as the economy and earnings are concerned, you are not going to see any positive news for some more time. So, what can sustain this market is if you get some good news from the government. If you look at the oil sector for example, we have started on process of deregulation. But I don’t know what happened in the middle of this month when there was suppose to be the third round of price increases as far as retail diesel is concerned that seems to have been pushed off till the parliament is in session. I am not sure whether right signals are being given to investors; you start on a certain reform process and then go back, fearing some amount of social or political backlash. So unless and until you give right signals to investors, I am not very sure these stocks are really going to perform. It is a fact that most of the India story is very expansive.  If you look at consumer staples, barring a couple of names, most names are now at 25-30-35 price-to-earnings ratio (P/E) on March 2014 earnings. Pharma is relatively expensive. IT is again given the run up in this quarter is again becoming very expensive. Banks are not looking very good primarily based on the NPL concerns. So, you really don’t have many stocks which you can invest in given one problem or other, whether it is valuations or it is operations or some other issues. The companies which you could have probably invested, some of them are government owned companies where valuations have become very reasonable. There are triggers in the form of reforms but we are not seeing the full impact of reforms coming through. It is an on/off process. Whether you look at for example Power Grid, Coal India, ONGC, Oil India, these stocks are very cheap compared to their fundamentals but the investors are not able to take a view given the mix signals we are getting from the government. This basket of companies could have absorbed a lot of money if you sent the right signals for investors but I guess that is what the government has to resolve. So, hopefully you will see a price increase in diesel once the current session of Parliament gets over on March 22. If you get a price increase then there is some amount of faith coming back to the oil stocks and you will see some price increases over there as far as the stocks are concerned. But other than that, I am not sure there is any real catalyst for the market at this point in time. _PAGEBREAK_ Q: What about NMDC? Lot of global appetite was seen for that because the pricing seemed attractive but the stock has lost quite a bit of ground even post that attractive price. What’s going wrong here? A: The stock is quite cheap. I think on 2014 EV/EBITDA it would be about 3.7-3.8 time, so clearly very attractively valued stock. There are two concerns; one is on the pricing front. In January when iron ore prices were going up, suddenly you had a cut in the domestic prices which obviously confused the market as to what kind of pricing mechanism is being followed by NMDC, and whether there is some sort of covert pressure being exercised by the government in terms of pricing of iron ore so that’s one generic factor for PSU companies in general, the amount of government influence on pricing of products. The second point of concern in NMDC is the use of cash because this company is sitting on around Rs 200 billion of cash. One of the concerns which has come up is that NMDC maybe asked to put money in the SAIL OFS. All sorts of rumours obviously do the rounds whenever there is government divestment or it could be asked to put money in some steel plant along with joint venture (JV) with SAIL, something like that. So the concerns are again very generic. It always will be around pricing of products of government owned companies and then the use of cash, which could be for some non economic purposes or a project where internal rate of return (IRR) may not be really acceptable for investors. It is nothing new. I think we have seen these problems for many PSUs for a very long time and the oil sector is a classic example. We have seen this problem for the last eight-nine years now. Q: You have tracked telecom for a while. On that, opinion seems to be split on whether or not the sector is really coming out into its own as yet. Would you bet on telecom right now or you are not feeling that confident? A: I would like to wait and see two things evolving. One is where does this regulatory framework eventually settle down into, there is so much of confusion over there. You still don’t know what is going to be the pricing environment as far as spectrum pricing is concerned. Most of the auctions offlate have not been very good. We are not getting good indication as to what will be the charges which the incumbent telecom companies will have eventually bear as far as renewal prices are concerned and one off charges for the additional spectrum which they own is concerned. That is one area where there is still a lot of uncertainty. One can make a call that most of these regulatory related impact will eventually get passed on to consumers assuming that impact is pretty much the same for everybody. The second issue which I am still not very sure about is the pricing power which is available with the industry. As of now, it looks like we only have three players who were doing relatively well compared to the others but it is not as if others have thrown in the towel and disappeared. So, even though we keep hearing that between a combination of Bharti, Idea, Vodafone - these companies can take prices up. We haven’t seen any evidence of that. There is also a lot of speculation around Reliance’s eventual entry into telecom. In what shape and form it will be, whether it will be allowed to offer voice services along with data, how aggressive it is going to be? At this point in time there is lot of uncertainty with respect to both, regulatory environment and operating/pricing environment. As of now, in my model portfolio I have just left it as a neutral position as far as Bharti is concerned. It is a stock which is somewhere at a price where I can’t take a very strong buy call or a sell call. We have a fair value of Rs 350, the stock is above Rs 300. That means there is some amount of upside but that factors some amount of improvement in the medium term as far as pricing environment is concerned. But let’s see how that evolves going forward. Q: On that point you were making about NMDC earlier. Is there a problem with the whole PSU basket for the market? Someone was pointing out yesterday that the PSU index is trading at significantly lower levels than what the rest of the market is doing. In the past, it has been some sort of harbinger of optimism from the retail crowd at least. This is where the primary market action is going to come from. Are you disappointed about the way the PSU fraternity has moved? A: No question about it. Many of these companies are reasonably well managed companies. The fundamentals are very good and most of them are trading at pretty attractive valuations. However, the government ownership is what scares away a lot of investors and then you have actions which really do not give investors much comfort. The classic example is of ONGC. Last year, you had a big divestment in ONGC and most of it was subscribed by LIC because there was a huge amount of uncertainty with respect to the subsidy sharing mechanism at that point in time. Then 20 days later, post that divestment, the government went ahead and raised the Cess on crude oil. So what is the kind of message are you giving to investors? That you can change the rules of the game at any given point in time and if that is the case then I don’t think investors are going to take these stocks very seriously no matter how effective valuations look and no matter how good they maybe on say medium term prospects assuming some of these issues on pricing, etc get resolved. If one looks at the case of ONGC, this company could be worth north of Rs 400 if the government allows two things to happen that is give some sort of a clear signal as far as subsidy sharing is concerned. Even now, we don’t know what is going to be subsidy sharing for 2013, forget 2014. There has been some amount of provision made in the Budget. It seems to be a reasonably good amount but there is a huge confusion in minds of the investors as to how much amount pertains to 2013, how much amount pertains to 2014, what’s going to be subsidy sharing arrangement etc. So somewhere there has to be some clarity on these issues, otherwise, how will investors take a call? The good news is stocks are trading at, for example ONCG as reference point, even in 2012 earnings, when it did Rs 33 earnings per share (EPS), the stock is trading at about less than 10 times. On 2013 numbers it will be slightly lower because of problems in overseas operations. It is still at about 10.5 times. So, unless and until you give the right signal to investors as far as the pricing in the sector is concerned, subsidy sharing is concerned, how investors can take a call and put their money in the stocks.