Significant reforms from current govt unlikely: Sanju Verma

Delhi today woke up to the news of National Congress Party chiefs Sharad Pawar and Praful Patel resigning from the Cabinet, putting a dampener on the market’s hopes for policy reforms.

According to Sanju Verma of Violet Arch Capital, this move, however, will not be a major threat to policy moves. On the downside, she tells CNBC-TV18 that she isn’t holding high hopes for significant reforms from the current government. “As a house we have never believed that big bang reforms can happen. It’s not even a question about whether the government wants to do it or not, it’s no longer about the attitude,” she said. Last night the Cabinet Committee on Economic Affairs imposed a 21% import duty on power equipment, and passed a decision on a list of other pending reforms, giving some hope to the market that the government may kick into action soon. However, Verma says even these moves are misleading in nature. “That is prima facie misleading because the actual protection to power equipment manufacturers works out to just 9% because they any case pay 12% by way of excise duty,” she explained. Therefore, she is not too bullish on BHEL or the capital goods space. Meanwhile, from the auto space, she is positive on Mahindra & Mahindra, Tata Motors and Maruti. However, she adds that Maruti may see a downgrade if its labour unrest continues. Below is an edited transcript of her interview with Udayan Mukherjee and Mitali Mukherjee. Q: This morning the market will be a little overwrought about these political developments -Sharad Pawar and Praful Patel resigning. Do you expect it to come in the way of the market’s policy expectations at all or do you think it will blow over? A: I think by and large it should blow over and I don’t think policy expectations if any will change. I say this because I think the developments over the last two months have clearly emboldened the current Congress-led UPA after reigning in a truant Mamata Banerjee. The only thing that the market will be worried about is whether there will be big bang reforms, and as a house we have never believed that big bang reforms can happen. It’s not even a question about whether the government wants to do it or not, it’s no longer about the attitude. The timeline simply suggests that if you are expecting big bang reforms by way of the GST Bill for instance coming through in FY13, that is certainly not going to be achievable. Maybe FY14 is more like it, and I say this because it’s not only to do with the constitutional framework with respect to the GST Bill that needs to be put in place. The legislative process I am told has already started, but there is a plethora of other things that need to be done. States have been asking for 50% say in the GST council which will be formed, which the Center has yet to take a decision on. The Center a couple of months back had reduced the central sales tax from 4% to 2% and have told the states that we will compensate you before we introduce the GST. Till date states have been clamoring, but that 2% loss which the states incurred, that compensation works out to Rs 20,000 crore and the Center has just kept mum not disclosing whether it intends to compensate states for the loss in CST. So I think there are a lot of other smaller nitty-gritties which need to be taken care of. As far as FDI in retail is concerned, I have always maintained that there will be a bit of ad hocism, some kind of tweaking around, ditto with the Pension Reforms Bill. Q: What did you make of that import duty news and does it change anything in terms of expectations for BHEL, L&T and BGR? A: As far as the 21% import duty is concerned, that is prima facie misleading because the actual protection to power equipment manufacturers works out to just 9% because they any case pay 12% by way of excise duty. That said, 9% protection in real terms and not 21% as people would like to believe is not less. More so because it comes at the expense of somebody else taking the pain and that is the power generative companies. There has always been a debate in the recant past about whether to go overweight on power generation companies or power distribution companies if at all you have to be in the power utility space. I think that debate will continue for a while. I am not particularly gung-ho about BHEL. The point is that these kinds of regulatory concessions can only do so much for a company, the classic case being BHEL which reported Rs 28 by way of EPS in FY12. In FY13 and FY14, I will be surprised if they manage to even do something like Rs 24-25, which is what the market consensus seems to be. Here is a stock which use to trade close to 20 times 2.5-3 years back and use to have CAGR growth of 25% plus both in terms of top-line and bottom-line. Today this stock has a dividend yield just shy of 3%, it is trading on both FY13 and FY14 earnings at less than 10 times but still there are no takers. I think this is a classic example of the fact that legacy is not good enough and these kind of regulatory concessions are not good enough either. You really need to re-invent yourself, which the likes of BHEL have not done, So while they may get some breather from further competition, at the end of the day it is only a breather and they need to re-invest themselves. Particularly for BHEL they have nothing much to look forward to because the 12th Five year plan orders have been given and it is too early to bid for the 13th Five year plan orders. In the 12th Five year plan I don’t think BHEL has really got much to be proud of. At the end of the day my personal sense is that even at less than 10 times a company which is likely to de-grow over the next two years is best kept away from with respect to making an investment there if at all. _PAGEBREAK_ Q: Where do you stand on Maruti? After the damage that we have seen in the stock price, would you buy it in a contrarian call or are you also surprised by how events have turned out? A: We just released an exhaustive auto piece. While the pecking order with respect to four-wheelers at our end continues to be M&M, Tata Motors and Maruti in that order, I personally thought that Maruti is high beta, high risk but incidentally a high return stock as well. This was obviously before the events of the last 48 hours. Now as things stand today, assuming that this production loss and strike out continues for the next 15 days, we have done an analysis which says that every day shut means loss of 2,200 units by way of production which basically translates into loss per day of Rs 6 crore, which in terms of EPS precisely speaking is Rs 0.2. So I think people who have been working with an EPS number of Rs 85-88 for FY13 will stand reduced going forward to something like Rs 75-78. So one really has to wait and see how the situation pans out. But clearly if this lingers on for another three-four days and more, an EPS downgrade is certainly on the cards. That said, I think fundamentally if you strip this one off event out of the way, fundamentally I think this looks like a great story, more so coming on the back of just a measly Rs 58 EPS which the company reported in FY12. Also, today 80% of the incremental demand in the passenger car segment is from the diesel space where as the capacity is just 25%, which means that actually petrol capacities are underutilised to the tune of 40%. I think Maruti is a very sweet spot given that from 72% which was the case a year ago, today petrol vehicles are down for just about 50% of its sale. Yes, if there is a diesel price hike to the tune of Rs 4-5 per litre then the differential between diesel and petrol vehicles, which is currently 60-65%, will stand reduced to 45-50%. Then Maruti may start looking less attractive because it is the best proxy to diesel at this point in time. But I don’t think you will see Rs 4-5 hike in diesel prices anytime soon, which means that if you are really looking to put your bet with respect to a proxy on how the diesel space will grow then Maruti is something that you should be looking at. The only caveat to that being if the yes starts appreciating, because every 2% depreciation in the rupee versus the yen impacts EBITDA margins by something like 30-40 basis points adversely for Maruti and also the EBITDA numbers by about Rs 70-80 crore or maybe Rs 100 crore. So I think clearly the rupee-yen factor is the big caveat that one should be looking at. Otherwise I think fundamentally it’s in a pretty much sweet spot at this point in time. Q: What about two wheelers? Where do you stand on Hero MotoCorp and Bajaj Auto after the numbers that you have seen and the management commentary? A: I don’t think there is any need to even have a debate with respect to Bajaj versus Hero MotoCorp. Till fourth quarter of FY12 both Bajaj and Hero MotoCorp were mirror images of each other at least with respect to top-line growth. Fourth quarter of FY12 both saw a top-line growth in the region of 11-12% primarily driven by volume growth of 4-5% and the balance coming by way of price increases. Now first quarter of FY13 things have changed dramatically for the worst for Bajaj and I think Hero MotoCorp continues to hold its ground rock steady. Look at the top-line growth of Bajaj Auto for instance; this quarter they have done net sales growth of just 3.5% whereas Hero MotoCorp sales growth has come in at 10%. Even profit growth is at 10% and interestingly Hero MotoCorp has actually seen volume growth of 7%. I think that is a big positive. In the case of Bajaj, domestic volumes in the first quarter were marginally down by 0.3% and even export growth which has been one of the biggest positive for Bajaj Auto in the last couple of quarters saw a decline of close to 3%. I think it is not going to be easy for Bajaj to recoup market share in Egypt and Sri Lanka where in this quarter they have lost anywhere close to potential sale of 40,000 to 45,000 units. Remember that the big positive for Bajaj has been the stupendous growth in the three wheeler segment, because this is the high margin segment for them. This is where they get their 30% margins from, which translates into an overall EBITDA margin of 20% or so. But three wheeler growth has been on a declining spree. In the first quarter of FY13, Bajaj three wheeler segment actually de-grew by more than 20% which is unheard off. I don’t think it will be in a rush that Bajaj can solve its problems, it will take a while. You can take comfort from the fact that Bajaj Auto still has EBITDA margins of 19% thereabouts versus a Hero MotoCorp which has margins of 15%. Hero MotoCorp is more expensive trading at 15 times FY13 whereas Bajaj is available to you cheaper at about 12 to 13 times. But I think valuations do not matter in this case given the fact that Hero MotoCorp is clearly on a growth trajectory. Yes 46% of its sales come from the rural space and there are concerns with respect to the monsoons, but the big positive is that they have tremendous tax benefits from the Haridwar plant and these tax benefits will only expiry in FY14. The Haridwar plant currently accounts for about 35 to 38% of the sales. Bajaj on the other hand has lost its tax cushion; if you look at the numbers their tax rate has gone up to 28-29%, so clearly there is no room for doubt that Hero MotoCorp is what you should be betting on if at all two wheelers is what you are looking to invest in within the auto space. Q: Some of the private sector banking numbers have not been up to speed. It happened with Axis Bank and yesterday with Kotak Mahindra. How do you approach some of these private sector names where there is the risk of much more premium valuations? A: My personal sense is that NPAs and the restructured asset book may continue the way they are, so for PSU banks that number will be close to 10% by FY13 which is not very flattering. Coming to private sector banks, I think the problem here is that banks like say Axis for instance have been lending on both sides of the balance sheet, basically borrowing short and lending long, and I think this will translate into huge asset-liability mismatches going forward. Also if you look at Axis’s numbers, a large part of that 26% growth in profit is misleading because that has been aided by non-recurring trading gains. Also do note that both in the case of Axis and HDFC Bank, a large part of the profit growth has come in from other income. I don’t know why everybody is going gung-ho about the fact that HDFC Bank has shown a 30% plus growth in profits. Don’t forget that has come driven by a 36% growth in other income which in turn has been driven by a 26% growth in fee income. The dots don’t connect; how have they managed to get a 26% growth in fee income in their books when capital markets have been staid. Also, note that bond yields had come down substantially by 35-40 basis points in the first quarter of FY13, all the way from 8.35-8.40% levels to about 8.10% or so. So a lot of these banks have booked profits there. For instance, 63% of Axis’s investment book is in G-sec, 78% of HDFC Banks’ investment book is in G-sec. Also, don’t forget that the huge expansion in net interest margins for HDFC Bank has happened because of the 120 bps sequential jump in their bond portfolio thanks to falling yields. But the million dollar question is whether this will continue. As I see things currently, we will continue to stick to our big call of switching out of HDFC Bank and into ICICI Bank because I think there is no reason to pay close to 3.5-4 times price-to-book for an HDFC Bank where the large part of growth has been driven by the retail portfolio, basically credit cards, personal loans, low yielding mortgage loans. So I am not particularly convinced that the 30% growth is actually something that one should be flattered about. Don’t forget last quarter their operating profit growth was just 15%. So I think there is a huge volatility in earnings with respect to the quality of earnings in the case of HDFC Bank. So at this point in time the pecking order within the private banking space would be ICICI Bank followed by Yes Bank and within the PSU banking space it has to be SBI.