Midcaps to gain interest, Sensex seen at 23000: Ambit Cap

Midcap stocks have been bruised and battered this month, with most of the companies like Bharat Forge, Lanco Infra and Voltas making losses in the December quarter earnings. However, there is still optimism left for the midcap sector as analysts feel that the next quarter looks hopeful. According to Saurabh Mukherjea, Head of Equities, Ambit Capital midcaps will regain investors' confidence as fourth quarter earnings improve.

Mukherjea argues that most of the midcap companies are trying to basically pack away the bad news in this quarter through exceptionals and one-offs to help them raise money with a better set of numbers in the March quarter or Q1FY14.

Aslo read: Mkt may go below 5900: Sell Cairn & GAIL, says Sukhani

"In a way this is an end of season, end of recession cleaning season for small and midcaps where they are really trashing their results through exceptionals and one-offs. This is before they try to show a better set of numbers hopefully with a better economy and a better stock market in three-four months time," he said in an interview to CNBC-TV18.

On a more positive note, Mukherjea is hoping that the Sensex is likely to touch 23000 by the year-end on growing public sector capex.

However, at the same time, he is not looking for a pre-Budget rally. Mukherjea is only expecting the Budget itself to turns out to be a 'dream Budget'.

As an investment strategy, he is positive on Tata Steel post its third quarter earnings. Oil marketing companies (OMCs) are also on his radar as fuel price hikes look probable in the next 6-7 months.

Below is the verbatim transcript of his interview to CNBC-TV18

Q: Just about a fortnight to go before the Union Budget. Is there scope or reason for a pre-budget rally this time?

A: I do not see a pre-budget rally honestly. I think the Budget itself is the most likely bet, the positive catalyst in the month of February. Investor sentiment has weakened.

The Gross Domestic Product (GDP) data will not bring too much joy in the next couple of months. So, our best hope is that the Budget itself turns out to be a dream Budget and the FM gives us a firecracker.

Q: What kind of range are you working, with budget around it?

A: The way we tend to work is we have these yearly targets. Our target for the year is 23000. We are still focused on that. We think the economy is recovering albeit slowly. The key driver of the recovery that we are looking for is capex.

Clearly corporate capex is not coming, but the signs are looking better in terms of public sector capex. The Cabinet Committee on Investments (CCI) is having some effect. The FM (finance minister) has made it clear that the Public Sector Undertakings (PSU) companies either have to announce capex plans and spend money on investment in FY14 or lose their cash.

So, the critical dynamic to look forward to in the next three or four months in terms of getting the capex engine in our country revved up.

Q: What do you takeaway from this earnings season? The first start to the earnings season was almost with a bit of a flourish and then towards the end it has not quite panned out very well. Are you left with a trace of disappointment?

A: This has become par for the course in our country that the star companies who feel they have nice things to tell us come first. Those who would rather not talk to us hold their earnings back as long as they possibly can. So that pattern was pretty predictable.

However, if one looks at the earnings season totality he does not forget results such as Larsen and Toubro (L&T), Maruti Suzuki, Infosys and the overall picture is one of the downgrade cycle having bottomed out. There aren’t heavy downgrades coming for FY14 earnings.

By and large most economists and analysts believe FY14 will be a recovery year. There won't be rush to cut Earnings Per Share (EPS) forecast for next year. That is the critical part because before this we were seeing relentless downgrades. That cycle has broadly stopped and that is good news for everybody.

_PAGEBREAK_

Q: Are you sure that this expectation of recovery talk is not at least partly a function of the strong flows that we are seeing globally and the prices flashing on the screen? Chief Executive Officers (CEOs) do not seem to be emanating that much confidence as brokers to today about this recovery.

A: I think there is a reason for that. The financial services companies have been very successful in raising a fair bit of money. The PSU disinvestments have proceeded broadly on track. However, outside financials and PSU disinvestments raising money has been very difficult. That has made corporates feel quite bitter about the whole thing.

A number of relatively well-known companies have tried to raise money, have not got anywhere. They are somewhat nursing their wounds. I think that will only happen once the next leg of confidence comes back into our economy.

That is probably a good budget from the FM followed by some signs in Q1 next year that at least public sector capex is clicking into life. That will then lead the next bout of fundraising. It is only then that corporate India will actually have a smile on its face. At this juncture, corporate India is not particularly happy with life. However, it has got a lot to do for the difficulty of raising money rather than the state of the economy per se.

Q: I am interested to see that you remain a buyer on Tata Steel and you believe the results were in line at the operating level. How do you say it move for the stock and do you guys work with a target right now on Tata Steel or you are just buying it?

A: I have to confess that in the last three or four results what we found really frustrating with the company is the operating level numbers are all right. They seem to have is this sort of relentless stream of almost recurring one-offs which disappoint.

The reason we stay buyers is our reading is that steel prices have gone up in India over the last month. We reckon that will continue through February and March. Overall something like a 3-4 percent steel price hike from Tata Steel looks to be on the cards. That should translate into something like 200 bps of operating margin improvement and that is the core thesis in our buy case.

We are hopeful that this time in Q4 we will not get another one-off because those honestly are very unpredictable. That is what is robbing the stock off its sheen.

Q: Do you really believe it is a money raising problem for corporate right now that is affecting sentiment? Which companies deserve to get the capital and which ones do not?

A: Absolutely. I agree with you that the financial services companies have been successful in raising money. The government has been successful in raising money. The problem is the whole bunch of other promoters who want to join the party. However, they are not being given the invitation cards and that is leaving them feeling very disappointed.

 It is what seeping into the market into earnings guidance into promoter speak. That will only change once the broader market has some confidence in the economic recovery. That I do not think will come in the next three months. We need a good budget and we need the first signs of at least the public sector capex engine clicking into life. That is when I think even the better midcap companies will be able to raise money at that stage.

At this juncture it is a very one-sided capital raising story - fin services companies. The Government of India, pretty much everybody else is locked out.

Q: What about the midcap end of the market? That has been the big disappointment of the last one month. Have you downgraded any of those outside the index?

A: I think you are right. If one looks at small and midcaps and if one looks at the discount of small and midcaps to large caps, it is at something three-four year high. I had expected three-four months ago that as we go into recovery. Both a market and economic recovery, I expected some strength and confidence to come into small and midcaps. This clearly has not happened, part of the reason is weak earnings.

There is another dynamic though there. My reading of a lot of small and midcap results in this quarter is that there is a fair bit of kitchen sinking going on. There I get the sense that companies are trying to pack away the bad news in this quarter, through exceptional and one-off.

So that comes Q4 or come Q1 next year when they perhaps might want to raise money. They can show a better face and a set of numbers. So in a way this is an end of recession cleaning season for small and midcaps. There they are really trashing their results through exceptional and one-offs before they try to show a better set of numbers. Hopefully with a better economy and a better stock market in three-four months time.

The overall construct, it is probably the heaviest discount I have seen in small and midcaps trading. For a good four years the foreign money is disproportionately flown into the Nifty. At some stage that will have to revert. Small and midcaps cannot sustainably trade at such a discount.

When will this happen, my bet is you are looking at a horizon somewhere around summer where the first signs of a recovery click in and foreign investor confidence stays, but the Domestic Institutional Investor (DII) confidence comes in. That is how I think small and midcaps will recover. However, that discount to small and midcaps and large caps is the largest I have seen for a good three or four years.

_PAGEBREAK_

Q: There is some talk that a diesel price hike will happen this weekend. Which of the oil companies are you bullish on?

A: I think one of the better things to be talking about is the government deregulation of fuel prices. We have got a good six-seven months visibility that we will see fuel prices rising for sometime to come. Indian Oil is the disinvestment candidate for next year.

My reckoning is whilst all three, Oil Marketing Companies (OMCs) Indian Oil, Hindustan Petroleum Corporation (HPCL) and Bharat Petroleum Corporation Limited (BPCL) will see their P&L benefit from diesel prices going up. Indian Oil is the one I would stick to. As there is a very strong incentive for the powers that be in our country to get this P&L sorted out before that 10 percent stake is sold.

Q: Speaking of kitchen sinking how are you approaching the PSU banks and what do you expect to see from State Bank of India (SBI) today?

A: We remain sellers of the sector in general. We remain sellers on SBI. We note that the Reserve Bank of India (RBI) published this draft circular last week saying that from 1st April this year the provisioning on restructured assets will be double. From roughly 2.5 percent it will go to 5 percent. This will set off a whole flurry of banks running to get as many assets restructured in the next three-four months as they can. As one really does not want to leave assets for FY14 to restructuring, if the provisioning charge doubles.
 
So, we might see a nasty surprise from banking system as a whole on restructuring. The biggest losers on that front will clearly be the PSUs. Amongst the private sector, ICICI Bank and Axis Bank will also have some worries.

Q: Which was the most disappointing sector in terms of its earnings where you have had reason to switch out the most by the end of this earnings performance?

A: Clearly consumer. It was discussed earlier in the program that consumer has been a star that has held up through this downturn. However, 8-9 quarters into an economic downturn I think the Indian consumer is throwing the towel in.

Fuel price hikes, power price hikes, interest rate hikes, the consumer seems to have had enough. Even more surprisingly consumer essentials seem to be cracking more than the aspirational side of the story.

In real estate for example, residential real estate launchers in India seem to be at a three-four year high. Titan Industries is all right. Maruti Suzuki seems to be slightly on the mend. It is the day to day essentials where I think the numbers have really got hit hard and it might continue.

Until the economy recovers, until they create jobs in this country the common man will remain under severe pressure. That will hit the Fast Moving Consumer Goods (FMCG) sector very hard.

Q: The government says it is keen on doing part sells in Steel Authority of India (SAIL) and National Aluminium Company (NALCO) by the end of this fiscal. Do you think it will be successful in pushing through that kind of paper? Would you buy any of those two?

A: My reading is we will get a disinvestment target somewhere around Rs 40,000-50,000 crore in FY14 budget. It will be a fairly punchy disinvestment target. The government has taken a lot of heart from how successfully the disinvestment has gone this fiscal. Out of the various candidate that they line up for disinvestment, my best bets would be Indian Oil for the reasons we discussed around oil and gas deregulation.

I will also be looking at Coal India quite carefully. In the run up to the elections next year we all know the imperative that the government faces to jack up coal production and get coal price pooling going and resurrect the coal production scenario in our country.

My sense is the CCI will make a few announcements going forward. This will help Coal India’s share price. Then I think you will get a 10 percent disinvestment in Coal India next year. If I had to choose two I will go for Indian Oil and Coal India.

They are not only critical for the country’s energy scenario, but also from a fiscal perspective that is a lot of money for the government. 10 percent of Indian Oil and percent of Coal India each will be juicy disinvestments. I think those companies stock prices should do well in the next six months.