Can govt push through diesel price hike? Tall order: UBS

The government may struggle to push through a phased hike in diesel prices as it attempts to implement the recommendations of the Kelkar Committee on subsidies, feels Gautam Chhaochharia of UBS.

In an interview with CNBC-TV18, Chhaochharia says that at best, diesel prices could be hiked by a rupee or two near term. Given that inflation is not yet under control, hike in diesel prices may not be the best option, he feels. Even if fuel prices were to be hiked, UBS says it would prefer to buy upstream oil companies like explorers and refiners rather than oil marketing companies like HPCL and BPCL. On the broader market, Chhaochharia feels the investment cycle has to pick up for the recent upmove to sustain. UBS is underweight on the IT sector in general, and expects Infosys to cut full year guidance while announcing its third quarter numbers. At the same time, Chhaochharia sees the IT sector bottoming out during the quarter. On specific stocks, he says valuations of Sintex are cheap, but third quarter performance could be mediocre and the investors need to see if the management is able to tackle the issue of high receivables. Below is a verbatim transcript of the interview: Q: What are your expectations from the cabinet meet on fuel pricing and how would you be approaching that entire complex now? A: Our view is that the fuel price mechanism is still likely to be in steps rather than a clear path ahead. There has been talk that you could see almost a rupee kind of a hike every month ahead. However, I think in the current inflationary environment it will still be difficult for the government. You will more likely see Re 1 or Rs 2 per litre hike happening sooner through this cabinet committee meeting, unlikely to be a big hike. For the entire space, we still prefer the upstream guys Cairn India specifically and Oil and Natural Gas Corporation (ONGC) rather than the downstream Bharat Petroleum Corporation Ltd (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL) variety. We have seen this kind of talk and scenario play out for that complex many number of times over the last decade. You could have a trading move up again this time for HPCL, BPCL etc. However, for that to sustain and therefore for us to be fundamentally bullish, I think we do not have the comfort of the inflation environment around us to be convinced on that. So we still avoid them. _PAGEBREAK_ Q: What about the markets in general, what are your expectations there? Are you constructive now or are you cautious? A: We have been bullish for a while now and we still remain bullish for 2013. We expect the current reforms or the positive announcement momentum to continue because I think that is backed by other changed political compulsion of the government. More than announcements, how it translates into a recovery in the economic cycle will be critical to watch out for. We are building in a mild cyclical economic recovery but what will be more important for the market to sustain beyond the next couple of quarters would be if this recovery sustains into a broader investment cycle recovery. That is something to watch out for even in this quarterly results as to whether you finally see that corporate sector starts thinking about reviving capex cycle. Q: What are your expectations from Infosys specifically this week and how are you positioned on that stock? A: We have a neutral rating on the stock. As a strategy, we are underweight IT services. We have been bearish on this space for a while now, the reason being the declining growth and the outlook on the US. For Infosys, the cut in guidance has been interesting to note for the last few quarters. We could still see another cut in guidance even this quarter. What will be more important is not just the trajectory -- which the company talks about in terms of broad expectations for this year -- but also in terms of specific numbers whether they hint at recovery in the growth momentum that they had slipped on. This could very well be a quarter where they could be bottoming out soon in terms of the growth declining. Q: The banking space has been the forefront of this move, within that space itself which are your most preferred picks and what could the triggers be lined up now? A: We are overweight banks. We like banks and we have also upgraded government banks about a month back. Among the preferred picks we prefer ICICI Bank among the bigger ones, then State Bank of India (SBI) and Punjab National Bank (PNB). Among the midcap names, we prefer Federal Bank and IndusInd Bank. From a banking bill perspective, it is still early. Just like the oil part, we have seen these kind of promises hold up for a long time. I would necessarily not bet on that happening for sure. However, the progress is definitely there unlike in the past. Even the Reserve Bank of India (RBI) seems to be much more constructive in terms of being planned towards giving out licenses. When we see the final guidelines coming through, we do expect it will give us better sense. Today, press is talking about Mr. Rangarajan giving it out specifically to non corporates to begin with. There is still some cautiousness in RBI commentary. I think the ball is still in RBI's court so let us see what happens there. Q: Some other midcaps like Sintex Industries and Petronet LNG also report numbers this week, any thoughts on these two names? Would you have them under coverage? A: Yes, we do cover both of them. Petronet LNG looks very interesting. We are not very bullish on them for a while. We have upgraded the stock about a month back. The interesting thing for Petronet LNG is that the visibility on growth is now coming closer. In a year or so, you will start seeing volume growth coming in. The management commentary on the new expansion plans would be interesting to watch out for in this quarterly commentary. When we see that coming through, you will see the stock pricing that in. That looks interesting again. The top-down story about the gas shortage still remains and they remain best place to benefit from that. Sintex Industries appears cheap. They have also recently done a convertible bond issue. This quarter per se it will not be a big event because they have clearly slowed down execution. So, how the balance sheet has shaped up will be important to watch out for. So you will not see any growth or margin surprise per se. If they are able to bring in their receivables issues in control compared to the last couple of quarters and if they are able to demonstrate improvement in that, that will be a positive catalyst for the stock especially given where the valuations are. Q: You have Hindustan Unilever Ltd (HUL) in your least preferred list. You think it would be difficult to cough up returns in the fast moving consumer goods (FMCG) space because of how expensive it is or because there are some chinks showing up in the earnings now? A: Definitely. I think that is one of the more high commissioned calls we have made from a strategy point of view to be underweight on consumption names in general for 2013. If you look at two scenarios, one scenario is where you see a mild cyclical economic recovery, which is a base case. In this case because where the stocks are valued at and given the ownership that these stocks have, you will see investors switching out from these defensive names to more cyclical names this year leading to the underperformance. The other scenario is, all the hopes which we are building and the market is building does not pan out. There again we look at consumer income proxies for government wages, for private sector, etc. We do not get enough data on that. However, if you look at the proxies there, it indicates that for the last couple of years the real income levels on a per capita basis has stagnated or even declined compared to the massive upmove that you saw over the last decade. This has not yet showed up in consumption growth perspective by the corporate sector. The primary reason being that the consumer is saving less and still holding on to consumption, which cannot sustain in the face of a continued weak economic cycle. So, in the second scenario where we do not see an economic cycle recovery happening this year, this will flow through in terms of weaker consumption and therefore earnings cuts and therefore de-rating for these stocks. So, in both scenarios we do see this sector not doing well this year.