Diesel hike to be modest; 50 bps cut on cards: Ambit

Saurabh Mukherjea, head of equities, Ambit Capital explains, in an analysis of the market on CNBC-TV18, that he does not foresee any possibility of an aggressive hike in diesel prices and expects the government to opt for modest hikes. The proposal to hike diesel has not triggered any interest in oil PSUs and Mukherjea adds that he expects 15-20 percent returns from Indian market this year.

Mukherjea estimates the likelihood of a 10-percent rally in three-to-four months and is positive on cyclicals for the first half of current year 2013. The analyst indicates that markets are likely to underperform in the second half of current year 2013 on political concerns. "The RBI is likely to cut rates by 50 bps on January 29 and fiscal deficit for FY13 is expected to be at 5.7 percent. There has been a sharp fall in 10-year yields on account of OMOs," he highlights. Mukherjea adds that L&T Finance is pricing-in a bank licence and prefers Shriram City Union to play with the grant of a new banking licence. He expects the issue of  only two-to-three bank licences in the near-term and urges investors to focus on stocks with strong balance-sheets and cash-flows in case of correction in the market. "The recent regulatory developments are largely favourable for RIL and RIL's downstream business needs to be closely watched." Below is the edited transcript of his interview on CNBC-TV18 Q: What are your expectations from the cabinet meet on fuel pricing, where are you pegging your expectations this time? A: Given that it’s a pre-election year, it is hard to see a very aggressive stance on diesel prices. That being said the way we read the upcoming Budget is, going into the Budget, the Finance Minister (FM) will make all the right noises on diesel prices, on kerosene, and perhaps at the Budget there might be a bit of profligacy. In the run up to the election year, it is very difficult to expect fiscal conservativism but on Thursday we might hear the right things from a market perspective on diesel prices that is modest hikes in diesel prices this side of the Budget, and perhaps in the Budget, we get the blast of populism that one would expect at this juncture of electoral cycle. Q: You are not rushing into buy oil stocks just yet, are you? A: I wouldn’t rush into buying oil stocks just yet. There is a chance that he does the right thing from a Budget deficit perspective i.e. announce calibrated hikes in diesel prices. As we go further into FY14, it very difficult to see how given the ruling parties electoral position and given that we have got big ticket state elections right through the year, given all of that it very difficult to have a upbeat outlook on the oil marketing companies (OMCs). Q: How are you positioning yourself on the market, now at 6000 Nifty? Do you think most of the low hanging fruit is plucked or do you think another 5-6 percent can happen before the Budget? A: The market as a whole, over the course of the year should give us 15-20 percent upside. So, 23,000 on the Sensex remains our year-end target that is around 15 percent up from where we are. Of that upside, the first 90-120 days of the year, so upto say April we will bring around half of it. I think it would have a very good run between now and April because you have got the Budget session beginning, there will be a wave of legislation in that session. In the run up to the session, the Finance Minister (FM) will say all the rights things about the fiscal consolidation. So, with global liquidity conditions being benign you have got good three or four months, perhaps as much as the 10 percent rally in the market. Beyond that as we go into summer and then we move into the monsoon session, the going will get harder, will get trickier as the politics becomes more vitiated and as the reform outlook becomes more clouded. The first 90-120 days, I would certainly say cyclicals have to be the way to go; they should be the dominant part of your index with the more defensive sectors like IT, FMCG, pharma taking a backseat for the first four months of the year at least. Q: There are some of your peers who believe that globally, markets might actually correct in January, in the first four-five weeks of the year before moving further ahead. Do you see that possibility or is it a low probability outcome in your eyes? A: At least based on the flows that we are seeing from our foreign institutional investor (FII) clients, we don’t see any impending correction in India in January. The appetite remains high, liquidity conditions remain good, and many of the large FII funds have seen significant inflows and the smaller FIIs funds are seeing fairly punchy inflows. A combination of that with the right mood music from the Reserve Bank of India (RBI), from the finance ministry should really give us a good beginning to this year. I don’t see any obvious reason as to why India should pullback in January. _PAGEBREAK_ Q: What do you expect from earning season? Do you think it will be a non-event for the market or do you see it as a substantive trigger? A: It is not so much the numbers per se that will have any great messages. It is more the guidance. I think on the numbers side you will see around 10-11 percent earnings growth, you will see continuation of decent margin trajectory but sluggishness on the volume and revenue front. So, the key area where the market will focus on is guidance. Guidance not just from the usual IT companies but also guidance from banking pack as to what exactly does the Q3 and Q4 hold from a credit quality perspective. We all know the restructured assets story but a lot of investors out there have bought into banks expecting an improvement in credit quality. So guidance on that front will be critical. Similarly on the industrial sector, the market will be keeping its ears and eyes open to see if there is a recovery out there over the next six months or so. So it is not the numbers per se, but it is the management tone and guidance for the coming six months that will drive stocks in the result season. Q: In the event of any kind of pullback in risk where do you see a floor for this market? A draw down to which level you would consider a good buying opportunity again? A: From where we stand, and from what we can see in the economy that is a decent reform momentum, a degree of global conditions improving, where the most obvious spots of value could open up is light industrials. If the market pulls back by say 10 percent over the next three-four months although I am not saying that’s likely. However, in the instance of the market pulling back 10 percent in the next three-four months, the spot where a lot on investors will focus on is Indian companies with strong balance sheets, strong cash flows and where valuations are still in the early teens. They will say can we go out there and buy these companies because these are companies doing well, the Indian economy seems to be recovering, and the market has pulled back for whatever reason. Can we go out and buy Larsen and Toubro (L&T), a Cummins, a Voltas, those names. The biggest risk area for the market is the banks because banks have rallied very strongly, much against my expectations on the back of a swift pickup in power, infrastructure, construction. If that expectation is not met that’s where the pullback in the market could really arise, that’s where the biggest downside risk for the Indian market currently lies in the banking sector. Q: Bond yields have softened quite considerably and have surprised a few people with the intensity of the draw down. Now if the government does move on diesel prices, the clamour for RBI rate cuts is getting even louder. Do you think we could have a positive surprise on the 29th of January?
A: It does look like the RBI will cut on January 29. The base case consensus expectation is 25 basis points, so I would go as far as 50 basis points (bps) looks likely on January 29. However, the part on bond yields, which could surprise the market, is the government coming back to the market for one more tranche of borrowing. I don’t see how the government will keep the budget deficit south of 5.4-5.3 percent which is its own target. I reckon the government will end up with around 5.7 percent borrowing. That would suggest one more visit to the bond market by the government and if that does happen, then it pushes yields up. I am surprised that the 10 year yield has come off as much as it has and I can only presume that RBI Open Market Operations (OMO) has something to do with it. Q: The other thing which will happen pertaining to the sector is that the final bank license norms will come out and you guys have been tracking that space. However, now peoples' expectations are getting a little wider in terms of which companies may qualify, which horse would you bet on?
A: The horse that market seems to have already bet on is L&T Finance Holdings. The kind of rally the stock has had quite clearly factors in a license into that stock price. The horse worth considering at this juncture is Shriram City Union Finance. It is a small Non-Banking Financial Banking Company (NBFC), it has a good track record and the promoter group as a whole has a good reputation. It is a good candidate for a bank license. M&M Financial has already done pretty well but there is some more juice left in it. I reckon it will go all the way up to three times book value, which is around 10-15 percent up from where it is. Beyond that it is all in the realms of speculation. There are five-ten names out there of which I reckon only two-three will get it. My sense is there are dozens of applicants in there. The three names L&T Finance, Shriram City Union, M&M FS are the ones we have most confidence in.
However, I would urge clients not to get too excited about all of this because what we have seen in the past is once an NBFC gets a bank license; the share price performance from that point really tails off dramatically, as it takes a long time three-five years for a bank to actually show promising numbers. To the extent you want to play the trade, it is between now and the date the names are announced. From that point, the upside becomes muted. Shriram City Union Finance for retail investors is as good a bet as any.
_PAGEBREAK_ Q: You don’t think that IFCI has a good chance of getting a bank license that’s what the market seem to have been betting on, on Friday?
A: I won't be able to comment on it. I know the rumours are out there but it is very difficult to choose between IFCI, IL & FS Investment Managers,IDFC. There are a lot of names out there and we all know it’s highly unlikely that more than five bank licenses will be given by the RBI. Q: There is also a lot of chatter about Reliance because that’s now trading at Rs 860 leading to talk that, may be that big one will finally move out of a trading range and that can propel the index. Would you bet on it?
A: No we wouldn’t, we have been sellers on Reliance Industries (RIL) for the last year-year and a half not because of KG-D6 because on KG-D6, by and large the regulatory developments have been broadly favorable for RIL. We have been negative because in the core petrochemical and refining business it is not obvious to us what the triggers are. Obviously, the petrochemical and refining cycle doesn’t seem to be trending in any particular direction and 80 percent of RILs valuation arises from that.
It does look to us to be a middle of the road petrochemical player now and it should trade at valuations accordingly. Unless on the exploration and production (E&P) side, on the KG-D6 side there is some wild surprise that none of us can currently foresee, I don’t see why there should be upside in RIL shares from this point. Q: What about metals, any contra calls out there? Last few weeks there has been some pickup in metal stocks; would you buy any of them?
A: We have been advocating Tata Steel for a good six months now. In a note in September, I named it as one of my top turnaround plays. It is the cheapest converter of steel in our country with assured access to coal, assured access to iron ore. It is in a very strong position. The Supreme Court has shut down so much of the over mining in our country, that a player like Tata Steel is the only large player with access to iron ore and coal.
In Europe as well their Dutch plant is one of the cheapest converters. So in a world where low cost steel is a premium commodity and with steel prices edging up in our country we see Tata Steel as an attractive buy. I know the balance sheet is under some pressure at one times debt-equity but given the company’s competitive advantage, the market will overlook that and I would see it as our favourite metals mining play.