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Last Updated : May 13, 2013 03:39 PM IST | Source: CNBC-TV18

Maruti a yen play; like NTPC, midcap pharma: Kotak's Prasad

Maruti is a play on the yen more than anything, says Sanjeev Prasad of Kotak Institutional Equities. He is bearish on FMCG stocks, and says will not buy them at the current price to earning multiples of 30-35 times.


Sanjeev Prasad of Kotak Institutional Equities is advising investors to book profits in index stocks that have outperformed in the recent rally, saying that valuations are expensive. In an interview with CNBC-TV18, Prasad says there is lot of value in state-owned stocks like NTPC.


He is bullish on oil & gas shares and sees earnings of oil marketing companies rising significantly this financial year. He says that the bunching of diesel price hike reflects a pragmatic approach of the government.  Among other sectors, he is bullish on midcap pharma.


Prasad sees clear signs of slowdown in consumer demand, and says it is inevitably lined to the investment cycle in the country. He is bearish on FMCG stocks, and says will not buy them at the current price to earning multiples of 30-35 times. He does not see consumption growing without an improvement in investment. But he does not expect the investment cycle to recover for another 18 months.


On specific stocks, Prasad says both HDFC and HDFC Bank are looking expensive. He is bearish on Reliance Communications, saying that nothing has fundamentally changed for the company. In fact, he is surprised at the company posting a strong operating profit. He sees Maruti as a play on the fluctuations in the yen more than anything else.


Also read: Good Q4 earnings so far, but upgrades unlikely: StanChart


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


Q: We have had a very good rally over the last 20 days, how are you approaching equities now? Are you happy to book profits selectively or do you think valuations can expand further?


A: I would think in the top 20 names valuations have become pretty expensive whether it is the consumer staple names, some of the pharmaceutical stocks, and also some private banks, Housing Development Finance Corporation (HDFC) etc. It may make sense to start booking some profits over here and would take some of the names where one still sees valuations being somewhat reasonable.


For example, if one looks at pharma space, Sun Pharmaceutical has done very well over the last 3-6-12 months whichever period one looks at. The valuation gap between Sun Pharma and the tier II pharma names has opened up quite significantly. Sun Pharma is trading at about 24 times March 2015 earnings per share (EPS) and investors at this point in time seem to be valuing a lot of one off earnings numbers in perpetuity. Whereas if one looks at Dr Reddys Laboratories, or Cipla, they are more like 16-17 times March 2015 basis, so it would be a smart strategy to just rotate some money out of the names which have done very well, go into the tier II names.


If one sees some closure of the valuation gap between the two, well and good. We do not lose money either way, in the sense if Sun Pharma comes down and Dr Reddy’s and Cipla hold on to where they are, that is fine otherwise we could also see Cipla and Dr Reddy’s also getting rerated over a period of time not to the same extent as to where Sun Pharma is but even 10-20 percent rerating is good enough for them.


So, that is probably the way to play this market as far as the tier I names are concerned. Some of the names which are primary government owned companies we still think there is a lot of value, something like National Thermal Power Corporation (NTPC), Power Grid Corporation, oil and gas names etc. We are putting a fair amount of money in some of these names particularly tier II pharma, oil and gas and regulated utilities.


Q: You have done an interesting switch though which is that Tata Motors and Maruti have entered your portfolio and Oil and Natural Gas Corporation (ONGC) and Cairn India are out - what is that premised on?


A: ONGC still remains very much in our portfolio. In fact, it is serious overweight in our portfolio currently and Cairn India was never there. Maruti is zero weight and Tata Motors continuous to be an overweight in our portfolio.


Q: What about the oil marketing companies – on that where do you guys stand and what did you make of this big diesel price hike they managed to push through?


A: It is a pretty smart move. In the sense, we got two rounds of price increase in one round. Basically, it is a pragmatic approach. The government and the companies waited for the right time, waited for the Karnataka elections, and the parliament session to get over and then they implemented the price increase.


This move will raise our confidence about oil reforms and the earnings numbers of the downstream, upstream companies should look up pretty well. Assuming that the government does not do anything irrational with respect to the subsidy sharing arrangement, there is still fear that government may continue to charge USD 56 per barrel from the upstream companies but I don’t think it is going to be the case for 2014 at least, maybe for 2013 but definitely not for 2014.


The earnings numbers of all these companies can look up pretty smartly in 2014. For example, for Bharat Petroleum Corporation Limited (BPCL) as of now we have Rs 22 EPS for 2014, and that assumes fair amount of under recoveries being borne by the downstream companies of about 75 billion. However,  in the context of the declining subsidies which is seen, the government can easily accept the downstream companies from various subsidies.


If that is the case, then earning numbers of BPCL and Hindustan Petroleum Corporation Limited (HPCL) will increase quite dramatically. BPCL’s Rs 22 EPS could go up to about Rs 39 EPS and add to that the value of investment the stock could be about Rs 550 if all goes well.


Q: Generally what is your call on the market now? Do you think global liquidity will continue to rerate or take prices higher or are you cautious about the second half for Indian stocks?


A: For the top tier names, I am not too sure how much rerating can happen? In the last three months one has seen rerating in some of the tier I names. Hindustan Unilever got retated because of the open offer issues. Sun Pharmaceutical Industries got rerated on one off opportunities which people are valuing in perpetuity. HDFC, HDFC Bank both are looking fairly expensive.


I am not very sure whether just global liquidity can continue to rerate the stocks without any great change in their fundamentals. So, unless and until earning numbers start looking up I am not a big believer in chasing multiples just like that.


As far as earnings are concerned, we are not seeing any change in our earnings forecast at least for the tier I names. In one of stocks we would see some earnings upgrade – for example in the oil and gas space, based on going reforms one could see some earnings upgrade. However, as broader market so far we have not seen any earnings upgrades. We continue to look at about 9 percent earnings growth for 2014 financial year, and that has come down significantly in the last 3-4 months


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Q: You track telecom quite closely. What have you made of recent developments on RCom and the phenomenal rally that the stock has seen?


A: Fundamentally, I do not think much has changed for Reliance Communications. It is very hard to figure out what is exactly going on in the company. For the last 13 quarters the EBITDA number has been pretty consistent, which is quite remarkable in the context of the fact that at least based on Telecom Regulatory Authority of India (TRAI) data, you have seen a fair amount of revenue market share loss. There would be some seasonality in telecom revenues and EBITDA.


We have seen Idea Cellular’s and Bharti Airtel’s numbers at least being fairly volatile on a quarterly basis, but somehow RCom continues to report pretty steady numbers at the EBITDA level.


Fundamentally it is very hard to take a call in a stock where you really do not have a lot of understanding of the financials.


Q: What did you takeaway from some of the consumer facing names which reported last week? The market seemed a bit unhappy with Jubilant Foodworks and even Asian Paints?


A: Clearly, you are seeing a slowdown as far as consumer demand is concerned. It started with the investment cycle being very weak, and then it spread to consumer discretionary. You have seen auto numbers for the last six months - passenger car volumes have declined in the last six months and now seeing weakness in consumer staples.


So. the valuations in this context actually become quite interesting in the sense you have seen a big rerating of most of the consumer staple names, at a time when fundamentals seem to be weakening. I am not very sure whether you are going to see a quick reversal as far as economic growth is concerned without investment cycle picking up.


One must keep in mind the fact that in the last 10 yearsm the consumption boom has been driven by both structural and cyclical factors. Structural factors mean a lot of investment in the economy coming in from new sectors been opened up;  power, road, telecom etc. and you had lot of support coming from government’s fiscal stimulus in the form of minimum support price (MSP) increases, subsidies, social welfare schemes etc.


Now that the structural factors are also looking quite weak I do not see the investment cycle is recovering for another 12-18 months and when the government itself is tightening on the other side, I am not sure whether the consumption demand really going to surprise on the upside.


Just to give its numbers for example, subsidies used to stand at Rs 1 trillion in fiscal 2007, that went up to Rs 3 trillion in fiscal 2013. That numbers is definitely going to decline in absolute terms going forward.


So to some extent both structural and cyclical factors for consumption are looking weak. I would not be paying 30-33 multiple, which most of these consumer stocks are trading at currently. The average basket of consumer stocks, which we look at on 2014 basis is about 33 times on, and 2015 basis 28 times. That is plain expensive.


Q: What about a stock like Maruti Suzuki? What people have made of this big crack in the yen and the potential impact for Maruti?


A: It is becoming a complete play on the yen. If the yen keeps appreciating the stock will continue to do well irrespective on what is happening on the fundamentals. The auto numbers have been very disappointing in the last six months. We have seen negative numbers. Even in the April month you had a 10 percent decline on Y-o-Y basis for passenger car sales.


Maruti is doing reasonably better compared to the others, but even Maruti had flat domestic numbers in April. I think the company is going to miss numbers on the volume side based on split expectations, but the earnings numbers could be anywhere depending on where the Yen is. Currently we are looking at about Rs 100 EPS based on 97 yen to the dollar. Looking on where the yen is the numbers could surprise on the upside. This is becoming more a play on the yen than on the domestic Indian consumption story.


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Q: The space that people are beginning to recommend (roughly to call it a space) is some of these stocks and companies with high leverage on their balance sheets suggesting that perhaps from here the recovery could be quite sharp, both for the stock and the balance sheet situation. Is there merit to that argument?


A: No way. It makes no sense looking at any of the leveraged companies till the time they actually do something good in terms of improving their balance sheets. If you look at most of these companies, the net debt would probably account for 80-90 percent of the enterprise value (EV) now. I am not even sure who is the owner of these companies these days and what is the interest of promoters in reviving the companies. They have absolutely no stake in the company.


So at some point of time the banks will have to step in and do some forced restructuring of these companies because I do not see how these companies are going to survive or recover on their own.


As the investment cycle is still 12-18 months away and I do not think you are going to fix some of the fundamental issues that quickly, whether it is availability of fuels for the power sector, faster clearances, land acquisition, allocation of resources. That is still 12-18 months away.


I would not be betting on a quick recovery as far as the investment cycle is concerned.


Q: We are seeing some of these play out in names like Orchid Chemicals which is now in the NPA list of banks, S Kumars is a deep NPA. Those stocks have collapsed but do you think public sector banks may see some more pain over the next few quarters as more of these companies turn defaulters?


A: I would not be surprised because so far whatever pain you are seeing on the PSU bank space is coming from agriculture sector and more in the smaller names in stuff like chemicals, pharma, steel, textiles etc.


Most of the larger companies barring Suzlon Energy seem to be still being recognized as the standard assets in the books of the PSU banks or for that matter private banks and unless and until we see some resolution to the problems in the power infrastructure space, I am not very sure how some of the larger entitles in this space are not going to be classified as NPLs or restructured assets whichever way you look at them eventually.


We are a long way in terms of resolving the NPA issues. The market is taking a rather cavalier attitude towards the fact that NPA cycle is already over. The real pain is still out there if some of the larger entitles start going under.


Q: Do you think it is one more of those phases in the market where people are optimistic because stock prices have run up quite a bit and in a few months the first prospect of global liquidity waning again will be faced with a deep correction?


A: It is a possibility. So far the run up which we have seen has been mostly in good quality names. What you have seen is not so much improvement in earnings of the consumer staple companies, HDFC, HDFC Bank, some of the better quality private banks, pharma names etc, but you have seen a bit rerating in the names. So as long as global liquidity is fine I assume the stocks will remain where they are, but in the next six months if you see some reversal in global liquidity or god forbid something goes wrong in India in terms of politics, reforms etc. then the worry is some of the rerating which has happened of late could come off.


As I mentioned earlier most of these consumer staple companies are trading at above 33 PEs; a 20 percent correction, you are still looking at maybe 26 PE. So, a 26 PE still looks rather expensive to me in the context of the kind of numbers many of the companies are reporting.


I would not be very surprised if you see a deep correction at some point of time, if you have situation where global liquidity turns negative and something goes wrong in India in respect to the politics or the reform process.


Q: You have tracked media for a while and there was some action around that place last week driven by some earnings surprises. Is it time at all to look at media because it has been ignored for a really long time?


A: We have been generally positive on that space, more so on the print side where the balance sheets are still looking quite reasonable. Of course on the television digital side, valuations have become fairly expensive now.


Clearly investors are already factoring in some amount of improvement as far as both ad revenues and subscription revenues are concerned, betting more on the second factor in terms of digitisation taking off in a big way in the country and contributing to the earning numbers of the entities.

This is a great story longer term. There is no question about it that eventually both the revenue streams will start kicking in pretty strongly. It is just a question of how much you want to pay at this point in time.

First Published on May 13, 2013 10:19 am
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