Overweight on IT now; expect weak Q1 nos from metals: Kotak

Sanjeev Prasad, senior executive director and co-head, Kotak Institutional Equities expects the Infosys stock to perform after the IT major posted better-than-expected Q1 numbers. He advises investors to remian overweight on IT.

"The concern for Infosys was stemming more from the top-line itself given the concerns about a weak demand environment etc. So, I think a pretty decent set of numbers hopefully translates into good stock performance during the day," adds Prasad

On his expectations from the Q1 earnings season, Kotak expects metals to post weak numbers. From other sectors, he is overwight on Mahindra and Mahindra and Tata Motors from the auto space. Additionally, Prasad says that the Government should take up some radical measures to rescue the rupee that has seen a severe battering in the past few days.

On how foreign investors are viewing the market, Prasad adds that the volatile rupee and other macro weakness is keeping investors from having a positive outlook on the Indian equity market in the near-term. Below is the edited transcript of Prasad’s interview to CNBC-TV18. Q: What have you made of what you have heard from Infosys and the fact that dollar guidance is intact and people are feeling more charitable towards the stock this morning? A: The numbers turned out to be pretty good. The kind of Q-o-Q revenue growth, both in dollar terms and constant currency as well ahead of what the market was expecting, it stood at 2.7 percent versus 1 percent on dollar terms. So, it is a pretty fantastic performance. This business is ultimately all about the top-line. The top-line based on reasonably strong momentum on volumes, atleast this quarter, is okay. Given the fact that one has a fair amount of tailwind coming from currency depreciation, I think margins will hold up reasonably well. The concern for Infosys was stemming more from the top-line itself given the concerns about a weak demand environment etc. So, I think a pretty decent set of numbers and hopefully that translates into good stock performance during the day. Q: How are you feeling about the market now which has had a good pullback over the last two or three sessions? A: In this market you need to look at the things on a week to week basis, because at this point in time thanks to the statements of Ben Bernanke and Infosys numbers things look okay. However, I do not think the fundamentals of the economy make us any excited about it given the fact that we are still running a very large structural Current Account Deficit (CAD) and I do not know how that is going to be bridged. The thing which worries me is more the outlook over the next few months. At some point in time the US Fed is going to start its tapering of the bond buyback program. Commentators are hopeful that it will be eventually delayed, but I think the day of reckoning is not too far away and the worry for us is we still have not resolved all the underlying issues, and as we head closer into elections there will be more political uncertainty. If you look at the broad math on the current account side you are looking at about USD 75 billion of deficit in this year. If you take oil at around USD 100/barrel then you are looking at USD 75 billion of CAD, which means required capital flows of that account just to be stable. Every month we require about USD 6-7 billion of capital flows and I just cannot add up the math over there. Unless and until people become very generous and global liquidity again becomes very good I do not think how we can get that kind of capital flows into India, which is where the concerns would come in.  If the currency once again starts slipping, then this whole equation goes into a big mess given the linkages between the currency market and equities and debt market. Q: How ugly do you think earnings season is going to get this time? Are you priming yourself for big disappointments? A: As of now yes. If you look at our BSE 30 Index projections, for first quarter, we are looking at a decline of 4 percent on a Y-o-Y basis. That primarily reflects two sectors which we expect to do quite badly, one is the oil sector and in this case that is Oil and Natural Gas Corporation (ONGC) which is going to pull down the numbers significantly. Oil prices are lower on a Y-o-Y basis by about USD 7/barrel, but the government continues to follow a subsidy system which is based on a fixed subsidy number for ONGC and Oil India which is USD 56/barrel. So on a net basis ONGC's net realisation will decline about USD 7/barrel and that is where we are looking at a 33 percent decline in net profits. The other sector which we expect to do quite badly is the metals space and there are combination of reasons for that. Forex losses in some cases in Y-o-Y, Q-o-Q, or London Metal Exchange (LME) prices are lower, and there are some production shutdown issues in some companies. Therefore, all put together nothing much to look forward to in this results season. However, two companies have reported much better numbers that what we are expecting IndusInd Bank and Infosys. Q: What is your view on the IT space generally in terms of a weightage? What would be your pecking order in terms of top IT names right now? A: In the model portfolio we had a slightly overweight position on technology. We have been very worried about the rupee for sometime now and even though we were not very confident on the underlying trends in the sector both in terms of the demand environment, and also concerns emerging from the Immigration Bill which is probably going to get diluted now. So, we have just taken a slightly overweight position in the sector. Infosys we turned overweight in April, so that has played out reasonably well for the time being. Wpro also we are overweight more as a valuation call. Tata Consultancy Services (TCS) is the one which is underweight but that seems to be performing reasonably okay. On a broad basis we are okay with our positioning on the tech sector. _PAGEBREAK_ Q: What have you made of this controversy on capping gas prices etc. which seems to have dented Reliance a bit, but ONGC has gone back to Rs 300. That is where it was before the gas price hike came in. How have you read these movements and this news? A: I do not know what this controversy is about. India is ultimately an energy short country. If we do not give the right prices to domestic producers, the option is to import Liquefied Natural Gas (LNG) at anywhere north of USD12/mmbtu FOB level. So, I think it is a much better choice to give higher prices to domestic producers, incentivise them to produce more. Over a period of time, we will see more investment in the Exploration and Production (E&P) sector and hopefully we will see production improving over a period of time. Otherwise what option do we have? We will have to import more and more of LNG at much higher prices. Ultimately, if you have to enhance energy security of the country you have to have a pricing environment, which results in domestic production. Looking at math, as far as the two sectors, which have been making the most amount of opposition against the gas price increase - the fertiliser sector and the power sector. As far as the power sector is concerned even if gas prices go from USD 4.2/mmbtu going up to USD 9/mmbtu, the impact comes to somewhere about Rs 100 billion. If you do a simple math, just divide the increase in the impact on the power sector by the total amount of power generation of the country which was about 900 billion units in 2013, which will probably go up to more than a trillion units in fiscal 2015 when the higher gas price becomes applicable - you will need to increase prices by somewhere about 10 paise on an average basis. So, I think the consumers can bear it and the best thing is to just pass it onto consumers. If you look at the fertiliser sector the impact of USD 4.2/mmbtu going up to USD 9/mmbtu will come to somewhere about Rs 120 billion for the sector. In this case, the government will have to absorb the impact through higher subsidy amount. However, the good news is if you look at the collection of the government in terms of higher revenues coming because of higher profits and revenues of Oil India and ONGC, there are four ways the government will gain. First is higher royalty, second is higher income tax, third will be dividend, fourth dividend distribution tax and if you do the math the government will actually cover about Rs 120 billion in terms of higher royalty, income tax, dividend distribution tax from Oil India and ONGC. So net-net there is no impact on the central government's revenue. Therefore, the math is pretty clear. The sectors can absorb this kind of a price increase. It is in the interest of the nation that we go ahead with the price increase so that it can incentivise higher domestic production. Otherwise we might as well start importing USD 15/mmbtu and in that case I do not think any of this debate would be valid at all. Q: The space that has begun to crack is autos. Labour unrest, production shutdowns, poor sales - Are you guys getting out of that space? How are you feeling about autos? A: Only overweight positions which we have in auto sector are Mahindra and Mahindra (M&M). We have been generally comfortable with the business model which is more dominated by Utility Vehicles (UV) and tractors. Given the election year and general monsoons are good, so tractor segment will do well. Even with some concerns emerging on the UV segment, valuations are quite reasonable for M&M, if you adjust for the value of the subsidiaries that stock is available at somewhere about Rs 700. If you adjust let us say Rs 225 for the value of subsidiaries, about Rs 60 EPS the auto business will do this year. It is trading at about 12 times, which is quite reasonable Then we have an overweight on Motherson Sumi and Tata Motors, which have really got nothing much to do with India now. So as far as the India players are concerned the two wheeler companies and also Maruti, my worry is the amount of much higher competition at a time when the domestic market is just not growing. We have seen the numbers for the last 3-4 quarters; volumes continue to be pretty abysmal and I do not see there is going to be any recovery for some more time. Till the time we fix the investment cycle which is another debate. It is not happening over the next 12-15 months at this point in time. Therefore, unless and until the basics of the economy get fixed there is no way you will see consumer discretionary spending starting to pick up and in that case auto volumes will continue to languish. If that is the case then given the amount of new competition which is coming in in both the two wheeler space as also in passenger car segment, I would be very worried about the margins of the players in that segment. Q: You were talking about the rupee. What are you hearing about flows and whether that pressure still continues both for the equity market and the bond market as well - that has been the biggest source of outflows? A: I think as far as flows are concerned India has no option but to start doing something radical. You no longer can depend on foreign flows to bail us out. If you look at the bond market; something like USD 25 billion came in calendar year 2010-2012. This year as of now it is marginally negative number and if the balance amount of money also goes out given the fact that interest differential between - if you look at India 10-Year paper that is about 7.5 percent and US is currently maybe 2.6 percent, so you are looking at interest differential which is less than 5 percent now which is probably not enough to cover the hedging cost. It is a pretty obvious thing that some more flows could take place on the debt side. On the equity side the worry is, one, obviously the global environment is not looking that great for the emerging market space and India falls over there. Most of the stocks that you want to own India are trading anywhere north of 20 PE, anywhere from 20-40 PE. So I am not very sure whether global investors are going to be too excited about India. We will have to seriously look at curbing gold imports even more. Other thing is to try and see how we can get some capital inflows into India and one of the options is try and see what we can sell to foreigners. We may want to divest the government owned companies, but that is not what people are interested in. People are interested in consumer plays and banks etc. and one of the options which India can explore is try see if we can sell some of the Specified Undertaking of UTI (SUUTI) owned companies between Axis Bank, ITC and Larsen and Toubro (L&T). The government owns something like Rs 50,000 crore of valuable assets over there. That is the kind of companies which foreigners would be very interested in. So if we can divest some of those stakes to investors, you could actually see a fair amount of portfolio flows coming back into India. That is probably one of the options which India would have to explore. Selling the likes of some of these government owned companies where there is no interest, I am not really sure what we are trying to achieve over there. That is also a big cause of concern now. One of the things which we should worry about is the fiscal deficit side also because we had a target of Rs 56,000 crore of divestment. I am not too sure how that is going to be achieved unless and until you go for some very different kind of companies where there is actual interest in the market. And the other side of the equation is what is happening to oil prices and oil subsidies.