Good Q4 earnings so far, but upgrades unlikely: StanChart

The market will maintain its uptrend in the short term, feels Rahul Singh, Head of Equity Research, Standard Chartered Securities. In an interview with CNBC-TV18, he said that the earnings season so far has been better-than-expected with positive surprises outnumbering negative ones.

Also read: FIIs may be buying; but not a bull market yet However, Singh cautioned that earnings upgrades were unlikely for the next six months. He says oil marketing companies would be able to overcome their problem of under recoveries if crude remained at USD 100 per barrel. Singh is bullish on TCS and HCL Tech in the IT space. In the banking sector, he prefers private sector banks over public sector ones. He has a ‘neutral’ rating on HDFC, as he feels the stock is fairly priced at current levels. Singh is bearish on FMCG stocks despite their strong performance recently, as he feels valuations are expensive. Below is the verbatim transcript of his interview on CNBC-TV18 Q: It has been fantastic couple of weeks and a surprise kind of May – how are at StanChart calling the market now and what is your sense tactically of what this market is pushing to do? A: Yes, it has been a surprising move despite whatever Reserve Bank of India did and whatever has been happening on the political front. I think one has to step back and look at whether the traditional way of looking at market valuations of 14-14.5 times and comparing it with the mean is a valid comparison or not. The sense one is getting is that there is global liquidity out there, which is chasing yields, chasing highly predictable earnings and probably chasing it at the cost of equity, which is much lower than the domestic cost of equity. We have to put that move in that perspective and that what seems to be happening. It is very difficult to say how long it will continue but in the short-term the trend seems to be more of the same rather than this trend actually waning off immediately. Q: The market up move has been relatively shallow, it has come courtesy the foreign institutional investor flows but domestic institutions still continue to be sellers. There is hardly any retail participation in the market – do you see the participation pick up in the next leg of an up move if there is? A: Eventually, it depends on the rate cycle and what the other financial savings are offering and in the long-term, on the money coming into equity markets but that is for the long-term. For the immediate term, till the time one is looking at the interest rates and debt mutual funds offering you 8-9 percent without taking too much of a risk, the immediate fund flows for equities would therefore be contingent on that rather than the retail mood per se. Q: The underpinning of any market move has to be earnings performance at the end of the day - what have your takeaways been from earning season so far? A: The earning season has been better than what we were expecting in some respects. But we don’t expect too many earnings upgrades to start happening in the next six months and definitely not, if the interest rates are going to be much stickier and the policy rates are not going to come down as fast as we were hoping, especially after crude prices and gold prices came down. So the earnings outlook looks much more of a sideways movement or maybe marginally downwards, In the next two quarters, if the consumption spending continues to slow down because the bulk of the 14 percent earnings growth rate, which we are projecting next year, is coming from consumer, consumer discretionary and banks and to some extent from IT services and pharmaceuticals as well. _PAGEBREAK_ Q: You raised an important point about the commodities and where that may move and our market move is almost perfectly linked with that crash we saw in commodities – what are you factoring for the course of the next couple of months on commodities and how important will that be in terms of having a bearing on our market you think? A: It is important in the sense that, it affects our macro much more than it does in other emerging countries and therefore the softer oil prices to my mind is the single biggest factor. Gold, the prices have come off but the demand has gone up, so I am not sure how much net-net benefit it will come in terms of the current account deficit. We have a flat to marginally down view on commodities, on oil prices for the rest of the year. If looks at the global demand outlook, whether it is the developed markets, the Organization of Economic Co-operation and Development (OECD) markets or the emerging markets like China, the demand is slowing down and the economy growth is slowing down and that cannot mean good things for commodities in general and obviously for oil in particular. That is what is putting India in some kind of a sweet spot because if the money goes out of China, Korea, it will go to Japan but Asean markets are not big enough to absorb that kind of capital outflows or capital reallocation from the large emerging markets to markets like India which actually benefit from lower commodity prices. Q: I heard you mention that earning season has been better than your expectations, which are the stocks that delivered good earnings where you could be confident of putting in more money? A: In IT services, select stocks still definitely look good, so we like HCL Technologies and Tata Consultancy Services (TCS). We like telecom. Overall, the results have been better than expected and the trend there will get better. One might actually see upgrade cycle starting in that sector earlier than the other sectors. These are the two sectors one can clearly highlight apart from one of cases like Maruti Suzuki and so on. So, there have been bright spots in this result season. There have been some disappointments but overall the extent of positive surprises has been more than the extent of negative surprise. Q: You have tracked energy for a long time- given the point you were making about commodities what would you pick from amongst that basket between Reliance Industries, Oil and Natural Gas Corporation Limited (ONGC) or some of the oil marketing companies? A: The upstream companies look little better than the others. I think everywhere one can see value especially if crude prices are going to stay low at USD 100 per barrel or so, there is a potential for these companies to come out of the subsidy mess over 12 to 18 months, especially post the general elections next year. If one were to take a more calculated risk, I would probably go with ONGC and Oil India because not only do they benefit from lower subsidies but in my view the gas price hike is going to happen, whether it happens in three months or six months, twelve months you will see an uptick in gas prices which will benefit both ONGC and Oil India. Q: How would you approach the entire consumer space at this point – Hindustan Unilever Ltd (HUL) has been excited ever since the news that came in on it but would you say there is a case to be it for valuations to go down the band a little bit for consumer durables or are you still positive on that space? A: On consumer durables, we have been underweight and the issue has been valuations. Of course, event like Unilever’s open offer has pulled up the valuations band again upwards for most of the companies. That has been an unexpected event. If one looks at the staples, there is a slow down but there is no significant slow down. In terms of discretionary we have seen starting with autos and to some extent in other discretionary segment there has been some slow down. We will probably see a sideways correction or time correction for a long period of time maybe including Levers, which is what I think the current valuations could mean going forward. Given that the triggers for a rerating further up from here seems to be a little bit few because of the way the consumption is slowing down gradually although not  a steep cliff kind of a fall We are probably not seeing earnings growth similar to what we saw in the last two to three years. _PAGEBREAK_ Q: What is the approach towards the banking space? A: Clearly private sector banks. We don’t think we are out of the woods in terms of the non performing loans (NPL) cycle for the PSU banks. We saw it in the numbers which have come out so far from the PSU banks. The private sector banks have been the other extreme. We would stay with the private sector banks clearly as a preferred pick even to play a recovery in the economy which could be back-ended but even if the recovery does not happen, the private sector banks are managing the growth versus risk environment much better than the public sector banks. Q: Purely from a valuation parameter at about 14-15 times Sensex PE, how much more elbowroom do you think this market could have on the upside or do you think we have reached fair valuations? A: One has to start looking at these 14-15 times and comparing it with the last 10 year mean a little bit differently now, because there is a section of the index which is being chased by global liquidity and that is chasing yields and that is chasing predictable growth much more aggressively than what we have seen in the last 10 years. So we have to be cognisant of that. That does not mean we ignore valuations completely. At the end of the day it all comes down to bottom-up stock picking and that is what I firmly believe in. The portfolio is a net result of stock picking rather than the other way around. Q: By which quarter do you think we can confidently start to see earnings improvement – I am not talking about there not being that many downgrades but the potential for an upgrade either to stocks or the markets because up until now the markets rewarding stocks which are not disappointing but the positive surprise is still not apparent? A: Yes positive surprises are not big enough to pull up the Sensex earnings chart aggressively up, so, clearly that is at least three to six months away in my view. We are seeing consumption slow down which is still evolving capex cycle, has no hope for a revival in the next three to six month, at least the private sector capex cycle, the government spending could go up. One will see pockets of upgrades maybe in cement, telecom and part of auto and maybe tech but it is not a clear trend for the market as a whole. I think that will have to wait at least six months. We should not forget that some of these spending decisions, the capex decisions are also consciously or unconsciously dependent upon the election timelines and some of that could start getting deferred because we would be looking at elections six months down the line. We would be talking about general elections much more than we are doing now. Q: It is too broad a term to put them under but just on midcaps some aggressive recommendations have started being made within the midcap space. Do you sense there is appetite yet though for some of these midcap stories where there is both less certainty in terms of earnings and the technical problem of exiting these stocks? A: Yes. We do cover lot of midcaps in the consumer space and otherwise which have an improving trend in profitability and return on equity (ROE). There is always going to be scope for some of these midcaps to do well. One can’t have a broad brush kind of statement saying midcaps are out of favour. I think that is not really the case actually. Q: Any thoughts on Housing Development Finance Corporation (HDFC) because this morning a lot of brokerages have upped their target price and recommendations on the stock post the numbers that it delivered yesterday? A: We have a in-line rating on HDFC. There are strengths and businesses growing well but the valuations are also reflecting that strength and that growth. In my portfolio, I have private sector banks and I have HDFC at an in-line weight and that kind is a reflection of the fact that we don’t like the public sector space. We like the private sector space and HDFC as a holding finance company is also something which is growing much faster and managing the environment much better than the public sector banks.