Market valuation not cheap, see correction: Sanjeev Prasad

The first quarter GDP data for financial year 2013 will be announced today.  According to a CNBC-TV18 poll, the number will be a mediocre 5.3%.

Like most experts, Sanjeev Prasad of Kotak Institutional Equities expects Q1FY13 GDP to be at 5.2%. But, he doesn't see the market giving much weightage to it unless it falls below 5% to 4.5-4%, which will be a shocker. Meanwhile, the risk sentiment in the market globally was supported expectations of stimulus action by global central banks. On the domestic front, expectations of improvement in the economy were based on change in the finance minister, he explained. However, if these expectations are not fulfilled then one should be ready to see a correction because market valuation is not very supportive, he cautioned. "If you look at the market, BSE 30 on free float basis, you are looking at the market which is trading at 15 times now, so that is not very cheap. Most of the stocks which we want to own whether it is in consumer sector, pharmaceutical sector or private banks have become very expensive now." Below is the edited transcript of Prasad's interview with CNBC-TV18. Q: Your thoughts on the GDP number and what kind of impact it might have if any on the market? A: We are looking at about 5.2% GDP growth for this quarter, pretty much inline with consensus of 5.3%. I am not very sure if backward looking numbers are that much of significance now because we know what is happening on industrial production and the IIP number for April to June period was flat. I would be surprised if the industry numbers comes in more than 1%, agriculture more or less doesn’t surprise on the upside or downside that much. Most of the swing will come from the services sector. So, we will have to wait and see what is happening here if there is a bigger than expected slowdown even in services sector. The quality of data itself is a big issue when it comes to some of the government related data. I am not sure that this is going to have a big impact on the market unless and until you see a slippage below 5% to something like 4.5-4% kind of a number then people will get a bit more shock than what a 5% number anyway implies. Q: What is your call on the market? You sounded a bit cautious for some time; do you think there could be downside given the kind of macro policy noise from New Delhi that one has heard for the last fortnight or so? A: What has happened over the last two months is some sort of a risk-on trade as far as global risk appetite is concerned. It started from end of June when Euro Zone summit happened, and then Draghi came out and made some positive statements. All that resulted in creation of a positive momentum as far as global risk is concerned. There are expectations of some sort of QE3 and ECB will do some bond buying program. So, all that supported risk sentiment globally. Domestically, there has been lot of expectations based on change in the finance minister, the expectation of interest rate cut and so forth. So, again that supported sentiment to some extent. We have seen very strong inflows of more than USD 3 billion between July and August. The problem is if some of the expectations both on the global side and domestic side get belied then this market is coming down because valuation is not very supportive. If you look at the market, BSE 30 on free float basis, you are looking at the market which is trading at 15 times now, so that is not very cheap. Most of the stocks which we want to own whether it is in consumer sector, pharmaceutical sector or private banks have become very expensive now. If there is no solution to some of the issues surrounding the sectors, I do not know how much more of Hindustan Unilever one will keep buying at 36 times 2013 price earnings. There is a fair degree of chance of market correcting if we do not see positive momentum on all the promises been made as far as resolution of Euro Zone problems and improvement in governance in the country are concerned. Q: What do you make of coal block de allocation talk because there is some thought that after the Monday meeting you could see some de allocation of blocks? What impact might that have on market sentiment if that were to come through? A: I do not see much of a direct impact because if the government de allocates some of the blocks where you haven’t seen any commercial production starting then I do not think it makes any difference. There will be some sentiment hit for some of the stocks but that’s about it. The bigger issue is the kind of flip-flop you are seeing policies in most of the natural resource space. If you look at the mess in the telecom sector and now you are seeing problems in the coal sector and then there were GAAR issue and so on, a bigger issue over here is how quickly can the government can lay down the rules of the game. First of all, you need to lay down pretty much in a transparent open policy in the first place and make sure you are following them. That is the bigger message here rather than cribbing about what is the loss to the exchequer. On those numbers you can keep on debating, but the way in some of the natural resources have been given to the private sector in the past – these are questionable. So, the bigger issue is how quickly you can fix these processes and go about handing about natural resources in more open and transparent manner. _PAGEBREAK_ If we keep on fighting, I do not think he will see resolution of this issue for the next 12-18 months. We do not have any time to lose. We could see a potential problem in the banking sector also because you would have projects which are halfway done and now suddenly you do not have any coal blocks available for it. Q: How do you approach the whole infrastructure space right now? It seems unlikely that they will led the government come away with any kind of positive policy spin on this coal issue. If they continue to block do you think this whole investment cycle problem might get stretched out to longer than you might have thought earlier? A: There are no silver bullets at this point of time whereby you can kick start the investment cycle. Typically what you see is when the companies are under some sort of stress, which is the case currently for the fact all the infrastructure developers are having serious strain as far as the balance sheets are concerned – net debt to EBITDA numbers are very high. In some cases it is virtually unsustainable, so many of these will be restructured at some point of time. Then clearly it becomes the task of the government to take over the mantle of infrastructure development for some time. Increase the fiscal deficit and kick start the economy. The problem is India anyway runs a very high structural deficit to start with. This year you are probably looking at a 5.7% - 5.8% of gross deficit to GDP, so where is the question of government pumping extra money as far as the investment cycle is concerned. If the private sector is capable of doing it given its balance sheet issues where is the money going to come in especially at the time when you have so much of uncertainty with respect to most of the policies in the sector. On the distribution side, the financial condition of SEBs is pretty bad, so we have to restructure loans over there. Roads are the only space where you have seen some activity, but even that has slowed down. Most of the government is not in a position to take decisions very quickly. In this kind of a situation clearly investment cycle is going to suffer. Unfortunately, if you do not solve this mess immediately, it looks like we are off for the next 18 months given the fact that we have whole host of elections over the next 12 to 18 months. We have the national elections in April-May of 2014, so where is the question of some sort of a political compromise emerging which could kick start the economy. Q: The three stocks which have held the Nifty at a respectable level despite all this gloom and doom and the collapse in the midcaps this series are probably HUL, TCS and Reliance. If you had to pick of these three which ones would you have the most comfort buy? A: It is a very difficult one, honestly none of them. HUL at 35 times 2013, about 30 times 2014 I do not know it is already discounting 2014 numbers. From visibility and earnings it is probably the most visible one at this point of time so maybe that is the one I would look at. TCS looks okay at 19 times earnings which are based on current earnings what we have. But given the fact that the rupee is much weaker than what we had assumed for our full year numbers there would be some upside to the EPS numbers. The volume environment does not look to encouraging there. If some of the struggling tier I companies decide to get more aggressive on pricing then you could see maybe Q3-Q4 some sort of pressure emerging as far as EPS is concerned. You still have some visibility on the earnings numbers, but that is coming because of some support from rupee depreciation. As far as Reliance is concerned, the stock has moved up based on short term improvement in refining margins, which we saw in the month of August. In the last two weeks the refining margins have already come down. If you take a more medium term view you are looking at large capacity additions. We are looking at about 2.9 million barrels per day of new refining capacity additions in 2013-2014 calendar years. I doubt refining margins are really going to surprise on the upside. On the chemical side, margins are quite weak. This stock has gone up more on short term expectations. There is a chance it could correct. Q: How do you construct a model portfolio in such a situation? It almost seems like most of the stocks you maybe owning at this point would be reluctantly because you have to create an equity portfolio? A: That is what we have highlight in the last report also. In fact we have 10% of model portfolio in the form of cash and honestly, I am struggling for ideas at this point of time because most of the stocks if you want to own are very expensive. If you look at the consumer space, every stock is above 28-29 PE now. Even Tata Global Beverages and companies like that have become almost 30 times now. Hindustan Lever is at about 35, ITC is about 30, Asian Paints about 32 and then you have Nestle at 40, Jubilant at 50 – so how much conviction do you have on earnings growth of these companies for the next several years that you are willing to pay between 30 to 40 PE for these companies. If you look at the pharma names, most of them are the larger cap funds that would be in the range of 20-25 times. They look okay and also have some upside from rupee deprecation I would still keep some money over there that is one of our overweight positions. Technology which is another big one has some protection from the rupee but demand environment is not very supportive over there. Baring that, private banks have become very expensive at least the retail oriented ones. HDFC Bank is about 4 times; HDFC is about 4.5 now on 2013 times price to book. As far as most of the PSU banks are concerned, there is so much of uncertainty on the quality of book over that nobody is willing to take a call. Most government owned companies have so much of uncertainty on the earnings numbers, nobody knows how the subsidy issues going to resolve, what kind of subsidy mechanism is going to come for 2013. Some of largecap sectors have become virtually un-investable, so you are left with a very small set of stocks to start with anyway. In many cases valuation is just not supportive, so it is very-very hard to construct the portfolio now.