Reliance likely to surge in 2014; cautious on retail: HDFC

Sheth further adds that Reliance is likely to breakout in 2014. "

"They are aggressively reinvesting in both their core manufacturing businesses- petchem and refining. The incremental return on capital employed in both these investments is going to be well in excess of 20 percent," he adds.

Below is the edited transcript of Sheth’s interview.

Q: It has been good days for our markets. We are at the cusp of a new high or we are struggling to get above that but most analysts or experts believe that we could scale up in the month of January, are you of that view as well?

A: Quite frankly, it is a little pointless trying to predict what will happen in January. I think we are at a time when we need to take a longer-term call. The uncertainties in the short-term are always there by definition but this time the uncertainties are even more,  especially on the back of the rising expectations.

Right now, the wall of worry has been breached and the wall of expectations now has to be decisively broken. So, we will probably hang around where we are for the next few months. There may be some volatility for sure as we approach elections and as the end game plays out.

So, the more there is anecdotal evidence of one or other political configuration coming to power and even a lot of that evidence is going to be speculative in nature or expectations playing out. So, this is the time not to take a very deep and concentrated call but rather to hedge your bets. I am not ashamed to say we cannot figure out what is going on and those who are dead sure that they have figured out this game are either going to be very lucky or very unlucky and maybe that is not such a wise thing to do.

Q: Gas price has been hiked of course from April, 600 million mobile phone users today in India and internet users stand at a 140 million. Something very substantial has also gone without too much of hoo-ha about it, all that is already priced in you think these administrative disasters being somewhat set right?

A: The government has done brave, bold things in a sustained way over a period of times. Some of it is end-game playing out in the last few struggling moves to show that we are not a complete disaster, much of it is basic demographics. The fact that we have 1,200-1,300 million people in this country which is now getting increasingly connected, aspirations are looking up and so on. We also know the political fallout of young aspirations looking up and then, there’s the political situation in Delhi.

Q: You were telling us about the IT space and how there could be more over there, what else?

A: With the US economy picking up, growth will surely percolate into IT services demand not withstanding the fears on migration or immigration restrictions and so on. The other place where we see value is pharmaceutical, selectively of course.

Again because of its dollar-denominated earnings and its extremely high capabilities vis-à-vis what India has with respect to the rest of the world; the largest number of US-FDA approved manufacturing locations; very talented and clean promoters mostly; relatively clean cash flows; very good returns on ratios and valuations around 18-20X in some cases but still compelling enough for us to say that some allocation should remain there.Q: A lot of people are now talking about Reliance breaking out of that multi-year range and perhaps being the leader of this next rally on the upside, any thoughts on that and would you bet on that at all?

A: We have an equal weight on Reliance in portfolio- 7.5 percent or thereabout. I don’t see why I should say it is not there in my list. We are very gung-ho on Reliance. The second last update that we published to our model portfolio, we said that we are increasing our weight to Reliance.

This was triggered by the clear understanding on two fronts- earlier there was a challenge in terms of clarity on capital allocation at Reliance, what were they going to do with the kind of money they were generating Rs 30,000-40,000 crore every year and over the last year or so there has been more clarity on that front.

They are aggressively reinvesting in both their core manufacturing businesses- petchem and refining. The incremental return on capital employed in both these investments is going to be well in excess of 20 percent.

I think that is a great reason to go out and buy the stock. Then, there’s the news of the gas price hike. So, I think that at USD 8.4, the stock should be adding substantially.

The year 2014 is very likely to be a breakout year for Reliance because a lot of things are coming together. They have gone cautious on being capital or trigger happy on capital spend in their telecom business. They are willing to share infrastructure, retail is now a large enough business and we are told it is at EBITDA breakeven.

Reliance is a good company but they are blowing money in a whole lot of unrelated things. Those arguments are going to come down. The reinvestments of Rs 30,000-40,000 crore per annum into their mainline businesses of refining and petchem are going to be very meaningful from an incremental EBITDA perspective and they have got this 4.2 to 8.4 uptick on the gas pricing. So everything is coming together for Reliance, it surely merits a rerating.

Q: It was big news that Tesco got permission to hitch up with Trend and despite the fact that they could use even their existing outlets, the Greenfield outlets had to come only in the next three years, is this a space that you will watch out for?

A: In principle yes, a lot of good things are yet to play out in the retail space. We have had about 4-5 years, I would say a decade of -- the last 4 years have been a disillusionment cycle and before that we had about five years of illusionment cycle if you let me coin a word here. So retail is definitely an area, where money is required, investments are required, it is a great business, demographically it is what we need a lot of supply chains need cleaning up and getting efficient and foreign money will certainly help but if you tell me the government allowing FDI into retail, there is still such a lot of micromanagement, you can do these three things and you cannot do those four things and Tesco can do this much and you cannot do that much and okay, we have opened up these two conditions, I am saying stop doing the micromanagement, it is not government’s job to run a business.