See 75 bps rate cut going ahead; like IoC, GAIL: Sanjeev Prasad

India’s macro story looks very good, says Sanjeev Prasad of Kotak Institutional Equities. Speaking to CNBC-TV18 Prasad said that global events are hard to predict. The upcoming US elections and US Fed meet are just two of the important events that will unfold in the next one month. European Central Bank meeting slated for November will be on the market’s radar. But bond markets are starting to price these in, he said.

He has been bullish on oil and gas companies. Prasad believes that upstream companies in this sector are trading at correct valuations, given their RoEs. However, he added that he would have to rethink some of the names in the portfolio. He is upbeat over IOC and GAIL. Petronet LNG is fairly priced, he said.

As regards the telecom space, he said the auction has turned out to have a reasonable outcome for the operators. “Operators didn’t go overboard,” he said, adding that it is soon going to be a four-player market consisting of Bharti, Idea, Vodafone and Reliance Jio. Short-term negative sentiment will continue for the sector for some time. In the next 6-12 month period, investors will start to take a positive call on the sector.

He sees inflation at 4.55 percent by March 2018. And he sees a 75 bps cut going ahead. “You could get a 25 bps in the second half of this fiscal year,” he said. We could see another 50 bps cut in FY18 also, he said.Below is the verbatim transcript of Sanjeev Prasad’s interview to Anuj Singhal and Latha Venkatesh on CNBC-TV18.Anuj: Last time you were very candid, you said that this is a market in which you have dropped your entire midcap portfolio. But since then we have seen a bit of a dichotomy play out, largecaps have corrected a bit led by the Bank Nifty but midcaps have continued to move on. What is your overall sense of this market? Do you get a sense that finally we are at a cusp of a bigger correction?A: It is hard to say that given the number of moving parts, which are there in the market. However, if you look at the fundamentals, this market has become fairly fully priced at about -- if you look at the Nifty 50 index for example that is already at 19.5 times on March 2017 basis, slightly above 16 times in the March 2018 basis. So, I don't know how much more valuations can expand from where we are.At the same time, the good news is the macro is very good, in fact it has never been as good as we are seeing as of now. 10-year yields keep on coming down, you are seeing a big correction over here which obviously results in earnings yields also dropping and accordingly you can argue for higher multiple if the macro is looking so good.If you look at the global events, we have a number of events over the next 1-1.5 months and it is very hard to take a call on any of them, let alone all of them put together. So, we get into US elections over the next one month or so. If the polls continue to suggest that Hillary Clinton and Donald Trump are reasonably close then this market will start to be little bit worried as to what is the eventual outcome and start with building in some possibility of Donald Trump becoming the president of the US, which some people may not take very positively.Then you have the US Fed meeting coming up before the US elections, maybe nothing happens over there but the data points in the US suggests that the recovery is very much on. Labour market conditions have become tighter, inflation is not very low. So, at some point in time US Fed will act, maybe if not before US elections then the next meeting which is on December 13-14 and you can see the bond markets are starting to price in some of these interest rate increase as US.Then we don't know about the European Central Bank (ECB) and as to what game plan it has in mind as far as the quantitative easing (QE) program is concerned. Presumably, it will continue to buyback the bonds which it had been doing for some time but there are some thinking as to when do you unwind the QE program, which is on currently.Finally, you also have a Italy referendum, which is coming up somewhere around December 4 if I remember correctly. So, you have a number of events out there, it is very hard to forecast any of them and each of them is meatier in its own way.If all the four goes against whatever is the conventional wisdom at this point in time then you could look at a serious correction. Hopefully, nothing of that materialises and the world goes on.Latha: Oil and gas, that is the one if anything has leadership now it is oil and gas. You are a long veteran of this space. How do you look at it, is there juice here?A: Now it has become a relative game. If you look at the likes of the downstream oil companies Bharat Petroleum Corporation Ltd (BPCL), Hindustan Petroleum Corporation Ltd (HPCL), Indian Oil Corporation (IOC), they are now trading at 10-11 times on a March 2018 earnings per share (EPS).Logically, fundamentally that is probably the valuation which these companies should trade at given the kind of return on equities (RoEs) they make and the capital expenditure (capex) intensive nature of the business but if you are looking at a market, which is trading at 16 times on a March 2018 basis some section of the market can take a call that maybe the company should trade higher. So, that is always the possibility. So, we have been quite positive on these names BPCL, HPCL, IOC. IOC is still there in our model portfolio but now they are getting to a point where I have to have a rethink on some of these names.IOC we are still okay. The gas companies structurally we are very positive about them given our big long-term theme of air pollution and gas playing a big role over there to eventually reduce air pollution in the country. So, I am quite okay with the likes of Gas Authority of India Limited (GAIL) now.Obviously in case of GAIL there is one big concern about the US liquefied natural gas (LNG) contracts but whatever math we have done if you take USD per million BTU hit because of hit, at best it is about Rs 10 EPS. So, if you look at our EPS numbers for GAIL on March 2019 basis assuming that is hewn the US contracts will kick in we have over Rs 37 EPS. Even if you take out Rs 10 which is the outside limit or the losses on this contracts, we are still looking at about Rs 27 EPS and just for the dividend it is about Rs 20.Gas company in India should trade somewhere around 15 times or even higher I would assume given the growth nature of the business. So you are looking at a stock, which on an ex-investment basis is about Rs 350, it has about Rs 130-140 of investments in a lot of downstream gas companies, Indraprastha Gas Limited (IGL), Mahanagar Gas Limited (MGL) etc. So, I am still okay with GAIL.If you remember the capacity utilisation of all the pipelines is still very low. So, you can still make a case for some of the gas companies. IOC we are fine, Reliance we are fine, BPCL, HPCL I would say less so at current levels.Latha: Petronet?A: Again we have been very big bull on this one for a fairly long time. So, the stock has done very well. At least over the last one year it is probably 70-80 percent up or something like that.We like the long term story, if I remember the numbers correctly March 2018 we should have somewhere about Rs 24-25 EPS. I can argue for a 15-16 multiple for this kind of company. So, it looks reasonably priced at current levels at Rs 370-380. But I am okay holding on to the fact that this company will still continue to grow for the next several years.The five million tonne expansion at Dahej is just complete, they will get the volume growth out of that. And as far as Kochi is concerned, clearly there is no earnings contribution. In fact, if anything there is a negative contribution because the interest and depreciation being incurred on Kochi terminal. So, still looks like a reasonably good medium-term story, maybe in the short term you may not see that much of an upside given the fact that the stocks has done very well.Anuj: You have been a long tracker of telecom space as well. What have you made of the auctions and the fact that these stocks have destroyed wealth or have been relative underperformers for so many years now, do you think that underperformance continues or are you tempted to look at Bharti and Idea positively now?A: On the first one as far as the auction is concerned, it turns out to be a reasonably good outcome for the telecom companies. None of the companies have bid aggressively. Our expectations are about Rs 700 billion of money coming to the government as part of the spectrum. Rs 660 billion looks very much in line. What the operator has done is very smartly just put in additional spectrum wherever they required, they haven't gone overboard in acquiring spectrum for the sake of acquiring spectrum. So, this is a good outcome as far as the industry is concerned.The second way to look at this auction is very clearly the industry is consolidating around four players which is Bharti Airtel, Idea, Vodafone incumbents and of course you have Reliance Jio. If you look at the other companies they just bid here and there but clearly this market is moving to a four player market.This also leads me to the second part of the question in a sense that if this market eventually becomes the four player market hopefully at some point this becomes a much more rational market in terms of pricing. So, obviously in the short-term you are seeing the negative impact of Reliance Jio coming in very aggressively which is obviously deterring investors into taking a positive call on the sector.But assuming this industry consolidates into a four player market eventually which is the way it will go given the fact that these are the only four serious players left in the sector. Over the next 6-12 months whenever the first impact of Reliance Jio is absorbed that is when you probably start seeing some pricing power coming back to the industry. Also, keep in mind the fact that Reliance Jio has made a big investment and it has to at least make some return on its investment. So, how long can Reliance Jio also be a very rational player, I would discount that.So, the short-term negative sentiment, which is there in the sector will probably continue for some more time and as we go along for the next 6-12 month period, we will start seeing some investor that is starting to take some more positive call on that sector. Based on the fact that the longer term sector prospects will look better given the structure of the market in a sense it will become a four player market._PAGEBREAK_Latha: You began by speaking about bond yields. There were some people on the channel who were even talking about 6 percent yields in the next one year. How do you operationalise that as an investor and I wanted to ask you, metal prices have also gone up, we saw a lot of companies backing steel, that also should be salutary to the non-performing assets (NPA) picture for banks. Any public sector undertaking (PSU) banks you will pick up generally, the interest rates?A: Yes, lots of questions here. First of all on the interest rate, clearly, that will depend on how inflation pans out. We are looking at inflation of about 4.5 percent by March, 2018 and if that is the case, obviously, that is subject to a reasonably good monsoon. If we assume that we get to 4.5 percent by January-March 2018 period, then you probably can see a 75 basis point (bps) cut from where we are and the math is pretty simple. If you have a consumer price index (CPI) inflation above 4.5 percent, you add about 125 bps, which is what RBI is now hinting at in terms of the real interest rate.So, you are looking at a three-month table rate of about 5.75, which means the policy rate can be in the range of 5.5 percent. Current policy rate is 6.25 percent. So, you can get about 75 bps cut. So my sense is if inflation remains in this 4-5 percent band which is what we are looking at for most of the second half, it will fall pretty dramatically in the next few months eventually down to somewhere slightly below 5 percent. You could get a 25 basis point cut somewhere in the second half of this fiscal year probably in the January to March calendar, maybe in the February meeting.Subject to a decent monsoon and no real negative impact coming from Seventh Pay Commission implementation, I am ignoring the house rent allowance (HRA) part, because that is purely statistical. That does not matter as far as underlying inflation is concerned and goods and services tax (GST) -- no real negative impact I would think. 10-20 basis points we can absorb. We could probably see another 50 bps cut in fiscal 2018 also. So, that is the view on interest rates.If you look at our portfolio, we have a huge amount in utilities, NTPC, Power Grid which are anyway proxy bond plays in a way. Then you have GAIL, which is a growth story as I discussed earlier and also, reasonably steady business which again benefits from lower interest rates given the fact that it slowly turns out regulated as part of the business at least. So, we already have over 12 percent, which are fairly sensitive to interest rates in that sense and again, we have a huge amount of banks in our portfolio.Now if you look at the other thing, which you raised about metal prices having gone up, yes that is clearly the case and also at the same time, given the fact that you have antidumping duties in place in India, the profitability of the steel sector will start to look a little better. So, accordingly, over the last 3-4 months, we have included State Bank of India (SBI) in the portfolio. Now it is up to about 5 percent in the model portfolio, which I run. Again, it is a fairly cheap stock.Let us look at the math over here. Rs 40 is the value of all the investments put together. You take out Rs 40 from Rs 250-260, you are looking at Rs 210-220 and March 2018, adjusted book value -- that is adjusted for all the net NPL -- is somewhere around Rs 230-240 is what we are looking at. So, it is still trading at below one time book. SBI at least does not seem to have that level of exposures to some of the troubled sectors. If you look at power, it has high exposure, but that is mostly to the companies like NTPC, Power Grid, etc. Steel, it is already sitting at 17 percent NPL so it is already recognised a fair bit of NPLs out there.So SBI, in that context looks pretty decent and obviously, it will also benefit from lower interest rate as far as the bond portfolio is concerned.Anuj: We are heading into earnings season now. I was reading your strategy report yesterday. You expected 10 percent year-on-year (Y-o-Y) growth excluding banking for Sensex and including banking about 4 percent. So, your overall thoughts on how the overall earning season will pan out and what are your earnings per share (EPS) estimates now for the Sensex and Nifty now?A: If you look at this quarter, it is going to be a little bit funny quarter. It depends on which universe of stocks you are looking at. So, if I look at the BSE Sensex, we are only looking at 4 percent growth because there is a negative impact of the banking sector on the numbers. So, you have SBI, you have Axis and ICICI, all report a big decline in profits on a Y-o-Y basis between 20 and 30 percent given the high amount of loan loss provision, which each of the banks will show.In case of Axis Bank and ICICI Bank specifically, obviously, the slippages will also be on the higher side. Probably that will not be the case for SBI. So, that is what is pulling down the numbers. If you look at Nifty-50, the numbers look slightly better because you have BPCL in there which will show a reasonably good Y-o-Y growth. So, we are looking at somewhere about 7 percent growth for the Nifty-50 index.If I look at the Kotak Institutional Equities (KIE) universe and we cover about 186 stocks now, there we are looking at a 15 percent Y-o-Y growth in the net profits and the reason for that is that also includes HPCL and IOC, which will have a huge swing in the profits. If I remember correctly, IOC had somewhere about Rs 600 crore of net loss last year, that is Q2 of FY16 because of large advantageous losses. This quarter, it will report somewhere about Rs 36 million of net profits. So, it is a massive swing over there. Same is the situation for HPCL.So, as I was saying, depending on which universe you are looking at, the numbers will be somewhat different, but the broad message is because of the NPL problem, which is still in the banking system loan loss provision will continue to be on the higher side and that is what is pulling down the overall numbers for the BSE, Nifty as also for our coverage universe.The next quarter numbers will start to become slightly better because even the base quarters you had reasonably high amount of loan loss provision. Recollect, Bank of Baroda (BoB) had a big loss in the third quarter of last year. So, the Y-o-Y comparison will start becoming a lot better as we go forward.Now coming to our EPS numbers for Nifty, if I remember correctly, we have about Rs 440 for March 2017, Rs 540 or so for March 2018 and somewhere about Rs 620 for March 2019. So, if you look at our numbers, we are looking at 15 percent growth for March 2017, 20 percent for March 2018 and about 14-15 percent for March 2019.