Too much optimism over Budget; correction soon: Dimensions

He feels state-owned banks in general are better trading bets than investment bets, though a handful of them may outperform privatye sector banks. He says much of the margin expansion for companies is being driven by lower raw material costs.

Below is the transcript of Ajay Srivastava's interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.Latha: No butterflies in the stomach when you look at the market going higher and higher with each passing day?A: No, there are no butterflies in the stomach but it is very interesting to see the moths coming to the fire in the lower midcap category. It is very interesting; they need to be burnt again they will do so.Latha: We have seen some quality names as well in the midcaps going, isn't it? We were talking about even stocks like Wockhardt, TVS has seen a come back. So, is that there is also value hunting?A: There is a difference between value hunting and being overly optimistic. Some of the names you mentioned have a very checkered track record in terms of regulatory governance and in terms of performance. Actually if you look at how would you identify these guys? There is a moth to the fire. You look at the last three to five years governance, performance of these companies and you will find either the balance sheet or the management or something is seriously wrong in the companies. That is why they have been relegated to the backwaters of valuation.You can buy them provided something is changing in those stocks. Just the fact that economy is changing and foreign institutional investors (FIIs) are investing and quantitative easing (QE) is on all over the world doesn’t dictate that these will go up in the same manner.You already saw in October the correction which happened; some of the stocks, the bad ones, have still not come back to the same highs as October including some of the largecaps which tells you a story that at the end of the day whenever there is a correction the value stocks will remain where they are at least retrieve back and the other ones are going to perish and which is already seen from October to now from the lows. Some of the stocks have been distilled down 20-25 percent.

Sonia: Are you getting a sense that we are headed for a correction? You were making that point in our last interaction as well but since then things have changed for better, we have seen crude prices go lower, we have seen the macro situation improve, are you still feeling nervous about this market?A: When I say we look for a correction in the month of January, there is overly optimism on behalf of the government in the budget. I think market has kind of ignored that real economic fundamental dictating and you saw the emergency to excise increases in the oil sector, which came into the last one month. That is telling you a stress story out there. You can have all the attentions of world ever how do you spend this kind of money, you can say I want to do this, this and this but the budget is telling you the government cannot spend this money that is one.Number two, the government is banking on a trickle down theory. Of course, it can do without the distractions of parliament today but what it is also gearing up to the fact is that the trickle down theory has not worked. If the budget still sticks on to the trickle down theory, there will be huge opposition to it. So social sector allocation will be under immense scrutiny out there. So there is a lot of optimism for what the government can do in the budget, my fear is that optimism to a large extent is misplaced, the reality of the budget will look very different when it will be presented before the parliament.Latha: How do you play the market at all, do you still keep the faith and get into the capital goods and some of the not so beleaguered infrastructure names as a good two-year bet?A: If you look at it in a construct of the market, we believe that one of the sectors, which will underperform related to the market is going to be the IT sector. That should underperform the markets. So one would like to pare down the allocations to the IT sector. One would tend to increase the allocation to the large scale engineering sector at this point of time for the simple reason that any revival has to start from there. We would like to increase our allocation to the cement sector definitely because that is where the value is going to come. Automobile we will get a good share of the allocation because the cost of raw material should drop quite substantially in the months to come as the steel prices, aluminium prices trickle down into ancillaries and into lower procurement cost, either there will be expansion of margins or there will be reduction in price and therefore expansion in volumes, one of the two.So one would tend to play sector by sector and go to the stocks but be very careful that we have to remove also some sectors in the markets, like I said IT will underperform given the market construct.

Latha: What about the PSU Banks? I mean we were just discussing with Udayan as well, 65 percent year-to-date(YTD) performance by the bank index and I think the PSU bank index did even better. That is double the gains you saw in the Sensex and the Nifty. Now is it time to say that enough is enough or do you think this outperformance continues may be for another two quarters?A: Outperformance relative to the private banking sector may still continue in the select stocks for the simple reason that the valuation gap has gone up enormously. Although Udayan is little more positive than I am about these banks because really speaking these banks balance sheet are really in a bad shape. If the government is telling us let us restructure the power assets, let us restructure the infrastructure assets that is 60 percent of the portfolio. What do you want to do with a bank whose asset portfolio is 60-70 percent is restructured? What are they doing in the market? Look at the quality of the people, processes and systems. I always maintain PSU banks are a good trading opportunity, never a good investment opportunity; maybe it is totally biased. However I do not think you walk into a PSU bank, would you feel comfortable putting equity in that company? I would guess not.Latha: I am only asking you if the trading pop continues; if there is still more juice in the trading strategy.A: It is the best trading opportunity. There is a best trading juice in the opportunity and one of the best trading juice comes from, I am not being fictitious is the moment a chairman leaves you sell the stock, believe me the next result is going to bad. The new chairman, the next quarters results will be very good. You can track it down, believe me it has worked 100 percent of the time.

Sonia: Coming back to the point you were making about IT, in the last interaction we had, you told us that one should be looking at names like Tech Mahindra, Infosys, etc to buy and that was about 15-20 days back. What should one be doing now?A: I am not saying don’t hold any IT stock, I am saying the allocation should be kind of paired down to an extent. These are good quality stocks that you have named but as a sectoral allocation you want to be low on IT if you expect the market to boom up because two things are happening one is that we don’t expect the rupee to go haywire in the short-term; that is one.Two, if global economies are under whatever they are and needing QE and that is a pre-requisite to Indian market that means they are not doing well which means the demand scenario for this company is not exactly the most rosy. So, on two parameters these companies would weigh down.Three, the rerating happening in the Indian economy plus the margin expansion. The raw material cost is going down. We will see not the result in December quarter but we will see in the March quarter. At least there should be a margin expansion if not a volume expansion in most Indian companies. So, you would tend to be on the side where the margin expansion is taking place with possibility of value expansion, rerating rather than sticking and putting more money behind regular stories happening; nothing new extraordinary is happening in IT sector.It is a safe bet but I am saying for the next year you would get better buying for your buck if you are in other sector than IT.

Latha: The government or the Railway Minister is holding a meeting with some industry majors as well as some investors. He has an excellent track record of at least getting to the brass tags when he was a power minister 10-11 years ago. Never mind what happened after that and the sector got back into the mess. He has a way of going into the fundamentals and trying to set it right. How would you play this? The market knows only one way of playing it which clear is the moths to the fire logic, all of them running to the few handful of small rail stocks that is available. How would you approach it as an investor for the long haul?A: On a serious note, these companies that you spoke on about are the typically always go up pre the railway budget. It is not today, we can track it for last 5-7 years and they always correct. That has been the pattern of these companies. Not saying that this will happen again but having said that any initiative by the government and I keep saying this requires money on the table. It is nice to say, I want to see this money on the table, I want to see Railway Budget allocations because if the companies are not getting paid for the project that they do for the railways who is going to invest in it.The question really remains where is the money for this projects because no one can at least bet on these companies that they will get the best projects, they will get funding from railways or banks are going to fund. Incidentally, banks do not fund you against railway bills because there is no finality to when the payments comes.So,  question is intentions are all good but is there money on the table to do these projects and therefore is this reach of these companies? The benefit of this railway will come to the bigger engineering companies not to the so called typical names or wagon industry etc, or railway lines who have been played before. They will come to the bigger engineering sectors who have the power to have  joint ventures aboard rather than local players.