Vote-on-account unlikely to address tax issues: Kotak

On the deregulation of oil and gas prices front, he feels on the paper both Oil India and ONGC stand to benefit unless government decides to cap the net realised price for ONGC to provide for the subsidies of the fertiliser segment.

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Below is the verbatim transcript of his interview on CNBC-TV18

Q: What have you made of the Reliance numbers and how should investors approach the stock going forward? One understands gas output has clearly bottomed out and will start increasing next year?

A: The numbers are quite good. Compared to about Rs 52 billion which we were looking at the net level, net profit came at Rs 55 billion that is about 6 percentage points higher than what we had built in. Some of the beat was at the operating level with refining segment doing slightly better than our expectations and of course other income was on the higher side than what we had built in - that accounted for the positive surprise at the net income level.

Going forward the stock does have some triggers, a gas price increase that is now known and factored in and hopefully we will see some production ramp up by the end of this year to maybe about 15 million cubic meters per day. So as far as 2015 numbers go we are looking somewhere about Rs 78 of EPS.

The more interesting thing in Reliance is what kind of earning numbers they assume for fiscal 2017 when the two new core projects in petrochemicals and refining come on-stream and how quickly does the market start discounting it? For example, based on our projection we are looking at about Rs 110 EPS for fiscal 2017, so obviously that is a very big jump from about Rs 70 for fiscal 2014 and maybe it starts getting discounted 1-1.5 years down the line. So that is the tricky thing for Reliance.

At this point of time it does not look like you have any short-term triggers, but then you have a big increase in earnings coming in three years time. So how do you play the stock? Does the stock gradually starts discounting the 2017 numbers or it is only 1.5 years down the line that people start focusing on it more seriously?

Q: There was an analyst earlier who was arguing that the lack of clarity on their telecom plans and higher capex that they may have to incur to get into the full voice service operations could actually put some pressure on the stock. Would you be worried about that?

A: We will have to wait and see how much money Reliance eventually wants to put into this business. If it is an asset-light model which it has talked about earlier, well and good, but if it is a very intense rollout with lots of upfront capex etc. then there is a cause of worry. That could be a little bit of a dampener.

However, having said that, in our models we actually ascribe zero value for the telecom business. Of course the market will be worried if you see a lot of money being raised for the telecom business and being invested. So let us see we will get some idea on Reliance's plans when the actual bidding for the new telecom spectrum takes place.

Q: How are you approaching Oil and Natural Gas Corporation (ONGC)? There was some cheer when the gas price hike was announced, but looks like that is only going to go back to government's coffers.

A: As you have said nobody knows what is the net benefit to the upstream oil companies of the gas price increase or even of continued monthly diesel price increases that we are seeing. So on paper both Oil India and ONGC should be big beneficiaries of any move towards deregulation of oil and gas prices. Theoretically, if you look at ONGC for example from USD 4.2/mmbtu you are going to USD 8/mmbtu assuming there is no change in royalty and the government does not take any money from ONGC, the EPS number would go up to the extent of about Rs 11, so that is the kind of upside one is looking at, that is about 30 percent in earnings terms.

However, there is a concern that the government may cap the net realised price for ONGC to provide for subsidies for the fertiliser segment. We have been arguing to some extent that it makes more sense for the government to allow Oil India and ONGC to realise the full market prices, because the government itself is going to be a big beneficiary of higher revenues and taxation if Oil India and ONGC make higher revenues.

In four ways the government will stand to benefit - that is higher royalty, higher dividends, higher dividend distribution tax and income tax and in fact the government can recover somewhere about Rs 120 billion from higher revenues and profits of these two companies which can easily fund any increase in subsidies for the fertiliser companies. So I think that is a much better route to go rather than just capping the price at a certain artificially low level.

Q: The biggest gainer today is Wipro, up 2.5 percent post its numbers and of course the Q4 dollar revenue guidance of 2-4 percent has enthused some on the street and it has been multi quarters of an improvement in margins. How does it feature in the top four now and what would you do with that stock?

A: I guess it is going to be the number three, number four stock among the top four stocks in the IT sector. Nobody has any doubts about execution of Tata Consultancy Services (TCS), but having said that the stock is trading at about 20 times on March 2015 basis. People have gradually started to bite into the Infosys story and given the fact that the tailwinds are very strong based on very strong global recovery and with Europe showing signs of improvement, people are willing to take a call on Infosys no matter some of the issues with respect to the structuring etc. maybe slightly negative. So, even that stock has got rerated to about 17 times now on 2015 basis.

What we are seeing is to some extent an upward rerating of Wipro and HCL Tech now. Wipro is about 15.5 times. So I guess there is some scope for rerating over there assuming the management can show signs that it is scaling the business and execution is improving in line with numbers demonstrated by the peers. So if in the next one or two quarters that becomes visible you could see some more rerating in Wipro stock too.

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Q: What should the strategy be for investors of Hindustan Zinc (HZL)? Are you assuming that the roadblocks are out and now the sale will happen?

A: I would assume so. I guess the government requires money and there is ready way to get some money into the government coffers through a sale of 29.5 percent stake which the government owns in HZL.

Let us see how much money eventually comes.  Based on the current market price it is somewhere around Rs 160 billion, but presumably there will be some premium to that so the government could actually rake in a decent amount of money from the residual stake sale in HZL.

If you look at earnings numbers of this company it is going to be somewhat flat for another one or two years because there are some issues in production ramp up in both zinc and silver in the Rajasthan mine. At about Rs 16 EPS you give about 8-9 multiple, you have small upside from current levels.

Q: The vote on account has been confirmed that may take place on 17th this time around. What is your expectation from the vote on account in terms of any kind of tax changes, what may come through and what should the market basically look out for?

A: There is only one thing to look at in the vote on accounts keeping in mind the fact that this is not the full Budget presentation so we are not going to see any changes in terms of policy direction or in terms of taxation rates etc. I guess it is more a presentation of the Budget for FY14, so the one number which the market would be looking at very closely is the fiscal deficit number. How much within 4.8 percent that number is, the Finance Minister is committed to meeting that 4.8 percent target, so we will have to wait and see how that comes about. How much of expenditure is cut, specially planned expenditure and how much a roll forward of expenditure takes place next year. So I guess within the broader 4.8 percent or whatever number the revised numbers may reveal we will have to see what is the contours as to how that number has been arrived at.

Q: How are you going to approach markets? Is there more juice? Will we get past the 6400 range? If yes by how much or will we remain a prisoner to this range?

A: You have to watch out for two things, one is what is the trajectory of inflation in the next few months. We are looking at some amount of discretionary trends than a sharp decline in inflation by September to November of 2014. it is obviously starting somewhere around May-June we will see a steep correction in both wholesale price index (WPI) as well as consumer price index (CPI) and assuming the numbers are correct we are looking at WPI falling as low as 4 percent by around September-October of 2014. If that is the case I would assume we have a fair bit of leeway for the Reserve Bank of India (RBI) to act on the monetary side.

So that is something to keep an eye on which could be positive for interest rate sensitive names in the auto and banking sectors.

The second thing to focus on is the national elections which will take place in April-May of 2014 and outcome of that. If we have a stable government post the national elections which focuses on continuation of economic reforms such as fiscal consolidation, improvement in investment cycle etc. I think this market would pick up in the second half and you could see some of the domestic cyclical sectors finally starting to perform.

At this point of time I guess till the time the selection thing is out of the way market is probably going to be somewhat range bound. Focus will continue to be on outsourcing names in IT and pharma and given the fact that those names have run up quite a lot, if you look at the performance in the last whichever period 1 month, 3 months, 6 months, 9 months 12 months they have been outstanding performers and of course the stocks have got rerated quite significantly, one of the points which we were discussing earlier on IT as to how TCS has already moved to about 20 times in March 2015, so the scope of rerating maybe somewhat limited in these names which could probably cap the upside as far as overall market is concerned.

So this market movement if and when it happens will be based more on domestic cyclicals performing and that will depend on formation of a stable government and decline in inflation.