Are you a bit surprised with the recent market strength? Indian markets have gone up about 5% in 5 days and fundamentally nothing has changed for India.
Not really. Valuations have started a bit to look quite okay in several of the large cap names. Remember the index had come off before this recent rally, may be 10-12% from the peak, if you saw in November, but then a lot of stocks have corrected a lot more. Many of the stocks have corrected and these are very high quality recent names anyway from 20% to even 50% in some cases.
So I assume there was some amount of bottom fishing that would emerge at some point of time and there have been two positive triggers in the short term. One clearly is that there is a lot more faith coming back into the technology sector; and about two weeks back there were a lot of concerns about the earning numbers which have been talked about. Revenue growth which has been talked about may not come out to be as strong as what people are looking at.
Suddenly you had very strong numbers coming from Accenture with lot of experts reinforcing the view that demand environment for the technology sector is very strong and in fact it is a case of price improvement as far as the sector is concerned, which has not been the case for the last couple of years. So we have mostly relied on volume growth in this sector and remember it is a big sector in terms of market weight. So if it does well, then clearly you will see overall index also doing well.
The other thing which has happened is this entire macro issue, more because of the government borrowing programme which looks a little bit better, even the numbers may still be on understated side and we will have to wait and see where crude prices will settle down to hit the final grip on the eventual fiscal deficit and the government borrowing programme. But so far it looks like it is not going to be very large and whatever government borrowing programme numbers have come out, they look pretty much within expected range.
This has resulted in some amount of improvement in sentiment for the banking sector and remember the valuations there were quite cheap, most of the PSU banks have been hovering at around 1 time small midcap PSU banks, larger ones would be about 1.3-1.4 and then BoB is about 1.6. So we have seen a fair amount of re-rating in technology and banking names and again we have had two very large rates as far as any index is concerned. If we do well, the market also does well.
Is it time to perhaps take a re-look at the telecom space and if so, which one would you pick?
I would like to have a re-look in terms of selling the sector. If there is a lot more increase from where we are, I do not think fundamentally much has changed as far as the telecom sector is concerned. Yes maybe there is some amount of stabilisation as far as price competition is concerned. But the price competition move from virtually visible forms of price cuts to more. I would say less visible forms of price reduction as far as the postpaid segment is concerned where it does not get advertised too much.
It is still a very meaningful segment not maybe in terms of prices, but in terms of revenues and EBITDA it is a meaningful segment. If you look at Bharti's case, about 25% of their EBITDA comes from the postpaid segment and clearly you are seeing voluntary price reductions in the postpaid segment. So that is one concern which we have that I do not think we have seen the end of price competition, although the pace may be stabilised now.
The second thing is, a lot of faith getting built in around African operations over the next few quarters as far as Bharti is concerned. Those expectations are probably a little bit ahead of actual turnaround and we have to wait and see whether that is really the case because Africa is not a very easy market to crack and remember there is fairly stiff competition out there in form of MTN and especially in market matter, Bharti does not have really a strong position.
Thirdly, I do not think we have seen the end of regulatory confusion as far as the sector is concerned and I assume the government has to be seen doing something in the 2G scam case. I would not rule out large penalties on the new 2G operators who probably flouted some norms in terms of getting a license or have not rolled out the operations as far as rollout obligations are concerned. Even for the old operators, I put it across the government in terms of increasing the spectrum charges for spectrum beyond 6.2 megahertz. So that will have a one-time negative impact on operators. If this rally continues for some more time, I would be looking at exiting the space.
What about NELP-9? Would you call it successful considering they went all across the globe Calgary, Houston even Moscow this time with just two foreign players?
Not at all, at least looking at in terms of foreign participation that was an interest or the intent of the government. But that has been the case for sometime now starting for NELP. I have not seen too much of foreign participation, but I do not think we should get too frustrated. In NELP-9, I think a lot of this block are recycle blocks. So that obviously puts a question mark on the prospectivity of the blocks.
The second issue is that large E&P players will not come under exploration space in a new country. Most of them would look at the exploration risk to be taken by the smaller players. And then once some discoveries are made and when it comes to actually spending money in terms of development where you have large requirements of capex, then only you will see the foreign guys coming in like the Mobil , Shell, BP , etc.
It is frustrating that India has not been blessed geologically, but I guess we will have to live with that especially if you have another prospects available globally. We have West Africa, the entire area from Ivory Coast down to Equatorial Guinea, including Nigeria. Obviously that will be prospective and there is a lot interest. Russia has been opening up slowly. Central Asia has always been prospective. So in that context India will not stack up very well. So unless and until you see a few meaningful discoveries only then you will see interest coming back to India.
For the year 2012, would you buy commodity owners or would you buy commodity consumers?
I would still be in favour of the commodity owners because let us look at the commodity consumer space. You have some amount of consumer staple names - you have automobiles, you have some industrial names. First of all, I am not very comfortable with the valuations of the consumer staple company to start with and you were also seeing a fair amount of new competition coming in every segment. Earlier it used to be on nicely carved out segments between the larger players, but you have this situation where every player is getting into more segments which means into the territory of some other strong players.
Price competition is going to be a lot stiffer than what we have seen in the consumer staple space for the last 5-6 years. Most of these companies have seen a very big expansion in EBITDA margins over the last 5 years. There is a cause of concern as far as EBITDA margins are concerned; you will see some squeeze over there. And just not a rising from increase in commodity prices. So it is at a time when you have limited pricing power, you are seeing raw material pricing moving up, margins are going to get squeezed to some extent. So that is one space we have some concern.
The next one is automobiles. I would say a similar situation over there seeing a lot more competition coming in every segment. So again the pricing power is limited. In most cases except from CV market and I would say the UV space and tractor space, which is where M&M operates.
Finally, if you look at industrial space, apart from the commodity price angle, you also have to worry about what is the order booking looking like and unfortunately at this point of time you are not seeing too much of improvement in the investment environment. Net-net I would stick to commodity owners at this point of time given all the other issues which are there in the commodity consumer space.
For the year gone by, Indian markets are down about 7%. Now by the time we wrap the calendar year 2011, what are your expectations?
This is not very difficult or in other sense not a very easy answer because you have so many global events which you have to take into confidence. At the same time it depends largely on where the food prices are heading. If we have food prices coming off to about, say, 85 to 95 levels in India, then it looks like a very strong candidate in that case. But if we have food prices hovering at about $115, then the macro situation will not improve for India.
But you have some serious implications if food prices continue to be around $115 a barrel. When you are looking at much higher Government of India borrowing programme, which has its own implications for interest rates or if you try and raise prices to match the increase in food prices, then you are looking at much higher inflation because it cannot be good for Indian macro situation. So that is one part of the equation which we have to consider that the macro does not look that great at this point of time.
Not really. Valuations have started a bit to look quite okay in several of the large cap names. Remember the index had come off before this recent rally, may be 10-12% from the peak, if you saw in November, but then a lot of stocks have corrected a lot more. Many of the stocks have corrected and these are very high quality recent names anyway from 20% to even 50% in some cases.
So I assume there was some amount of bottom fishing that would emerge at some point of time and there have been two positive triggers in the short term. One clearly is that there is a lot more faith coming back into the technology sector; and about two weeks back there were a lot of concerns about the earning numbers which have been talked about. Revenue growth which has been talked about may not come out to be as strong as what people are looking at.
Suddenly you had very strong numbers coming from Accenture with lot of experts reinforcing the view that demand environment for the technology sector is very strong and in fact it is a case of price improvement as far as the sector is concerned, which has not been the case for the last couple of years. So we have mostly relied on volume growth in this sector and remember it is a big sector in terms of market weight. So if it does well, then clearly you will see overall index also doing well.
The other thing which has happened is this entire macro issue, more because of the government borrowing programme which looks a little bit better, even the numbers may still be on understated side and we will have to wait and see where crude prices will settle down to hit the final grip on the eventual fiscal deficit and the government borrowing programme. But so far it looks like it is not going to be very large and whatever government borrowing programme numbers have come out, they look pretty much within expected range.
This has resulted in some amount of improvement in sentiment for the banking sector and remember the valuations there were quite cheap, most of the PSU banks have been hovering at around 1 time small midcap PSU banks, larger ones would be about 1.3-1.4 and then BoB is about 1.6. So we have seen a fair amount of re-rating in technology and banking names and again we have had two very large rates as far as any index is concerned. If we do well, the market also does well.
Is it time to perhaps take a re-look at the telecom space and if so, which one would you pick?
I would like to have a re-look in terms of selling the sector. If there is a lot more increase from where we are, I do not think fundamentally much has changed as far as the telecom sector is concerned. Yes maybe there is some amount of stabilisation as far as price competition is concerned. But the price competition move from virtually visible forms of price cuts to more. I would say less visible forms of price reduction as far as the postpaid segment is concerned where it does not get advertised too much.
It is still a very meaningful segment not maybe in terms of prices, but in terms of revenues and EBITDA it is a meaningful segment. If you look at Bharti's case, about 25% of their EBITDA comes from the postpaid segment and clearly you are seeing voluntary price reductions in the postpaid segment. So that is one concern which we have that I do not think we have seen the end of price competition, although the pace may be stabilised now.
The second thing is, a lot of faith getting built in around African operations over the next few quarters as far as Bharti is concerned. Those expectations are probably a little bit ahead of actual turnaround and we have to wait and see whether that is really the case because Africa is not a very easy market to crack and remember there is fairly stiff competition out there in form of MTN and especially in market matter, Bharti does not have really a strong position.
Thirdly, I do not think we have seen the end of regulatory confusion as far as the sector is concerned and I assume the government has to be seen doing something in the 2G scam case. I would not rule out large penalties on the new 2G operators who probably flouted some norms in terms of getting a license or have not rolled out the operations as far as rollout obligations are concerned. Even for the old operators, I put it across the government in terms of increasing the spectrum charges for spectrum beyond 6.2 megahertz. So that will have a one-time negative impact on operators. If this rally continues for some more time, I would be looking at exiting the space.
What about NELP-9? Would you call it successful considering they went all across the globe Calgary, Houston even Moscow this time with just two foreign players?
Not at all, at least looking at in terms of foreign participation that was an interest or the intent of the government. But that has been the case for sometime now starting for NELP. I have not seen too much of foreign participation, but I do not think we should get too frustrated. In NELP-9, I think a lot of this block are recycle blocks. So that obviously puts a question mark on the prospectivity of the blocks.
The second issue is that large E&P players will not come under exploration space in a new country. Most of them would look at the exploration risk to be taken by the smaller players. And then once some discoveries are made and when it comes to actually spending money in terms of development where you have large requirements of capex, then only you will see the foreign guys coming in like the Mobil , Shell, BP , etc.
It is frustrating that India has not been blessed geologically, but I guess we will have to live with that especially if you have another prospects available globally. We have West Africa, the entire area from Ivory Coast down to Equatorial Guinea, including Nigeria. Obviously that will be prospective and there is a lot interest. Russia has been opening up slowly. Central Asia has always been prospective. So in that context India will not stack up very well. So unless and until you see a few meaningful discoveries only then you will see interest coming back to India.
For the year 2012, would you buy commodity owners or would you buy commodity consumers?
I would still be in favour of the commodity owners because let us look at the commodity consumer space. You have some amount of consumer staple names - you have automobiles, you have some industrial names. First of all, I am not very comfortable with the valuations of the consumer staple company to start with and you were also seeing a fair amount of new competition coming in every segment. Earlier it used to be on nicely carved out segments between the larger players, but you have this situation where every player is getting into more segments which means into the territory of some other strong players.
Price competition is going to be a lot stiffer than what we have seen in the consumer staple space for the last 5-6 years. Most of these companies have seen a very big expansion in EBITDA margins over the last 5 years. There is a cause of concern as far as EBITDA margins are concerned; you will see some squeeze over there. And just not a rising from increase in commodity prices. So it is at a time when you have limited pricing power, you are seeing raw material pricing moving up, margins are going to get squeezed to some extent. So that is one space we have some concern.
The next one is automobiles. I would say a similar situation over there seeing a lot more competition coming in every segment. So again the pricing power is limited. In most cases except from CV market and I would say the UV space and tractor space, which is where M&M operates.
Finally, if you look at industrial space, apart from the commodity price angle, you also have to worry about what is the order booking looking like and unfortunately at this point of time you are not seeing too much of improvement in the investment environment. Net-net I would stick to commodity owners at this point of time given all the other issues which are there in the commodity consumer space.
For the year gone by, Indian markets are down about 7%. Now by the time we wrap the calendar year 2011, what are your expectations?
This is not very difficult or in other sense not a very easy answer because you have so many global events which you have to take into confidence. At the same time it depends largely on where the food prices are heading. If we have food prices coming off to about, say, 85 to 95 levels in India, then it looks like a very strong candidate in that case. But if we have food prices hovering at about $115, then the macro situation will not improve for India.
But you have some serious implications if food prices continue to be around $115 a barrel. When you are looking at much higher Government of India borrowing programme, which has its own implications for interest rates or if you try and raise prices to match the increase in food prices, then you are looking at much higher inflation because it cannot be good for Indian macro situation. So that is one part of the equation which we have to consider that the macro does not look that great at this point of time.
The second thing is what can India do and what kind of policy is made to improve sentiment for India which has not been that great as of now given all the issues on corruptions. If you see starting from whenever elections get over, that is mid of May, you start seeing policy makers announcing a slew of the latest projects, improvement in governance, etc., then again you could see some rapid improvement in the investment environment. The good point is as of now at least earnings numbers look reasonably comfortable.
We are looking at around 18% growth in the earning numbers for fiscal 2012 and given the composition of India's earnings, I am not too worried about risk arising from high inflation because of high commodity prices. On the other hand, high interest rates will affect the earning numbers of some of the high debt sectors like real estate, infrastructure owners, telecom, equities etc. Net-net you have a funny situation of a bad macro.
We will have to wait and see which way this two things dominate. If the macro improves at the same time, then suddenly the market could get related on the fundamental basis. If I just add up the fair value of the BSE 30 stocks, then I'll get a valuation target of about 20500 as the fair value of the market.
Your large cap or your top large cap ideas for the year 2012 then?
Anything in the technology space. So you looked at a combination of Infosys or TCS and in the banking space I would look at any of the large PSU banks like BoB, PNB , Indian Bank , whatever combination you want to own. SBI and I would look at ICICI Bank on the private side.
We are looking at around 18% growth in the earning numbers for fiscal 2012 and given the composition of India's earnings, I am not too worried about risk arising from high inflation because of high commodity prices. On the other hand, high interest rates will affect the earning numbers of some of the high debt sectors like real estate, infrastructure owners, telecom, equities etc. Net-net you have a funny situation of a bad macro.
We will have to wait and see which way this two things dominate. If the macro improves at the same time, then suddenly the market could get related on the fundamental basis. If I just add up the fair value of the BSE 30 stocks, then I'll get a valuation target of about 20500 as the fair value of the market.
Your large cap or your top large cap ideas for the year 2012 then?
Anything in the technology space. So you looked at a combination of Infosys or TCS and in the banking space I would look at any of the large PSU banks like BoB, PNB , Indian Bank , whatever combination you want to own. SBI and I would look at ICICI Bank on the private side.
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