Despite the macro-economic headwinds and the policy logjam, Suresh Mahadevan, managing director and head of equities at UBS Securities (India), feels India is comfortably placed among its BRIC (Brazil, Russia, India and China) peers. However, the current equity valuations do not reflect the poor fundamentals, he tells Puneet Wadhwa in an interview. Edited excerpts:
It has been a mixed first half of 2012 that saw the markets react to the gush of liquidity and then the rally fizzled out given the macro-economic conditions. Would you like to take a chance and crystal gaze on what second half may hold for the Indian markets?
If globally things are tough, then the rule of thumb is to reduce beta; and India is a high beta market. If the global risk appetite improves, we will stand to gain. India is in a unique position as it needs foreign capital. However, the macro-economic fundamentals of the Indian economy are in a poor shape. This can be seen from the recent data such as gross domestic product, the index of industrial production figures, etc.
We think the equity market is looking ahead and may be hypothesising that things will turn for the better. The current level of equity valuation is not really reflecting the poor fundamentals we have.
So, do you see more downside for the markets in the remaining half?
Yes. If things don’t improve in India, primarily the government-led action, then I think the markets can drift lower. Despite the recent strength in Indian stocks, the next two to three quarters are likely to be challenging. The current account deficit makes India vulnerable to foreign flows, particularly if the EU (European Union) situation does not get resolved.
Is the pessimism given the economic developments justified, or are the markets and rating agencies over-reacting, and painting a doomsday scenario?
We all know that the macro-economic fundamentals are bad and the government is not taking action yet, as it still believes India can grow at seven per cent. Therefore, I don’t think the rating agencies are doing anything wrong. In fact, the rating agencies are saying if the government doesn’t resolve this situation, India’s rating could get downgraded.
What is your assessment of the quantum of portfolio flows that India can attract in second half of 2012 among its BRIC and emerging market (EM) peers?
BRIC is not in a great shape and this is good news for us. Brazil has its own set of problems and Russia is largely commodity-driven. China's economic growth is slowing. So, as compared to its BRIC peers, India seems relatively attractive.
What are you advising your clients?
We are advising our clients to stay defensive. As a strategy, we are overweight on defensive sectors such as consumer staples, pharmaceuticals, power and telecom. Our top picks are Hero MotoCorp, Idea Cellular, Infosys, Federal Bank and TTK Prestige.
Can you elaborate your stance with respect to the underweight sectors?
For cement, the risk-reward ratio is not favourable given the onset of monsoon, continued cost pressures and the adverse impact of the Competition Commission of India’s report. We expect the industry utilisation to remain weak in FY 2012-13 at about 76 per cent. The increase in risk to earnings is not reflected in the current share prices.
The biggest overhang on India’s banking sector is the weak macro-economic outlook. Therefore, banks, especially the PSUs, could face headwinds in the near term. However, we think valuations already reflect asset quality stress. Our top picks are ICICI Bank, SBI (State Bank of India), Federal Bank and YES Bank.
No policy measures on fuel deregulation/subsidy in a tight fiscal scenario with a weak rupee, the failure to address the gas shortage issue and an increased regulatory action have made us adopt an underweight stance on the energy space. We believe sector outperformance will be event-driven—fuel/gas price hikes and KG-D6 gas visibility. We are positive on Cairn India and Reliance Industries as we believe their risk-reward is attractive.
Do you see more pressure on earnings over the next few quarters for India Inc, or is the worst behind us? How have the rupee depreciation and inflation levels made you tweak your estimates?
EMs will be impacted if the risk appetite is low. Markets always react to “at the margin” changes. Currently, there is some optimism built around Manmohan Singh and at a personal level, I don’t expect much to happen. So, we will have to wait and see how things pan out.
The earnings momentum has been weak since quite some time now, at least since a year or so. Going ahead, I feel the earnings downgrades will be limited.
As regards the rupee, it has already depreciated nearly 25 per cent in the last one year. A fall in inflation should stabilise the currency, but the trade gap and lack of growth is a drag. We think the sectors that are positively impacted by rupee depreciation are IT services, pharmaceuticals and materials. Infrastructure is one sector that should be adversely impacted.
Are there any specific companies that are affected by adverse currency moves?
Companies that are likely to be negatively impacted by the depreciating rupee are Suzlon Energy, Asian Paints, Adani Enterprises, GMR Infrastructure, GVK Power and Infrastructure, Adani Ports and Special Economic Zone, Adani Power and Lanco Infratech.