As markets brace up for any negative surprises from the June quarter results, Rakesh Arora, managing director and head of research, Macquarie Capital, tells Puneet Wadhwa the current valuations do not appear stretched. However, India can be downgraded to non-investment grade if the government doesn’t address key issues. Edited excerpts:
The recent announcements from central banks across the globe and the European Union summit have failed to cast a lasting impression on markets. What is the road ahead for the next few quarters?
The announcements have all been focused more on averting adverse market reactions to risks emanating from Europe. These are all short-term fixes, and hence, the market reaction to such events has also been short-lived. What it does, however, reflect is the willingness of central banks to intervene in order to support markets. We expect global central banks to continue with their monetary easing stance in order to support growth.
How high is the probability of India being downgraded to non-investment grade?
We do not expect any big bang reforms to come by from the government anytime soon. However, the government may continue undertaking a series of small steps in the infrastructure space, announce clarity on GAAR (General Anti Avoidance Rules), raise FDI (foreign direct investment) limit, etc.
Over the last few months, Standard and Poor’s (S&P) and Fitch have revised their sovereign outlook on India from stable to negative. This is a wake-up call for the government to act on both fiscal consolidation and creating conducive investment climate. If we don’t see any action from the government in addressing these bottlenecks over the next three-four months, we might see the risk of India being downgraded to non-investment grade.
Do you think Indian markets could go back to the 2008 levels again? Can you highlight a few pockets where the risk-reward ratio still seems favourable?
Going back to 2008 level appears unlikely. The events in 2008 were sudden, unprecedented and there was a lag between those events and the eventual monetary support. Earnings expectations, too, were overly optimistic and had to be scaled down sharply.
Today, central banks are much better prepared to step in and support markets in case of such adverse events, and earnings expectations are reasonably muted. Specific to India, current valuations don’t look stretched and the macro weakness is well factored into earnings numbers.
We think risk-reward remains favourable in infra sectors, particularly power. The government has taken some steps and shown its intent to revive infra activity. Banks, too, look attractive as asset quality issues are well-known and valuations are at reasonable levels.
Have the last couple of months made you tweak the earnings estimates of India Inc for the June quarter and the remaining half of FY13? Can you elaborate on your stance regarding the banking sector?
Earnings estimates have come off significantly over the past six months. We expect a growth of 10-11 per cent in FY13 EPS (earnings per share) for the Sensex. The first quarter results of FY13 would be important, as they would set the tone for the earnings revision cycle. As regards the banking space, the concerns regarding asset quality have been known since the past few quarters. Banks surprised positively in the March quarter, leading to overall better-than-expected FY12 numbers.
We believe large-cap banks are likely to be in a better position to manage asset quality issues. We think the street is already building-in weak credit growth, which is well reflected in valuations. ICICI Bank and HDFC Bank are preferred plays in this space.
Defensive bets have done quite well recently. Do you see the momentum continuing?
India is a consumption-driven story, hence defensive bets like consumer and pharmaceuticals / healthcare will continue to do well. Their momentum would depend on the market’s risk perception which is currently on the weaker side and hence the outperformance of defensive sectors.
If policy making improves, interest rate cuts come through and global risk mitigates further, defensives would likely start underperforming. However, we do like the fundamental stories in HUL (Hindustan Unilever Ltd), ITC and Dr Reddy’s which are our preferred picks in this space and think that valuations still have upside potential.
What about the auto and metal stocks in the light of how the commodity markets may pan out going ahead?
Autos are experiencing a cyclical slowdown in demand, which is well reflected in the valuations. We prefer four-wheelers over two-wheelers, and more specifically Maruti Suzuki, which is coming off a very low base of last year and has a strong product pipeline.
We remain cautious on the metals space, but believe there will be some support coming from policy action in China. However, given the uncertainty, we prefer companies with lower commodity price risks like Coal India, NMDC and Jindal Steel and Power.
What is your view on the oil and gas space given the recent price hikes in petrol and compressed natural gas, possibility of diesel de-regulation and the outlook for subsidies?
We are an underweight “energy” sector because it has historically under-performed in a slowly improving macro-environment. Also, we expect Brent crude prices to sustain around current levels of $100/barrel.
The petrol price hikes are a positive, but we are not so optimistic about diesel price de-regulation actually happening and think that companies will have to bear the subsidy burden. Our top pick in this space is BPCL (Bharat Petroleum Corp Ltd), largely because of the rising contribution from its upcoming upstream business.