Q&A: Rahul Singh, Standard Chartered Securities (India)

'Consumer demand fall key risk to 2012-13 earnings'

Consumer demand could see some sluggishness, believes Rahul Singh, head of research at Standard Chartered Securities (India). In an interview with Sheetal Agarwal, he says markets could stabilise at 16,000 levels by September 2012. Edited excerpts:

When do you expect Indian stock markets to stabilise?
Our September 2012 Sensex target is 16,000, based on a price-to-earnings (P/E) ratio of 12 times 2012-13 estimated earnings, the mean of valuations witnessed during the last prolonged slowdown of 2001-04. We believe the market is not in a ‘safe buy’ zone, given risks of a sustained slowdown and that the risk-free rate (10-year G-sec yield) at around nine per cent is 200 basis points higher than what we saw during 2001-04. The potential inflationary pressure from a weaker rupee is an additional risk, if commodity prices don’t decline enough to compensate.

What’s your view on foreign institutional investment (FII) flows?
What we are witnessing is a weaker rupee triggering an additional spurt in FII outflows. We believe things will settle down a bit as valuation stabilises near the 12-times P/E multiple and as the rate pause takes effect.

How do you rate the September quarter earnings? When do you expect the margin pressure to ease?
Our earnings per share forecasts for 2011-12 and 2012-13 stand at Rs 1,159 and Rs 1,314, respectively. However, the earnings, hit on account of forex related losses witnessed in the second quarter, are being broadly balanced by gains in some sectors, most notably information technology (IT) services, and some large companies like Reliance Industries, which have dollar-denominated revenues.

We believe there could be margin pressure on the consumer discretionary side, as it becomes increasingly difficult to pass on cost pressures, given risks of softening demand from the end-consumer. In fact, the incremental risks to 2012-13 earnings now reside more in the domain of consumer demand and how it copes with elevated interest rates and economic slowdown. The consumer demand has so far held on nicely, except for rate-sensitive segments like cars and real estate. But the risk of it spreading to other discretionary segments has risen recently.

What are the promising themes? And, what sectors would you avoid?
We like consumer staples, as some segments/companies (like HUL) are benefiting from strong trends in uptrading and penetration, offsetting any impact of economic slowdown on consumer spending. While staples have been a huge ‘outperformer’ in this market and valuations are demanding, we still feel comfortable as long as you are in the right segments. We also like cement, as prices and profitability are being supported by pricing discipline, necessitated by higher costs and break-even. It also remains a clean option to play the pick-up in infrastructure capex. We think capital goods and public sector banks will continue to face challenging times over the next six-nine months. While there are limited opportunities in the listed space, e-commerce and education seem to be attracting some attention.

Which sectors will gain or feel the heat of a falling rupee?
Export-oriented sectors like IT services and some large companies will benefit on the top line and bottom line. Other than that, we really have to evaluate this issue on a company-by-company basis. So, things like which company has the requisite pricing power to pass on the higher imported cost of raw materials or what is the forex-denominated debt on the balance sheet and how much of it is hedged, etc.

How do you think the markets stack up vis-a-vis its peers in the emerging markets?
The poor performance of China and India this calendar year has led many investors to question the attractiveness of these markets and the growth premium being enjoyed. On a relative basis, the challenges facing China are bigger relative to India. We focus on structural as opposed to cyclical issues here, believing these are the long-term drivers of shareholder returns. Over the long term, India stands out ahead of China, given the closure of demographic window for China; China’s labour force is forecast to contract from 2015, whereas India’s will continue to expand. Leveraging the demographic window in India, however, is not a foregone conclusion. In the absence of policies to promote education, population control and prudent macro economic regulation, the potential benefits can be lost. Pushing forward polices to ensure this window stays open are a challenge. Nevertheless, in contrast to China, India’s growth agenda has always had setbacks.