The markets have been choppy in the recent past due to domestic concerns regarding rising rates and slower growth. Also, a pick-up in economic growth in the US is making it attractive. In this backdrop, Jitendra Kumar Gupta, spoke to Rahul Singh, managing director and head of equity research India at Standard Chartered Securities India for his views on these developments and the outlook on earnings and the markets. Edited excerpts:
What are your views on the recent correction in the markets?
I think probably the equity investors are saying look the US and European markets are not looking that bad, let me reduce some weightage in India, as the risks have increased here. Also, as a result of the expected rise in interest rates (our forecast for the ten year bond yield is 8.5 per cent) the risk free rates for India have gone up a bit and there is also a slight increase in the risk premium due to political and currency risks. As a result, the cost of equity has gone up slightly. So there are two risks. First, for the next financial year the earnings growth might slow down and the cost of equity might go up. Both put together may have an impact on the price earnings ratio of the broad market. Even if there is a small risk to earnings slowing down, it is natural for investors to reduce the weightage and then take a more informed call later in the year.
How could the Sensex trade for the rest of the year?
The consensus EPS for the Sensex is Rs 1,270 in 2011-12 and Rs 1,470 in 2012-13 . Even if we assume a five per cent downside risk to earnings, we are talking of an EPS of Rs 1,200 for the next year and Rs 1,400 in 2012-13. Let us also assume that investors are willing to give a lesser PE multiple, as a result of higher risk and increase in cost of capital, which could be 15 times forward earnings as against the 17 times earlier. Fundamentally, Rs 1,400 EPS and a multiple of 15 times still gives us a Sensex of 21,000 by the end of this year. But, the market could trade sideways in the next three-six months, depending on how inflation behaves and interest rates move.
Do you see earnings risks in the future?
I think, because of high interest rates, some sectors might be affected more than others. Second, interest rates going up will affect the margins for everyone below the operating profit line. Similarly, credit to some specific sectors might be crunched, which too, will have their impact on the earnings. However, the risks to the consensus earnings next year may still not be very high, as we believe the growth might be supported by commodities.
Could this also have its impact on economic growth?
Next year I think the discussion should be more on the IIP than GDP, given that it is difficult to predict agriculture growth, especially with what’s happening on farm prices. On the consumer side, 0.5 per cent rise in the interest may not hit the consumer pocket too much. However, investments in the projects could get impacted.
What sectors and stocks you like?
We like commodity stocks and steel/iron ore in particular. Supply across the board is a key concern, because post 2008 crisis, a lot of projects and new investments did not take off, because of lack of funds. Now, they have started to get funds, but even in this case, the projects will come only in 2013. So, for the next two years there is no supply. Our call, therefore, is based on supply concerns and not by the Chinese demand alone.
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In automobiles, given the current environment, we think Maruti is better placed because the demand for cars is much more of a structural kind, which will not get disturbed by a 0.5-1 per cent interest rate movement. We also have a contrarian view on cement. Even though demand is taking time to manifest, capacity utilisation has bottomed out. And next year, even with a 7-8 per cent growth in demand, we see this improving. The concern we have is that demand from infrastructure is not picking up, but we have comfort in cement valuations. So, it is for someone who buys with a 12-month horizon.
We like telecom and the reason is that the sector is through its worst and if some sort of market pricing of spectrum is implemented, the cost structure of the new entrants could go up even further.
