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Rupee fall largely done; see scope for pullback: Kotak AMC
21 Jun 2012 10:31 AM
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Alroy Lobo of Kotak AMC believes global events are likely to determine the market direction ahead, with issues in the Eurozone remaining the key overhang.

The BSE Sensex opened lower on Thursday, tracking the sharp selling across Asian bourses. The Nifty index came close to falling below the 5,100 mark, and the rupee was sharply lower against the dollar.

Overnight, the Fed said it was extending Operation Twist to keep long-term interest rates low. But markets were disappointed by the move.

According to Lobo, Nifty may test support levels post the first quarter results, which he feels may be disappointing. On the positive side, he says, the rupee depreciation is largely done and he sees scope for a pullback.

The rupee fell on Thursday, coming close to a record low against the dollar, as risk assets fell on disappointment about the scope of US Federal Reserve's bond purchases and after HSBC factory data from China showed a contraction.

Traders are on watch for any potential intervention from the RBI to defend the currency. However, Lobo feels, policy transmission is more important than rate cuts.

Commenting sector-specific, Lobo says, the current correction in cement stocks is a good opportunity to increase exposure in the sector.

Cement companies are under selling pressure over concerns of a penalty for alleged cartelization. "I think many investors are looking for an opportunity to buy cement," he told CNBC-TV18 in an interview.

Among other sectors, Lobo is overweight pharma on account of rupee depreciation.

He remains underweight on Reliance Industries, citing limited upside for the stock.

"We also remain cautious on the banking sector," he says adding, the NPA cycle is stillto bottom out.

Below is an edited transcript of the interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying video.

Q: Will the global liquidity carry us higher in the near term or are you circumspect?

A: I would say this market will a market of risk on and risk off. So its not going to be a market which will be trending just one way. There would be windows in between where you would get upsides and windows where you would actually get quite sharp downsides. Having said that, global events will play a bigger role in the direction of the market going forward.

Q: Two events have been put behind us with no real activity for the market. Which event do you think could determine the market direction?

A: I would say that the eurozone issues still continue to drive markets. I dont think the issues in eurozone are completely resolved. They will come to haunt the market time and again. So what we are doing is just postponing these issues. Eyes will now be focused on the forthcoming EU summit to see how Greece negotiates their bailout plan. They did mention that there would be some relaxation of austerity measures. We need to see how that works out and how do we accept it. The Spanish banking crisis doesnt seem to be out of the way.

Q: Is there a case for India outperforming other global markets because of the way crude has slipped off or you dont get that sense when you talk to many of your clients?

A: I think the key issue is the rupee. As long as the rupee stays weak or there is expectation of it depreciating further, its unlikely to see investors getting too excited particularly the foreign investors who measure the return in dollar terms. So I think what matters is growth because growth will drive capital flows into the country. Irrespective of whether the current account deficit will improve going forward, the key issue is whether we are back to the growth path.

Once they get a sense that we areback on the growth path, I think capital flows will come in and you will see the rupee getting strength. At that point in time, we would see a significant reversal in the flows in the sense you will see lot of interest of FIIs back into the country.



Q: If your call is that things are going to be volatile, what kind of range would you work with for the market especially keeping into consideration the highs that we saw in January and the lows that we saw in December?

A: In terms of domestic issues, the market definitely has a very good support level of around 15500 to 16000 levels on the Sensex, and on the upside, between 18500 and 19000. This assumes that there is no major shock globally. I think most of the domestic issues are well known. You would see some play out of this in the result season, which will be very shortly announced and by which time it could test some of the support levels that I spoke about. But post that, it would definitely depend on how the global scenario pans out.

Q: Do you think the earning season will not be great or supportive to stock prices in July?

A: I dont think the earning season is likely to be very good given the fact that growth is clearly slowing down, the impact on earnings is likely to be far more severe. Also, the rupee having depreciated, we need to see the impact of the rupee depreciation on the earnings and the balance sheets of some of our companies and that will play out in the June quarter. So it is unlikely to see any major earnings revision. In fact, earnings have already been revised downwards and they are now trading at about 10% earnings growth for FY12. I would believe that in some cases it could be far lower than and even negative earnings growth for those companies which have been hit by the foreign exchange issues.

Q: We have had a lot of negative news flow in India over the last couple of months but we have not seen any great FII selling at all despite the currency beingvery weak, what would you attribute that to?

A: I think the fact is in dollar terms foreign investors have already lost fair degree of money and taking a call whether the rupee depreciation is largely done rather than sell out in a hurry at this point in time. If things reverse, they could reverse quite quickly in terms of their dollar returns. So I think at the early stage of the rupee depreciation, there could have been some outflows.

But as rupee has depreciated around 56 level plus, they would take a call that most of the rupee depreciation would have been done. It is better to stay invested rather than take money out at this point in time. In terms of valuations, when you look at on FY14 basis, it is not really over duly stretched. While we were doing a review recently, we found that there were more buys in the market than sells.

Q: What are you telling your clients to do now in terms of positioning for the next 2-3 quarters in terms of sector overweights and underweights?

A: What we are doing right now is first focus on companies where we see there is visibility of growth in the near term. We do believe that GDP growth estimates in real terms are being reset to around 6-6.5 levels not only for this year but also for the next year. This means companies, which can actually demonstrate growth, will tend to do well. Growth will be at a premium as we go forward.

Secondly, companies which have the potential to improve their return ratios or their cash to profile going forward are companies to focus on. In that context, we have actually done a screening across sectors and quite a few sectors meet this kind of criteria.

Consumption is still a very strong theme for us. We do see a lot of companies down the market cap curve, which actually exhibit such kind of properties. We are seeing it also in cement and I do understand that there is news of an impending CCI order coming in but we would look at that opportunity to buy. This is asector where cash flow profile is pretty good, return ratios are pretty good and we do see it as a very strong proxy for the infrastructure space. So, cement is another sector where we are overweight.

We are also overweight on pharmaceuticals. We think its relatively immune to the global weakness and it also is a very good play on the rupee. So we are focused on that sector where we are overweight and autos after the recent correction we have definitely increased weight. We see potential for that sector also to do well in over the next 12 months.

Q: Do you expect there to be a lingering regulatory overhang on some of these sectors? You talked about cement earlier, the gas stocks had to live through a period of that?

A: Yes, I think we need to examine each of these more fundamentally. I know that there is news of an impending CCI order on cement. But lets assume today you have to set up a cement plant and you have to earn a return on capital employed of around 15% then what would be the price of cement that would be necessary to generate these returns? And if you compare it with the current price, is it higher or is it lower? In case prices are going to be lower than what new plant would be required in terms of it getting 15% RoE then you have a situation where future cement capacity may not come in.

All these considerations would definitely way down before any order is passed. My sense is that given where costs are in the cement sector, some of the price increases could be justified just on a cost based basis. If you look at the EBITDA per tonne of cement companies, for example, they have actually trended down. Its not that pricing has gone up without any commensurate cost increases. All these needs to be taken into account to get a fair assessment of how these orders would impact cement companies. In case this does come through, my sense is that would be a one time impact. A lot of investors are waiting on the sideline to buy this sector.

Q: You were talking about liquidity earlier. How will investors view the second half in terms of both the other legs, monetary policy where there was a surprise that came through this time? It seems unlikely there will be very aggressive rate cuts and fiscal policy where nothing much has moved really with any policy impetus but there is talk now of a new finance minister, more happening on that front.

A: I would say that there is clearly constraint on any kind of stimulus coming from the fiscal policy. We need to rein in our fiscal deficit. In fact, the recent increase in MSP was quite a negative surprise to me given the stocks that are already with the Food Corporation of India and the fact that there is surplus amount of stocks available in the market and we go and increase MSP. We have very little leeway to really do much as far as the fiscal policy is concerned. But on the monetary policy, the key issue is not about policy rate cuts, its about translating that into lending rate cuts.

So till lending rates come down, its very difficult to give an impetus to growth. I would basically look at that transmission to be a bigger factor than just the policy rate cut. Also the hands of the RBI are tied given where the rupee is. They need to strike a very strong balance between managing the rupee and managing inflation going forward. Going forward, the central banks policy would be more dictated by exchange rate rather than pure inflation.

Q: Want your thoughts on Reliance? Niko has announced D6 production profile and they expect no improvement there. In fact they expect production to reduce from 28 mmscmd to 11 mmscmd in 2018 is that in the price or do you expect the stock to soften on this news?

A: I would say that if you look at most of the analyst estimates both on the sell side as well as your own buy side, we clearly believe that some of it is already getting priced in. Having said that, we are underweight the stock at the moment.It is purely on the back of the fact that we do not see very powerful upside triggers for the stock. While the downside risk maybe relatively limited in our view, there are better stocks to play in the oil and gas sector. I would be definitely overweight the upstream and downstream oil companies like the ONGC or BPCL, HPCL where there is potential for the weakening crude price to play out in terms of stock price movements.

At the same time, we believe there will be some action on subsidies, which is a big issue hurting our fiscal deficit. If these are taken into consideration, these companies may tend to benefit better than Reliance. So if you look at our overall oil and gas portfolio, we have tried to balance it in this manner.

Q: You mentioned that you do not expect a great earnings season. Where do you think the key disappointments might come from?

A: The impact on operating leverage coming from slower growth, I dont think, is fully put into earnings numbers of analysts. There are lot of companies with high fixed cost structures. When growth tends to slow down, you normally see the earnings impact to be far severe than what you would expect if there is a variable cost model. I think that is where you will see a negative surprise.

Secondly, with the rupee depreciating, some of these companies could have been caught off guard so that will basically start playing out. I would believe that in general there would be several sectors where you would see lowering of growth estimates and this includes even the consumption sector. Disposable income is clearly likely to narrow going forward. It will play out in the consumption sector, which has got very rich valuation.

It has been the darling of the stock market, they have done very well and we are still positive on the sector. But we are completely cognizant of the fact that you would see slowing growth rate in that sector as well. There would be across the board disappointment. Also theNPA cycle for the banking sector hasnt bottomed out. It gets enhanced if the growth continues to slow down because cash flows get delayed and corporate debt restructuring could be order of the day even going forward. I would be cautious on the banking sector particularly on banks where the potential for NPA increase is relatively high.

Q: In the near term, do you think markets have been over doing this clamor for liquidity. The commentary from the Fed didnt seem to indicate that they would do anything as they didnt last night and the commentary from Bernanke as well has been that he does not think throwing more money at the situation necessarily solves it should one be very hopeful of any big liquidity gush doing something for markets?

A: I think it is only a matter of time by which they will have to open the tap and Operation Twist was coming to an end. So it was quite expected that they would go for an extension. My sense is that QE3 is not completely ruled out. The US will have to go in for austerity measures post the presidential elections. We could see that fiscal policy will be difficult to drive growth in US so they will have to come in for some kind of quantitative easing, maybe in the last quarter of this calendar year or maybe the first quarter of calendar year so I would not rule that out.

As far as Europe is concerned, the LTROs havent really had a big impact on market, credit creation hasnt really happened. A lot of the money which was pumped into LTROs has been pumped back into the ECB. They would be thinking twice in terms of easing but a rate cut by the ECB is clearly well on the cards and you could see that materializing in the future.

Quantitative easing, given that its impact is getting diminished going forward, they would be relatively more measured but they will definitely do all it takes to make sure that there is no exit of any kind of euro member from the euro. It will also make sure that rescue packages at leasttake care of the near term risk, which are emerging particularly in Spain, perhaps in Italy going forward and also in Greece.

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