Indian Stocks - October, 2006 Strategy - ENAM

Enam has come out with its October strategy.

It has said that while the near term prospects are priced in, investors should be careful of year end momentum trap. It has also categorised sectors and companies that may surprise in the coming quarters.

Nandan Chakraborty, Head of Research at Enam Financial gives the details.

Nandan Chakraborty believes that India is insulated even in case of a 50 basis points rate hike. He feels that higher oil prices is a greater fear for India than rate hikes.

Chakraborty does not expect any mispricing at current valuations. He informs that the FY07 Sensex EPS is seen at Rs 685, while that of FY08 is seen at Rs 803.

Chakraborty also adds that Enam is bullish on banking.

Excerpts from CNBC - TV18’s exclusive interview with Nandan Chakraborty:

Q: What do you expect from Q2 earnings, this time around? Do you feel that most of the good news, earnings wise is in the price?
A: In the secular sectors, such as FMCG and pharma, which are normally thought of as defensive sectors, the growth is not very high. The valuations are pretty high too. But in terms of cyclical sectors, the rest of the sectors show extremely strong earnings. So while there is some execution risk in the long term, there is no issue in terms of earnings in the short term, that we can see right now.

Q: How are valuations compared to earnings now? Has the main line run up quite a bit and factored all of this in?
A: Before that, I would like to take a step back and talk about what has been happening for the last few decades. The politics of this country has not been in a challenged environment, which is why we have had an economic path or the reform path, which has been one step forward and two steps backward.

India operates best in a challenged environment. Whenever there is a strong opposition within the government, or on the opposition benches, that is when the nature of our economic process changes to one step back and two steps forward. So I don’t think one should pay complete attention to valuations because there are fundamental changes, which are happening in the Indian economy.

Secondly, India now has a universe of investible stocks, which it didn’t have 2-3 years earlier. So there are newer funds, which are coming in and India is an investible basket in its own right. For example, India’s valuation premium goes up, if something happens in an emerging market, which is negative, which is far away from India.

So at these valuations, one should not expect any mispricing. So one should not expect that a stock or a sector is undervalued, without a reason. There will be execution risk but one should not search for mispricing, Hence, the strategy is to look at where there could be a surprise in terms of EPS or PE re-rating upgrade or downgrade. One should look at the risk profile of each stock. This is not the time to take a huge market call or a sectoral call, in terms of mispricing and valuations.

Q: Will you go a sector up or are you going stock up?
A: As I said before, I don’t think this is the time to look at mispricing of the market, or the sectors or stocks. One will not find anything substantial, which is mispriced. One should look at one's portfolio, in terms of what can happen on a 3-year horizon and check out what can surprise on the way down or the way up, in terms of PE as well as EPS. That is the main point.

In terms of the market as a whole, a lot of people are focussing on interest rate fears, whereas I have a difference in view. I don’t think interest rate is a real fear in India because India is now at a stage, where even if interest rates move up by 50 bps or so, our demand-supply situation is such that it will not hit the demand of any particular sector. A part of the fear is really in the oil prices.

Q: Going by the very parameters that you mentioned that one should look for companies or sectors that can deliver, give us some ideas?
A: This is not the time to be defensive. FMCG and pharma, which are traditionally known as defensive sectors, are fairly valued and their growth is actually fairly lackluster. So one actually looks at two factors in the secular sector; one is in some of the smaller companies, which are taking on the giants.

Especially in the FMCG space, there could be a severe PE re-rating considering the way they are tied up with foreign players and the way they are eating into the bigger players. The other is in areas of telecom, media and retail, which are sectors where there could be severe EPS upgrades over the next three years because that's where corporate ambition is playing a huge part.

Coming to the cyclical sectors, the only fear there is actually a market fear. There could be a problem, if oil prices really rebound, if China really starts buying, and if oil prices dip too much.

On a domestic scenario, I do not really see much of a negative. The negative is basically only in terms of execution risk, which one has to figure out stock-by-stock.

Q: What is the earnings per share that you have got for the Sensex?
A: On FY07, we have got Rs 685 and on FY08, we have a little above Rs 800. One should remember that our EPS targets are always on a consolidated basis. One will find a little difference from others, who take it from a standalone basis.

Q: You have mentioned in your report that from the IT sector, you expect Infosys to deliver positive surprise. What do you expect to hear in terms of earnings tomorrow?
A: We don’t mention earnings upgrade to the media; that is for our clients. Our calls have been a 3-year call. The concern on Infosys has been one of whether they can continue to scale up and manage processes and we believe that it can. The grid that we have drawn for each stock, in terms of EPS and PE for Infosys, has been positive on a 3-year horizon.

Q: A lot of people have been very bullish on banks and the financial sector. According to your report, you don’t see much surprises left in banks?
A: In the banking sector, in those grids, we have not taken a sectoral approach in the strategy report at all. So the way this strategy report is to be interpreted is that we have selected one or two stocks from the sectors, where there could be a severe upgrade or downgrade. We are bullish on banking. Banking in India is one of the most undervalued across the world and that is where maximum fears of interest rate increase arises. And that is where the valuation actually discounts most of the fear.

Q: You spoke about management ambition; so does that mean that you are not bullish on public sector, where the management is not traditionally ambitious? You also spoke about reforms getting its leg up because of the internal conflict, which you say, will lead to more reforms. On the other hand, does it mean that you see some valuations being unlocked because of some aggressive PSU divestment, so how would you look at PSUs?
A: In general, I don’t think a PSU call is one of PSU divestment alone. There are excellent PSUs in this country, which have very high secular growth.

But there are sector dynamics, which prevent them from flowering. I cannot mention stock names to the media. But in general, what I am saying is that where there is secular story, the earnings will usually be lumpy. Hence, there are secular earnings in a particular PSU, and when the earnings are lumpy, even if it does badly, that is the time to load up on one's stocks. But I don’t think PSU should be looked at, as a divestment story per se, it should be looked at, in an investment thesis.

Q: With the EPS, that you have set out, what is the year-end target for the Sensex now?

A: We don’t give Sensex targets for the year-end.

Q: But would you say that valuation wise, most of the good news is in the price for the market, at these levels?
A: The main risk is execution risk on a stock-specific basis. The main fear is in terms of oil rebound. So I don’t think there is any need to worry. I don’t think one can take a three-month window from October to December. It is meaningless to take a three-month window in a market like this.

Q: The automobiles sector could be adversely affected by an oil rebound. Where do you see the opportunity; do you see it in the smaller midcaps or larger auto component players or do you see it more in the four-wheelers and two-wheelers?
A: There will be a lot of corporate ambition in the larger companies; not just auto ancillaries. Hence, while an interest rate rise or oil price rise might hurt the EPS slightly, they could really be more than offset by a PE upgrade. In the smaller auto companies obviously, there is a lot of corporate ambition. So the entire auto sector looks optimistic.

Source from: www.moneycontrol.com