Sunday, December 23, 2007

Ajay Bodke, Fund Manager,StanChart MF- Sector likes and dislikes

On IT companies…
India imports a lot of oil, $61 billion of it to be precise. This adds majorly to our current account deficit. However, with all the gas being found on the coast and since gas and oil are fungible, gas usage is set to rise. This would help save on subsidies and lead to the imports coming down, as a result of which, the current account deficit will come down and the rupee appreciate further.

In addition, the staff cost of IT companies is huge. Tax sops are about to vanish in 2010. With global firms also playing the ‘labour arbitrage game’, things really do not look good for IT companies.

In the last few quarters, they have been able to protect their margins by entering into more fixed price contracts and doing more work offshore as against onsite, besides reducing bench strength and emphasising on recruitments at the lowest level.

However, most of these companies would like to move up the value chain by getting into consulting. Now, consulting requires more employees onsite and that too senior, highly experienced ones. So, they are in a Catch-22 situation. If they want to go up the value chain, they have to have more employees onsite. If they do that, their margins take a beating, and if they don’t, they do not move up the value chain.

On telecom companies…
The low-hanging fruits have already been plucked. New customers are coming in at lower margins and that explains why the average revenue per user has been coming down. A large chunk of new business is expected to come from rural locations spread across a huge geographical area.

In order to service them, companies will need to put up more towers. Now, putting up a single new tower costs around $65,000. Hence, companies will have to make a whole lot of capital expenditure and this in turn will impact the margins. Number portability remains a major issue, too.

On state-owned refiners…
These companies, for no fault of theirs, have ended up developing a unique business model. The more they sell, the more losses they make. Also, with privatisation of these companies nowhere in sight, there is deep value that cannot be realised.

On interest rate-sensitive sectors…
These sectors do well when the interest rates are low and vice-versa. We believe that interest rates have peaked. We believe over the next 12-18 months, interest rates will come down again and consumption will take charge. This will benefit banks, which are major players in the retail segment.

Growth rates of both home loans and demand for homes have slowed because supply is there only in the super luxury segment. However, there is tremendous demand in the middle market segment. Real estate companies have woken up to that. Once supply in this segment starts hitting the market, the growth of home loans will take off again.

We are neutral on the auto sector. Competition is intense, so steep festival discounts continue and margins will continue to hurt.

On steel companies…
Indian companies in this sector are fully backward-integrated. Therefore, even though iron ore has gone up from $40 a tonne to $160 a tonne in the last few months, they have not felt the impact. Since the price of the steel is going up globally, Indian companies can hike their price as well.

On power companies…
In the XIth Five Year Plan, the outlay for the power sector is $250 billion. This will benefit companies that produce boilers and turbines for power plants. The earnings visibility of most of these companies is currently 2-3 years. There is a huge demand-supply gap. Given this, margins on incremental orders have been a lot better. Companies across the value chain benefit, including those that supply switch gears, transformers, cables and transmission towers, etc.

On air-conditioning companies…
The new civil aviation policy is expected to result in 35-40 new airports. Many real estate companies have made public their plans to make five star hotels. They are talking about supply levels in the next three years that have not been built in the last 30 years. Many corporate hospitals are coming up all over the country. All this tells me is there will be a lot of central air-conditioning needed.

On Sensex valuations…
At the beginning of the year, analysts expected earnings of Sensex companies to grow by around 18% from Rs 720. Now, two quarters down, Sensex earnings have grown by around 25%.

This has led to analysts upgrading Sensex valuations to around Rs 900 for this fiscal and Rs 1,080 for the next. Based on a level of 20,000, the Sensex is quoting at 22.2 times FY’08 earnings and 18.5 times FY’09 earnings. Is this expensive? No, if we look at other comparable emerging markets. Chinese markets are currently quoting at 45 times one-year forward earnings.

Brazil and Russia are quoting lower, but that’s because indices in both these markets have a huge weightage of commodity companies, which quote at lower multiples. Further, even if there is no further rerating in PE ratios, sustained earnings growth of 20-25% will ensure that Sensex keeps growing at a similar rate.

Source: DNA

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