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'IT stocks' valuations uncomfortable'

August 22, 2006 16:23 IST

Prabhat Awasthi of Brics Securities says that they have been positive on banks and that there is still value in public sector banks.

He says that they are bullish on RIL, and positive on the retail business. He adds that IT stocks are reaching uncomfortable valuations. He further adds that the rupee depreciation has been factored in and the US slowdown could be negative.

As far as the market goes, he says that FY07 Sensex earnings growth is seen at 30-35%. Also, he adds that fundamentally, there is not much upside left in markets.

Excerpts from CNBC-TV18's exclusive interview with Prabhat Awasthi:

You had a ten months target starting in August after the results, at 11,400. We are already at 11,600, so do you see much upside from here?

When we had written about the quarterly earnings, we said that earnings were definitely better than expected. I think we have not put out a formal target post that, but clearly 11,400 was based on certain set of assumptions on earnings, and there was a positive surprise there. We expect some positive surprise for the earnings on the full year, but earnings were even better than what we expected.

So I think there won't be an upside to the target that we had put out of 11,400. But having said that, even if one assumes that there will be an earnings upgrade, the market has probably reached a zone where I would not be comfortable buying big time into it.

What was your total Sensex earnings per share target after upgrades for the full year? Was it 700 plus or below that?

We started with about 20%; we thought that there would be an upside to this 20% number.

Post Q1 we are standing at about 26% for the Sensex companies. I would think that there would be a further upside to this as we go forward into the next few quarters, but I think the earnings for Sensex could grow between 30-35% for the full year.

So if one looks at this from where we started in the beginning of the quarter, we were looking at 20%, and we will probably end up between 30-35%.

If one looks at our market target, it will not move up by a whole of 10% because the market target is based on expectations of earnings even going forward beyond FY07. But I would think that there would be an upside of 5-6% at least to our market target, that is 11,400.

Today, we are looking at about 11,500-11,600. So from there, fundamentally the upside to the market will not be very large. If one is looking at a one year forward target, then obviously one needs to make at least 12-13% returns on the market; that's the least that one can expect. So to that extent the market is reaching zones where fundamentally one will not be very comfortable.

Obviously, the issue is that external factors have eased, interest rate fears have receded, crude oil has come off and technically the market is much lighter today, compared to earlier where we had huge long positions which led to the steep fall in the market that we saw early in May.

So from that perspective, the market is now technically light, the news flow is decent, so it is running up. But I would think that the upside would be limited.

Purely in terms of earrings though, don't you think there is any reason to be concerned that we may have seen best in the quarter gone by?

No, not really. I think the earnings will probably look better going forward because what one must remember, is that last year was not a particularly a good year for earnings. If one looks at BSE 30 or BSE 100 companies, the margins actually were dropping QoQ through the year, and the reversal that we have seen in this quarter has been across sectors.

So margins have improved dramatically. As we go forward, the base comparisons will get better, unless and until we have a slow down. If one continues on the trend line that we have been on, the earnings growth in terms of percentage, will actually get better as we go forward in the next three quarters compared to Q1.

The one space that has began to move now is oil, particularly oil marketing. What are you factoring in terms of earrings and how will that impact the moves of this market?

We had a buy call on the oil marketing stocks about three to four months back. That was when the package from the government was announced and we thought that basically took care

of fairly high levels of crude.

For the sector to get much higher multiples, the clarity on the whole issue of how these companies can price their products and government control has to be addressed. So for the time being, the run that one has seen already is factored in the falling prices of crude. But the fact is that we still have a policy overhang, which is not very clear.

So from here onwards, we would probably look at selling into any strength that these stocks might actually see. So I would not think that these stocks would have any further impact in the market.

What about Reliance Industries? Do you have a view optimistic enough for that stock to lead the market up?

Yes, we are positive on Reliance. On an overall basis, the market is not very cheap today. So essentially what we are saying is that there will be stocks which will go up, there will be stocks which will probably come down.

But Reliance as a stock, we would be overweight in this kind of market, primarily because we are very positive on their retail business. We think that they have done a huge amount of work. There are going to be more news flows on retail as we go forward, starting September, as that is when they are opening their first store.

So we are very positive on their retail business, and we think that this is an additional upside that will start getting factored into the stock price as we go forward in the next six months. So yes, we are positive on Reliance.

How have you changed your view, if at all, in autos and PSU banks?

We have been positive on banks. When we put out our quarterly update on earnings before the earnings came through, one sector which we suggested to buy into before the results, was banking. This was primarily because we do not feel that there is much downside left as far as interest rates go.

We have actually maintained 8% forecast with a maximum bias up to 8.5%, and I am talking of domestic bond yields. So we were pretty sure that banking stocks have reached their bottom in terms of news flows. They were always cheap fundamentally. So they needed a trigger from that perspective.

We have not changed our view on banking though. The change in view was regarding when to buy the stock, which we changed in the pre-results season. We think that there is still value especially in PSU banking stocks, because these companies do a decent RoE.

We are very positive on the overall economic scenario. As external factors get taken care of, these stocks should do all right.

Any sectors that you have cut your exposure on coming out of earnings?

We have not come out with a formal strategy product, but at this point of time we feel that external growth is probably slowing down, given the fact that even interest rates across the world have increased considerably from where they were.

They might be pausing, but the follow on impact of that growth is still to flow through. So I would think that global cyclicals especially metals, which we have been positive on for a long time, could actually start to cool down primarily because there is fairly large amount of supply which has come out of China in all these metals, especially steel and aluminium, and that is still going to increase going forward in the second half.

On the other side, demand seems to be cooling off in the United States and Europe; inventory levels have been running decently high. So in terms of performance, these stocks tend to follow the price performance of the basic underlying metal, and there we are bit concerned that one might not see the kind of upmove that one has seen so far in prices. So we would be more cautious on metals.

IT is reaching valuations, which are now making us a bit uncomfortable, especially given the fact that multiples are rich. We are getting a bit more concerned about global growth, especially in the US.

If interest rates in the US are going to pause, then the rupee probably will not give that depreciation, it might appreciate from here. So, going forward, we think that domestic cyclicals will probably outperform the overall market, and the market as a whole might remain rather rangebound. But within that there will be a churning of sectors.

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