‘Steep fall in commodity prices is negative for markets'

Vidya Bala BL Research Bureau | Updated on May 17, 2011

Mr Gaurav Dua, Head of Research, Sharekhan

It may lead to earnings downgrade, says Sharekhan

Indian markets would benefit more from a stabilisation in commodity prices rather than a steep fall, says Mr Gaurav Dua, Head of Research at Sharekhan. In an interview with Business Line, Mr Dua discusses the implication of commodity price movements on markets and also give his take on the earnings season.


What is your take on the results so far?

The March quarter results have more or less been a mixed bag. If you see the broad market (last week) for around 500 companies, there was a healthy revenue growth of 20-21 per cent. There was some pressure on margins but the profit after tax also grew at a healthy 18-19 per cent.

In terms of frontline stocks, there are some disappointments from heavyweights such as Infosys, Wipro, Axis Bank and Bharti Airtel, which failed to meet market expectations. So, overall, the downgrades in earnings estimates outpace upgrades.

So do you expect the Sensex estimates to fall further by the end of earnings season?

The Sensex earnings estimates have been downgraded over the past couple of quarters. The consensus earnings growth estimates were scaled down from around 21 per cent levels to around 18.5 per cent during the Q3 results season. The estimates are likely to get further downgraded by 2-4 per cent by the end of Q4 results season as impact of deterioration in the macro environment and the rising input cost pressures are factored in to estimates.

So would you say the markets are overvalued now?

See, the Sensex EPS of Rs 1,260-1,280 that you were looking at 6-8 months ago might come down to Rs 1,200-1,210 at the end of the earnings downgrade cycle. Taking that into account, the Indian market is trading at close to 15 times one-year forward earnings, which is in line with the long-term average multiples.

However, the Indian market is valued at 30-35 per cent premium to some of the other comparable emerging markets. That leaves scope for further de-rating of multiples due to strong macro headwinds in India.

Besides earnings, what other factors are likely to act as impediments for markets to move higher?

There are several domestic and global factors that can influence the markets in the near-term. Domestically, in addition to corporate results, the street would keenly watch for any progress on policy and reforms front, which were on hold due to the Assembly elections.

In addition, the monsoon will be another critical factor both in terms of easing inflationary pressures and sustaining economic growth momentum in FY12.

Globally, there could be some nervousness before the expiry of ongoing quantitative easing programme in June besides developments in European debt crisis and unrest in the Middle East and North Africa. However, the volatility index is trading at multi-year low levels and indicates lack of any risk aversion globally.

Among global factors a sustained easing of crude oil prices is one of the major factors that can drive higher FII allocation to India among emerging markets.

If commodities do see a decline, could that trigger an upward revision in earnings estimate?

From India's perspective, a steady decline in the commodity prices to a reasonable level where they ‘stabilise' is the best-case scenario. If you have a steep decline in commodity prices the way it happened in the latter half of 2008 or early 2009, that is going to have a very negative effect on the earnings and sentiments in the immediate term.

But if crude comes down to a range of $80-90 per barrel and stabilises that would be fine.

A steep fall in commodity prices is negative for Indian markets in the immediate term for two reasons. First, it could result in downgrade of earnings for stocks in oil and gas stocks such as Reliance Industries, ONGC and metal stocks like Hindalco Sterlite and Tata Steel. This would drag down the overall earnings estimates for Sensex and Nifty given the high weights of these sectors in the indices. Secondly, some of the manufacturing companies could also have inventory losses in the immediate term.

Every company builds and keeps inventory for 3-6 months. So even if the cost of the input goes down sharply, they are typically stuck with the high inventory costs that will show in earnings.

Mid-caps are currently trading at low valuations and don't many have takers? Why the negative perception?

I don't think there is anything wrong per se with the mid-cap story. Many mid-caps in the consumer and pharma space have done well in the past couple of years. However, a big chunk of mid-caps are driven by the investment cycle; capital expenditure in the infrastructure and industrial space for example has not picked up.

This has kept some of the favourite mid-cap stocks in sectors such as engineering, capital goods and infrastructure out of favour.

So does the space offer a buying opportunity?

We have been positive on mid-cap stocks in the IT services and healthcare sectors. Moreover, we work on bottom-up approach and believe that there are opportunities available across sectors.

For example, financials and engineering sectors are out of favour currently but there are certain stocks that look very attractive to us in that space. The concerns are already largely adjusted in the price.

Published on May 17, 2011

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