What's the safest bet in IT sector

Mumbai: Earnings season is almost here and most brokerages have been betting on a good second quarter. Motilal Oswal Securities has upgraded both earnings growth and Sensex target for FY07-end. Motilal Oswal's Raamdeo Agrawal gives his view on the market and Q2 earnings.

Agrawal expects Q2 sales to go up 27 per cent, EBITDA and net to go up 39 per cent. FY07 Sensex EPS is seen at Rs 686 and for FY08, it is seen at Rs 780. Margin expansion is likely across the board, he says, adding that cement and telecom sector will see major margin expansion.

Further, Agrawal says that fall in crude prices has eased interest rate worries and that expectation of good Q2 is already factored in the prices.

However, Agrawal says that earnings will need to match expectations. He cautions that markets may not surge even if results exceed expectations. Infosys remains his safest bet in the IT sector.

Exclusive interview with Raamdeo Agrawal:

Q: Do you think that this earnings season is going to be as optimistic as most analyst are predicting?

A: Q2 earnings estimates are out. Based on the 127 companies that we follow, top down sales are going to be up 27 per cent, EBITDA is going to be up 39 per cent, and net profit is also likely to be up 39 per cent.

So clearly not only the topline is expected to be up, but there is also gong to be significant margin expansion, which is terrific news.

Some of the industries which look like they will be very big performers are cement with 157 per cent, wireless cellular companies with about 180 per cent, pharmaceuticals with about 57 per cent, oil and gas 50 per cent, media 60 per cent, retail 49 per cent. So you have a big growth companies coming in on largecap kind of issues

Q: What is your EPS estimate on the Sensex and your revised target for it now?

A: In the current year, it will do about Rs 686 for March 07, which will be about 31 per cent growth over March 06. And for ’08, we have pegged it at about 14 per cent growth at Rs 780, which at current levels, almost six quarters ahead, it looks to be all right at 14-15 per cent. But Rs 686 is very strong call.

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Q: Are you in the camp that believes that perhaps in terms of earnings we might have seen our best or are seeing our best, and post this quarter things will start peaking off a bit?

A: As regards the numbers that our analysts have filed, right now we are seeing not only the topline growth of 26-27 per cent but we are also talking about marginal expansion. So if you look at it, corporate profits all over the world are booming big time.

Corporate profits of GDP in the US have gone as high as 12-13 per cent. In India, it is about 5.1 per cent against what it was last year at about 4.8 per cent. If we expect the GDP to grow at more than 8 per cent, I don’t think the corporate profits are going to slow down.

Q: Where is this margin expansion coming from? Is it coming from internal efficiencies or are we seeing it because of pricing power returning to companies?

A: Yes, clearly one of the categories where we are seeing margin expansion growth is cement, where clearly the pricing has come in big time compared to last year. In Telecom, which is very rapidly growing, also we are seeing EBITDA expansion on a very rapid growth of 40-45 per cent.

So I think it is much more of a productivity gain, because scales are climbing very fast. So I think the economies of scale are coming into companies, and pricing is stable.

Q: Your range for the market on the top end is about 12500 we are almost there. At this point most of the good news in the price you feel?

A: That is another aspect. Apart from strong earnings upgrades, things have happened between last quarter and this quarter. Oil prices have come down significantly, and that has kind of taken off the inflationary pressure. Hence on the interest rate side, things are looking much easier.

Our 10 year paper has come down from 8.4 -8.5 to as low as 7.6. I don’t know how to read this, but at the time of the announcement of the June result we were more muted in terms of valuations- more like 10,000 or below 10,000. But now the expectation is built clearly into the price.

The stock market has moved ahead of the September announcement. Earnings must meet the expectations, and if it surpasses expectations, the salute of the market to the earnings will not be as big as what we saw post June quarter, because that is already there in the price.

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Q: What is your outlook on technology because it has not reflected as a top pick, either in your stock picks or in your sector picks?

A: One of the things, which is happening, is that technology stocks have moved big time. As an aggregate, the sector will grow at 40 per cent and all the biggies are included in that. The strength of the rupee is expected to come down from 46-46.50 to maybe 45 or 44.5. This will weigh on the mind of the analysts, in terms of making a much more aggressive call from here.

Q: Infosys, of course, is considered to be the flag bearer of the technology lot. Do you hold any specific expectations from this company?

A: No, it is just that the much bigger deals are being talked about. I think Infosys will participate all the way over there. They have their metrics under control. So we think that if one has to take a call on one specific stock in the technology pack, one cannot go wrong with Infosys. One might meet 5-10% lower return than some other stocks. But I think Infosys is one stock, which will give people a peaceful sleep.

Q: Have you re-rated MphasiS BFL after the development on EDS?

A: I am not on top of company-specific earnings right now.

Q: As a sectoral story, is there anything that the market is ignoring at this point; perhaps, a sector that deserves attention, but is not getting enough?

A: Automotive, to some extent. Wireless, I would say, is another one and maybe the steel industry might surprise people. Cement will come out with terrific numbers. Going into Q3 and Q4, it would be even more strong.

But my sense is that stocks have moved significantly. So a build up, which used to about 200-220 has gone to about 340. ACC, which used to be closer to Rs 700 is closer to Rs 1,000. Hence, the scope there is limited. But in terms of valuation, there are very few loose spots, where one can get very significant moves from here.

Q: One final word on the markets because you made the point that perhaps most of the good news is in the price. Tactically, would you be sitting on a higher degree of cash, as you step into earning this time?

A: I always have 100 per cent into the market. I think in June when the market fell, I felt that I could have had some cash in hand, so that I could buy at the bottom. But I think this time, it is good that I am fully invested. So there are no cash positions.