For many stocks in the PSU banks, industrial and metals sectors, we do not see any fundamental changes
After several stocks have run up over the past two weeks in anticipation of future positive developments, we would urge investors to review their investment thesis on them. For many stocks in the PSU banks, industrial and metals sectors, we do not see any fundamental changes. The expectations around further reforms notwithstanding, there are several real challenges (financial, operating and regulatory) for companies and the economy, which simply cannot be wished away.
We note that SEB restructured loans account for only 25% of the restructured loan book of PSU banks. The restructured book largely reflects problems in several other sectors. Also, we expect several infrastructure and power sector loans to become NPLs over the next 12-18 months without meaningful restructuring of assets and businesses.
In the industrial pack, nothing much has changed with respect to BHEL and L&T. We have a structural negative view on BHEL given likely declining revenues and earnings over the next 3-4 years.
BHEL stock is trading at 10X FY2014E EPS, which does not seem justifiable in the context of declining net profits. In fact, our ‘stable-state’ analysis of BHEL suggests a fair valuation of around Rs 150. A restructuring of SEB loans is unlikely to impact BHEL’s revenues, order inflows or margins. Similarly, LT stock is quite expensive at 17.5X FY2014E EPS.
We model a 9% growth in EPS in FY2012-14E, which seems fairly challenging in the context of (1) paucity of large projects in the pipeline and (2) an extremely weak investment environment.
In the metal pack, the coal issue is quite relevant for Hindalco and JSPL.
Both Hindalco and JSPL are trading around our 12-month fair valuations. However, our fair valuations do not take cognizance of potential negative developments on the coal issue. Hindalco’s new plants may not be profitable without captive coal.
The JSPL stock is fairly valued even assuming a benign situation on the coal issue. The stock price does not reflect the very real threats of (1) additional royalty on coal produced from coal blocks awarded in the past and (2) capping of prices (and returns) on power generated from coal from aforementioned blocks. Finally, JSPL faces earnings risks from a weak steel cycle.
Remember, there is a long grind ahead for the real economy but stocks have already started discounting a smooth recovery. In our view, the Indian economy faces significant challenges with high (and rising) inflation in the short term and high fiscal and current fiscal deficits in the medium term.
These problems are of a structural nature and cannot be addressed easily and certainly not with the government’s recent announcements (we hesitate to use the word reforms).
We rule out meaningful reforms in the short term given (1) inflation, (2) fiscal and (3) political compulsions. The government has probably done enough to avoid a meltdown and will probably skirt around tough reforms given political and social compulsions.