Shankar Sharma of First Global says that earnings for HPCL, BPCL can quadruple, factoring in oil bonds.
He adds that crude might cool off to $50 per barrel and that will help HPCL and BPCL.
He also says that oil bonds and the fall in crude prices will be a major catalysts for oil stocks.
He is bullish on the tech pack and Ranbaxy, but not too bullish on ONGC as he feels that there is not too much money to be made there.
Excerpts from CNBC-TV18's exclusive interview with Shankar Sharma of First Global:
Your reports say it is time to buy stocks like HP and a BP, tell us why?
Last time, I had mentioned that the stocks had turned very attractive and that there was a pretty reasonable chance of an uptrend. We think that HP and BP are absolutely at the top of their business cycles and they can only get better in terms of the earnings outlook.
Our forecast is for earnings to roughly quadruple over the next two years time. That includes the effect of oil bonds, etc.
But what I don't think the market is factoring in is the fact that there is a distinct possibility that oil prices can definitely cool off from the levels of $70-75, where it has been over the last 12 months. Should that happen, while there is no one-to-one relationship between the oil price decline or a rise and a commensurate rise or fall in HP, BP's profits, there will be a lose relationship.
That lose relationship, and rest everything being equal will mean very good signs if oil were to fall to levels of $50-55 or even $45. Our forecast is that oil will probably see those levels during the course of the next 12 months. Hence, if that happens, one will be looking at a very strong earnings growth scenario.
Even if that does not happen, the stocks are very cheap. There is 50% of replacement value, 0.1 time sales and the fact that even excluding the effect of oil price decrease, we are looking at a tripling of the EPS over the next two years. I don't think there is risk in buying these companies at these levels. That's really what our basic take on the sector is.
The counter point for a lot of investors would be that there might not be too much downside from a valuation perspective. They may not start a bout of out performance because of policy issues and if oil does not cool down, as we expect it to, then why be in a sector where there might not be too much downside, but there might be restricted upside?
When there is skepticism, there is money to be made. When everybody has an agreement, usually most of the money has already been made. So there is skepticism and there ought to be skepticism in terms of these oil-marketing companies because even the government has rarely handled them.
But that's exactly our point that at some point, the skepticism is actually tending on the verge of paranoia, while the stocks and the valuations have reached a level, wherein the smallest of catalyst, will drive these stocks up. I think the catalyst will be number one, the oil price and oil price decline.
Another catalyst, which we expect to happen, is of course the oil bonds being issued by the government in the second quarter; these two catalysts, I think are enough to drive these stocks up.
Once the market sees that things are panning out, in a sense that there is a positive tailwind behind these companies, then one will see these concerns and skepticism simply melting away. We have seen it happen in several other sectors and companies before. I see no reasons why these companies should continue to have investor's skepticism attached to them.
You have done some sensitivity analysis as well of how much their earnings could go up if crude cools down by X and Y and how their valuations would look, could you take us through that?
Basically, if you look at HP, BP and take the best case earnings forecast that we have, if we were to sensitise and say that crude were to cool off to $60 on an average, one will be looking at another 10% upside to their earnings forecast for FY08. Nothing much will change in FY07 because we are already pretty much half way through.
But the real effect of an oil price decline will factor into FY08 earnings and at the margin again, there is no one way to calculate the effect of an oil price decline on the earnings upswing for these companies. But there is relationship that one can establish.
So a 10% rise of roughly every $4-5 in crude oil fall is what one can see if we bet on. Our view on oil is actually that it will probably surprise us all
Hence, our take is that one is probably looking at $40-45; definitely it's out of 50 over the next 12 months time. Should that happen, add another 25% to our best case earnings forecast for HP, BP for FY08.
So one is looking at a company, which will quadruple, perhaps even five times their earnings of FY06. What's there to lose; the EBITDA margins we are talking about are 2-2.5%, in FY04, they were at about 7% odd.
So we are still conservative when we are forecasting EBITDA margins going forward. Should there be a minor uptake on the EBITDA beyond our best case, again one will be looking at a substantial upside. So one has to weigh the negatives and the positives and our sense is that the positives far outweigh the negatives in these two companies.
Is there anything that you like in the standalone refineries as well at this point?
No, I would hold back an opinion on that. HP and BP are the two we liked and that's where we are advising people to put their money in.
How are you feeling about the market, I was reading another report of yours, which said that within emerging markets, you actually see India taking out its previous highs?
That's a view we maintained all of July. We see nothing on the radar to compel us to alter our view. If you look at the markets, they have been very strong; there have been no problems whatsoever on the earnings front in the first quarter.
I think the global factors were again exaggerated in terms of the effect on India. India is still largely an insulated economy. But even if one were to say that okay, what happens if interest rates rise, or the dollar sort of falls, or commodity prices rally; the fact is that none of those scenarios we think are likely.
We don't think inflation is going up, we don't think that the dollar is going to fall, on the contrary a case can be made for the dollar to strengthen; we don't think oil prices are going up. If you put everything together and see, we think the environment for global equities is very good, probably the best it has been in the last six-eight months time.
Within the context of global equities, India is clearly a standout performer; I don't think any market has seen the kind of earnings growth that India has seen in the last 12 months, even the last quarter.
If there is one destination within emerging markets or within global equities that one wants to definitely be in because of size, liquidity and earnings growth, I think one can't do much better than buy in India. The fact is that India is very optimistic, now that markets are sold off, consolidated a bit, a bit of the froth has been taken out, I think investors are in a good shape.
Would you extend your optimism by giving your view on crude to things like ONGC and Gail, or your view is not very positive there?
In ONGC again, the government is definitely an issue, we have been negative on ONGC for quite a while now and we have just turned moderately optimistic on it.
But I don't think that is a place where one will really look at making serious money and that is not a stock that is going to go up 40-50-100%. So we will probably stay on the sidelines for ONGC. We don't cover Gail.
Do you still stick to the view that midcaps will continue to outperform as they have in the last one week or so, or do you think much of the pullback has happened already?
No, midcaps started showing their weakness the same time last year and they have endured a one-year bear market. I think looking at the numbers Q1 delivered, a number of those stocks in the hindsight have proved to be very cheap.
We think, the market will continue to re-rate them; we are very optimistic on the future of midcaps and in large caps, the refiners; Reliance, the technology pack and Ranbaxy continue to be our favourites.
Construction is a sector we turned negative on about a month and half back. The margin pressures have been evident in the last quarterly numbers that have come out for most of those packs. So there are no permanent likes or dislikes
Construction is something we liked for three years and we don't like it anymore. On the other hand, the refineries again are not something that we have not liked for all these reasons, now we sort of like them.
One has to keep moving in pace with where the market is telling one to go and we think these are the spaces in which one will outperform in the market.
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