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Midcaps to outperform largecaps in next 12mths: SSKI
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July 17, 2006

Pathik Gandotra, head of research at SSKI expects midcaps to outperform largecaps in the next 12-18 months. Technology will grow by about 12 per cent for the quarter and serious volume growth will be seen going forward, he adds.

Excerpts from CNBC-TV18's exclusive interview with Pathik Gandotra:

What is it that you are expecting from the first quarter and which sectors are you backing?

We expect a 32 per cent growth in Sensex earnings for the first quarter; this means that we have taken some earnings in SBI [Get Quote] on a P/E exceptional basis and therefore we are getting this 32 per cent growth. We expect all sectors to contribute equally to Sensex earnings but if you look at the broader market, we would expect the financial sector to be weaker on earnings.

What do you expect for the remaining three quarters because there seems to be a view that maybe this is going to be the best quarter for earnings for a while now. Probably, next year we will see earnings pick up after a bit of a lull, do you agree with that theory?

A: hat theory is right as far as commodity earnings are concerned because commodity stocks will report an 80 per cent growth in earnings in the first quarter and we expect commodity earnings to eventually decline by FY08.

So there will be a natural progression of slow earnings growth leading to a decline. That is what I would expect. In terms of non-commodity earnings, we think it will still remain robust at around 25-27 per cent over the next two years.

Are you scaling down your margin expectations for the rest of the year because we have seen a few margin pressures coming into a couple of auto numbers, in few of the chemical numbers, which have been reported. Are you building any kind of margin pressures for the remaining three quarters of the year?

No, we have already built that. Hero Honda Motors [Get Quote], for example, was where we saw margin pressure, which was slightly outsized so we have built most of it, we would have scaled it down marginally but not majorly. Bajaj Auto [Get Quote], for example, the earnings, which were reported, the margins have fallen only because of some extraordinary expenses and not necessarily due to raw material costs.

What is it that you expect to see in the next few quarters though; volumes will keep covering up the margin slippage?

Yes, I think that you would see some serious volume growth and margins may not decline across all sectors, but in few sectors, you will see some declines.

For example in autos, the current quarter earnings will be around 40 per cent and then we will eventually expect the full year to report something like 17-18 per cent growth in auto earnings. So you will see a natural progression in which auto earnings will slow down on a YoY growth basis.

It is a large universe; can a case be made for earnings and valuations to push the midcaps a little bit ahead of the frontliners?

In our results preview, we have upgraded weightage on midcaps from the levels because we had revised them downwards in May. Then we thought that the market correction would invite a bigger correction on midcaps but now if you look at the valuation differentials and the embedded earnings growth rate, we think that midcaps will have a fair chance of outperforming largecaps for the next twelve-eighteen months.

However, you might see more volatility in these stocks than one could sometimes digest and so one will have to hold on to these stocks over twelve to eighteen months.

What do you think Reliance [Get Quote] will report this week?

We are expecting a 10-12 per cent growth in earnings, YoY.

What about the other major technology results, starting with TCS [Get Quote] tomorrow?

I do not have stockwise estimates but I think that for technology on the whole, we are expecting a 35 per cent earnings growth for the quarter.

As a sector, are you picking anything as a Dark Horse this time?

It could very well be banks. I think this is the worst result that you will see because we have seen a huge level of rise in interest rates and one could fathom a reasonable guess that this kind of interest rates rise will not happen in every successive quarter from here.

So on a QoQ basis, I think that earnings will start improving, which is why one can say that this is the worst result that a PSU Bank is giving, so buy it after a result.

In the near-term, what kind of a range do you see in the market and maybe twelve months out from a strategist perspective, what kind of Index target would you have now?

Our Index target range for the next twelve months is about 11,500-11,800; over the next one month, I think the market will respond positively to earnings because earnings news is going to come in very strong.

But once the earnings season is through then you might see some volatility in the market given the fact that then you would have the spectre of the US raising interest rates, lot of news flow coming in from US on inflation, which could be negative and which could impact the market till the next earning season. Over twelve months, however, we expect about 11,500-11,800.

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