The Exit Stocks

 

The Indian equity market trading close to record highs is keeping retail investors interested in the markets, despite dizzy valuations. There is no doubt that the Indian markets are trading at above average historical valuations.

Although the major benchmark indices gained nearly 2 per cent in the current series witnessing good amount of long additions, strong hands seem to be pessimistic and remained net sellers in the cash as well as derivatives market. The selling from the FPIs is partly negated due to strong buying momentum from the DIIs and retail investors. 

In such a market environment, where valuations are stretched and individual stocks are showing lot of positive traction, there are very many stocks that are languishing and deserve no place in the portfolio in the current market scenario. These laggards need to be sold and the money so encashed can be optimally used to add on to stocks that are expected to do well. 

After scanning various sectors, we find that telecom and power sectors are the two sectors having inherent problems and may struggle to grow. These two sectors may disappoint investors looking for growth. 

Telecom sector 

Telecom sector is one of the most important sectors in India which is also bestowed with the infrastructure status in India. The sector is also the bedrock of Digital India. However, the sector is going through a rough patch currently and the very existence of some of the telecom players is at stake. 

With competition intensifying in the past couple of years, FY17 was the first time since inception that the Industry’s revenue and EBIDTA declined. The combined revenues of the industry went down in FY17, standing at Rs2,10,000 crore and is estimated to decline further by ~ Rs25,000 crore in the coming fiscal. 

The drop in revenues due to intense competition has resulted in a fall in EBITDA by Rs12,000 crore, thus leading to significantly lower operating cash flows for the telecom companies. 

Several of the rating agencies have also raised concerns on the sector outlook and its profitability. Telecom industry is also one of the industries which is taxed heavily. The cumulative tax incidence of ~33 per cent of revenues is amongst the highest in the world. 

At the current juncture, the reduced EBIDTA of the industry poses a risk of failure to cover the existing debt obligations and deferred payment commitments.

The data realisation per MB may continue to fall and decrease by 20-25 per cent in 2017, as per PWC estimate. The Jio pre-launch unleashed a price war on mobile data in India and the results will be seen on profitability of old telecom players in the current year and the coming fiscal as well. 

Investors can expect telcos to experience reduced data realisation in 2017 as the increase in data traffic will not compensate for the reduction in data revenues. Poor fibre infrastructure is also a bottleneck in providing cheap data services in India. GST implementation also ensured that telcos will face significant compliance costs in the new GST regime. 

All these factors prompt us to recommend avoid on any investment in the telecom sector. 

Recent development 

The Telecom Regulatory Authority of India (TRAI) has announced a cut in mobile termination rate (MTR)
1) To 6 paise/min from the current 14 paise/min effective October 1, 2017 and
2) Further down to zero (i.e. India moves to a bill-and-keep regime) effective January 1, 2018. 

Impact on the sector 

The Telecom Regulatory Authority of India's (TRAI) move to cut interconnect usage charges by 57 per cent is likely to negatively impact incumbent telecom operators such as Bharti Airtel and Idea Cellular.

Idea cellular is expected to be worst hit by the new development. IUC formed a 9-15 per cent of the consolidated revenue for Bharti Airtel and Idea. 

Internet usage charge is the fees paid to telecom operators where the call is terminated by the operator from where the call is originated. Jio will be the biggest beneficiary of a cut in the IUC rate as it has a higher share of outgoing calls. 

According to Goldman Sachs, the cut in IUC will negatively affect Bharti Airtel's annual cash flows by around $ 150 million. The current move by TRAI is expected to negatively affect Idea's EBITDA by 7 per cent anGST implementation also ensured that telcos will facesignificant compliance costs in the new GST regime.d Bharti Airtel's EBITDA by 4 per cent, as per experts tracking the industry. Few brokerage firms tracking the telecom sector have even estimated a hit of 12 per cent on EBITDA margins for Idea. 

Says Rohit Chordia at Kotak Institutional, “Implications of MTR cut go beyond immediate EBITDA hit. TRAI has announced a cut in mobile termination rate to 6 paise/min (from the current 14 paise) effective October 1, 2017 and to zero effective January 1, 2020. We note that regulatory deliberation on the issue was on for nearly a year now and there was an increasing sense of inevitability about an MTR cut. The quantum of cut was the only uncertain variable and the announced cut of 57% (from 14 paise to 6 paise) is certainly higher than our estimated 30-50%. 

Conclusion 

The telecom industry in India is currently at its weakest and the problems of the industry are magnified due to high degree of financial leverage. The margins are impacted due to increasing competition from new player Reliance Jio. We can expect slowdown in investment in the sector and some consolidation. Weaker players will find it difficult to survive and the high debt levels will make it difficult for the weaker players to exit. In such a scenario, investing in telecom stocks could be suicidal.

Power sector 

Power sector in India is another crucial sector accorded the infrastructure status in India that is struggling at the current juncture in spite of encouraging growth trajectory in the energy space over last few years. 

The power sector has still not been able to sustain the required capacity addition matching the growing demand for power in India. 

The risk profile of thermal power plants is growing and is leading to increase in the cost of capital for the thermal power companies in India. The volatility in coal prices has increased and the uncertainty with respect to the cost-efficiency of domestic coal production is becoming a cause of worry for the sector. Non-availability of coal is yet another issue that could easily turn the a lucrative and viable coal power plant into a non-performing asset. 

As of now, a large percentage of India’s thermal power capacity is stranded and several of the thermal plants are running at just above 50 per cent capacity utilisation. With such a situation, it becomes difficult for the lenders to finance thermal projects. The thermal power producers, on their part, have also not been able to upgrade technology to meet the standards owing to high costs and complicated procedures. 

When it comes to renewable energy sector in India, the sector’s reliance on imported solar panels exposes the sector to the foreign currency risks as is the case with the coal imports. 

For the renewables sector, the curtailment risk is omnipresent due to unavailability of transmission infrastructure, grid congestion and grid instability. Even though the renewables sector is exempt from environmental clearances risk, there is always additional risks such as delays in executing off-take agreements, delays in payments from utilities, etc. plaguing the industry. 

Conclusion 

Looking at the multiple challenges faced at the macro level by the industry and the heavy financial leverage various power companies are faced with, there is a very low probability that these power companies will outperform the broader markets. In fact, there is increased probability of the power stocks under-performing the broader markets. In the current market scenario, it is recommended that one should exit the power stocks mentioned below.