IIFL - India - Strategy 2015 - Earnings Bouncing Back - 20141217_15!18!23

8/10/2019 IIFL - India - Strategy 2015 - Earnings Bouncing Back - 20141217_15!18!23

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Earnings bouncing backWe believe that 2015 will be another good year for Indian

equities. The earnings downgrade cycle of the past six years(FY09-14) will likely end in FY15 when actual growth shouldmatch consensus estimates in the beginning of the year. Weexpect to see earnings upgrades from FY16 onwards. Keymacro factors are already showing signs of turning around.Indian households are expected to emerge as big buyers ofequities in coming years, making Indian markets lesssusceptible to FII flows. Valuations are reasonable vis--visthe historical and global context.

Earnings are depressed; recovery can be sharp: For BSE500non-financial companies, Ebitda and PAT margins are at a 15-yearlow, net debt/equity is at a 15-year high and ROE has nearly halvedfrom the peak level of FY07. A cyclical upturn will drive the earningsbounce back, reinforced by pro-business initiatives of the newgovernment. The recent sharp fall in prices of crude oil and industrialcommodities can save India more than $30bn annually, equal to thecountrys current account deficit in FY14.

Key macro factors are showing signs of turning around: Expectations abound of acceleration in GDP growth, narrowing offiscal and current account deficit, fall in inflation, reduction ininterest rates, stable INR, growth in GFCF, and an increase inhousehold savings. After going through great stress in the past threeyears, Banks and Financials, the largest constituent of Indian equity

indices, should record an improvement in asset quality and higherearnings growth.

Domestics to emerge as major buyers of equity: Indianhouseholds are expected to emerge as big buyers of equities. Theyhardly participated in equities in the past six years. We estimatehouseholds to invest about $74bn over the next three years (FY16-FY18E) versus $40bn in the past six years (FY10-FY15E). This shouldmake the Indian markets less susceptible to FII flows.

Valuations reasonable vis--vis historical and global context: Niftys current one-year forward PE of 14.9x is slightly above itslong-term average of 14.3x. We believe this would appear morereasonable as we enter an earnings upgrade cycle. Valuations are inline with long-term average premium/discount to global indices suchas S&P500 and Euro STOXX600. The current trailing PEx is wellbelow the peak PEx of the last three bull runs that ended in Feb00,Dec07, and Nov10.

Top picks for 2015 Top Large Cap Buys Top Mid Cap Buys

ICICI Bank Tata Chemicals HCL Tech Mindtree Maruti Kaveri Seeds Ultratech Cement JK Lakshmi Cement Shriram Transport Finance Blue Star

Source: IIFL Research

Sector weights Key overweight sectors Key underweight sectors

Financials Consumer Staples Auto Energy IT Metals Industrials Cement


Performance of 2014 Top buys Return (%) Absolute Relative

to Nifty

Nifty 28.0 Largecap Dr Reddys 24.8 (3.2) Hero MotoCorp 56.5 28.5 ICICI Bank 52.9 24.9 L&T 39.9 12.0 Wipro (2.6) (30.6)

Mid cap Crompton Greaves 32.2 4.2 IPCA Labs

0.5

(27.4)

Ramco Cements 59.8 31.8 Motherson 127.7 99.8 Shriram Transport 62.7 34.7 Source: Bloomberg, IIFL Research. Based on market data as on 16Dec2014

Prabodh [email protected] 91 22 4646 4697

Amit [email protected] 91 22 4646 4649

Institutional EquitiesIndia Strategy


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India StrategyInstitutional Equities

[email protected]

Key Macro TrendsRecent past trend FY1617E

GDP growth to accelerate Sub5% growth in FY13 and FY14, non agri

GDP growth at lowest level in the past 20 years

Expected to grow at 67%

Fiscal deficit to narrow Declined to 4.5% in FY14 from the peak level of 7.9% in FY09 perceived visually rather than the actual reality

Expected to remain between 3.5%4.0%

Current Account Deficit to narrow

Reduced to 1.7% in FY14 from the peak level of 4.7% in FY13

Expected to reduce further primarily due to falling commodity prices

Inflation to fall CPI has averaged above 8% for the past six years and is currently at ~6%

Expected to average ~6% over the next few months, with a downward bias over next two years

Interest rates

to

decline

Bank

PLRs

have

risen

100bps

in

the

past

three years. In contrast, 10year GSec yields remained unchanged in this period but they fell by 90bps in CY2014

Policy rates

expected

to

decline

by

100bps

in

next 12 mths and 150bps in next 24 mths. With liquidity improving, banks should pass on the reduction in policy rate to borrowers

Stable Rupee Depreciated by 17% in the past three years Decline in CAD and buoyant outlook for capital flows will keep rupee largely stable; we expect an average 34% annual depreciation going ahead

Bank loan growth to pickup

Loan growth has decelerated for the past four years and the current growth of 12% YoY is the lowest in past two decades

Expected to grow in mid teens at 2.5x real GDP growth

Gross Fixed Capital Formation growth to accelerate

Near 0% growth in the past three years, the worst phase in the past 25 years

Expected to grow at 510% annually

Consumption growth to remain slow

Consumption, in particular rural consumption, was the key driver of economic growth in the past 45 years

Rural consumption is likely to continue to moderate as rural wage growth and pace of MSP increases have slowed down

Agriculture growth unlikely to accelerate

Agriculture growth has averaged ~4% in the last few years

Agriculture growth is unlikely to accelerate and should continue at its trend growth rate of 34%

Household savings to rise Dropped from peak of 25% in FY10 to 22% in the last two years; within that, the share of financial savings dropped from 48% to 35%

Expect a gradual pickup as real interest rates become positive; the share of financial savings is also expected to rise as returns from physical assets have become relatively unattractive

Fuel subsidy to decline Seemed out of control and peaked at 1.6% of GDP in FY13

Expected to be 0.6% of GDP in FY15 and fall further to 0.3% next year, assuming oil prices remain at the current level

Total subsidies remain high

Aggregate subsidies averaged 2.6% of GDP during FY0914

Aggregate subsidy likely to fall to 1.8% of GDP in FY16, primarily due to fall in fuel subsidies, whereas food and fertiliser subsidies would continue to rise; shift to AADHAARbased distribution can bring down other subsidies


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Key Industry TrendsRecent past trend FY1617E

Investment legs

Iron & Steel Low single digit demand growth in last 23 years, expected to be flat in FY15; prices were flat

Expect demand to pick up to 67% YoY from FY16 onwards; however, prices are likely to remain weak due to weak global demand and prices

Aluminum Domestic demand grew 2.0/2.5% in FY13/FY14 and is expected to rise slightly to 6% in FY15; prices declined by 15% in FY13 and 10% in FY14, before rising by 10% YTD in FY15

Domestic demand expected to accelerate to 7% Cagr in FY16 and FY17; we expect prices to rise 23% annually

Petrochemicals Polymer volume growth of 45% in last two years as GDP growth slowed down; prices have been firm due to supply constraints

Volume growth expected to accelerate to 56% as GDP growth picks up; prices expected to remain stable

Diesel Volume growth was negative in FY14 and is expected to be flat in FY15

Expected to grow at 5% Cagr, in line with longterm trend

Cement Volumes grew at 3%YoY in FY14, but are expected to pick up to 67% YoY in FY15; prices declined 4% in FY14 and have risen 23% so far in FY15

Volume growth expected to accelerate to 78% YoY in FY16/FY17; prices expected to rise 78% annually

Coal Domestic consumption grew at 57% Cagr in the past three years whereas domestic production grew at only 35% Cagr; imports grew 80% over this period and will constitute nearly 20% of India's consumption in FY15; domestic prices have been flat in this period

Expect domestic production to grow at 1213% annually in FY16 and FY17; import growth likely to slow down; we expect price increase of 45% annually

Capital Goods new order inflows

New order inflows grew at an average 34% Cagr in past five years

Expected to accelerate to 2025% YoY growth in the next two years

Bank loan Loan growth decelerated over the past four years and current growth of 12% YoY is the lowest in last two decades

Expected to grow in mid teens at 2.5x real GDP growth

Consumption legs Two wheelers Average volume growth of 5% in FY13/FY14

and picked up to 13% YoY in FY15; prices grew at 2% Cagr

Expect volume growth of 1314% YoY in FY16/17; prices expected to rise at 2% Cagr

Passenger cars Average volumes declined 2% in FY13/FY14 and picked up to 3% YoY in FY15; prices grew at 12% Cagr

Expect strong volume growth of 1516% YoY in FY16/17; prices expected to rise at 3% Cagr

Light Commercial Vehicle

Volume declined 18% in FY14 and are down further 14% YTD in FY15; prices were flat

Expect strong volume growth of 15% YoY in FY16/17; prices expected to rise at 3% Cagr

M&H Commercial Vehicles

Volumes declined 24% each in FY13 and FY14 and picked up to 8% YoY YTD in FY15; prices declined by 3% Cagr

Expect strong volume growth of 24% Cagr in FY16/17; prices expected to rise at 4% Cagr

Commercial Real Estate

Office space absorption dropped from 40m sq ft annually in 2007 to 1215m sq ft in 2014; rentals were flat (Bangalore and NCR)

to down 4050% (Mumbai)

Expected to rebound and grow by 50%YoY to 2022m sqft in FY16 and to 30m sq ft in FY17; rentals expected to rise 5% annually


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Recent past trend FY1617E

Residential Real Estate Residential sales volume: NCR down 75%, Mumbai down 4050%, Chennai down 6070%, Bangalore up 1012% from the peak in 2009; residential prices: NCR down 25

30%, Mumbai flat, Bangalore up 1012%

NCR sales volume can jump 34x, Mumbai & Chennai can double over next 3yrs, Bangalore can grow by 1012% annually; NCR prices can go up by 3040%, Mumbai 20%, Bangalore 2025%

over next 3yrs FMCG Volume growth slowed down from 8% in

FY13 to 6% in the past two years; annual price increases have averaged 6% in the past three years

We expect volume growth to remain weak at 6% in FY16 and pick up to 8% in FY17; we expect price rise of 34% in FY16 and 6% in FY17

Advertisement revenue

Growth of 9% in FY13/FY14 and 11% YTD in FY15

Expected to accelerate to 15% annually in FY16 and FY17

Mobile revenue Revenue growth slowed down to 910% Cagr in the past three years from an average of 12% growth in the previous five years

Expect revenue growth to accelerate to 12% annually, driven 1/3rd by voice min, 1/3rd by voice pricing and 1/3rd by data

Quick Service Restaurants (QSR)

Same store sales (SSS) growth was 616% in FY13 but it declined 38% in each of the past two years

Expect SSS growth to rebound and grow 8/13% in FY16/FY17

Airline passenger traffic

After near flat growth of 3% in 2012 and 4.4% in 2013, traffic has picked up to 9% YoY in CY2014YTD and 18% YoY in Oct'14

We expect traffic growth of 1214% as affordability increases due to a sharp decline in aviation fuel prices


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Corporate profits are depressed; recovery can besharp

An analysis of BSE500 non-financial companies shows that aggregateEbitda and PAT margins are at a 15-year low, net debt/equity is at a15-year high, and ROE has nearly halved from its peak in FY07. Wesee considerable scope for expansion of PAT margins and ROE forcompanies in the Industrials, Materials, Real Estate, Telecom, andUtilities sectors.

Only 273 non-financial companies out of the current BSE500constituents were part of the index 15 years ago. In our view, thissample is a fairly good representation of the investible universe forforeign and domestic institutional investors.

For these 273 companies, sales growth fell to single digits in the pasttwo years from 20-25% growth YoY for much of the last decade.

Figure 1: Sales growth has slowed down to single digits over the past two years

Source: CMIE, IIFL Research. Note: Based on common sample of 273 non financial BSE500 companies that have data since FY2000

Ebitda growth was slow in five out of the past six years.

Figure 2: Ebitda growth has slowed down over last six years


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EBITDA Growth Average(YoY%)

Aggregate Ebitda and PATmargins are at 15-year low,Net Debt/Equity is at a 15-

year high and ROE hascollapsed by nearly half

from its peak in FY07

Sales growth has sloweddown to single digits over

the past two years

Ebitda growth was slow infive out of the past six

years


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Similarly, PAT growth also slowed down significantly over the pastsix years.

Figure 3: PAT growth also slowed down over the past six years


Figure 4: Ebitda margin are at 15year low


PAT margins are also at 15-year low, 40% below the peak level ofFY07. Except for Consumer Discretionary, Consumer Staples, HealthCare and IT, they are sharply down for all other sectors.

Figure 5:

PAT

margins

are

at

a 15

year

low,

40%

below

the

peak

level

of FY07


(20)(10)

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PAT Margin Average(%)

PAT growth also sloweddown significantly over the

past six years

Ebitda margins are at 15-year low

PAT margins are also at a15-year low, 40% below

the peak level of FY07


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Net debt/equity is at a 15-year high. It troughed at 0.3x in FY05 andsince then has more than doubled to 0.7x in end-FY14. It isespecially high for Telecom (2.6x) and Industrials (1.4x).

Figure 6: Net debt/equity is at a 15year high, having nearly doubled since FY07


Interest expense/Ebitda at an average of 14.5% for the universe, isat a 12-year high. It remains extremely high for Real Estate (69%),Industrials (52%), Telecom (30%), Consumer Discretionary (24%)and Utilities (22%) sectors. The actual interest burden would bemuch higher, since a large part of interest expenses are capitalisedby companies in these sectors.

Figure 7: Interest/Ebitda is at a 12year high; actual debt burden would be muchhigher since a large part of the interest expenses are capitalised

Source: CMIE, IIFL Research. Note: Note: Based on common sample of 273 non financial BSE500 companies that have data since FY2000

ROE for the 273 companies nearly halved to 12.1% from the peak of21.5% in FY07. It declined for all sectors except Consumer Staples.The sharpest declines have been in the Industrials, Materials andReal Estate sectors.

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Interest /EBITDA Average(%)

Net debt/equity is at a 15-year high, having almost

doubled since FY07

Interest expense/Ebitda isextremely high for the Real

Estate (69%), Industrials(52%), Telecom (30%),Consumer Discretionary

(24%) and Utilities (22%)sectors


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Figure 8: ROE has nearly halved from the peak of FY07


Figure 9: Sector wise breakdown of Ebitda margin Figure 10: Sector wise breakdown of PAT marginEbitda Margin (%) FY07 FY14Consumer Discretionary 10.7 11.4 Consumer Staples 13.8 16.1 Energy 12.2 9.1 Health Care 19.8 22.8 Industrials 10.8 11.2 Information Technology 20.6 23.3 Materials 25.1 14.1 Real Estate 50.4 27.4 Telecommunication Services 20.1 21.8 Utilities 27.0 24.9 BSE500 15.3 12.6

PAT Margin (%) FY07 FY14Consumer Discretionary 6.5 5.0 Consumer Staples 9.1 10.3 Energy 6.7 3.9 Health Care 13.7 13.5 Industrials 6.0 2.0 Information Technology 16.5 16.5 Materials 15.1 5.7 Real Estate 38.8 8.3 Telecommunication Services 0.5 (4.8)Utilities 18.6 9.9 BSE500 9.1 5.3

Source: CMIE, IIFL Research. Source: CMIE, IIFL Research.

Figure 11: Sector wise Net Debt to Equity Figure 12: Sector wise ROENet Debt to Equity (%) FY07 FY14Consumer Discretionary 0.6 0.8 Consumer Staples 0.3 (0.0)Energy 0.3 0.5 Health Care 0.4 0.2

Industrials

0.4

1.4

Information Technology (0.3) (0.3)Materials 0.4 0.8 Real Estate 2.3 0.7 Telecommunication Services 0.4 2.6 Utilities 0.4 1.0 BSE500 0.4 0.7

ROE (%) FY07 FY14Consumer Discretionary 20.6 16.3 Consumer Staples 27.3 31.6 Energy 22.1 13.4 Health Care 23.3 17.9

Industrials

18.6

4.5

Information Technology 29.7 21.3 Materials 29.6 9.7 Real Estate 46.8 2.6 Telecommunication Services 0.6 (12.8)Utilities 12.0 9.3 BSE500 21.5 12.1

Source: CMIE, IIFL Research. Source: CMIE, IIFL Research.

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ROE Average(%)ROE for the 273 companieshas nearly halved to 12.1%

from the peak of 21.5% inFY07


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Financials under great stress, asset quality andearnings growth to improve

Financials, the single largest component of Indian equity indices,have been under great stress in the past three years. NPAs andrestructured loans have ballooned and earnings growth has sloweddown due to slowness in loan growth and fee income growth andhigher loan loss provision (LLP) charges. We expect asset qualityconcerns to ease and earnings growth to accelerate.

Figure 13: Net Profit growth of Banks & Finance companies in BSE500

Source: CMIE, IIFL Research. Note: Based on common sample of 59 BSE500 financial companies that have data since FY2004

Figure 14: Share of Private Banks and Financials in total Net Profit


(20)(10)

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PAT Growth Average(YoY%)

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35

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45

50

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Share of Pvt. Sector in Financials(%)

NPAs and restructuredloans have ballooned and

earnings growth has sloweddown due to slowness in

loan growth and fee incomegrowth and higher loan loss

provision charges

Private banks and financials

accounted for nearly 50%of the total sector profit inFY14, compared with only

25% in FY04


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Figure 15: ROE of Private and PSU Financials


Figure 16: Total stressed loans of banks (NPAs + Restructured loans)

Source: CEIC, IIFL Research. Note: Based on Banks and NBFCs in IIFL coverage universe

Figure 17: LLP charges as % of average loans

Source: CEIC, IIFL Research. Note: Based on Banks and NBFCs in IIFL coverage universe

5.0 7.0 9.0

11.0 13.0 15.0 17.0

19.0 21.0

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Private Financials PSU Financials(%)

3.1 2.5 2.4 2.4 2.6 2.5 3.0

3.4 3.8 4.2 4.6 4.1

1.7 3.4 3.0

3.8 4.0 4.3

4.3 3.0 2.1

0

2

4

6

8

10

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15ii FY16ii FY17ii

GNPA ratio Restructured loans ratio(%)

0.3 0.4 0.5 0.6 0.7 0.8

0.9 1.0 1.1

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15ii FY16ii FY17ii

PSU Banks Private Banks IIFL UniverseLoan loss provision charges

% of average loans

We expect total stressedloans to peak in FY15 andstart declining thereafter

We have currently assumeda gradual decline in LLP

charges in FY16 and FY17;there is scope for earnings

upgrades if provisioncharges reduce further led

by improvement in assetquality

ROE of private banks andfinancials has risen

whereas it declined sharplyfor PSU financials


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PAT forecast and earnings upgrade potential forIIFL coverage universe

For 159 companies under IIFL coverage for which financial data isavailable since FY09, we forecast acceleration in aggregate PATgrowth to 18.6% YoY in FY16 and 17.6% YoY in FY17, from only 9%Cagr in the previous three years (FY12-FY15ii).

We forecast higher PAT growth for companies in the ConsumerDiscretionary, Energy, Financials, Industrials, Materials and RealEstate sectors. We believe that there is potential for earningsupgrades in the Consumer Discretionary, Financials andIndustrials sectors. In addition, the IT sector may seeearnings upgrades in case of gradual depreciation in INR.

INR depreciation has a much larger impact on bottom lines of ITcompanies than any other sector. For example, an x% depreciationof INR has a 2-3x% impact on PAT of IT companies versus 0.5x%impact on PAT of Pharma companies.

Figure 18: Sector wise earnings growth of companies in IIFL coverage universe Sector Mkt Cap Net Profit (YoY %)

(US$ bn) FY10 FY11 FY12 FY13 FY14 FY15ii FY16ii FY17iiConsumer Discretionary 105 252.6 75.2 15.0 0.2 26.0 14.4 19.2 18.2 Consumer Staples 114 19.1 17.9 19.3 20.4 12.6 20.3 19.3 17.9 Energy 163 34.1 17.5 14.3 1.8 4.9 2.7 18.9 11.3 Financials 221 19.9 17.8 22.5 18.1 3.1 17.5 19.6 25.5 Health Care 73 17.4 20.9 20.3 24.5 30.2 14.0 28.1 14.8 Industrials 65 22.9 23.1 5.3 (3.4) (17.6) 3.5 17.3 26.0 Information Technology 145 18.2 18.5 26.3 28.5 31.7 12.4 13.4 13.5 Materials 84 (13.3) 30.5 0.3 (6.5) (5.7) 11.7 23.9 22.6 Real Estate 5 (55.5) (10.4) (17.5) (26.9) 24.5 (3.7) 53.3 34.8 Telecommunication Services 43 (4.0) (41.1) (24.6) (28.1) 44.5 70.0 13.6 8.8 Utilities 49 17.5 10.4 6.9 1.9 14.7 (6.1) 9.5 10.2 IIFL Universe 1,067 19.0 18.1 12.9 6.8 9.2 11.0 18.6 17.6 Source: Company, IIFL Research. Based on 159 companies that have data for FY09FY17ii and market data as on 16Dec2014

Figure 19: Sector wise earnings contribution of companies in IIFL coverage universe Sector Mkt Cap Earnings Contribution (%)

Share (%) FY10 FY11 FY12 FY13 FY14 FY15ii FY16ii FY17iiConsumer Discretionary 9.8 2.0 5.8 8.6 8.8 8.2 10.0 10.0 10.1 Consumer Staples 10.7 4.1 4.1 4.1 4.3 4.9 5.3 5.3 5.3 Energy 15.3 24.5 27.6 27.5 27.8 26.5 23.6 23.7 22.4 Financials 20.7 19.9 20.0 20.0 21.7 24.0 24.0 24.2 25.8 Health Care 6.8 2.8 2.8 2.8 3.0 3.5 4.3 4.7 4.6 Industrials 6.1 5.8 6.0 6.3 5.8 5.3 3.6 3.5 3.8 Information Technology 13.6 7.1 7.0 7.1 7.9 9.5 11.7 11.2 10.8 Materials 7.9 14.6 10.7 11.8 10.5 9.2 8.0 8.3 8.7 Real Estate 0.5 2.4 0.9 0.7 0.5 0.3 0.3 0.4 0.5

Telecommunication Services 4.1 8.2 6.6 3.3 2.2 1.5 3.0 2.9 2.7 Utilities 4.6 8.5 8.4 7.9 7.4 7.1 6.2 5.7 5.4 IIFL Universe 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Company, IIFL Research. Based on 159 companies that have data for FY09FY17ii and market data as on 16Dec2014

PAT growth for IIFLuniverse to accelerate to18.6%YoY in FY16ii and

17.6%YoY in FY17ii, fromonly 9% Cagr in the

previous three years (FY12-FY15ii)

We believe there ispotential for earnings

upgrades in ConsumerDiscretionary, Financials,Industrials and IT sectors


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Figure 20: Capital Goods: Growth in new order inflows

Source: CEIC, IIFL Research. Note: Based on data from ABB, BHEL, Crompton, Cummins, L&T, NCC, Sadbhav, Siemens, Simplex and Thermax

Over the last few months power sector has seen consolidation whichshould be good news for banks.

Figure 21: M&A in power sector since Nov 2014 Project Capacity

(MW) Acquirer Seller Type EV

(Rs bn)Status

Karcham Wangtoo/Baspa II

1,391 JSW Energy JP Power Hydro 97 Operational

Udupi Power 1,200 Adani Power Lanco Infra Coal 120 Operational; Sale agreement signed Korba 600 Adani Power Avantha Power Coal 42 Operational; Sale agreement signed Nagpur 540 Tata Power Ideal Energy Coal 16 Under construction (one unit

commissioned); Sale agreement signed

Bina/Nigrie 1,820 JSW Energy JP Power Coal 120 Partially operational (as per media reports, no formal announcement)

Total 5,551 395


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Order Inflow(YoY)Pick-up in new order

inflows of the Capital Goodssector can be stronger than

our current forecasts


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Falling commodity prices A major boost for India

Prices of major commodities have softened 5-40% YTD and aredown nearly 20-70% from their ten-year peak. Prices of crude oil,hard commodities, and agricultural products have all declined. Priceshave declined significantly in CY14 YTD: Brent crude was down 47%,Newcastle coal fell 27%, rubber corrected 30%, palm oil slipped23%, and copper slid 12%.

This is a significant positive development for India since thecountrys net imports of commodities were at $178bn in FY14 (9.5%of GDP), including crude oil, industrial commodities, coal, andprecious metals. A 10% average decline in prices of thesecommodities can halve the countrys CAD.

Indias net oil import bill is estimated to fall from $102bn in FY14 to$85bn in FY15 and further to $75bn in FY16.

The BBG commodity index declined for five years in a row and iscurrently 55% below its 10-year peak. Economic slowdown indeveloped nations and China has reduced demand for commoditiesand softened prices.

Figure 22: CRB Commodity Index

Source: Bloomberg, IIFL Research. Market data as on 16 Dec2014

Indias CAD expected to moderate sharply in FY15

In FY14, India was a net importer of crude oil and petroleumproducts worth US$102bn and of precious metals worth US$33bn. Itwas a large net importer of coal and coke (US$16.4bn), iron andsteel, ores, scrap (US$8.2bn), fertilisers (US$6.5bn), non-ferrousmetals (US$5.4bn), paper and paper products (US$3.9bn), andrubber (US$2.1bn). In aggregate, these commodity importsamounted to US$178bn or 9.5% of GDP. Indias current CAD ofUS$32bn or 1.7% of GDP in FY14 is expected to sharply moderate inFY15.

400

425

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475

500525

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Jan 10 Aug 10 Mar 11 Nov 11 Jun 12 Feb 13 Sep 13 Apr 14 Dec 14

CRB CMDT Index

Decline in prices of crudeoil, industrial commodities,

coal and precious metal is a

big positive for the Indianeconomy

Indias net oil import bill isestimated to fall from

$102bn in FY14 to $85bn inFY15 and further to $75bnin FY16

Indias CAD of US$32bn or1.7% of GDP in FY14 is

expected to moderatesharply in FY15


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Figure 23: Net imports of India Net Imports (FY14) US$ bn % of GDP

1 Petroleum, Crude and Products 102 5.5 2 Commodities 26 1.4 3 Capital Goods 23 1.2 4 Gold & Silver 33 1.8 5 Coal, Coke & Briquettes 16 0.9 6 Agriculture & Allied products (31) (1.7)7 Pearls, stones, textiles etc (29) (1.6)8 Others 7 (0.4)

Trade deficit 148 7.9 Current Account deficit 32 GDP 1,877 Net import of commodities (1+2+4+5) 178 9.5


The decline in prices of oil and industrial commodities would benefitcompanies in the Airlines, Consumer Discretionary (Auto, Autoancillaries, Paints), Consumer Staples, and Industrial sectors. On theother hand, commodity producers in the Metals and Energy sectorswould be losers.

Figure 24: Commodity prices declined sharply over the last one year

BBG Ticker Commodity Unit CMP Performance Since (%)

31Dec12 31 Dec13 10 Yr PeakXAU Currency Gold US$/Oz 1,197 (28.6) (0.4) (37.0)XAG Curncy Silver US$/Oz 16 (48.2) (19.2) (67.5)LMAHDY Comdty Aluminium USS$/MT 1,877 (8.1) 6.9 (42.6)LMCADY Comdty Copper USS$/MT 6,410 (18.9) (13.1) (37.0)LMPBDY Comdty Lead USS$/MT 1,905 (17.8) (13.0) (52.2)LMZSDY Comdty Zinc USS$/MT 2,124 3.6 3.5 (53.9)MBSTST58 Index Steel USS$/MT 458 (17.6) (13.7) (55.6)LMSNDY Comdty Tin USS$/MT 20,023 (14.4) (10.4) (39.8)LMNIDY Comdty Nickel USS$/MT 15,928 (6.3) 15.2 (70.5)EUCRBRDT Index Brent Crude USS$/bbl 59 (47.1) (46.6) (59.4)

NAPHSINF Index Naphtha fob Singapore USS$/bbl 53 (48.8) (50.8) (61.0)CLSPAUNE Index Coal (Newcastle) USS$/MT 62 (31.8) (27.0) (67.9)SPGSWH Index S&P GSCI Wheat Index 423 (19.9) 3.0 (51.4)SPGSCN Index S&P GSCI Corn Index 335 (41.9) (3.8) (51.6)SPGCSOP Index S&P GSCI Soybeans Index 447 5.2 (4.8) (20.7)SPGSSB Index S&P GSCI Sugar Index 155 (24.6) (10.4) (58.3)SPGSCT Index S&P GSCI Cotton Index 85 (20.4) (29.4) (72.1)RRS4KO Index Rubber RSS4 Kottayam Rs./MT 11,425 (29.8) (30.3) (52.9)PFA0MYM1 Index PFAD Palm Fatty Acid USS$/MT 555 (7.1) (22.7) (48.9)

Source: Bloomberg, IIFL Research. Based on market data as on 16Dec2014

India was a net importer of commodities of US$178bn

or 9.5% of GDP in FY14

Decline in prices of oil andindustrial commodities

would benefit companies inthe Airlines, Consumer

Discretionary (Auto, Autoancillaries, Paints),

Consumer Staples, andIndustrial sectors


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Domestics to emerge as major buyers of equities,after a gap of six years

In the past six years (FY10-FY15E), Indian households invested anestimated US$40bn into equities at an average annual rate of$6.7bn. This included direct equity purchase and purchases throughmutual funds and life insurance. During the same period, FIIs inflowsamounted to US$108bn at an average annual rate of $18bn. Thisexcessive dependence on FIIs is likely to change as domesticinvestors warm up to equities.

We estimate households to invest $74bn over the next three years(FY16-FY18E) at an average annual rate of nearly $25bn. Two keyassumptions here are: 1) a slight pickup in household savings ratefrom 20.3% of GDP in FY14 to 23.5% in FY18 (it was 25.2% of GDPin FY10); and 2) increase in share of equity investments from 1.6%of total household savings in FY14 to 5.0% in FY18 (it was 5.0% inFY08).

The last time Indian households were bullish on equities was in FY08.In that year, 52% of household savings went into financial assets(they have since fallen to 35% in FY14) and an estimated 5.0% oftotal savings went into equities (they fell to 1.6% in FY14). In FY16,when we expect households to again warm up to equities in a bigway, Indias nominal GDP is estimated at Rs137tn (US$2.2tn atcurrent exchange rate) versus Rs50tn in FY08. In other words, thesize of GDP in FY16 would be 2.7x that of FY08 and so would be thesize of household savings and potential flows into equities.

Figure 25: Share of annual household savings invested in equities

Source: CEIC, RBI, IIFL Research.

1.6 1.5

3.33.9

5.0

1.1

2.9

1.1 0.9

1.8 1.62.0

3.5

4.55.0

FY04 FY06 FY08 FY10 FY12 FY14 FY16ii FY18ii

Share of household savings flowing into equity(%)

In the past six years (FY10-FY15E), Indian households

invested an estimatedUS$40bn into equities as

against investment of $108bn by FIIs

Indias estimated nominalGDP of Rs137tn in FY16

would be 2.7x the nominalGDP of Rs50tn in FY08, the

last time Indian householdswere bullish on equities


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Figure 26: Estimated equity investments by households (US$bn)

Source: CEIC, RBI, IIFL Research.

Figure 27:

FII

inflows

(US$bn)


Figure 28: Table of household savings invested in equities

Rs. bn FY09 FY10 FY11 FY12 FY13 FY14 FY15ii FY16ii FY17ii FY18iiHousehold Savings 13,309 16,308 17,833 20,522 22,135 24,898 26,230 29,540 34,315 40,141 YoY% 19.0 22.5 9.4 15.1 7.9 12.5 5.4 12.6 16.2 17.0

Share of financial assets (%) 42.9 47.5 42.4 30.7 32.4 32.6 38.0 42.0 45.0 50.0 Share of physical assets (%) 57.1 52.5 57.6 69.3 67.6 67.4 62.0 58.0 55.0 50.0

Household savings (% of GDP) 23.6 25.2 22.9 22.8 21.9 21.9 21.0 21.5 22.5 23.5

GDP 56,301 64,778 77,841 90,097 101,133 113,551 124,906 137,396 152,510 170,811 YoY% 12.9 15.1 20.2 15.7 12.2 12.3 10.0 10.0 11.0 12.0

Source: RBI, IIFL Research

2.3 2.66.4

8.6

13.8

3.2

10.0

4.1 3.87.3 6.1

8.7

16.8

25.1

32.6

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Household's investment into equity(US$ bn)

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FII Flows(US$ bn)

We estimate thathouseholds could invest

$74bn over the next threeyears (FY16-FY18E), at an

average annual rate ofnearly $25bn


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Figure 29: Significant jump in flows into domestic equity mutual funds since May 14

Source: Bloomberg, IIFL Research.2014 data based on flows for Jan to Nov 2014

New paper supply still muted; can rise significantly to absorbdomestic and FII inflows: Primary equity issuance has remainedmuted in the past two years, after peaking in FY08. Given its currentsize, the market can easily absorb a much higher level of new papersupply, including divestment of PSU stakes by the government. Newpaper supply as a percentage of year-end market capitalisation issignificantly below the previous peak level.

Figure 30: Primary Equity issuance (IPO + Additional Equity + Rights + QIP)

Source: Bloomberg, IIFL Research.

Real interest rates turned positive after a long time, which increasesthe attractiveness of financial assets.

14

(158)

77

(156) (104)

428

2009 2010 2011 2012 2013 2014

MF Equity(Rs bn)

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Domestic mutual funds arewitnessing robust inflows

since May 2014. We expectthis to accelerate

New paper supply aspercentage of year-endmarket capitalisation issignificantly below the

previous peak level


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Figure 31: Real interest rates (10year GSec yield CPI)

Source: Bloomberg, IIFL Research. Based on monthly average of 10 Yr GSec yield and CPIIW

Valuations are reasonable vis--vis historical andglobal context

After rising 28% in CY2014 until 16-Dec-14, the Nifty trades at 14.9x one-year forward PE versus long-term average of 14.3x andat 2.3x one-year forward PB versus long-term average of 2.6x.

Figure 32: Nifty forward PEx

Source: Bloomberg, IIFL Research. Based on Bloomberg consensus estimates

Figure 33: Nifty forward PBx

Source: Bloomberg, IIFL Research. Based on Bloomberg consensus estimates

(10)

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Real Rates(%)

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12m Fwd PE 1 Std Dev Average +1 Std Dev

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12m Fwd PB 1 Std Dev Average +1 Std Dev

Real interest rates turnedpositive after a long time,

which increases theattractiveness of financial

assets

The Nifty currently tradesat slightly above its long-

term average valuations


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These valuations are based on assumption of EPS growth of 20% forFY16 and 15% for FY17 for the Nifty. As discussed in the earliersections, these earnings growth forecasts are rather conservativeand do not build in sufficient economic recovery in FY16. Companiesare still not confident of a strong recovery in FY16 and are providing

muted guidance.For the past six years (FY09-FY14), actual earnings growth wasbelow consensus estimates in the beginning of the year. FY15 willlikely see actual earnings growth in line with consensus estimates inthe beginning of the year. We expect to enter an earnings upgradecycle from FY16 onwards.

Figure 34: Consensus estimates in year beginning versus actual earnings growth

Source: Bloomberg, IIFL Research. Based on Bloomberg consensus estimate. *for FY15 current estimates versus beginning of the year estimate

Nifty forward PEx and PBx are not significantly above their long-termaverages even on the current earnings forecasts. As earningsupgrades come through, valuations would appear more reasonable inhindsight and continue to propel the market to higher levels.

Current bull-run has long way to go

The Indian markets have experienced six major bull runs since 1991,including the current one, which technically started in June 2012.Having run for 30 months, it is already the second longest runningbull-run after the 57-month long bull-run between April 2003 andJanuary 2008.

However, in terms of returns, the current bull-run has so fardelivered the least upside among all the previous bull-runs. The BSESensex has risen 67% since its bottom in June 2012, versus 611% inthe biggest bull run of Apr03-Jan08, and between 100-300% inother previous bull-runs.

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Consensus Estimate Actual(YoY %) NiftyEPS

For the past six years(FY09-FY14), actual

earnings growth was belowconsensus estimates in the

beginning of the year

We expect to enter anearnings upgrade cycle

from FY16 onwards


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Figure 35: BSE Sensex History of Bull and Bear phases

Source: Bloomberg, IIFL Research. Market data as on 16Dec2014

Figure 36: BSE Sensex returns in Bull and Bear periods

Source: Bloomberg, IIFL Research. Market data as on 16Dec2014

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Sensex Returns in Bull and Bear Periods(%)


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In the last three bull runs, which ended in Feb00, Jan08 andNov10, the BSE Sensex peaked at trailing PE of 24-28x, versus itscurrent trailing PE of 18x. That leaves enough upside through acombination of higher earnings growth and further expansion in PEx.

Figure 37:

Bull

and

Bear

periods

%

returns,

duration,

start

and

end

PEx

Period % Returns Duration (mths) Start trailing PEx End trailing PExJan91 Apr 92 319 15 17.8 55.8 Apr92 Apr 93 (54) 13 55.8 25.3 Apr93 Sep 94 127 17 25.3 47.0 Sep94 May 95 (35) 8 47.0 26.8 May95 Nov 98 (6) 43 26.8 11.2 Nov98 Feb 00 110 15 11.2 25.5 Feb00 Sep 01 (56) 20 25.5 13.5 Sep01 Apr 03 13 19 13.5 12.8 Apr03 Jan 08 611 57 12.8 28.5 Jan08 Mar 09 (61) 14 28.5 11.6

Mar09 Nov 10 157 20 11.6 24.2 Nov10 Dec 11 (28) 14 24.2 16.2 Dec11 Jun 12 6 6 16.2 15.7 Jun12 Dec 14 67 30 15.7 18.0Source: Bloomberg, IIFL Research. Market data as on 16 Dec2014

Nifty not expensive versus global indices - S&P500and Euro STOXX600

Nifty not expensive versus S&P500: In the past 13 years, Niftystrailing PEx has been at an average 4% discount to S&P500.

Currently it is at a 6% premium. On the two recent bull runs in Indiain Dec 2007 and in Sep 2010, Niftys PEx was at 40-55% premium toS&P500.

Since Jan 2006, Nifty has traded at a discount to S&P500 only fortwo periods May 2008-Apr 2009 (during the global financial crisis)and Jul 2013-May 2014. In other words, in the last nine-year period,Nifty has traded at a discount to S&P500 for just less than two years.

Figure 38: Nifty PEx premium/discount to S&P500


(60)

(40)

(20)

0

20

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60

Jan 02 Nov 03 Sep 05 Jul 07 May 09 Mar 11 Jan 13 Dec 14

Nifty PE Premium(+)/Discount( ) wrt S&P500 Index

The BSE Sensex has risenby 67% since its bottom inJune 2012, versus 611% in

the biggest bull-run ofApr03-Jan08, and between

100-300% in otherprevious bull runs

In the past three bull runs,which ended in Feb00,

Jan08 and Nov10, the BSESensex peaked at trailing

PE of 24-28x, versus itscurrent trailing PE of 18x

In the past 13 years, Niftystrailing PEx has been at an

average 4% discount toS&P500. Currently it is at a6% premium, but much

lower than 40-55%premium in the two recent

bull runs in India


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In terms of PBx, Niftys average trailing PBx premium over S&P500has been 21% in the past 13 years. It is currently trading at only 7%premium. Since July 2005, Nifty has always traded at more than21% premium to S&P500, except for brief occasions in Jan-Mar 2009and since Jan 2013 until date.

Figure 39: Nifty PBx premium/discount to S&P500


Nifty versus Euro STOXX600: In the past 13 years, Niftys trailingPEx has been at an average 10% discount to Euro STOXX600.Currently too, it is at 9% discount. On the two recent bull runs inIndia, in Dec 2007 and in Dec 2010, Niftys PEx was at 50-80%premium to Euro STOXX600.

Trading history of the past nine years suggests that Nifty hasgenerally traded at a premium to Euro STOXX600. It has traded at adiscount in only two periods - between Dec 2008 and Dec 2009, andsince Apr 2012.

Figure 40: Nifty PEx premium/discount to STOX600


In terms of PBx, in the past 13 years, Niftys average trailing PBxpremium over Euro STOX600 has been 64% and it is currentlytrading at 66% premium.

(50)(25)

0 25 50 75

100 125 150


Nifty PB Premium(+)/Discount( ) wrt S&P500 Index

(100)

(75)

(50)

(25)0

25 50 75

100


Nifty PE Premium(+)/Discount( ) wrt Stoxx600 Index

In terms of PBx, Niftysaverage trailing PBx

premium over S&P500 hasbeen 21% in the last 13

years. It is currently tradingat only 7% premium

In the past 13 years, Niftystrailing PEx has been at

average 10% discount toEuro STOXX600. Currently it

is at 9% discount


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Figure 41: Nifty PBx premium/discount to STOX600


Nifty EPS Cagr superior to S&P500 and Euro STOXX600: NiftysEPS Cagr of 12.7% in the last decade (2003-2013) was superior toS&P500s 7.0% and Euro STOX600s of 5.9%. Consensus forecastsfor 2013-2016E suggest that Nifty earnings are expected to grow at18.9% versus 10.9% for S&P500 and 17.7% for Euro STOXX600.

EPS CAGR S&P500 Index Stoxx600 Index Nifty Index2003 2013 7.0 5.9 12.7 2003 2008 0.4 0.2 16.3 2008 2013 14.0 11.9 9.2 2013 2016E 10.9 17.7 18.9

Source: Bloomberg, IIFL Research

India A liquid and diversified market

Contrary to general perception of India being a relatively illiquidmarket, it is fairly liquid in terms of the number of stocks withmarket cap of more than $1bn and stocks that trade more than $1min daily value. Currently, there are 206 stocks with market cap ofmore than $1bn and 358 stocks with average daily trading value ofmore than $1m in the past three months.

Figure 42: Number of stocks with Market Cap of more than US$1bn

Source: Bloomberg, IIFL Research. Based on market data of calendar year end. 2014 data based on closing prices of 16Dec2014

(25)

0 25 50 75

100 125 150 175 200


Nifty PB Premium(+)/Discount( ) wrt Stoxx600 Index

6689

121

231

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In terms of PBx, in the past13 years, Niftys average

trailing PBx premium overEuro STOX600 has been64% and it is currently

trading at 66% premium

Consensus forecasts Niftyearnings to grow at 18.9%

versus 10.9% for S&P500and 17.7% for Euro

STOXX600 for 2013-2016E

India currently has 206 stocks

with market cap of more than$1bn and 358 stocks withaverage daily trading value of

more than $1m in the pastthree months


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Similarly, it is a much-diversified market in terms of the spread ofsectors.

Figure 43: Sector wise break up of Indias Market Cap

Source: Bloomberg, IIFL Research. Based on market cap of 2,988 listed companies as on 16Dec2014

Figure 44: Indias Market Cap in the global context Country MCap 2014 GDP MCap/GDP

(US$ bn) (US$ bn) (%)1 United States 23,400 17,416 134 2 China 4,938 10,465 47 3 Japan 4,392 4,670 94 4 Hong Kong 3,873 293 1,324 5

United Kingdom

3,568 2,815

127

6 Canada 1,987 1,785 111 7 France 1,930 2,868 67 8 Germany 1,846 3,775 49 9 Switzerland 1,596 672 238 10 India 1,474 2,115 70 11 South Korea 1,175 1,434 82 12 Australia 1,164 1,464 80 13 Taiwan 940 503 187 14 Brazil 737 2,202 33 15 Spain 731 1,384 53

16 Sweden 656 551 119 17 Italy 567 2,104 27 18 Mexico 422 1,300 32 19 Indonesia 393 852 46 20 Russia 325 1,967 17 Source: Company, IIFL Research. Based on 2014 GDP estimates of IMF and market data as on 16Dec2014

Cons. Disc., 11.6

Cons. Staples, 9.2

Energy, 11.4 Financials, 19.8

Health Care, 7.2

Industrials, 9.8

IT, 12.3

Materials, 10.4 Real Estate, 0.9

Telecom, 3.1

Utilities, 4.3

Share of Sectors in listed universe

India- a highly diversifiedmarket

Global funds cannot beindifferent to India, given

the size of its economy andits equity market and itsstrong growth prospects


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Sector and stock picks

Key overweight sectors:

1. Financials Play on falling interest rates and improved business

and consumer confidence, resulting in higher loan growth and feeincome and lower loan-loss provision charges.

2. Autos Play on falling interest rates, soft oil prices, and rise inconsumer confidence, resulting in higher volume growth andbetter operating leverage and pricing power.

3. Information Technology Play on sustained strongdiscretionary IT spend in developed countries and possibletailwind from INR depreciation (INR depreciation has 2-3x impacton the bottom line), resulting in strong USD revenue andstronger INR bottom line.

4. Cement Play on pickup in construction and acceleration in

demand on one hand and lagging new capacity additions on theother, resulting in higher capacity utilisation and better pricing.

5. Industrials Play on rising business confidence and proactivegovernment policies resulting in acceleration in new order inflowsand faster execution of existing orders.

Key underweight sectors:

1. Consumer Staples Consumption growth is expected to remainweak due to slowing rural income and cut back in governmentexpenditure. Ebitda/PAT margins and ROE are at peak levels,leaving little scope for improvement in the event of an economic

upcycle. 2. Energy Earnings momentum is unpredictable and likely to

remain weak. Valuations are cheap but the timing of re-ratingtriggers is uncertain.

3. Metals Global demand and prices are expected to remain soft.In addition, companies in this sector face execution and rawmaterial sourcing hurdles, which the new government will slowlyaddress; one would need patience.

Figure 45: IIFL recommended sector weights Sector

Weight Recommended

WeightIIFL Picks

Consumer Discretionary 10.1 12.5 Maruti, Hero, Motherson Sumi Consumer Staples 9.0 6.5 Marico, Emami, Britannia Energy 10.1 8.0 BPCL, ONGC, Reliance, Coal India Financials 30.2 33.0 ICICI Bk, Shriram Trans Fin, Bajaj Fin, Axis Health Care 6.1 6.5 Dr Reddy's Lab, Lupin, Cadilla Industrials 5.5 6.5 Blue Star, L&T, Voltas Information Technology 16.2 17.5 HCL Tech, Tech M, Mindtree Materials 7.2 4.0 Ultratech Cem, Shree Cem, JK Lakshmi Real Estate 0.2 0.0Telecommunication Services 1.9 2.0 Bharti Airtel

Utilities 3.5 3.5 Power Grid Nifty Index 100.0 100.0



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Figure 46: Valuation matrix of IIFLs top 5 large cap and top 5 mid cap picks Company Mcap Price PE Ratio PB Ratio EV/EBITDA ROE (US$ mn) (Rs.) FY16ii FY17ii FY16ii FY16ii FY16iiLarge Caps ICICI Bank 30,138 331 14.3 11.9 2.1 NA 14.7

HCL Tech 17,219 1,559 13.4 11.6 3.6 9.1 29.6 Maruti 15,736 3,310 19.8 15.9 3.6 10.1 18.9 Ultratech Cement 10,731 2,485 19.7 16.5 3.0 11.5 16.6 Shriram Transport Fin. 3,872 1,084 13.2 9.6 2.2 NA 18.3 Mid Caps Tata Chemicals 1,654 413 10.3 8.8 1.6 6.4 16.4 Mindtree 1,570 1,192 15.6 12.9 4.0 10.1 27.3 Kaveri Seeds 881 813 14.5 11.0 5.1 12.8 41.5 JK Lakshmi Cement 718 388 19.5 11.8 2.7 9.1 15.0 Blue Star 433 306 18.0 13.5 4.2 12.0 25.5 Source: Bloomberg, IFL Research. Based on IIFL estimates and market data as on 16Dec14


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Annexure I - Governments reform agendaKey areas, which we believe are top priorities of the Modigovernment where work has already started or is likely to start inthe near future include:

1. Subsidy reforms The government spent 2.3% of GDP on fuel,food and fertiliser subsidy in FY14. The subsidy bill is expected to fallto 1.9% of GDP in FY15 and further to 1.6% of GDP in FY16 due tolower global commodity prices, deregulation of diesel prices, and themove towards direct benefit transfer on LPG. The next logical stepwill be better targeting the recipients of these subsidies, to bringdown the subsidy bill further.

2. PSU reforms They aim to provide greater autonomy to PSUmanagements. Eventually, they would work towards a holdingcompany structure for all government stakes in PSUs to detach themfrom direct government interference.

3. Power Sector reforms They aim to strengthen powerproduction, transmission and distribution, fortify the SEBs, augmenttransmission lines, and fast-track execution of slow-movinggeneration projects. A proposal has been mooted to extend thefinancial restructuring package to SEBs until date; earlier, thepackage was for accumulated losses until FY12.

4. Pooling of imported and domestic gas and coal prices - CoalIndia may import coal to overcome the near-term demand-supplygap. Pooling of coal prices would ensure that tariffs are kept within

limits. Similarly prices of domestic gas and imported RNLG may bepooled for power plants. This would ensure that enough fuel isavailable for upcoming and existing power plants.

5. Coal sector reforms Auctioning of 72 coalmines de-allocatedby Supreme Court in Sep14 is expected to be completed by Mar15.Auctioning of the balance 140 odd mines would happen in phases.The government has set a target to raise Coal Indias productionfrom 462MT in FY14 to 925MT in FY20 (12% Cagr) and Indias totalproduction from 565MT in FY14 to 1200MT in FY20 (12% Cagr).Mine-wise plans are being drawn. Government is seeking to modifythe Coal Nationalisation Act to allow third-party sales by the private

sector.6. Labour reforms - Stringent labour laws, which place significantrestrictions on terminating employment and entail cumbersomecompliance process, are a major constraint for the manufacturingsector. The government has initiated labour reforms process withtwo key steps aimed to remove discretionary powers of labourinspectors and create transparency in use of labour rules. Thegovernment has also proposed doing away with stringent penalprovisions in some labour laws.

7. Amendment to Land Acquisition Act This needs to beamended for faster land acquisition for industrial and infrastructureprojects.

8. Amendment to Companies Act, 2013 Since the newcompany law came into effect on April 1, 2014, the government has


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[email protected]

made 45-odd changes and has proposed 14 more changes. Thesechanges pertain to provisions in related-party transactions, corporatesocial responsibility, issue of consolidated financial statements, andthe role of directors and key management personnel. These changesare driven by calls from the industry, auditors, and consultants, to

ease the environment to do business. 9. Goods and Services Tax (GST) Constitutional Amendment Billin this regard is expected to be introduced in the Parliament. There isa high probability of GST being implemented from April 1, 2016.

10. Infrastructure build-up Roads, Railways, Airports, andUrban Infra are among areas that are likely to see major policyinitiatives. National Highway Authority of India (NHAI) hasaccelerated tendering and awarding of new road projects. Pace ofwork on Dedicated Freight Corridors (DFC) is picking up. Thegovernments vision of new industrial corridors and smart cities istranslating into reality.

11. 3G spectrum availability to improve The Ministry ofDefence has agreed to release 15MHz of 2100MHz spectrum. Thiswill increase availability of 2100MHz spectrum by 75%. If 2100MHzis auctioned together with 900MHz, it would be positive for telcosbecause: 1) 2) higher spectrum supply would keep spectrum pricescooler; and 2) they would ease capacity constraints at a time whendata traffic is increasing rapidly. It would also be critical for enablingthe government to meet its budgeted telecom receipts of Rs455bn inFY15.

12. Stable and predictable tax regime - A High Level Committee(HLC) has been set up to provide a stable and predictable taxationregime with the objective of restoring investor confidence. The HLCwill interact with trade and industry and ascertain areas where clarityon tax laws is required. The HLC would then providerecommendations to the Central Board of Direct Taxes(CBDT)/Central Board of Excise and Customs (CBEC), which wouldthereafter be obliged to make changes and provide the necessaryclarifications and circulars within two months.

13. Ease of doing business From special courts to settlecommercial disputes in Delhi and Mumbai to a unique identitynumber for all firms and three forms instead of 17 for imports and

exports, the Prime Ministers Office (PMO) has listed out 36 steps tobe undertaken by various ministries by Jan-15 end as part of astrategy to propel India up the ranking in the Ease of DoingBusiness.


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CMP Rs331

Target 12m Rs420 (27%)

Market cap (US$ m) 30,075

Bloomberg ICICIBC IN Sector Banks

Dec 16 2014

52Wk High/Low (Rs) 366/189 Shares o/s (m) 5790 Daily volume (US$ m) 63.0 Dividend yield FY15ii (%) 1.5 Free float (%) 100.0

Shareholding pattern (%) Promoter 0.0 FII 41.1 DII 22.3 Others 36.6

Price performance (%) 1M 3M 1Y

ICICI Bank (2.3) 8.4 51.0Absolute (US$) (5.0) 2.6 49.0Rel. to Sensex 2.2 7.3 21.0CAGR (%) 3 yrs 5 yrsEPS 23.9 20.3 Stock movement

Sampath Kumar [email protected] +91 22 4646 4665

Abhishek Murarka [email protected] 91 22 4646 4661

www.iiflcap.com

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Financial summary (Rs bn)Y/e 31 Mar, Parent FY13A FY14A FY15ii FY16ii FY17iiPre prov. operating inc. (Rs bn) 132 166 194 227 270 Pre exceptional PAT (Rs bn) 83 98 113 133 160 Reported PAT (Rs bn) 83 98 113 133 160 Pre exceptional EPS (Rs) 14.4 17.0 19.5 23.1 27.7 Growth (%) 28.6 17.8 14.9 17.9 20.3 IIFL vs consensus (%) 0.4 0.1 1.1 PER (x) 22.9 19.4 16.9 14.3 11.9 Book value (Rs) 116 127 141 158 178 PB (x) 2.9 2.6 2.3 2.1 1.9 CAR (%) 18.7 17.7 16.7 16.1 15.5 ROA (%) 1.6 1.7 1.8 1.8 1.9 ROE (%) 13.1 14.0 14.6 15.4 16.5 Source: Company, IIFL Research. Price as at close of business on 16 December 2014.

ICICI Bank BUY

Improving fortunes

Institutional Equities

ICICI Bank (ICICIB) is well poised to benefit from recovery inthe economy and flexible structuring of long-term projectloans. This would lower risk of infrastructure loans. Strongcapitalisation ratios would allow ICICIB to exploit growthopportunities and deliver market share gains over themedium term. Robust earnings and sharp increase in ROE of190bps over the medium term are likely to provide significantupside to the stock price over the next 12-18 months.Improvement in subsidiaries performance too would be acatalyst for the stock.

Well poised to benefit from recovery in operatingenvironment: Improvement in macro-economic conditions andrenewed focus on expanding the retail lending franchise should helpICICIB to achieve higher-than-industry loan growth. Expandingmargins and uptick in non-interest income growth would boostrevenue growth. An enabling regulatory environment for resolutionof distressed assets, particularly in the infrastructure segment, wouldallow the bank to adopt flexible loan structuring and lower the riskprofile of assets over the medium term.

Robust earnings growth, sharp increase in ROE likely: Strongcapitalization places ICICIB well to exploit growth opportunities,deliver market share gains, and stronger earnings growth. ICICIB is

set to deliver 19% earnings Cagr over FY15-17, driven byacceleration in loan growth, increase in contribution of non-interestincome, sustained operating efficiency, and stable asset quality. Thebank is likely to record sharp increase in ROE of 190bps over thesame period.

Strong capitalization, attractive valuation to drive upside: High tier I CAR places ICICIB well even under the new capital rules(Basel III). Earnings growth would be non-dilutive despite highercapital requirements kicking in through FY19. Trading at 2.2X FY16iiP/B, ICICIB is attractively valued, given non-dilutive earnings growthand increasing ROE. In our SOTP, the bank contributes to 85% andlife insurance 7.5% of the value. Valuations of non-bankingsubsidiaries should increase significantly and aid in sustaining strongreturns over the next 12-months.


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CMP Rs1559 Target 12m Rs1880 (21%) Market cap (US$ m) 17,077 Enterprise value (US$ m) 15,937

Bloomberg HCLT IN Sector Technology

Dec 16 2014

52Wk High/Low (Rs) 1,776/1,159 Shares o/s (m) 702 Daily volume (US$ m) 27 Dividend yield FY15ii (%) 1.9 Free float (%) 38.5



HCL Tech (3.2) (3.0) 32.5Absolute (US$) (6.0) (6.3) 31.0Rel. to Sensex (1.3) (4.0) 3.0CAGR (%) 3 yrs 5 yrsEPS 57.4 37.7 Stock movement

Sandeep Muthangi [email protected] 91 22 4646 4686

Nandish Dalal [email protected] 91 22 4060 9310

www.iiflcap.com

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Financial summary (Rs m)Y/e 30 Jun, Consolidated FY13A FY14A FY15ii FY16ii FY17iiRevenues (Rs m) 257,337 329,180 365,650 413,931 468,201 Ebitda margins (%) 22.7 26.3 24.6 24.4 24.5 Pre exceptional PAT (Rs m) 41,027 63,237 71,964 82,206 94,680 Reported PAT (Rs m) 41,027 63,710 73,518 82,206 94,680 Pre exceptional EPS (Rs) 58.2 89.5 102.0 116.5 134.2 Growth (%) 66.0 53.9 13.9 14.2 15.2 IIFL vs consensus (%) (1.6) 1.0 3.4 PER (x) 26.8 17.4 15.3 13.4 11.6 ROE (%) 33.7 37.1 32.0 29.6 27.9 Net debt/equity (x) (0.3) (0.5) (0.5) (0.6) (0.6) EV/Ebitda (x) 18.1 11.7 10.7 9.1 7.5 Price/book (x) 7.8 5.5 4.4 3.6 2.9 Source: Company, IIFL Research. Price as at close of business on 16 December 2014.

HCL Technologies BUYStrong growth, cheap valuations


A lacklustre growth at HCL Techs non-infrastructure businesswas a key issue over the past three years (revenue Cqgr ofless than 1% over 4QFY12-1QFY14). However, this haschanged over the past year. The non-infrastructurebusinesses contributed to 55% of incremental revenue (vs.20% over 1QFY13-1QFY14). Deal wins continue to be strong(USD6bn over the past five quarters). These factors highlightthe underlying strength in business traction. Consequently,we expect HCLTs revenue growth to be among the best inIndian IT over FY15-17 (13% Cagr). Despite such robustgrowth, valuations are the cheapest in the peer group (13.5xFY16ii PER). We expect the stock to re-rate. BUY.

Growth is increasingly diversified: Infrastructure service (34% ofrevenue) was the key revenue driver for HCL Tech during FY13/14. Alacklustre market for ERP services (16% of revenue) and increasingcommoditization in ADM services (28% of revenue) were among thekey headwinds for HCLTs other services. Over the past one year,growth in the non-infrastructure business has improved. A cyclicalrecovery in engineering services (17% of revenue), better crossselling of ADM services, and strong demand for analytics serviceshave resulted in better growth. The strong deal wins (USD6bn overthe past five quarters) also indicate that the underlying businesstraction remains strong.

Benefiting from early entry into Europe: Over the past twoyears, European business grew 7-22% for the top-4 Indian ITcompanies, whereas US business grew only 3-14%. Low penetrationof offshoring and increased local presence of Indian IT have been thekey reasons for better growth in Europe. HCLT was an early moverwith the acquisition of Axon. Europe accounts for 32% of HCLTsrevenue now and should remain a key growth driver.

Cheapest valuations among large caps: We believe HCLTsrevenue growth to be among the best in Indian IT. Margins are likelyto be stable over FY15-17, following a sharp increase over the pastthree years. We envisage robust 15% EPS Cagr over FY15-17ii.

Despite such strong fundamentals, valuations (13.5x FY16ii PER) arethe cheapest in the peer group. HCLT is our top pick in IT services.


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Bloomberg MSIL IN Sector Autos

Dec 16 2014

52Wk High/Low (Rs) 3,440/1,540 Shares o/s (m) 302 Daily volume (US$ m) 16.0 Dividend yield FY15ii (%) 0.8 Free float (%) 43.8



Maruti Suzuki (0.6) 12.0 94.5Absolute (US$) (3.3) 8.0 90.0Rel. to Sensex 4.0 11.0 65.0CAGR (%) 3 yrs 5 yrsEPS 6.5 17.8 Stock movement

Joseph George [email protected] 91 22 4646 4667

Kevin Mehta [email protected] 91 22 4007 7193

www.iiflcap.com

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Financial summary (Rs m)Y/e 31 Mar, Parent FY13A FY14A FY15ii FY16ii FY17iiRevenues (Rs m) 435,879 438,436 492,210 592,152 701,919 Ebitda margins (%) 9.7 11.9 12.9 14.2 14.3 Pre exceptional PAT (Rs m) 23,921 28,923 36,451 50,538 62,927 Reported PAT (Rs m) 23,921 27,830 36,451 50,538 62,927 Pre exceptional EPS (Rs) 79.2 95.8 120.7 167.3 208.3 Growth (%) 39.9 20.9 26.0 38.6 24.5 IIFL vs consensus (%) 0.0 4.5 (9.9) PER (x) 41.8 34.6 27.4 19.8 15.9

ROE (%) 14.2 14.6 16.3 19.7 21.0 Net debt/equity (x) (0.3) (0.4) (0.4) (0.5) (0.6) EV/Ebitda (x) 22.1 17.4 14.1 10.1 8.0 Price/book (x) 5.4 4.8 4.2 3.6 3.1 Source: Company, IIFL Research. Price as at close of business on 16 December 2014.

Maruti Suzuki BUY

Ideally positioned for recovery


Maruti is the best auto OEM play on macro-economic recoveryin India. Following flat volumes for the past four years, weexpect car sales to bounce back, led by high pent-up demand,economic recovery, and deceleration in car ownership costs.Marutis strong product pipeline, coupled with lowercompetitive intensity, should help it consolidate itsleadership. Margins are likely to expand from the currentlevels, as demand growth would reduce discounts. Weak JPYwould help reduce import costs and aid margins. BUY.

Car industry showing initial signs of recovery; we expectacceleration in CY15: The passenger car industry is showing signsof recovery (up 3% YTD FY15) after remaining flat over FY11-FY14.An economic recovery, fall in ownership costs (fuel, interest cost)and high pent-up demand would drive improvement in demand. Weforecast industry volumes to grow at 15% Cagr over FY15-FY17.

Marutis competitive positioning extremely strong: Successfulnew models and a strong rural presence have helped Maruti improveits market share from a low of 38% in FY12 to 45% YTD FY15. Weexpect Marutis competitive positioning to remain strong over themedium term, driven by a pipeline of 4-5 new models scheduled forlaunch over the next 18 months. On the other hand, competitionseems to have taken the foot off the pedal, especially in the smallcar segment (Marutis forte). A sharp reduction in pricing premium of

petrol over diesel would work in Marutis favour as it has a muchhigher market share in the petrol segment than in diesel.

Margins set to improve: Margins are likely to expand from currentlevels, as demand growth would reduce discounts (average discountat 5% of ASP vs. 2.5-3.0% normally) and bring in operatingleverage. Marutis high import costs are likely to come down due tofocus on component localization as well as due to weakness in JPY.

Expect 30% EPS Cagr over FY14-17: A combination of industryrecovery, market share gains and margin expansion should drive30% EPS Cagr over FY14-17. We expect FCF generation to be strong(FCF=PAT in FY16, FY17), especially given that Suzuki is likely tofund Marutis capacity expansion in India.


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Bloomberg UTCEM IN Sector Cement

Dec 16 2014

52Wk High/Low (Rs) 2,872/1,634 Shares o/s (m) 274 Daily volume (US$ m) 9.4 Dividend yield FY15ii (%) 0.4 Free float (%) 38.3



UltraTech Cem (5.0) (2.6) 40.4Absolute (US$) (7.6) (7.5) 37.0Rel. to Sensex (0.5) (4.0) 11.0CAGR (%) 3 yrs 5 yrsEPS 13.4 (1.0) Stock movement

J Radhakrishnan [email protected] 91 22 4646 4653

www.iiflcap.com

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Financial summary (Rs m)Y/e 31 Mar, Consolidated FY13A FY14A FY15ii FY16ii FY17iiRevenues (Rs m) 201,749 202,798 244,949 290,624 333,977 Ebitda margins (%) 23.2 18.8 19.8 22.1 23.2 Pre exceptional PAT (Rs m) 26,516 20,489 25,546 34,646 41,371 Reported PAT (Rs m) 26,516 20,489 25,546 34,646 41,371 Pre exceptional EPS (Rs) 96.7 74.7 93.2 126.3 150.9 Growth (%) 8.4 (22.7) 24.7 35.6 19.4 IIFL vs consensus (%) (3.0) (5.2) (12.9) PER (x) 25.7 33.3 26.7 19.7 16.5 ROE (%) 18.9 12.7 14.0 16.6 17.1 Net debt/equity (x) 0.2 0.1 0.3 0.2 0.0 EV/Ebitda (x) 15.5 19.0 15.6 11.5 9.2 Price/book (x) 4.5 4.0 3.5 3.0 2.6 Source: Company, IIFL Research. Price as at close of business on 16 December 2014.

UltraTech Cement BUY

Industry-beating growth


We expect UltraTech Cement (UCL) to report 26% earningsCagr for FY14-FY17 driven by: 1) increased pricing power forcement producers with an improvement in industry demandand utilisation; 2) increased volumes driven by new capacityadditions; and 3) improved efficiency, led by a cost reductionprogramme. UCL trades at EV/Ebitda of 11.5x on our FY16and 9.2x on our FY17 estimates.

26% earnings Cagr in FY14-FY17 driven by volume grow

IIFL - India - Strategy 2015 - Earnings Bouncing Back - 20141217_15!18!23

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