India Strategy - Jan12 - IDFC · 3 India Strategy Our market call:Our sense is that 16000 levels...

India StrategyIndia Strategy

“Saat Khoon Maaf”

Nikhil Vora / Kavitha Rajan / Swati Nangalia

IDFC Securities Ltd(Dir) +91-22-6622 2567 / 2697 / 2576(M) +91 –98211 32471 / 90043 88616 / 99867 87125Email: [email protected] / [email protected] / [email protected]

February 2012

2


The ‘Seven’ deadly sins, also known as the cardinal sins - wrath, greed, sloth, pride, lust, envy, and gluttony – are a classification of objectionable vices. We believe the ‘Indian markets’ over the last one year have personified the ‘Seven Deadly Sins’. (a) Government inaction, (b) inflows, (c) currency, (d) inflation, (e) interest rates, (f) corporate earnings and (g) valuations, stand out as the 7 Sins committed by the Indian markets, eroding 25% value in the last one year. While almost ALL these variables offer extreme discomfort at this point of time and the fatigue among investors is of the highest order, we believe there are pockets of comfort emerging. While for some of the variables the change or reversal is evident (currency, inflation, interest rates!), for the others we'd like to take a subjective call based on the initial positive signs…And so we suggest ‘Saat Khoon Maaf’!Government Inaction: Hit by a bevy of scams, corruption charges and governance issues, decision-making by the government slowed down considerably all through 2011! While we do concur that there has been a marked slowdown in government policy initiatives, governments have ‘rarely’, if ever, been the reason for being bullish on markets! Also, in terms of the productivity of the government, in CY2011 the Indian government cleared ~40 bills, similar to its long-term average of ~50 bills per year. So could we attribute this heightened despondency to a case of ‘exaggerated expectations’? We believe so! We expect the equation to change after the upcoming elections and expect the government to kick dust on policy actions after March 2012. Further, there have been increasing concerns on “anti- corruption crusade derailing growth”. Strange but true; however, we strongly believe that investors should not overlook the long-term picture. What is good for the nation cannot be bad for the markets! While there could be near-term pain, cleansing of the system would lead to a long-term structural re-rating of the Indian markets!Inflows: While all-time-high alternate asset class (gold, debt, real estate) prices led to lower retail participation in Indian equities in CY11, decelerating growth and increasing global uncertainties limited FII participation (net outflows in 2011 as against average inflow of ~US$10bn-15bn!). Does that mean another year of insignificant market flows? We do not think so! Tapering demand in alternative asset classes, led by falling affordability and lower aggregate demand, should lead to incremental retail flows into equities! On institutional flows, we expect stability to set in and see net inflows of US$30bn-40bn over the next two to three years.Currency: The Indian rupee witnessed one of its wildest swings ever and was one of the worst performing currencies in 2011 (down 20% in four months!). While a tad reactive, the measures taken by the RBI, we believe, have stemmed speculative flows into the currency, validated by the ~6% reversal in the rupee in January 2012. We expect a rebound in FII flows and moderation in the current account deficit on the back of falling gold demand (read gold imports) to drive a steady appreciation in currency (average USD/INR at 49 in FY13) over 2012.Inflation: After seeing the longest stretch of high inflation (averaging 9.5% for 12 months!), headline inflation has finally moderated to ~7.5% in December 2012. While ‘core inflation’remains elevated, we expect moderation in aggregate demand, reversal in the domestic currency’s movement, and a favorable base to aid a deceleration going ahead. So, we expect headline inflation to moderate to 7% by March 2012.Interest rates: After hiking policy rates by ~375bp over 20 months, the RBI has finally paused! With inflation on a downward trajectory and increasing downside risks to domestic growth, we expect the monetary policy to turn more accommodative. Hence, 2012 is likely to be a year of ‘sustained’ and ‘savage’ interest rate cuts!Corporate earnings: Earnings growth has come off significantly in the last 3-4 quarters, with earnings growth expectation of Sensex companies being pruned to 10% yoy for FY12 (19% yoy in the beginning of the year!). However, demand drivers for India Inc remain intact, underlined by the strong top-line growth in most companies over the last few quarters. Also, balance sheets of corporate India remain healthy with decreasing leverage and increasing cash on balance sheets. Further, while higher interest rates dented earnings momentum leading to an eventual de-rating of equity markets, we expect market re-rating to precede earnings uptick when the reversal in interest rates occurs!Valuations: Market valuations have come off materially with significant deterioration in India’s premium over other emerging markets! Continuing our ‘core’ thesis from our last strategy report, we believe valuations have troughed, with more than 50% of the companies at index levels of 8000 and with more than 25% of the businesses trading at less than capital employed! This intuitively implies that one can buy companies at values on par with the promoters. Also, with valuations of most sectors (construction, power utilities, telecom etc) at ~70% discount to its peak valuations, we expect strategic value unlocking to kick-start soon. RIL’s US$2bn worth share buyback, strategic asset sale by Strides Arcolab, and the recently concluded Network 18-Reliance Industries deal are all steps in this direction, clearly indicating that “value” has finally emerged!

3


Our market call: Our sense is that 16000 levels for Sensex is an extremely strong base given the comfort on valuations (25% of businesses trading at less than capital employed!). Also, investor fatigue after staying on the sidelines for almost the whole of 2011 and corporate resilience amid the extreme pain further emphasize our argument. Further, expectations of the corporates and investors on various policy initiatives from the government have hit rock bottom; hence even a small progress on reforms could positively surprise the markets. We note that the current state of markets is extremely tough and there are innumerable variables that make it difficult to take a call on the markets. However, our sense is that even a progress from extreme ‘volatility’ to some ‘stability’ would drive a sharp re-rating of the equity markets. In this scenario, we prefer a bottom-up play with a definite bias for interest rate sensitive sectors like financials and infrastructure.Model portfolio: With an interest rate reversal on the cards, we suggest moving to interest sensitives like Infrastructure and Financials and trimming positions in global plays like IT Services, Metals, Oil & Gas, etc. Further, we have increased our weights in the mid-cap portfolio and marginally reduced positions in the expensive consumer goods space!Top picks:Top buys – Large cap (Mcap >US$2bn):Adani ports, Bharti Airtel, Cipla, Infosys, ITC, JP Associates, JSPL, L&T, SBI, ICICI Bank and Yes BankTop buys – Mid cap (Mcap – US$500m to US$2bn): Petronet LNG , United phosphorus , IPCA Labs, Sobha Developers and GPPLTop buys – Small cap (Mcap <US$500m): Educomp, KEC International, Den network and Provogue IndiaTop sells: Ambuja Cements, BHEL, Cairn India, Hero Motocorp, Idea Cellular, RIL, Tata Power, Tech Mahindra, Voltas and Zee Entertainment.

44

The The ““seven sinsseven sins”” of the Indian market!of the Indian market!

Delays in government decision making!Tepid foreign inflows!

Wild fluctuations in domestic currency!

Longest stretch of high inflation ever!

Aggressive monetary policy stance!

Corporate earnings on a downtrend!

Sharp de-rating of market valuations!

55

Bear markets are always ‘different’…

…and this one is no different!

66

‘‘SingularSingular’’ factors drove global bear markets in the pastfactors drove global bear markets in the past……

Great depressionOver exuberance and creation of investment

bubbles

1929

UK stock market crash

Spiraling oil prices

1973

Asian financial crisis

Large capital flows -Asset bubbles

1997

Financial crisisExposure of US banks to

sub-prime loans and credit default swaps

2008

US recessionSpending cuts to balance

fiscal budget

1937

Japanese asset price bubbleAsset bubbles

1991

Dot com bubbleSpeculative flows to technology stocks

2000

77

……BUT, the current crisis is led by BUT, the current crisis is led by ‘‘ALLALL’’ of them!of them!

15,000

17,000

19,000

21,000

Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12

BSE Sensex

Fed chairman announces QE2 of US$600bn!

China increases reserve requirement for banks by ~50bp to combat inflation!!

Euro zone approves Euro 85bn bailout package for Ireland!

Fake housing loan scam uncovered by CBI!

Crude oil rallies ~18% in 3 months!

Furore over 2G scam disrupts winter session of parliament

RBI pauses after hiking interest rates by ~150bp since March 2010!

Civil uprising in Egypt, Tunisia!

Crisis spreads across MENA region!

India inflation jumps back to 9.5% in Dec 2011!

High intensity earthquakes hits east coast of Japan!

Anna Hazare begins his hunger fast in Delhi for passing of Jan Lokpal bill!

RBI hikes policy rates by 50bp!

Euro zone approves Euro 78 billion bailoutpackage for Portugal!

S&P downgrades Greece debt to CCC

RBI hikes repo rates by 50bp; revises baseline projection for March 2012 inflation to 7% from 6%!

S&P downgrades US credit rating from AAA to AA+

China increases reserve requirement for banks for the 9th time!

Cabinet clears land acquisition and mining bill!

RBI hikes rates by 25bp; cuts FY12 growth guidance to 7.6% from 8% earlier!

Euro zone leaders agree on 50% write-off on Greek debt and increasing EFSF size to Euro 1 trillion!

IIP contracts by 5%; Q2 GDP falls below 7%!

RBI pauses interest rate hiking cycle!

Rollback of FDI in multi brand retail due to lack of political consensus!

Australian central bank cuts interest rate by 25bp

88

(50.0)

(10.0)

30.0

70.0

110.0

Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

MSCI India relative to MSCI World

While While ‘‘locallocal’’ events triggered past bear marketsevents triggered past bear markets……

Bear markets of past 20 years in India caused by local events -scams/ financial liquidity crunch!

Harshad Mehta scam and BOP

crisis!Asian financial

crisis!

Satyam scam and financial liquidity

crisis!!

Dot com bubble & Ketan Parekh

scam!

99

……first time ever we are in a first time ever we are in a ‘‘global bearglobal bear’’ trap!!!trap!!!

Global uncertainties puts further pressure on already mounting domestic concerns!

Euro crisis spreading to the ‘core’ economies! Recovery in US not yet on firm footing!

Concerns of growth moderation in China!

0

150

300

450

600

Apr-07

Aug-07

Dec-07

Apr-08

Aug-08

Dec-08

Apr-09

Aug-09

Dec-09

Apr-10

Aug-10

Dec-10

Apr-11

Aug-11

Dec-11

Spain Italy GermanyCDS spreads (bp)

0

30

60

90

120

Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Oct-11

Conference board leading index for US (MoM %)

5.5

8.5

11.5

14.5

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11

China GDP (YoY %)

1010

Indian marketsIndian marketsSaat khoon maaf!!!

1111

“Soch jab gehri ho jati hai…toh faisle kamzor ho jate hai”

Government Inaction!Government Inaction!1

1212

Case of Case of ‘‘exaggerated expectationsexaggerated expectations’’??

Numbers of bills passed by the parliament

Functioning of the government not ‘starkly’ different from its earlier standards!

BJPINC

15

30

45

60

75

90

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Bills passed by Parliament LTA

Average at ~50 bills per year!

Current performance not that different from govt’s usual

standards!

1313

Status check on reformsStatus check on reforms

With expectation at rock bottom, even a small progress on reforms could surprise the markets positively!

Reforms Parliament Act/LawCabinet Key measures

Mandatory digitization of cable TV

FDI in single brand retail

Land acquisition bill

Mining bill

Goods & services tax

Direct Tax code

Jan Lokpal bill

Not required

Digitization of cable has become a law; Sunset date for analog cable TV has been set; would resolve the issue of under reporting of revenues

FDI of 100% in single brand retail has come into effect; For FDI > 51%, mandatory sourcing of at least 30% from the domestic small and cottage industries!

Companies to pay at least 2x market price in urban and 6x in rural areas; Companies shall provide for rehabilitation and resettlement

Tax of 26% of profit of coal miners and 100% royalty for others;Also, central and state cess to be levied on mining companies

Move towards a common indirect tax regime across the country; According to CII, GST could add 1-1.5% to GDP growth

Move towards a simplified direct tax structure and lower tax rates; To improve tax collections due to lower evasions

It would enable filing of complaints against politicians and bureaucrats without prior government approval

Not required

FDI in aviation Not required FDI of 49% in aviation is on the cards! Not required

1414

‘‘PopulismPopulism’’ to take a back seatto take a back seat……soon!soon!Election schedule for 2012

Scams, lokpal and political consensus building left little room for reforms in 2011; expect politics to take a backseat post elections in 2012 and see more action on the reforms front!

State/UTs Incumbent Party Poll Dates % of Loksabhaseats

Punjab SAD-BJP alliance Jan-Feb 2012 2.4

Uttarakhand Bharatiya Janata Party (BJP) Jan-Feb 2012 0.9

Manipur Indian National Congress (INC) Jan-Feb 2012 0.4

Uttar Pradesh Bahujan Samaj Party (BSP) Feb-Mar 2012 14.5

Goa Indian National Congress (INC) Mar-2012 0.4

Gujarat Bharatiya Janata Party (BJP) Dec-2012 4.7

Next key assembly election is in May 2013 in Karnataka!

Window for policy action!

With elections due in a key state (UP), expect

material reforms to kick-start post March 2012!!

9-12 months

1515

““Kanoon ke haath bahut lambe hote hainKanoon ke haath bahut lambe hote hain””

1616

AntiAnti--corruption crusade derailing near term growth...corruption crusade derailing near term growth...

Fight against corruption resulting in prolonged decision making!

“There’s a sense that the bureaucracy has stopped taking decisions as they fear that action might be taken against them

in future even for honest mistakes.”

- Sunil Bharti Mittal

1717

……or sanitizing the system?...or sanitizing the system?...

For the first time ever, India saw a series of high level ‘corruption’ related arrests!

Politicians Corporates Bureaucrats

1818

……ensuring long term ensuring long term ‘‘sustainablesustainable’’ rere--rating!rating!

What’s good for the country in the long term cannot be bad for the markets…near term pain to build the case for long term re-rating!

Countries which are ‘perceived’ to have lower levels of corruption…tend to be less volatile and hence demand better valuations!

India has slipped to 95th position (out of 178 countries) in the transparency International corruption index!!!

P/BV (x)P/E (x)

0.5

2.0

3.5

5.0

6.5

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

UK India Singapore US

5.0

10.0

15.0

20.0

25.0

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

UK India Singapore US

1919

….“Khush toh bahut hoge tum Aaj”

InflowsInflows2

2020

All time high prices of All time high prices of ‘‘otherother’’ assetsassets……pulls out retail investors from equities!pulls out retail investors from equities!

Gold Real estateDebt

(Weighted average prices of all projects in Rs)

Strategy of downsizing their equity investments and increasing exposure to other asset classes like gold, real estate, debt etc have paid off well for the retail investors!

Retail participation in Indian equity markets has come off sharply in the last 5 years!

0

500

1,000

1,500

2,000

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Gold (USD/oz)

10.0

11.0

12.0

13.0

14.0

15.0

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

SBI PLR (%)

2,000

2,750

3,500

4,250

5,000

Jul-07 Jul-08 Jul-09 Jul-10 Jul-112,000

4,000

6,000

8,000

10,000

Bangalore (LHS) Gurgaon (LHS)

Mumbai (RHS)

0.0

3.0

6.0

9.0

12.0

FY06 FY07 FY08 FY09 FY10 FY11 H1FY12

Retail holding in BSE 500 (%)

2121

FII flows also turns negative in CY11!FII flows also turns negative in CY11!

After two years of healthy inflows, FII flows turns tepid in CY11!

-3,000

-500

2,000

4,500

7,000

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep

-09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep

-10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep

-11

Nov

-11

FII flows - Equity (USD m)

Net outflows of US$0.4b in CY11!

2222

Its time for participation!Its time for participation!

22

Retail investors: Time for reversal?

Institutional investors: Historically, India has seen FII outflows only once beforeand that too during a global meltdown!

Expect ‘stability’ to set in and flows to normalize in CY12 ; We

see net FII inflows of US$30-40bn in the next 3 years – in turn having a positive rub-off on currency as

well!

Higher prices have already started denting demand

With interest rate reversal on the cards, demand is expected to come off

Lower aggregate demand and falling affordability to impact prices

8.5 1.7 0.6 2.3 0.7 6.6 8.7 10.7 8.1

17.7 17.5

29.4

1.6

(12.0)

(0.4)

(15.0)

(6.0)

3.0

12.0

21.0

30.0

CY98 CT99 CY00 CY01 CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11 YTDCY12

FII f low s - Equity (USD bn)

We saw net FII outflows in CY11 as against average inflows of ~US$10-15bn!

With demand for alternative assets likely to taper off, expect incremental flow from retail investors into

equities!

2323

“Sabse bada rupaiya($)…”

CurrencyCurrency3

2424

15.0

25.0

35.0

45.0

55.0

Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12

USD- INR

Recent currency swing one of the wildest in 20 years!Recent currency swing one of the wildest in 20 years!

Rising current account deficit, heightened risk aversion due to Euro crisis and threat of large debt redemptions have led to sharp depreciation of the rupee!

India’s BOP crisis led to ~60% depreciation in INR

over 2 years!

Asian financial crisis resulted in ~19%

depreciation in 1 year!

During global financial crisis currency came off by

26% in 1 year!

Indian currency depreciated by~20%

in 4 months!!!

2525

Its time for stabilityIts time for stability……While a tad reactive, RBI actions have helped to stem speculative flows…Date RBI actions

Nov-2011 Increase in FII limits for investment in sovereign and corporate govt bonds

Dec-2011 Deregulation of NRE and NRO interest rates

Dec-2011 Limit on net open currency position – to limit speculative trades

Dec-2011 Curbs on cancellation and rebooking of currency forwards

RBI actions have put the brakes on speculative activity - ‘stabilizing’ domestic currency movement!

…reflected in the recent pull back in domestic currency!

After the recent RBI actions, domestic

currency has pulled back by ~6% in January 2012!

48.0

49.5

51.0

52.5

54.0

Oct-11 Oct-11 Oct-11 Nov-11 Nov-11 Nov-11 Dec-11 Dec-11 Jan-12 Jan-12

USD-INR

2626

……and appreciation over the long term!and appreciation over the long term!

With gold demand coming off, expect CAD to moderate going ahead – aiding rupee appreciation; expect USD/INR to average 49 in FY13!

Further, tapering off of gold demand… ..should moderate current account deficit going ahead!

Adjusted for gold imports, CAD is at a mere ~1.6% of GDP!

(1.2)(1.0)

(1.3)

(2.3)

(2.8) (2.9)

(3.5)

(0.6)(0.4)

(0.8)

(1.4)(1.6)

(1.2)

(1.6)

-4.0

-3.0

-2.0

-1.0

0.0

FY06 FY07 FY08 FY09 FY10 FY11 FY12E

Actual CAD as % of GDP Revised CAD as % of GDP

(100.0)

(50.0)

-

50.0

100.0

Jun-

06

Sep

-06

Dec

-06

Mar

-07

Jun-

07

Sep

-07

Dec

-07

Mar

-08

Jun-

08

Sep

-08

Dec

-08

Mar

-09

Jun-

09

Sep

-09

Dec

-09

Mar

-10

Jun-

10

Sep

-10

Dec

-10

Mar

-11

Jun-

11

Sep

-11

India - Gold demand (YoY %)

2727

“Kaun kitne pani main hain?”

InflationInflation4

2828

Longest stretch of high inflation everLongest stretch of high inflation ever……

Headline inflation has remained close to ‘double digits’ despite aggressive monetary policy tightening!

Inflation has averaged 9.5% for last two years!

Headline inflation spiked up from Jan-2010 due to spiraling food

prices!

Non food articles inflation inched up sharply in H2FY11 further

fueling high headline inflation!

While pace of primary articles showed some signs of easing, inflationary pressures spread to

‘core inflation’ from March 2011!

(1.0) 2.0 5.0 8.0 11.0

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

WPI (YoY %)

2929

……however, inflation has however, inflation has ‘‘finallyfinally’’ peaked out!peaked out!

Recent data suggests that inflation is finally showing signs of peaking!

Food inflation has come off sharply in the last month! Also, expect moderation in non food articles…

…to result in lower ‘core’ inflation going ahead!

-5.0

5.0

15.0

25.0

Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11 Dec-11

Weekly food inf lation (YoY %)

-10

-1

8

17

26

35

Apr-05 Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09 Jul-10 Apr-11

Non food articles inf lation (YoY %)

-1.0

-0.5

0.0

0.5

1.0

1.5

Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11

Core inf lation (3mma - mom %)

3030

Inflation to moderate to 7% by March 2012!Inflation to moderate to 7% by March 2012!

Inflation to further moderate going ahead in turn leading to a more ‘accommodative’monetary policy!

Inflation came off sharply to 7.5% in December 2011……to moderate further to 7% by March 2012!

-2.0

1.5

5.0

8.5

12.0


WPI (YoY %)

3131

Interest ratesInterest rates5

“Yeh one way street hai…”

3232

Interest rates at all time high!Interest rates at all time high!

Interest rates have risen sharply in the last one year…significantly impacting growth!

10.0

11.0

12.0

13.0

14.0

15.0

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

SBI PLR (%)

Aggressive monetary policy stance by the RBI……resulting in sharp rise in system lending rates!

Repo rates hiked by 375bp in 20 months..translating to a sharp rise in system lending rates!!

3333

0.0

2.5

5.0

7.5

10.0

Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11

GDP (YoY %)

With growth concerns outweighing inflationary concernsWith growth concerns outweighing inflationary concerns……

With GDP growth expected to be around 7% for FY12 and FY13…shift in policy stance of RBI likely!

Increasing growth concerns to accelerate monetary easing!

3434

……expect 2012 to be the year of expect 2012 to be the year of ‘‘sustainedsustained’’ & & ‘‘savagesavage’’ rate cuts!rate cuts!

Policy stance of RBI to turn more accommodative…expect repo rate cuts from March 2012!

“While inflation remains on its projected trajectory, downside risks to growth have clearly increased…based on the projected

inflation trajectory, further rate hikes might not be warranted..from this point on, monetary policy actions are

likely to reverse the cycle, responding to the risks to growth”

– Mid quarter monetary policy review

3535

“Hum to rangmanch ki kathputliyan hain jiski dor uparwale ke haathon main hai ...kab, kaun, kahan uthega ye

koi nahin janta”

Corporate earningsCorporate earnings6

3636

Earnings growth at a two year low!Earnings growth at a two year low!

Lag impact of interest rate hikes, policy uncertainties and currency fluctuations have impacted earnings momentum!

Earnings trajectory has clearly decelerated in the last 12 months!

6.4 7.2

(4.3)

(12.2)

22.9

26.9

18.6

23.620.2

11.9

(18.8)

30.6

(23.3)

27.1

16.2

-28

-13

2

17

32

Jun

08

Sep-

08

Dec

-08

Mar

-09

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

Dec

-11

IDFC Securities universe PAT growth (%)

(0.9)

15.610.8

(10.8)(16.1) (20.1)

5.18.27.99.713.8

28.430.532.5

78.5

-25.0

2.5

30.0

57.5

85.0

Jun

08

Sep-

08

Dec

-08

Mar

-09

Jun-

09

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

Dec

-11

Sensex PAT grow th (%)

3737

But all is not lostBut all is not lost……

3838

Domestic Demand Domestic Demand –– The BIG fallback!The BIG fallback!

Rising per capita income… …to sustain consumption momentum…

…supporting GDP growth at 7% levels in FY13!

9.5 9.6 9.3

6.88.0

8.5

7.0 7.0

0.0

3.0

6.0

9.0

12.0

FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E

Consensus FY12 GDP (YoY %)

0

17,500

35,000

52,500

70,000

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E

Per Capita Income (Rs)

4x rise in last decade!

5.5

6.5

7.5

8.5

9.5

10.5

Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11

Consumption growth (YoY %)

3939

Corporate resilience much stronger this time around! Corporate resilience much stronger this time around!

Indian corporates more resilient to withstand economic shocks than in previous downturn!

Lower gearing and higher cash on books for Indian corporates!

0.40

0.48

0.55

0.63

0.70

FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E20.0

30.0

40.0

50.0

60.0

Debt to Equity ratio (% - LHS) Cash as a % of debt (RHS)

4040

Market reMarket re--rating to precede earnings rating to precede earnings uptickuptick

When interest rate cycle reverses…expect market re-rating to occur first…followed by earnings uptick!!!

While policy rates started rising from March 2010, slowdown in earnings growth was seen with a 2-3 quarter lag..leading to an eventual de-rating of equity markets!

Interest rate cuts from March 2012!

Re-rating of equity markets!

Uptick in earnings momentum!

3.0

4.8

6.5

8.3

10.0

Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11

Repo rate (%) Reverse Repo rate (%)

(40.0)

(10.0)

20.0

50.0

80.0

Jun-04 Dec-05 Jun-07 Dec-08 Jun-10 Dec-1

IDFC universe PAT grow th (%)

0.0

5.0

10.0

15.0

20.0

25.0


Sensex PE (x)

Hike in policy rates from March 2010! Weak corporate earnings! Significant de-rating of

markets!

4141

ValuationsValuations7

“Najdiki fayda dekhne se pehle…door ka nuksaansochna chahiye”

4242

CorporatesCorporates trading at less than invested capital!...trading at less than invested capital!...

Over 50% of the companies are at index levels of 8000 with more than 25% trading at less than capital employed; implies that valuations are at par with promoters!

EV/capital employed

1/4th of corporate India is trading at less than capital employed!

0.0

0.5

1.0

1.5

2.0

2.5

Automobiles Engineering Cement Telecoms Power Utilities Logistics Infra Developers Construction Metals

FY12E FY13E

43

0.8

1.1

1.3

1.6

1.8

FY05 FY07 FY09 FY11 FY13E

Oil & Gas

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0


Logistics

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5


Telecoms

0.8

1.3

1.8

2.3

2.8

3.3

3.8


Pow er Utilities

1.0

1.6

2.1

2.7

3.2


Construction

1.0

1.5

2.0

2.5

3.0


Cement

43

……with sector valuations at all time lows!with sector valuations at all time lows!

With valuations at all time lows, believe valuations have become extremely attractive!

Valuation of most sectors are trading at ~50-70% discount to peak valuations!

Down ~70%!

EV/CE (x)

EV/CE (x) EV/CE (x) EV/CE (x)

EV/CE (x) EV/CE (x)

Down ~70%!

Down ~70%!

Down ~50%!Down ~70%!

Down ~40%!

4444

‘‘StrategicStrategic’’ value unlocking to be the value unlocking to be the ‘‘keykey’’ driverdriver

Acquisition value

Network 18 – RIL deal

Recent transactions suggests ‘value’ has emerged!

Strategic value

Strides Arcolab’s sale of overseas generic business

Inherent value

RIL share buyback

Best properties… …however highly leveraged! RIL turns the white knight!

Gross debt at Rs28bn(~5x its market cap!)

Interest cost > EBITDA!

Rs17bn cash infusion!

Share buyback at a maximum price of Rs870 amounting to US$~2bn (~4% of cash on books) – Largest ever buyback

by any corporate!

RIL slumped ~35% in 2011 as against ~25% correction in

sensex!

Sharp price correction… …has prompted share buyback!

Focus on ‘core portfolio…

…has led to stake sale in generic business …

… enabling deleveragingof balance sheet!

Stake sale enables the company to reduce debt on books by ~US$250m!

Stake sale for

US$393m!

Generic business

4545

Market call“Main apni favourite hoon…”

4646

Investors: Fatigue of being on the sidelines!

Our take on markets!Our take on markets!

We are positive on markets and favor bottom-up play in 2012!

Government: Expectations at

rock-bottom!

Corporate: Resilience amidst pain has stood out!

Volatility

To

Stability Case for re-rating!

4747

SensexSensex earnings growth to moderate to 10% in FY12Eearnings growth to moderate to 10% in FY12E

(% yoy) Net Sales EBITDA Profit After Tax

Sector FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY12E FY13E

Automobiles 30.5 17.8 15.4 50.4 10.5 19.9 68.7 3.2 21.7

Construction 18.6 19.3 13.1 16.9 8.2 12.8 (25.4) 15.1 14.4

Consumer goods 14.3 16.1 14.1 12.0 21.0 18.6 15.2 18.4 18.2

Financials 25.6 21.5 21.2 16.4 17.8 21.0 16.5 26.7 25.4

IT Services 20.5 25.7 14.6 17.3 23.1 14.2 14.6 21.9 16.4

Metals 17.1 12.4 0.5 34.3 1.6 19.5 87.4 (11.2) 10.6

Oil & Gas 27.9 26.6 (0.5) 18.4 6.7 1.3 23.7 3.8 10.2

Pharmaceuticals 21.0 18.8 16.2 15.0 27.8 18.2 16.6 20.4 16.8

Power Equipment 26.5 19.8 4.5 44.6 11.7 1.2 38.8 15.1 (3.1)

Power Utilities 12.1 13.9 15.2 3.9 (4.1) 16.4 10.1 (2.3) 17.8

Real Estate 28.8 4.6 2.6 6.9 19.0 0.6 (15.0) (1.2) 11.4

Telecoms 42.3 19.8 13.3 21.1 18.5 19.9 (27.7) (7.8) 51.7

Sensex Index 23.9 19.6 7.3 23.2 11.5 14.7 24.5 9.4 17.5

Our Sensex EPS stands at Rs1076 for FY12 and Rs1264 for FY13

4848

Sensex PE band

Source: Bloomberg, IDFC Securities Research

Valuations below long term averagesValuations below long term averages

Our sense is that 16,000 levels for sensex is an extremely strong base (comfort on valuations!); remain positive on markets with a 12 month target of 19000 (15x FY13E)!

0

7,500

15,000

22,500

30,000

Mar-94 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11

Index 10.0x 13.0x 17.0x 21.0x

Sensex is trading at 13.7x FY13E!

4949

Model portfolioModel portfolio

Sector Sensex Aug-11 Jan-12 Top picks

Automobiles 9.7 6.0 7.5 M&M, Tata Motors, Exide, Apollo Tyres

Construction/Power Equipment 6.9 11.0 13.0L&T, JP Associates, Adani ports, GPPL, KEC International

Consumer goods 10.6 11.0 10.5 ITC, HUL, Nestle, AgroTech foods

Financials 24.3 25.0 27.0ICICI Bank, Axis Bank, SBI, Yes Bank, ING Vysya Bank

IT Services 15.6 11.0 8.0 Infosys, Wipro

Metals 7.9 5.0 3.5 JSPL, Tata Steel

Oil & Gas 14.9 10.0 9.0 BPCL, Oil India, Petronet LNG

Pharmaceuticals 2.8 5.0 5.0 Cipla, Dr Reddy's, Strides, IPCA

Power Utilities 3.2 5.0 2.5 Lanco Infratech, Jaiprakash Power

Real Estate 0.6 0.0 0.5 Sobha Developers

Telecoms 3.5 2.0 2.5 Bharti Airtel

Others - 9.0 11.0United Phosphorus, Den networks, Educomp, Hathway cables, Jain Irrigation, PI Industries

Sensex Total 100.0 100.0 100.0

With interest rate reversal on cards, we suggest moving to interest sensitives like Infrastructure, Financials and trimming positions in global plays like IT services, Metals, Oil& Gas etc!

5050

Companies Price Mcap EPS Earnings CAGR P/E EV/EBITDA P/BV RoE RoCE

(Rs) (Rs bn) (Rs/share) FY11-13E (x) (x) (x) (%) (%)

Infosys Technologies 2,743 1,567 171.4 19.8 16.0 10.5 3.9 26.8 30.8

ITC 202 1,561 9.1 18.6 22.3 14.4 8.1 38.3 51.2

Bharti Airtel 361 1,372 23.9 18.3 15.1 6.6 2.2 15.5 11.4

Larsen & Toubro 1,345 819 87.5 14.1 15.4 10.3 3.3 20.5 16.7

Jindal Steel & Power 576 538 45.4 1.4 12.7 8.6 2.5 21.2 16.4

Adani Port & SEZ 144 288 8.2 34.5 17.4 12.9 4.4 27.9 16.9

Cipla 349 280 18.1 21.2 19.3 13.8 3.2 17.9 17.7

Jaiprakash Associates 73 154 6.3 (8.3) 11.6 8.4 0.2 7.0 8.2

P/Adj. BV (x) RoA (%)

State Bank of India 2,078 1,319 237.4 35.1 8.8 1.2 1.5 18.8 1.0

ICICI Bank 890 1,025 66.3 21.7 13.4 1.6 1.6 12.4 1.5

Yes Bank 336 117 36.8 32.6 9.1 2.0 2.0 24.7 1.5

Note: Based on FY13E, Prices as on 1 February 2012

Top buys Top buys –– Large capLarge capLarge cap (Mcap>US$2bn)

5151



Petronet LNG 165 123.4 14.6 33.0 11.3 7.7 2.7 26.5 19.8

United Phosphorus 147 67.8 19.1 24.2 7.7 4.9 1.4 19.0 19.1

IPCA Laboratories 319 39.9 27.7 15.2 11.5 8.0 2.5 24.1 23.4

Sobha Developers 263 25.8 22.2 9.7 11.8 9.1 1.2 10.3 10.2

Gujarat Pipavav 59 24.8 2.1 n/a 27.9 13.8 2.9 10.9 10.4


Top buys Top buys –– Mid cap & Small capMid cap & Small cap



Educomp Solution 221 21.1 41.5 8.8 5.3 4.4 0.7 13.8 15.0

KEC International 55 14.2 8.6 0.1 6.4 6.1 1.1 18.8 15.9

DEN Network 78 10.2 4.2 19.9 18.8 7.2 1.1 6.3 9.1

Provogue India 26 2.9 4.5 10.9 5.7 5.4 0.4 6.5 8.1

Mid cap (Mcap: US$500m to US$2bn)

Small cap (Mcap<US$500m)

5252


Top SellsTop Sells



Reliance Industries 831 2,718 67.1 4.2 12.4 6.7 1.4 12.0 9.8

Cairn India 347 659 37.6 6.2 9.2 4.7 1.2 14.2 16.9

BHEL 256 626 27.0 5.6 9.5 5.6 2.1 24.3 29.6

Hero MotoCorp 1,932 386 136.3 19.2 14.2 9.5 7.6 60.5 56.2

IDEA Cellular 93 308 4.7 36.5 20.0 6.4 2.1 11.2 11.7

Tata Power 110 261 5.2 22.6 21.4 15.4 2.2 10.7 4.2

Ambuja Cement 163 249 8.8 6.0 18.5 9.6 2.8 15.8 20.2

Zee Entertainment 131 128 7.0 12.1 18.6 13.4 4.0 21.8 28.8

Tech Mahindra 656 81 77.6 15.9 8.4 7.1 1.8 22.2 19.6

Voltas 96 32 7.9 (10.9) 12.2 8.4 1.8 16.1 15.9

Thank youThank you

Nikhil Vora / Kavitha Rajan / Swati Nangalia

IDFC Securities Ltd(Dir) +91-22-6622 2567 / 2697 / 2576

(M) +91 –98211 32471 / 90043 88616 / 99867 87125

Email: [email protected] / [email protected] / [email protected]

5454

DisclaimerDisclaimer

Our research is also available on Bloomberg and Thomson Reuters

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Explanation of Ratings:

1. Outperformer : More than 5% to Index 2. Neutral : Within 0-5% (upside or downside) to Index3. Underperformer : Less than 5% to Index

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India Strategy - Jan12 - IDFC · 3 India Strategy Our market call:Our sense is that 16000 levels...

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