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May 08, 2013Visit us at www.sharekhan.com

Small could be better nowWidened valuation gap offers opportunity in the mid-cap space

RBI delivers rate cut of 25 basis points but its

commentary turns distinctly hawkish: The macro-

economic variables have shown a mild recovery with

moderation in inflation and narrowing of the trade deficit

for March 2013. The softening of the commodity prices

(especially crude oil and gold) is like manna from heaven

for the import dependent Indian economy. Despite this,

one cannot neglect the challenges facing the economy.For FY2014 the Reserve Bank of India (RBI) has projected

a growth rate of about 5.7%, which is marginally higher

than the FY2013 growth rate. The central bank has obliged

by cutting policy rates by 25 basis points but expressed

concerns related to the unsustainable level of current

account deficit (CAD) and persistent inflationary pressures.

The tone has distinctly turned hawkish and the pace of

monetary easing is likely to turn subdued going ahead.

Political crisis deepens, economic reforms in limbo: The

ongoing political crisis over the leak of the coal scam report

and a slew of other scams (railgate being the latest in the

list of scams) leaves limited room for the government to

push through important pending legislative bills (such as

the land reforms bill, the insurance bill and the GST bill)

that require parliamentary nod. The RBI in its recent policy

statement articulated that governance issues were

dragging the economys growth rather than the monetary

policy. Moreover, the decisive victory in Karnataka state

election could increase the governments assertiveness

on reforms and/or prompt the ruling party to call for early

national election.

Q4 earnings meet expectations; margin expansion is

an encouraging sign: The corporate earnings growth for

Q4FY2014 trended largely in line with the estimates though

the estimates themselves were quite conservative. In

terms of the Sensex companies, the earnings growth was

largely in line with expectations (automobile and metal

companies delivered a surprise) though the revenue growth

fell short of estimates. In the near term, the corporate

earnings growth will remain subdued and may pick up

towards H2FY2014, led by improved macro-economic

conditions and the accumulated effect of some of the

measures announced earlier.

Global economyconsolidation in progress: The US

economy is showing firm signs of recovery as indicated by

the falling unemployment numbers and the recovery in

the housing sector. The fiscal stimulus announced by the

US government and the other governments (of China,

Japan etc) is likely to support the cyclical upturn in the

global economy. However, the European economies remain

in shambles and could continue to trigger bouts of risk

aversion.

Outlookpositive stance vindicated; expect

outperformance in the mid-cap space: We had been

constructive on equities in our last Market Outlook report

(Policy push dated March 6, 2013) and had expected

the budget hangover to recede and the global environment

to be supportive. The benchmark indices have performed

ahead of the consensus expectation and the crash in thecommodity complex has provided the trigger for a sharp

bounce. For the next two months, we see limited scope

for re-rating and the benchmark indices would do well to

consolidate in a range in the seasonally weak period of

May and June. However, we expect quality stocks in the

mid-cap space to outperform the broader market due to

the widened valuation gap and the expected improvement

in corporate earnings in the next few quarters.

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Sensex one-year forward P/E band

Source: Bloomberg, Sharekhan Research

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Avg PE

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2Sharekhan May 08, 2013

market outlook Small could be better now

75.080.0

85.090.095.0

100.0105.0

110.0115.0

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Brent crude Gold spot

(2.0)

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10.012.0

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GDP (%) WPI (%)

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7.9

8.1

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8.5

8.7

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Macro variables show mild improvement

The decline in the inflation rate to a three-year low (5.96%

in March 2013), a moderate pick-up in the Index of Industrial

Production (IIP) and contraction in the trade deficit (in

March 2013) are the variables that point to the easing of

concerns pertaining to the economy. The manufacturing

inflation has declined to 4.1%, though high food inflationremains a concern. The improvement in the trade deficit

was aided by moderation in imports and a slight pick-up in

exports. The economy seems to be heading for a cyclical

pick-up though the recovery will be modest, given the

multiple challenges the economy is facing right now. Apart

from policy action the economy needs to be supported by

sustained softness in the commodity prices and monetary

easing which seem a bit uncertain at this point of time.

But RBI turns hawkish after reducing rates by 75 basispoints in CY2013

Including the recent reduction in the repo rates the RBI

has reduced the repo rates by 75 basis points in the year

till date (YTD; CY2013) against the expectation of a 100-

basis-point reduction for CY2013. In view of the macro-

economic challenges (especially inflation and the twindeficits), the RBI will be constrained to ease the rates

further. Since the transmission of monetary policy has not

been very active due to the tight liquidity and higher cost

of deposits, the rates are unlikely to decline any further

significantly.

GDP, inflation growth

Source: Bloomberg

Easing of commodity prices provides relief

Driven by global factors the commodity prices have declined

significantly over the past several weeks. Gold and crude

oil prices have declined by 8-10%; together these two

constitute about 40-45% of the imports and a drop in their

prices has reduced the current account deficit. The exports

have shown a marginal recovery and a meaningful pick-up

will happen once the global economy starts improving. Going

ahead, the outlook on the key commodities will shape the

recovery trend for the domestic economy.

Crude and gold prices

Source: Bloomberg

10-year G-Sec bond yields

Source: Bloomberg

Reform momentum to be affected by political crisis

Due to the face-off with the opposition over several issues

ranging from the coal scam investigations to the institutionalintegrity of the Central Bureau of Investigation the

governments reform agenda has come under cloud. Several

key bills, such as the land reform bill, insurance bill, direct

tax code bill and the bill for deregulation of sugar, are likely

to be stuck indefinitely. In addition, the government has

entered into election mode with election in Karnataka and

four other major states which will shift focus towards

populist bills such as the food security bill. As rightly pointed

by the RBI, the governance issues have largely affected

the pick-up in investments and need to be focused upon.

Going ahead, the decisive victory in Karnataka could

increase the governments ability to push reforms.

Corporate earnings; revenue growth concerns remain,margins rebound

Amid conservative estimates, the corporate earnings growth

is largely in line with estimates. However, the pressure on

revenue growth is clearly visible due to the slowdown in

the economy. On the positive side, the margins have come

in better than expected and are driving the earnings. In

the given circumstances, the corporate earnings are likely

to remain subdued in the near term and follow the revival

in the economy, which is expected to recover gradually,

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market outlook Small could be better now

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World GDP (LHS, %)Inflation, average consumer prices (%)

possibly towards the second half of FY2014. Given the

expectation of ~14% earnings growth in FY2014, there could

be some downward revisions, as had happened in FY2013.

Cyclical recovery in global economy underway

As mentioned in our previous reports, the global economy

is heading for a cyclical recovery in 2013 and may pick upmomentum in 2014. The advanced economies like the USA

are showing firm signs of recovery while stimulus offered

by several other countries (Japan, euro zone) will facilitate

the global recovery. The emerging markets continue to

witness healthy consumption and investments in

infrastructure which will support the global growth. In

case of the euro zone, the major achievement has been

that the region has averted major crises which could have

destabilised the global economy.

Global GDP growth (IMF)

Source: IMF

Outlookpositive stance vindicated; expect

outperformance in the mid-cap space: We had been

constructive on equities in our last Market Outlook report

(Policy push dated March 6, 2013) and had expected

the budget hangover to recede and the global environment

to be supportive. The benchmark indices have performed

ahead of the consensus expectation and the crash in thecommodity complex has provided the trigger for a sharp

bounce. For the next two months, we see limited scope

for re-rating and the benchmark indices would do well to

consolidate in a range in the seasonally weak period of

May and June. However, we expect quality stocks in the

mid-cap space to outperform the broader market due to

the widened valuation gap and the expected improvement

in corporate earnings in the next few quarters.

Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

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Avg PE

-1

Sensex one-year forward P/E band

Source: Bloomberg, Sharekhan Research

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