>ROE pick-up likely to drive re-rating (UBS)

■ Two themes: ROE analysis; public sector undertaking (PSU) divestment
The BSE Sensex has gained 118% since bottoming out on 9 March 2009. We examine two themes in this report: 1) Does the Sensex warrant a further re-rating based on higher ROE? 2) Will PSU divestment limit secondary market gains?

■ ROE analysis indicates scope for further re-rating
We expect Sensex stocks’ (ex oil & gas) ROE to expand to 17.0% (+120bp) in FY11 and to 17.7% (+66bp) in FY12. With improving ROE, we believe stocks will trade at an average 12-month forward PE of 16.3x compared with 15x currently. Coupled with our 24% and 20% earnings growth forecasts for FY11 and FY12, we raise our March 2011 Sensex target from 21,000 to 22,000.

■ PSU divestment unlikely to derail stock market gains
India plans to raise Rs400bn from the divestment of PSUs in FY11. We believe this target will not hamper stock market momentum because of three factors. 1) Rs311bn was raised in the last eight months of FY10. 2) We expect FII and domestic insurance company flows to continue, driven by positive momentum in data points such as quarterly GDP and earnings growth. 3) We expect insurance companies in India to invest Rs777bn in Indian equities in FY11.

■ UBS India model portfolio changes
We move from Underweight to Overweight infrastructure and conglomerates; from Overweight to Underweight cement; from Neutral to Underweight consumer staples; and from Overweight to Neutral petrochemicals. We increase our real estate exposure from 2% to 5%. We add Adani Enterprises, GVK Power and Infrastructure, and Housing Development & Infrastructure (HDIL), and remove Ambuja Cements, Hindustan Unilever, Hindalco Industries and Nagarjuna Construction.

To read the full report: MARKET STRATEGY