Friday, February 3, 2012

>STRATEGY: Self-correcting mechanisms are already at play, which should make 2012 a better year for Indian equities

Looking back at 2011, Indian equity markets were struck by a multitude of issues, ranging from persistently high inflation, monetary tightening, stalling mining activity to sinking capital formation. The Eurozone crisis made matters worse, causing global financial markets to become all the more risk-averse. But self-correcting mechanisms are already at play, which should make 2012 a better year for Indian equities.

Most importantly, cooling of inflation and consequently interest rates should end the spell of margin compression, which has afflicted corporate earnings in the past several quarters. Also, India's widening current account deficit has been another macro overhang. But, here again, even at 49-50 levels, the 10-12% INR depreciation, in our view, should provide the requisite boost to India's exports to gradually self-correct the deficit.

Expect 19,300 Sensex by December 2012
Sensex FY2012 earnings growth is likely to be modest as high inflation and interest rates have battered margins. But with this scenario on its way to changing in FY2013, we expect the earnings growth rate to improve from 9.5% in FY2012 to 16.2% in FY2013. Also, in our view, risks that the government inertia continues and GDP growth remains at ~7% have already been largely factored in valuations by the market. We believe this offers a favorable risk-return trade-off, considering that several domestic negatives can be reversed by quick, simple and rational policy actions. For instance, quick approval of FDI reforms in aviation and insurance, among others, as well as pick-up in infrastructure ordering activity are low-hanging fruits. Already, ordering activity by NHAI and Power Grid is reasonably robust, and it is a matter of time before others would follow suit. The financial troubles of SEBs is another unnecessary crisis that is finally changing with recent tariff hikes. Amongst more difficult to push-through are measures to end the mining logjam, but in our view the government will soon have to balance environmental concerns and expedite mining and land acquisition to step up GDP growth.

In fact, we do not expect domestic factors alone to have the capacity to trigger new lows for the markets. It is only the Eurozone crisis that may still lead to volatility in the near term, but policymakers there as well are taking steps to avert any crisis event - accordingly, as of now we are basing our market view on a likely orderly outcome in the Eurozone. Considering that valuations are also reasonable, with domestic macro indicators improving and with earnings trajectory likely to follow suit, we have a target of 19,300 for the Sensex by December 2012. 

Select stocks to give better returns
Looking beyond the Sensex, there are a host of good investment opportunities in our view in companies across several sectors, such as banking, IT and pharma. On the other hand, there are sectors such as capital goods and cement where we still remain cautious. In this compendium, we have therefore given an overview of our entire coverage universe of 160+ stocks, having a combined market capitalization of ~`40lakh cr. Currently, we have a Buy recommendation on 82 of these, broadly preferring companies having high-quality cyclical businesses rather than high-quality defensives. Also, we have covered several mid caps, which in our view offer enormous potential - either because they are leading brands within their sectors trading cheaply or belong to high-growth sectors benefitting from rural, export or consumption themes.

To read the full report: STARTEGY