Wednesday, August 22, 2012

>STRATEGY: Silver linings aplenty, but cloud lingers on

A small reversion in the P/E and stable earnings growth could lift the Nifty by 20% within four quarters. However, uncertain macroeconomic trends and government policies tend to hold down the valuation. Silver linings are held out by the resilience in FY12 earnings growth and, the yield‐gap to the Libor nearing the low end. Twice within three quarters, FII buying rose when the gap fell near its low. Another protective factor is the cyclical high in interest rates and inflation, and low in industrial growth. In the near term, sectors with strong earnings momentum during FY12 may extend their run. Over the next four quarters, a few more ‘non‐defensive’ sectors could outperform; we advise an overweight position on Construction, Telecom and Utilities, and select segments in Banks, Automobiles and Oil & Gas.

Triple deficits; policy measures hold key to next rebound in P/E
The large potential rebound in the Nifty depends upon the resolution of challenges posed by deficits in the budget, current account and monsoon rains as well as by inflation, interest rates and exchange rates. Earnings growth has lesser influence on the P/E than feared, as indicated by the lower contraction in the P/E, even as forecasts fell in the last six quarters.

Resilience in profits of vulnerable sectors is a positive
Three sectors with a strong link to industry and infrastructure, viz., Automobiles, Cement and Financials drove a late rebound in consensus forecasts for FY12 earnings growth of the Nifty to c9%. The pessimism on 1H2012 earnings growth coincided with the gloom cloaking most aspects of India. However, the diversity of businesses saw the weakness in a group of sectors, viz., Utilities, Telecom and Construction, being more than offset by the strength in the above three. This indicates that businesses and companies represented in the index are capable of protecting earnings during tough times.

Gap with USD Libor has set bottom of range, also precedes FII rebound
Relative to the Libor, the Nifty P/E is much closer to Feb09’s eight‐year low compared to local yields. The yield gap to the one‐year USD Libor indicates that the Nifty is barely 10% above a level that corresponds to this worst case. We also find a surge in the FII purchase of Indian equities soon after the yield gap nears this low. Over the medium term, this metric may point to a likely low point in the valuation as well as a likely revival in FII inflows.

Select ‘non‐defensives’ outperform; may expand over four quarters
Over a four quarter horizon, we advise an overweight position on stocks within Construction, Telecom, Utilities, and select segments within Banks, Automobiles and Oil & Gas. The 2012 year‐to‐date outperformance in Cement, PSU Banks, Construction, among others, indicates that a swing towards ‘nondefensive’ sectors is under way. Our top picks for the near term are ACC, Ambuja, UltraTech Cement, Torrent Pharma, Unichem, NTPC, Tata Power, HDFC Bank, LICHF and RECL. Over the next four quarters, our top picks are SBI, Axis Bank, Maruti, Tata Motors, BPCL, Cadila, L&T, Wipro, Bharti and Tata Steel.

To read report in detail: STRATEGY