>INVESTMENT STRATEGY | INDIA (MERRILL LYNCH)

A year marked by dwindling hope and sense of resignation

2011 began with the hope of “muddle through” and is ending with a resignation to

“it’s so bad, it’s almost good”.

The year though will be remembered as a watershed year for many reasons:

■The wide spread social unrest that will likely leave some indelible marks on

the global canvass. Many countries, e.g., Tunisia, Egypt, Libya, Syria,

Yemen, etc. witnessed strong demand for a change in the extant political

structures; whereas many other in the west saw people coming to street

seeking significant structural changes in the functioning of financial markets.

India also witnessed a popular public moment against corruption and

accountability gap.

■The public debt crisis in EU assumed threatening proportions that could

impact the global fiscal policy framework in the decades to come.

■ A major nuclear accident in Japan triggered a debate on desirability of

nuclear energy in the global energy mix.

■ Enduring Japanese earthquake, US credit rating downgrade, a full blown

European sovereign debt crisis, and unrest in MENA, the asset class returns

in 2011 have been surprisingly resilient. Bond returns up 5%, commodities

flat, and global equities have lost only 6%.

■ Underperformance of BRIC markets. One of the most notable features of

global equities in 2011 was stark underperformance of BRIC, especially India

and China, still the two fastest growing economies.

■ Emerging markets underperformed the developed markets and US.

■The big story of 2011 was the de-rating of equity multiples, making equity

valuations cheap as compared to the historical averages.

Indian equities: down and out of favor

Led by deteriorating macro, slipping growth and consequent earnings downgrade

and negative publicity generated due to frequent scams and revelation of

accountability gaps in many instances, Indian equities find place amongst the

worst performers globally.

Domestic consumption largely saved the day for the economy, as the investment

cycle descended sharply. The trend was reflected in the sector performance

where consumers substantially outperformed.

To read the full report: INVESTMENT STRATEGY

RISH TRADER

>NON FERROUS MINING: Lowering estimates for metal price changes

■ Lowering estimates on metal price changes

Our Metals Strategist has cut metal price forecasts due to the global slowdown and MTM. Our global team has cut FY13e price forecasts for Al by 11%, Cu by 7% and Zn by 3%. We also factor in a weaker INR, which cushions the impact. We have cut our FY13e EPS by 6-16% and our POs by 4-11% across our base metal companies. We remain cautious due to macro concerns. Valuations appear reasonable, but downside risks to est. exist and upside triggers are lacking, in our view. We prefer Sterlite, as it offers deep value and the risk/reward appears positive. In HNDL, triggers are absent, as project issues are unresolved.

■ Zn: lower surplus; Al: tight physical mkts., but deficit lower

We expect zinc prices to be capped, as zinc markets are well supplied. But zinc prices should be supported near current levels as we expect concentrate markets to tighten through CY12 and eventually push refined markets into deficit in CY13. In aluminum, despite structural excess capacity, we believe financing deals should support Al prices in CY12. However, we expect physical markets to be less undersupplied due to slowing demand growth. Our FY12/FY13e LME price forecast for zinc is US$2029/t/US$2150/t and for Al, it is US$2247/t/US$2313/t.

■ Sterlite (STLT): Offers deep value, favorable risk reward

We have cut our FY12-13e EPS by 2-7% due to lower metal price forecasts. Downside risk to Zn prices appears low and the medium-term outlook appears positive. Saleable silver (Ag) volume is likely to increase post the expected commissioning of a 350tpa silver refinery in Dec Q. We expect Ag vols. to grow at a CAGR of 26% over next 3 years and should contribute to 8% of FY13e EBITDA. Coal supply issues should persist at SEL, but availability should improve

incrementally in 2HFY12, as CIL output improves post monsoon. Valuation, at 3.0x FY13e EBITDA, appears attractive and concerns around SEL and VAL assets appear to be already priced in.

■ Hindalco: Reasonable valuations, but catalysts absent

We have cut FY13e EPS by 6% due to the lower Al price est. We have also cut Novelis FY12-13e EBITDA by 2-5% (in US$ terms) due to softer demand, but the impact on group EBITDA is offset due to the weaker INR est. Govt. approval w.r.t. Mahan coal block is still pending. Govt. decision to scrap Go/No Go classification of coal blocks offers some hope, but production from new coal blocks could take over 12-15 months, even after approval is obtained. Thus, EPS impact will not be meaningful near term, in our view. Valuation, at 0.8x BV, offers downside support.

■ NALCO – cost pressures persist, valuation not compelling

Our FY12-13 EPS declines by 2-16% due to the lower AL LME forecast. We expect cost pressures to persist due to coal supply issues. The valuation, at 6 .6xFY12e EBIDTA, is not yet compelling, in our view. Hence, Underperform.

To read the full report: NON FERROUS MINING

RISH TRADER

>INDIA CONTENDERS AND DEFENDERS: Contenders outperform amid macro uncertainty

■ Contenders beat the markets

The India Contenders (-13.7%) struggled last month as equity markets retraced

amid European crisis and weakening rupee, but still managed to outperform the

MSCI India index (-16.0%) by +2.3% and the India Defenders (-23.8%) by +10.0%.

■ Implied Sector Allocation favours Discretionary

Our Implied Sector Allocation model is most overweight Consumer Discretionary

and Health Care, and most underweight Financials, Materials and Industrials.

Last month, the model increased the overweight in Health Care at the expense of

Financials. This sector tilts matches with our new Asia Pac Country-Sector

allocation recommendations.

■ New India Contenders: Hero Motorcorp, Raymond

The new India Contenders are Hero Motorcorp, and Raymond. The longest

standing Contender is Bajaj Auto (16 months). The other India Contenders are

Dish TV India, HDFC Bank, LIC Housing Finance, Petronet LNG, Satyam

Computer, Tata Consultancy Services, and Titan Industries.

■ New India Defenders: JSW Steel, Sesa Goa

The new India Defenders are JSW Steel, and Sesa Goa. The longest standing

Defender is Steel Authority of India (15 months). The other India Defenders are

Crompton Greaves, Hindalco Industries, Housing Development & Infrastructure,

Reliance Communications, Sterlite Industries (India), Tata Motors, and Unitech.

To read the full report: CONTENDERS AND DEFENDERS

RISH TRADER

>EUROPEAN CREDIT OUTLOOK 2012: fasten your seatbelts

■ Slaves to the Euro crisis

We would expect a small rally at the start of 2012 as risk appetite rises, asset

allocation into credits occurs and the probability grows of a greater policymaker

response. We would start the year with an overweight-30% on high-grade credit,

but we would not be wedded to this view for long if the sovereign prognosis

remains bleak. We see a trading market rather than a directional market for 2012

as the sovereign crisis continues to determine much of the direction of credit.

■ Know your benchmark in 2012

“Rich” or “cheap” is more than just about spread to Bunds now. We urge investors

to keep an eye on credit spreads vs domestic government bond spreads next

year. French names have repriced significantly wider lately because of poor

relative value vs. French sovereigns. In our view, German credits look good value

versus their sovereigns, as do UK and Dutch credits. Spanish and Italian nonfinancials

look tight. French non-financials look fair rather than great value.

■ Non-financials fairly safe for another year

We still see “core” non-financials faring relatively well next year, even if recession

hits. Maturing corporate debt isn’t demanding, cash holdings are strong and

spreads already discount a further earnings drop of about 25%. Defensiveness

and capital preservation remain paramount for credit selection, in our view.

■ The great opportunities as well as risks

Loan refinancings are a lot more demanding next year (€500bn) and banks are

preoccupied with deleveraging. We don’t think this means the end of loan

financing for large-cap, “relationship” non-financials, but funding could become

trickier for mid-tier companies. We expect companies to term-out some of their

loan financing into bonds next year, even if for precautionary purposes.

■ More corps, less fins

We expect fixed-rate senior unsecured issuance to fall 35% in 2012 vs 2011.

Conversely, we think non-financial supply could rise 20%.

■ Sectors – go for global

We have made some changes at the sector level. We upgrade consumers to ow-

30% given their global sales profile. We still remain uw-30% on retail however

given austerity. Senior banks is still an ow-30% as the market shrinks, but sub

debt is now uw-30%. Insurance fundamentals still justify an ow-30%. We have

reduced steel to uw-30% given waning steel demand.

To read the full report: EUROPEAN CREDIT

RISH TRADER