>INDIA STRATEGY: Budget 2012 impact on sectors at a glance

Now for the hard work. The recent sharp rally in the Indian stock market largely factors expectations of improved governance (fiscal consolidation, structural reforms) but there is little concrete evidence so far. The FY2013 Union Budget will be the first test of the Government’s willingness and ability to meet the market’s lofty expectations. We expect the Government to set the FY2013 GFD/GDP target at 4.7% with underprovisioning for fuel subsidies; we estimate 5.4% under more realistic assumptions. We have increased the concentration of high-quality names in our Model Portfolio; we have very little exposure to high-beta names now.

■ Model Portfolio: High concentration of high-quality stocks notwithstanding global liquidity
We find most high quality large-cap stocks offering 8-15% potential upside to, or trading at, our
FY2013E fair valuations. We expect moderate improvement in India’s macro-environment over the next 12 months but higher-than-expected crude prices may derail the recovery. Very high global liquidity has already pushed crude oil prices beyond India’s comfort zone. High crude oil prices will result in (1) high subsidies and fiscal deficit, (2) large CAD and (3) high inflation, which may limit the RBI’s ability to reduce policy (interest) rates.


■ Fiscal consolidation, though positive, is unlikely to be painless
The rally in the Indian stock market derives its strength from expectations of improvement in governance, including fiscal consolidation. Fiscal consolidation would be positive indeed, but is also likely to be painful. Fiscal consolidation can take place either through (1) higher revenues (increase in excise and service tax rates) and/or (2) lower expenditure, primarily reduction in fuel subsidies (increase in fuel prices). The ongoing global liquidity-driven rally in commodities, notably crude oil, will further weaken India’s fiscal and BOP positions.


■ We expect the Government to target 4.7% GFD/GDP in FY2013
We expect the Government to target an ambitious 4.7% GFD/GDP in FY2013, backed by nominal GDP growth of 13% (real GDP growth of 7.5% and WPI inflation of 5.5%). However, as has been the case historically, expenditure is likely to be depressed with under-provisioning for subsidies (fertilizer, food and fuel). We believe 5.4% GFD/GDP may be more realistic. Robust tax collections (negative service tax list, economic buoyancy) and 2G spectrum and coal block auctions may surprise positively but higher subsidies on food and fuel may disappoint.


■ Painful or not, the Government may have to bite the fiscal prudence bullet
In our view, India needs to tackle the problems of weak governance, high fiscal deficit and a vulnerable BOP position. Specific to the FY2013 Union Budget, we believe the Government can send the right signals through (1) taxation reforms to improve the low tax-to-GDP ratio (negative service tax list in FY2013E; commitment to implement GST and DTC by FY2014E) and (2) subsidy reforms with an increase in fuel prices and a commitment to reduce subsidies in the medium term through better targeting and distribution of subsidies.


To read full report: MARKET STRATEGY
RISH TRADER

>INDIA MARKET STRATEGY MARCH 2012: March: An “Eventful” Month but oil as important

Focus on the 3 events ….
Over the next couple of weeks, 3 events will be important for markets. Given the sharp rally in markets, expectations are high and the market could be vulnerable to a correction on any disappointment. However, price of oil may be as important as these events in determining the market direction (and of course will affect two of these events).


1. March 6 - Assembly election results: A Congress strong performance with a kingmaker role in Uttar Pradesh positive for markets. 
2. March 15th - Credit Policy: Consensus and our expectations are for a rate cut but high oil prices persist, RBI may do a CRR cut only.
3. March 16th – Budget: The key to watch is the fiscal deficit estimate.


… but oil prices as important
While an increase in crude oil is clearly negative for India’s macro-economy, the co-relation of Indian stock market and oil is strongly positive ie a rising crude oil prices lead to a rise in equity markets (co-relation is strong at 89%). However, this relationship turns negative at a tipping point (and we may be close to it) ie Indian markets fall even as crude continues to rally.


Sharp crude rallies break this co-relation: On 10 occasions over past 10 years we have seen a rally in crude prices by over 30% in 3 months. On 6 of these 10 occasions, markets gave a negative return over the next quarter. Similarly, India under-performed EMs on 8 of these occasions


Rising crude oil hurts the economy in 3 ways…
1. Inflation: A 5% increase in domestic oil prices increases inflation directly by app 75 bps (see Table 3)
2. Current account deficit: Oil accounts for 30% of total imports. A $10/bbl increase in oil prices will increase current account deficit by $8bn (0.4% of GDP).
3. Fiscal Deficit: Every $15/bbl increase in oil price can lead to an increase in fiscal deficit by roughly 0.3% of GDP assuming a 10% increase in domestic oil prices (see table 5).


.. but the positive is that the tipping point has gone up
In a macro sense, oil, at US$110/bbl today, is like oil at US$70/bbl in 2007. For example, net oil imports remain around 4% of GDP and the oil subsidy around 0.8% of GDP similar to 2007 although oil prices are over 50% higher.


To read full report: MARKET STRATEGY

>HAVELLS: Upbeat Outlook

■ Raising PO on higher EPS and re-rating
Our management meeting left us increasingly confident about margin expansion and 20%+ revenue growth. We have raised PO by 15% to Rs625 driven by (1) increase in our EPS for FY13 and FY14 by 5% and 8% respectively, and (2) increase in valuation basis of India entity by 10% to PE of 16.5x FY13E earnings owing to higher profitability. Our FY13 and FY14 EPS estimates are higher than consensus by 10% and 13% respectively. Stock at PE of 12.7x FY13E is attractive. Buy.


■ Margin improvement to continue
Havells has completed it’s investment in land and buildings for the next three years and is focusing on the expansion of margins and cash flow. The company is aiming to achieve 14%+ EBITDA margin in India and 10%+ EBITDA margin globally in two-three years. We have raised FY13/14e EBITDA margin to around 13.3% in India from 12.9% and maintain assumption of 8% globally.


■ Strong product pipeline for 20%+ sales growth
New product pipe line is very robust and is key to management target of over 20% revenue growth. The company has just launched air coolers. It will soon get into UPS, inverters and kitchen appliances. We have raised our 15% sales growth expectation to 18% in FY13 and 15.5% in FY14. Upside could come from faster
ramp up of new products.


■ Rising cash-flow to boost valuation
We expect the decline in capex, expansion of margin, and tight control over working capital to boost the cashflow of Havells like never before. Stronger cash flow will be key to a re-rating. We have valued Havells on a sum of part basis with (1) India entity at PE of 16.5x FY13E EPS of Rs31.9/sh, which is a 5% premium to Indian peers, and (2) Sylvania, the global entity at PE of 12.5x, and at a 15% discount to global peers.


To read full report: HAVELLS
RISH TRADER

>LARSEN TOUBRO: Presence in diversified businesses LIKE Turnkey projects, construction, engineered products & systems, electrical & electronic products & systems, IT& Engineering services, Machinery Valves etc

■ Best stock to play the Indian infrastructure theme
We believe L&T is best placed to benefit from the gradual recovery in the capex cycle, given its diverse exposure to sectors, strong balance sheet and cash flow generation as compared to its peers, which grapple with issues such as strained cash flow, high leverage and limited net worth and technological capabilities.


■ Presence in diversified businesses
Larsen & Toubro’s business as a whole are diversified in nature with the presence in different areas of businesses like Turnkey projects, construction, engineered products & systems, electrical & electronic products & systems, IT& Engineering services, Machinery Valves & Industrial Consumables, Financial Services, Shipbuilding etc would help the company to withstand the concerns in particular sectors.


■ Strong order book
As of 3QFY2012, L&T stands tall on an order backlog of 1, 45,768 crore against Rs 114,882 crore at the end of Q3 FY11 and Rs 142,185 crore at the end of Q2 FY12. With the current order book, book to book ratio (BTB ratio) stands at 3x its TTM revenue. L&T’s order book is majorly dominated by the infra (40%) and power (29%) segments. Process (15%), hydrocarbon (11%) and others (5%) constitute the balance part of the order book.


■ Outlook and Valuations: Attractive; Initiate Coverage with ‘BUY’
Larsen and Toubro (L&T) had posted good set of numbers for 3QFY2012, which mainly on account of robust top-line growth and higher other income. Order inflow for the quarter grew by stunning 28.2% to 17,129 crore covering some of the lost ground in 1HFY2012. We prefer L&T over its peers being the market leader and fundamentally the strongest infrastructure company. We maintain L&T as our top pick in the sector. Hence, we initiate a ‘Buy’ recommendation on Larsen with the target price of Rs. 1433 with a ‘Buy’ below Rs.1075 for those who have a moderate to aggressive risk appetite, as the stock looks very attractive at the current levels, given the steep price correction in the recent past and the improved outlook on the infrastructure space going ahead. Risks At the macro level, the current global economic scenario is the most worrying risk factor, as a fall of the global economy into a double-dip recession may lead to a slower growth in our economy. Apart from that, the other concerns include the stiff competition in each of the industries which would cause aggressive bidding and a drop in order inflow, persistence of the higher interest rate leading to drop etc. The company may also get affected by the delays in the execution of the long gestation projects, which might affect the cash flow from the projects that have a specific concession period. Apart from these, the increasing debt level also poses some risk to the future journey of L&T as it will increase the financial burden in the form of interest. The company’s debt to equity ratio, currently, stands at 1.52:1, which is further poised to go up as more projects are set to kick in.


To read the full report: L&T
RISH TRADER