Tuesday, December 27, 2011

>INDIA STRATEGY: Not the bottom yet (CLSA)

Despite the underperformance, MSCI India still trades at 15% premium to MSCI Asia leaving room for downside. On the positive, at 11.9xFY13CL earnings, Indian market now trades at 10% away from the Mar’09 lows which should limit downside, implying a range bound market. Our recent field trips make us more cautious on consumer discretionary demand outlook and we remove 3 ppts from our model portfolio. We also reduce 2.5ppts and 1 ppt each from banks and industrials to maintain UWT stance and add it to IT services to close the UWT there, primarily attributable to weaker INR outlook.

India premium has come down, but still a premium
 Indian stock market (Sensex) is now trading at 11.9xFY13CL earnings or 27% discount to the last five year average and 17% discount to the 10 year average.
 Over the last five years, Indian markets have traded at a 25% premium over Asian peers – which also stands corrected to 17% now. Indian market has traded at lower premium only during the GFC, when India traded at a discount.
 While the GFC type of situation cannot be ruled out now, India is only 10% away with Mar-09 low multiples and valuation support should restrict the downside.

Governance a drag but several negatives now built-in
 With a near roll back of FDI in retail, the Government inaction is once again in the forefront. The possibilities of agitation by Mr Anna Hazare, on the ‘Lokpal bill’ remains an outstanding issue. But the ‘Government paralysis’ is not really new.
 Many of the government facing industries viz. infrastructure /property stocks have already corrected by c.50% over the last one year and earnings lowered by 20- 50%. While more damage can happen but we believe downside is limited.
 33% of stocks (30% of mcap) of stocks under CLSA India coverage universe are already trading below Mar-09 PE multiples.

Consumer demand slowing
 Our recent field trips to the Northern state of Punjab and channel check by On The Road confirm signs of a consumer slowdown spreading. We temper our enthusiasm on consumer discretionary by slashing a 1 ppt each from Mahindra, Bajaj and Jet.
 We do see downside risks to some expensive staples names viz. HUL, Nestle, Colgate etc owing to the triple impact of a small slowdown in demand growth, margin pressure due to the INR depreciation and high valuations. Our key picks here include ITC, Godrej Consumer and Jubilant.
 We add 1 ppt to ITC by taking away 1 ppt from United Spirits to take into account the impact of higher ENA prices and a steep duty hike in West Bengal. 

Weights lowered in discretionary and banks; added to IT services
 Underperformance by the banking sector has reduced our UWT to only 2ppts. We reinstate our 4.5ppts UWT on banks by removing SBI (-1.5ppts) and 1 ppt from ICICI Bank. We continue to be worried about the growth slowdown and asset quality concerns for the sector. Similarly, we also take out 1 ppt from Jaiprakash to maintain our small UWT on industrials. The near term risk to our UWT on banks would be a potential rate cut by the RBI in January’12.
 We add these 6.5ppts to IT services sector to close our UWT position in the sector. While the companies will likely disappoint on US$ growth numbers, the reported performance, due to weaker INR, will drive street upgrades to earnings.
 Our portfolio now has a 57% active bet reflecting our view that bottom-up stock picking would be crucial for outperformance.
 Our top picks for the market are ITC, Dr Reddy’s, M&M and ICICI Bank. ITC and Dr Reddy’s appear good on earnings visibility. M&M’s volume sales have been robust so far and we expect similar trend to continue. Core auto business now trades at 10x. ICICI at 1.2x in line with PSU banks and already builds in asset quality risks.

To read the full report: INDIA STRATEGY