Saturday, December 3, 2011

>INDIA EQUITY STRATEGY: 2012 Outlook: Structural Pain In, Cyclical Gain Not

Structural snags... — India’s ‘secular investment story’ has taken several twists over
the year. The ‘democratic government’ has become directionless, the ‘fortune at the
bottom of the pyramid’ has turned into a structural inflation infuser, the ‘capital inflow
window’ has tipped into a currency crunch, and India’s much feted ‘entrepreneurial
energy’ has become more of a corporate governance quagmire. Yes, a lot has changed
in a year – including GDP growth expectations sliding from 8% to 7% – but it is the
-30% YTD currency-adjusted market swing that is now most dominating the mood.

...and cyclical stress – but cycles do turn — Inflation and interest rates are high,
government activity is low, oil is rising, capital is not coming, confidence is waning and
earnings growth is falling. But there is another way of looking at this way: Inflation is
statistically set to go down, interest rates will not continue to rise as demand falls (and
aggressive policy could well bring about rate cuts), and the government has recently
done more than in 2 years. And valuations are relatively attractive (and meaningfully so
for any inbound M&A activity – businesses are 30-40% cheaper than a year ago) and
earnings growth has been cut almost as sharply as in 2008. Cycles can be deep, but
by definition they turn…sometime.

Economy increasingly vulnerable to markets – Needs some luck — India’s high
dependence on excess external capital – for corporate/ investment growth, filling its
current account gap and keeping interest rates low – has only increased as the
economy has grown. What can be a virtuous circle has turned vicious – India is more
vulnerable now than at higher market and Rupee levels. The economy needs support
from the markets for the circle to revert to being virtuous: Risk on, easing inflation,
falling oil, falling commodities or other global market drivers/events.

Upsides, likely to be front-loaded — We set a 18,400 Dec 12 Sensex target (5520 on
Nifty), at a 1-year Fwd PE of 14x (a 10% discount to the long-term average as India
has fundamentally de-rated). We expect positive market movements to be more upfront
than back-ended (cyclical gains with structural caps from slower growth and FX
vulnerability), and have tweaked our model portfolio to continue to position relatively
aggressively. Overweight on Banks and Autos, in addition to the relatively defensive
telecom sector and pharma businesses. And underweight in Materials, IT, Utilities and

Top picks for 2012 — Our top buys for 2012 side are Axis Bank, SBI, Tata Motors,
Jindal Steel & Power and Dr Reddy.

To read the full report: EQUITY STRATEGY

>INDIAN FINANCIALS: Risks seep into FY13 (CLSA)

India’s capex cycle is facing multiple headwinds which will adversely impact loan and fee growth. We expect banking sector’s credit growth to moderate to 16% over FY12-13. A fall in share of capex-linked loans will hit fees harder which will impact private banks more. Asset quality faces
headwinds from slower growth and we forecast a three-fold rise in Gross NPAs by FY14. However, trends will be divergent and banks with higher exposure to risky segments and restructured loans (mostly PSUs) will see higher NPLs. We lower FY12-13 sector estimates by 3%-9%; ICICI and HDFC Bank remain our top picks and we remain U-WT on most PSU Banks. We also cut recommendation on Yes Bank to O-PF.

Slower investment cycle will affect loan growth and fee growth
India’s slower economic growth, near policy paralysis and gaps in execution of infrastructure projects will adversely affect banking sector’s credit growth.
We therefore believe that the growth in India’s bank credit is likely to slow from 21% in FY11 to ~16% in FY12 & FY13.
However, we do not see a major collapse in loan growth as a large share of loans is towards working capital, which will grow in line with nominal GDP.
Additionally, banks may also benefit from market share gains in foreign currency lending to Indian corporates as global banks are turning risk averse and are focussing on capital conservation.
Margins are likely to be stable as banks are focussed on profitability which was evident in 2Q results whereby most banks saw QoQ improvement in margins.
While credit growth may still be healthy, fall in share of longer-term / project loans will affect banks’ fee growth (these are fee intensive products); this will be a bigger risk for earnings of SBI, Axis and ICICI Bank.

Delinquencies will rise and PSU banks are more vulnerable
Asset quality will face pressures from (1) slowdown in economic growth, (2) high interest rates and (3) Sector-specific concerns, especially for SMEs.
We however expect asset quality pressures to be manageable as a) corporate leverage is low, (2) capacity utilisation is healthy, (3) loan growth multiplier has averaged 1x in past two years v/s 1.7x over FY07-08
We are building in three-fold rise in absolute gross NPL (Gross NPA ratio to rise from 2.4% in Mar-11 to 4.6% by Mar-14); loan loss provisioning estimated to grow at a cagr of 34% over FY11-13 (from 80bps in FY11 to 110bps in FY13)
However like 2Q, where private banks reported a 30% drop in loan loss charge and PSU banks reported a 42% increase (fig 19), we expect asset quality trends to continue to be divergent.
Asset quality pressures will be higher for banks with (1) lenient underwriting standards, (2) higher exposure to risky sectors- SME, power, real estate, textiles etc and (3) higher share of restructured loans.

Lowering earnings and target prices; prefer quality over value
We lower sector earning estimates for banks by 3% for FY12 and 9% for FY13 on the back of a cut in loan growth and fee growth as well as higher loan loss provisioning; we have also lowered our target prices.
Our sensitivity analysis indicates (1) 10bps higher LLP will impact FY13 earnings by 2-7% and (2) 1% higher gross NPLs will impact FY13 adjusted BVPS by 7-39%; banks with higher leverage and low ROA are more vulnerable.
We prefer banks with well capitalised balance sheet, stronger liability franchise and higher ROA with ICICI Bank and HDFC Bank being our top picks.
We remain underweight on SBI and most other PSU Banks; BOB is our only positive recommendation in the PSU space.
Downgrade Yes bank to O-PF as upside to price target is 11%.

To read the full report: INDIAN FINANCIALS


Key takeaways from management meeting

Focus on growing energy business to c50% of group sales; renewable portfolio to increase from c200MW to c1250MW

Remain selective in EPC business; focus on high margin projects & captive assets to maintain margin of c16%

Management expects c15-20% growth in EPC business; power portfolio to grow through a mix of greenfields and acquisitions (c60/40)

We recently visited Techno Electric as part of our ongoing investigation of the India Electrical Equipment market. We do not rate nor are we commenting on the investment merit of the company’s securities.

We recently met with the senior management and promoters of Techno Electric – Mr. P.K. Lohia (President, Finance) and Mr. Ankit Gupta (Management Executive). Below we highlight
some of the key takeaways from the meeting.

To read the full report: TECHNO ELECTRIC