Thursday, January 5, 2012

>INDIA STRATEGY: Uncertainty prevails, recommend stock-specific portfolio

Our December’12 Sensex target of 18,000 implies 16% upside from current levels.Global and Indian macro risks are both unlikely to diminish quickly in 2012. This makes it difficult to have high-conviction industry and/or sector bets. Instead, we advocate building up portfolio positions via stock selection (bottom-up) until more transparency emerges on key macro overhangs.

This approach results in a highly concentrated portfolio with a slight Overweight in Diversified Financials and Automotive and an Underweight in Metals and Real Estate. Our key stock selection criteria include: (1) a turnaround in fundamentals – WIPRO, (2) excessive pessimism priced in – STATE BANK OF INDIA, (3) sound fundamentals with an execution track record in difficult times – HDFC, (4) market share gains – HERO MOTOCORP, and (5) cheap valuations – BPCL.

 Domestic outlook still weak but bottoming out: We expect near-term growth to surprise on the downside and estimate GDP growth at 6.5% in FY12. However, inflation is now falling—largely driven by the base effect—giving the RBI the capacity to cut rates by 50bps in Q1CY12. We think growth is close to bottoming out, but don’t expect a significant improvement in the next 6–9 months.

 Global growth risks still on the downside: According to our global strategist, EM equities should outperform DM in 2012 by 10–15%. While austerity and weak growth will be dominant themes in the West, EM equity market performance will have an increasingly strong tailwind from more growth-supportive fiscal and monetary policy across the region. European recession appears inevitable but global recession is unlikely. Thus, investment should be made on the premise that growth surprises from the developed world are unlikely and that politics/policy will be the biggest sentiment and risk-asset performance drivers over the coming year.

 Earnings and valuation: Our FY12E/FY13E Sensex EPS is Rs 1,120/Rs 1,254, lower than consensus by 2.5%/5%. We think the market is already pricing in an earnings backdrop closer to our expectations. Hence, while we expect consensus estimates to adjust lower in Q1CY12, we don’t see this as a catalyst for another legdown in equities and would use any weakness as an opportunity to add to positions. Our December’12 target is based on a 13x forward P/E multiple, an 18% discount to historic multiples due to near-term growth fears, declining ROE and a perceived lack of governance.

 What could trigger a turnaround: (1) Internalising crude oil prices to address the twin-deficit problem. (2) A revival in governance, with fast-track implementation of projects in key areas, and long-delayed reformist legislation as confidence-building measures for the corporate sector and investors. (3) Sharp growth deceleration leading to a drop-off in inflation and cut in policy rates.

To read the full report: INDIA STRATEGY