>Manmohan’s Tryst With Reforms

PM redeems his pledge to revive animal spirits, not wholly or in full measure, but very substantially


Slowing revenue growth but rebound in EBITDA and net profit growth: Revenue growth of Nifty companies is expected to fall to a ten-quarter low of just 13.4% YoY (the previous time it had fallen lower than this was in Q3FY10 at 9.9%). Revenues excluding Oil & Gas are expected to fall at 10.5%, again a ten-quarter low. EBITDA growth, on the other hand, is expected to bounce back strongly by 12.4% YoY (excluding Oil & Gas by 14.5% YoY). Similarly, PAT growth will bounce back by 16.4% YoY (excluding Oil & Gas by 16.4% YoY). Moderation in input price inflation on a YoY basis and strengthening of rupee leading to near-absence of foreign exchange losses has been responsible for this uptick in net profit growth. Revenue and PAT growth for all the companies under PL’s coverage universe are expected to grow YoY by 12.4% and 2.9%, respectively and de-grow QoQ by 0.1% and 7.5%, respectively. EBITDA margin (excluding BFSI) is expected to decline YoY by 1.01% and 0.08% QoQ. Corporate India continues to encounter headwinds in the form of slowing demand due to uncertainty in macro-environment and high interest rates.

Strong performance from Cement, Pharmaceutical and Banking & Financial Services sectors: Strong growth in realizations offsetting a tepid volume growth, observance of strict discipline by various players in the sector helping to maintain prices, healthy balance sheets and lower leverage levels due to strong cash flow generation will lead to a stellar performance by cement companies. Strong growth in the US, better operational performance and boost provided to net profits due to expected forex gains on hedges & foreign loans due to favorable currency movements will underpin pharmaceutical sector’s earnings. It is a story of contrasting halves in the Banking & Financial sector. Private Banks and NBFCs would report strong operating performance helped by easing of wholesale rates and retail asset quality holding up well. PSU Banks, on the contrary, will be impacted by muted loan growth and continuing pressure on slippages in bad & restructured asset book. Banks with overseas exposure could see contraction in their international book due to 5% rupee appreciation during the quarter.

Metals, Power, Construction and Real Estate continue to be laggards: Deteriorating global demand environment raising downside risks to spreads, weak domestic demand and excess supply in the domestic market will put pressure on earnings in metals sector. Power sector will continue to reel under increased fuel and interest costs causing delays in execution. Rising debt levels would continue to strain balance sheets and raise questions on viability of some power projects. No significant pick-up in order inflows, earnings impacted due to large interest burden as a result of high debt levels and no improvement in working capital cycle will put pressure on construction sector. Challenging macro-economic environment with no respite from high interest rates and no significant drop in prices impacting buyer affordability will continue to impact the performance of the real estate sector.

To read report in detail: INDIA STRATEGY
RISH TRADER

>Adding to Cyclicals as Market Heads for Life High in 2013

Quick Comment – Cyclicals look cheap relative to defensives: We have already pointed out in our August 13 note Cyclicals Approaching Ultra Cheap Territory that cyclicals look ultra cheap relative to defensives (Exhibit 1). The decisive policy action at home (reduction in subsidies and opening up of FDI) and, more crucially, concerted action by European and US central banks have reduced India’s tail risk linked to poor macro stability (twin deficit). Our preference for quality cyclicals is already expressed in our Focus List. We now put money to work on cyclicals in our sector model portfolio (Exhibit 2). Accordingly, we go underweight consumer staples and raise energy and materials to overweight, as well as taking industrials to neutral. We are also trimming technology by 100 bps. Consequently, our average sector position has expanded, and we see this as our emerging strategy, as the average correlations of stocks to the market appear to be falling and no longer merits extreme focus on stock picking.

25% upside to Sensex to Dec-13: We are expecting Sensex earnings growth at 10% and 19% in F2013 and F2014. Significantly, broad market earnings may have troughed or could trough in the current quarter. We have seen M1 growth put in a firm base in and revenue growth should slowly accelerate in the coming months. Margins could rise in the coming months with a favorable base effect driven by the relative movement in the current and fiscal deficit. Interest rates are already down YoY, and that should stem the steep rise witnessed in interest costs in the previous 12 months. The risk to earnings is that the investment rate collapses, although recent signals suggest that the public sector is starting to spend money. We roll our market target to Dec-13. Our target of 23,069 implies that the market will be trading at 14.9x our F2014e Sensex earnings in Dec-13 (Exhibit 5).

New bull market? Conditions for a new bull market are getting slowly satisfied. The yield curve has stopped supportive and profit margin expansion is a growing possibility in the coming months. The market is likely to form a new base with positive developments on domestic policy. Key risks are that commodity prices rise quickly, bringing inflation pressures to the fore, and/or global risk appetite wanes as global policy makers slip into another cycle of complacency. Mid-term polls are also a possibility, but we do not necessarily see that as a downside risk to equities. flattening, liquidity is improving, valuations appear

To read report in detail: INDIA STRATEGY

>INDIA STRATEGY: Peak of NPA cycle still not behind us

We revisit our banking theme “Slippage not the only thing, new risks are emerging, May 2012” to assess the endurance of the rising NPA cycle and conclude that structural (and also cyclical) factors that sustained decline in NPA ratio during 1994-2008 are now receding, leading way for longer and structurally higher GNPA ratios. Inclusive of GNPAs and restructured asset, the stressed assets for the banking system have risen to 9% of total lending or equivalent to GNPA ratio seen during early 2000s. We see the ballooning GNPA cycle rooted to an overleveraged banking system and weak macro conditions. Sustenance of higher elasticity of GNPA/Credit
growth at 3.4x post 2008 and decline in credit growth in response to credit risk concerns will imply GNPA growth sustaining at 40% implying

GNPA/Advance rising to 4-6.5% in the next two years.
Ballooning NPAs rooted to the lack of countercyclical buffer
In our view, the fulcrum of the current NPA upsurge, steeper than in the late 1990s, can be
attributed to overleveraged banking system reflected in renewed weakening of counter
cyclical buffer which reversed the readjustment for the credit boom during FY04-07
instilled by decline in credit growth during FY08-FY10. The deleveraging process was cut
short by the lagged impact of liberal credit restructuring and fiscal & monetary expansion
in FY10. Phases of overleveraged banking is followed by multi-year moderation in credit
growth and cyclical upsurge in GNPA (FY86-FY89, FY97-FY00, FY008-FY10 and FY12).

Rising NPA also reflect weakening in macro conditions
The linkage of the macro economic conditions to the elevated leveraging in the banking
system is embodied in multiple variables including decline in domestic saving rate (public,
household and private), impairment of productivity growth due to persistently high inflation,
commodity prices & revenue deficit and decline potential GDP growth.

Post 2008 inverse GNPA/Credit elasticity has risen sharply
GNPA/Credit elasticity has risen to 18-year peak with six year rolling elasticity rising to (-)
3.1. As current level of GNPA excludes restructured assets, expected moderation in credit
growth will imply further and substantial rise in GNPA going forward.

To read report in detail: INDIA STRATEGY

>Draghi’s announcement of Open Market Transactions (OMT) to support sovereign short-end bond markets

Key Takeaway
Following Draghi’s announcement of Open Market Transactions (OMT) to support sovereign short-end bond markets, global equity stock prices and volumes roared. The jump in share turnover after weeks of moribund activity signalled that investor conviction over a euro break-up and peripheral contagion has receded. However, the ECB did not cut rates and GDP forecasts
both for 2012 and 2013 were lowered.

Longer term, it is supply side reforms that both Draghi and equity investors will need to see, in the short-term, the ECB has bought the most precious commodity of all, time. We are reinstating our Long EuroStoxx short German bund trade. We continue to believe that the Scandinavian and Swiss markets will outperform the EU region as their central banks loosen rates faster to counteract the slowdown in economic growth. Investors appear to have missed
that Sweden cut rates again last week while Denmark flirts with negative nominal rates (see Scandinavia: Embracing unorthodox monetary policy, 3 September, 2012).

“It is easier to rob by setting up a bank than by holding up a bank clerk”, Bertolt Brecht
The disappointing US August nonfarm payrolls data (96,000) puts the spot light back on
the Fed’s meeting this week with the likelihood of extended rate guidance and possibly a
MBS QE program. We continue to recommend a long position in the S&P homebuilders
and building materials (see US: For the price of one HK carpark you can buy 5 US homes,
6 August, 2012). The weakness in Asian economic data has been reflected in Korean and
Taiwanese industrial production for some time but the evidence of an unwanted inventory
build-up seems to have been overlooked by investors. The week-end’s release of August
Chinese industrial production (8.9% y-y) and inflation data points (CPI 2% y-y, PPI -3.5% yy)
to further softness in GDP data and trade data for the rest of Asia. There is plenty of room
for Asian central banks to cut rates and of course for the BoJ to follow suit.

For the first time in many months, it was a bad week for bonds. It was a good week for stocks and more importantly for equity volumes. Draghi essentially took away the tail risks of an imminent currency crisis with the backing of all but one dissenting EU central bank. Although the EU sovereign crisis is far from over, Draghi has bought time for the EU to undertake the supply side reforms to manage the fiscal crisis. While he did not commit to yield or spread targets, the markets appear to have missed that once again he reduced collateral rules and made further comments towards inflation targets. While the EU crisis has manifested itself as a fiscal problem, the reality is that there has been underlying balance of payments crisis. Ultimately, Europe like the US and the UK is going to have to run negative real interests for some time. Financial repression will be good for real returns of stocks versus government bonds, difficult for financials but extremely good for the lowest cost operators in each sector (see The long run, the short run and the in-between, 3rd Quarter 2012 outlook). Much like the transfer payments made between the core rich Europe to the periphery via TARGET 2, financial repression ultimately means changes in competitiveness between countries. Aside from changes in the exchange rate, higher inflation rates will ultimately erode competiveness if companies cannot make productivity gains quickly enough.

To read report in detail: INDIA STRATEGY

>INDIA STRATEGY:Tracking Promoter Pledging: What’s at Stake?

Quick Comment: As per the SEBI regulations initiated in March 2009, promoters/founders of companies are required to disclose the amount of stock they have pledged.

Key highlights from the latest quarterly disclosures:
Pledges slightly off March 2012 lows: In the quarter ending this June, 767 companies disclosed pledges on their holdings. The pledged value as a percentage of the market cap of these companies is marginally above its March 2012 lows – at 9.8% (up 11bps QoQ). Its share in India’s market cap increased a tad from 2.05% in March 2012 to 2.08% in June 2012.

Value of pledges falls: As at the end of June 2012, the total value of pledged stocks was US$23bn, down 8% QoQ. In rupee terms, the total pledged value stood at Rs1.28trn, up 1% QoQ. Marked to market, as per the previous day’s close, the pledged value of shares was ~ US$22bn, down 9% QoQ without accounting for any subsequent changes that may have happened to the number of shares pledged. In rupee terms marked to market, the pledged value of shares was ~Rs1.27trn, down 0.5% QoQ.

Assuming a 50% margin, the bank credit to these promoters at US$11.5 billion is 2.7% of outstanding bank credit.

During the quarter, Utilities saw the largest fall in share of pledging while Healthcare witnessed a pick-up. At the end of the quarter, Consumer Discretionary followed by Materials have the biggest pledging by promoters in value as well the most widespread promoter pledging. Separately, as a percentage of market cap, pledging is highest for Financials and Energy, while as a percentage of promoter holding, the percentage of pledging is highest for Energy and lowest for Technology.

To read report in detail: INDIA STRATEGY

>STRATEGY: Silver linings aplenty, but cloud lingers on

A small reversion in the P/E and stable earnings growth could lift the Nifty by 20% within four quarters. However, uncertain macroeconomic trends and government policies tend to hold down the valuation. Silver linings are held out by the resilience in FY12 earnings growth and, the yield‐gap to the Libor nearing the low end. Twice within three quarters, FII buying rose when the gap fell near its low. Another protective factor is the cyclical high in interest rates and inflation, and low in industrial growth. In the near term, sectors with strong earnings momentum during FY12 may extend their run. Over the next four quarters, a few more ‘non‐defensive’ sectors could outperform; we advise an overweight position on Construction, Telecom and Utilities, and select segments in Banks, Automobiles and Oil & Gas.

Triple deficits; policy measures hold key to next rebound in P/E
The large potential rebound in the Nifty depends upon the resolution of challenges posed by deficits in the budget, current account and monsoon rains as well as by inflation, interest rates and exchange rates. Earnings growth has lesser influence on the P/E than feared, as indicated by the lower contraction in the P/E, even as forecasts fell in the last six quarters.

Resilience in profits of vulnerable sectors is a positive
Three sectors with a strong link to industry and infrastructure, viz., Automobiles, Cement and Financials drove a late rebound in consensus forecasts for FY12 earnings growth of the Nifty to c9%. The pessimism on 1H2012 earnings growth coincided with the gloom cloaking most aspects of India. However, the diversity of businesses saw the weakness in a group of sectors, viz., Utilities, Telecom and Construction, being more than offset by the strength in the above three. This indicates that businesses and companies represented in the index are capable of protecting earnings during tough times.

Gap with USD Libor has set bottom of range, also precedes FII rebound
Relative to the Libor, the Nifty P/E is much closer to Feb09’s eight‐year low compared to local yields. The yield gap to the one‐year USD Libor indicates that the Nifty is barely 10% above a level that corresponds to this worst case. We also find a surge in the FII purchase of Indian equities soon after the yield gap nears this low. Over the medium term, this metric may point to a likely low point in the valuation as well as a likely revival in FII inflows.

Select ‘non‐defensives’ outperform; may expand over four quarters
Over a four quarter horizon, we advise an overweight position on stocks within Construction, Telecom, Utilities, and select segments within Banks, Automobiles and Oil & Gas. The 2012 year‐to‐date outperformance in Cement, PSU Banks, Construction, among others, indicates that a swing towards ‘nondefensive’ sectors is under way. Our top picks for the near term are ACC, Ambuja, UltraTech Cement, Torrent Pharma, Unichem, NTPC, Tata Power, HDFC Bank, LICHF and RECL. Over the next four quarters, our top picks are SBI, Axis Bank, Maruti, Tata Motors, BPCL, Cadila, L&T, Wipro, Bharti and Tata Steel.

To read report in detail: STRATEGY

RISH TRADER

>STRATEGY- Stratoscope: Show Me the Money

In the midst of the dividend payout season for Indian equities, we analyzed the payout policies of Corporate India and its relationship with stock price performances. We highlight key observations and stock ideas in the report.

 The median dividend payout ratio for the BSE 100 has remained stable over the last decade at about 20%. The flat trend is not satisfying from a minority shareholder perspective. But could be attributed to: a) the corporate sector in India being in a capital-intensive growth phase (both organic and inorganic), b) funding constraints post the global financial crises, c) increased competitive intensity has also resulted in a more cautious stance on sustainability of payouts.

 The cautious stance is reflected even in the payout policies of defensive sectors – Consumer Staples, Consumer Discretionary and Healthcare, wherein payout policies have remained stable or reduced. The payout of the IT services sector has almost doubled over the last decade. But it still remains around the broad market average. Payout of the Financials sector has also been limited to around the market average. The State-owned Banks have, however, seen a reduction in recent times due to capital constraints.

 It is also worth highlighting that only a few managements have a clearly articulated dividend payout policy. The state-owned companies typically try to adhere to Government guidelines which stipulate a payout of about 20-30% depending on the sector. Given the Government’s
fiscal constraints, we expect cash-rich, state-owned companies to continue to have a high payout policy.

 That said, managements wanting to enhance shareholder value would do well to have a consistent payout policy – with stable to rising dividends. Our analysis shows that companies with such a policy have consistently outperformed the benchmark over the last decade.

To read report in detail: STRATEGY

>INDIA STRATEGY: Sensex@20,500 by FY13 end (CENTRUM)

We estimate Sensex to post an EPS of Rs. 1416 for FY14E (15% growth over FY13E)  Applying a target P/E of 14.5x (inline with long term mean) we get Sensex target of 20500 for FY13 end, although this can be achieved earlier (by Dec 2012) if government reforms agenda takes off

The P/E for Sensex has seen high correlation with the Nominal GDP growth. Hence we believe that the target multiple applied for Sensex is appropriate considering the Nominal GDP growth expectations of close to 14%

Composition of incremental index earnings shows that the majority of earnings come from Financials, Materials and Auto sectors; softening interest rate cycle should aid recovery in the Financials and Auto sectors while a low base of FY13 would help sectors like Materials to post a good growth in FY14.c


To read report in detail: INDIA STRATEGY

>STRATEGY: At the limits of realism

Global Economy: Synchronised downturn

• US, Europe, China & Asia are facing an economic downturn, with Europe being the worst hit. However, latest steps initiated in the EU Summit have reduced the financial risks in the near term.
• It is a mixed blessing for India: Growth & INR to be adversely impacted, but fall in commodities & oil a big positive

Indian Economy: Growth to remain sub-par in coming quarters

• Lingering policy paralysis, weak external environment and high interest rates to impede economic activity in the coming quarters. We expect below-trend growth of 6.4% in FY13E
• However, few positives emerging—BoP stress likely to ease, RBI likely to turn more growth supportive and undervalued INR to support economy

Corporate earnings: To stabilise/improve as businesses shift focus from growth to profitability

• In a slow growth environment, businesses undertake cost rationalisation (through deleveraging, cutting SG&A and employee costs etc). This helps stabilise/expand PBT margins even as sales continue to slow. History offers ample evidence of the same
• Accordingly, while there will be some further downgrades in FY13 Sensex earnings of INR1,280, as per our bear case estimate we do not foresee earnings falling below INR 1,220. Hence, assuming a below-average multiple of 13x, Sensex downside is protected at ~16000.

Sectors to play
Given weak macros we favour a bottom-up approach. For next couple of quarters, we play interest rate cycle theme, moving real estate to OW, and retaining OW on autos. Further, given demanding valuations of consumer sector, we are downgrading it to EW from OW. Meanwhile, telecom is upgraded to OW, while IT continues to be OW


Model portfolio: Outperformed Nifty by 100bps in CY12 YTD. Since CY09, outperformance has been ~630bps


To read report in detail: STRATEGY

RISH TRADER

>STRATEGY – With Crude’s decline, expect short-term rally to continue…

Executive Summary
We can all breathe a sigh of relief as last week’s events have come to an end. If we look at the past week in hindsight, key negative risks such as Greece’s exit from the Eurozone have clearly been avoided, which has been enough to calm frayed nerves in the markets. Similarly, in the US, the Fed extended its Maturity Extension Program (MEP), or Operation Twist, by $267 bn and assured markets that more will be done if required thus expanding chances of another round of Quantitative Easing. Thus, things on the global side played out in the favor of bulls. On the domestic front, the RBI delivered a surprise by keeping policy rates and CRR unchanged, contrary to market expectations.


The joker in the pack, however, has been crude oil. Brent crude has dropped to $90/barrel on global growth concerns and a 22-year high stock pile in the US. The fall in crude prices has become one of the biggest game changers for India with its ramifications pretty strong on account of our twin deficits.


On the political scenario, the Prime Minister has taken up the Finance portfolio as Mr. Pranab Mukherjee resigned to contest for presidential elections. This raises some hopes that the PM will act once again as he had done in 1991. Thus, any strong move could have a strong signaling effect on the markets.


Technically, we are well placed above 200 DMA. The recent fall in crude oil prices coupled with strong technical indicators suggest that the current rally may extend to previous highs of 5,500. Hence we recommend trading on the long side in the next 3 to 6 weeks.


Recent events - No complaints as negatives avoided
Greece election results helped restore some calm in the markets with the New Democratic Party (NDP), Pasok and the Democratic Party of the Left forming a coalition government with a total seat count of 179 out of 300 (60%). Thus, the near-term fear of Greece moving out of the Eurozone has been put to rest as the new government realizes the importance of its existing Eurozone membership. This is the outcome that markets wanted to see as the new coalition has generally signaled a willingness to go along with the current bailout path and not buck the rest of Europe.


The Federal Reserve, too, did not deliver any major surprises as it announced a continuation to its MEP (Operation Twist) to the tune of $267 bn. Further, the Fed decided to keep the target range for federal funds rate at 0 to 0.25% and exceptionally low levels for the federal funds rate at least through late 2014. The Fed’s acknowledged that the US economy is expanding only moderately and that growth in employment has also slowed in recent months, keeping unemployment rates elevated. The Fed’s assurance that it will be ready to support the market as needed however lends assurance of another round of QE in the near term.


The RBI, meanwhile, in its June 2012 mid-quarter monetary policy review maintained a status quo on repo rate and CRR at 8.0% and 4.75%, respectively. This move was made in contrast to both our and market expectations of 25bps reduction in policy rates. The Reserve Bank cited concern on inflation and shifted the blame of slower investment growth on the government and other reasons. It is interesting to note that RBI once again has shifted focus on headline inflation rather than the more encouraging core inflation number and going forward monsoon’s performance will play a pivotal role in determining headline inflation trends.


Crude comes to the rescue
The joker in the pack has definitely been crude oil. Brent crude has fallen to $90/barrel on global growth issues and a 22-year high stock pile in the US. The fall in crude prices has become one of the biggest game changers for India, with its ramifications pretty strong on account of our twin deficits. The current account is sensitive by 45bps for every $10/barrel move in crude and crude’s decline from $120/barrel to $90/barrel means that we can now expect CAD at 2.5% in FY13 if crude ends the year averaging at $90/barrel. On the fiscal account as well, a decline in crude helps bail out the central government as they continue to struggle to push a hike in diesel prices. Further, even adjusted for a fall in Rupee, domestic cost of fuel has declined by over 10% since January. This lends some comfort to OMCs given that they have been unable to hike diesel prices.


To read report in detail: STRATEGY


RISH TRADER

>Investment Strategy to beat inflation

The inflationary environment is continuing for more than 18 months now. The RBI, through its tightening of its monetary policy, has already increased the interest rate 13 times in the recent past. Inflationary expectations continue to be a challenge not only for policy makers but also for the common man who is struggling to retain his purchasing power, savings and return from investments. There are challenges for the investor in both finding means to earn a positive real rate of return from his investment and in identifying the asset class.


The risk-averse investor tends to invest in debt-related instruments like FDs etc over a period of time. This is because in absolute terms people see their savings grow but over time there is a reduction in the purchasing power due to inflation. With food inflation hovering in the zone of 16% and WPI around 8.5% even after change in the base year, it has become almost impossible to maintain the purchasing power. Fixed income debt instruments which provide returns in the range of 8-12% with moderate risk are currently giving negative real returns or in other words are not able to beat inflation (Investment return – inflation = real rate of return). Over and above this, the investor needs to pay income tax on income from investments thus suppressing the returns further. In such an inflationary environment, investors need to make investments where they can beat inflation. Hence, investors must allocate a sizable portion of their funds in assets such as equity which have proven in the past their potential to give positive returns even after inflation.


History has shown that equities have been the best investment class over any long-term period. However, most of the people you would have asked, especially retail investors, would have said that they have lost money in the stock market. Why is it so? Firstly, we need to understand that the market in the short run is a function of human sentiments rather than the fundamental value of the underlying companies. It is there where most of people lose out as they get carried away by other people’s mistakes. In the long term, the equity markets tend to mirror the economic growth of the economy but people tend to time the market, and that is where they lose out.


To read report in detail: INVESTMENT STRATEGY
RISH TRADER

>STRATEGY: Global worries remain, domestic environment to improve going ahead

4QFY2012 and FY2012 earnings snapshot: Sensex companies reported adjusted earnings growth of 19.2% yoy for 4QFY2012, against our expectation of 13.8%, aided by unexpected earnings surprise by ONGC. Excluding the ONGC’s suprise, earnings grew by 13.7% yoy, compared to our expectation of 15.1%, as lower-than-expected earnings of metal and telecom companies (sectoral earnings declined for both) largely offset better-than-expected performance of auto companies (primarily Tata Motors), Sun Pharma, SBI and ICICI Bank. Overall for FY2012, the earnings performance story was directionally similar to that witnessed in 4QFY2012, with lower-than-expected sectoral earnings of cyclical and structurally stressed sectors largely offseting better-than-expected yearly performance of few sectors like Private banks, auto, pharma, FMCG and IT. In fact, excluding Tata Motors (which was aided more by its foreign subsidiary) and SBI (which had a low base of earnings in FY2011), overall earnings growth for Sensex companies came in at just 9.6%.


Global worries remain, but domestic environment to improve going ahead:
Concerns about a crisis in Eurozone, which had earlier abated somewhat, have risen again on the back of recent developments in Europe (particularly regarding elections in Greece and the intensifying banking crisis in Spain), which coupled with series of lower-than-estimated economic data have led Indian markets to fall in April-May 2012. However, going ahead we expect the domestic macro environment to improve on the back of easing commodity prices, moderating inflation, further monetary easing in the form of repo rate cuts and narrowing current account deficit. Weak demand outlook have led to a significant decline in commodity prices including crude oil. The decline in global commodity prices, which generally gets reflected in inflation levels domestically with a lag, is expected to lead to a further decline in manufacturing inflation, while current forecasts suggest good monsoon levels which is expected to keep food inflation under control.


CAD to narrow going ahead: Indian exporters are expected to benefit significantly from INR depreciation, as it has improved their competitive edge vis-a-vis global competitors such as China. Also, imports are expected to decline on 1) lower domestic demand on account of slowing capex activities; 2) moderating global commodity prices including crude oil prices; and 3) reduction in gold imports (~10% of total imports) as gold is unlikely to generate similar supernormal returns as it did in last few years. Hence, we expect the trade deficit (in USD terms) also to narrow from here on, leading to a reduction of 50-100bp in current account deficit.


Outlook and valuation: Overall, for FY2013, we expect corporate earnings to be aided at the revenue level by better growth prospects than in FY2012, at the earnings level due to directionally better inflation scenario and lower interest costs. We expect Sensex companies to deliver EPS growth of 11.4% in FY2013E (12.2% CAGR over FY2012-14E). We continue to prefer rate sensitives like financials, infra and auto sectors, which are likely to benefit the most from the expected correction in interest rates and also select export-oriented IT and Pharma companies. We arrive at our 12-18 months Sensex target of 19,800, maintaining our conservative multiple of 14x FY2014E earnings. Our target implies an upside of ~19% from current levels.



Sensex earnings performance aided by ONGC surprise; Ex. ONGC performance remain mixed
For 4QFY2012, on a yoy basis, Sensex companies' adjusted earnings grew by 19.2% yoy as against our expectation of 13.8%, aided by the unexpected earnings surprise by ONGC. Excluding the positive surprise from ONGC, earnings grew by 13.7% yoy, compared to our expectation of 15.1%, as lower-than-expected earnings of metal and telecom companies (sectoral earnings declined for both) nearly offset better-than-expected performance of auto companies (primarily Tata Motors), Sun Pharma, SBI and ICICI Bank. Sector wise, on a yoy basis, Sensex earnings growth was primarily contributed by BFSI stocks, followed by auto, oil and gas and IT stocks. Excluding SBI (which had a low base in 4QFY2011 due to exceptional pension-related expenses) and ONGC (on unexpected earnings surprise), overall earnings growth for Sensex companies came in at just 4.1% yoy, as against our anticipation of 6.7% yoy.


To read report in detail: INDIA STRATEGY

RISH TRADER

>STRATEGY: Staying away from the “fright club”

Summary: There are three very good reasons, we believe, for not joining the “fright club” against India being orchestrated by parts of the brokerage community. Firstly, a significant part of the ongoing economic slowdown has been caused by the fact that the supply of equity to the promoter community has been cut off by the European crisis (rather than by the Government of India). Secondly, a number of regulatory institutions which have come to the fore over the past two years (eg. CAG, Competition Commission) will help the Indian economy going forward even though they might result in short term economic costs. Thirdly, India’s GDP data is so compromised that drawing any conclusions about the state of the economy based on this data could result in poor investment decisions.


We reiterate that this is a good time to invest in India as valuations are the most attractive that they have been in a decade (leaving aside the quarter following the Lehman bankruptcy).


It is common knowledge that the Indian Government has played its hand badly over the past four years. For example, with regards to coal scarcity, most of the damage was self-inflicted as the Environment Minister dithered on the “go/no go” areas and then instituted an over zealous process (and arguably faulty) process of checking emissions in the vicinity of Coal India mines. The totality of these measures has probably set back Coal India’s production by 5-7% per annum. Another example of self-defeating intervention is the hasty introduction of GAAR
in the Union Budget. 
However, is the Indian Government so influential that its blunders have bought our economy to its knees? We do not think so. Three other factors have played a powerful role in India’s humbling.


Firstly, a range of problems which prima facie appear to be caused by the Government’s “policy paralysis” are arguably linked to the global seizure in risk appetite.


 The “under-the-table” model was used in the noughties to lubricate our political and bureaucratic system as aggressive promoters sought to build construction, infrastructure, real estate and mining empires. Now many of these promoters simply do not have the means to use this model on such a scale (partly because with the QIP/IPO market shut the most obvious route for financing such large backhanders is gone).


 Promoters these days are quick to blame “policy paralysis” for their inability to get projects off the ground. However, some basic number crunching and discussions with financiers suggest that in many instances these Power, Infra, Real Estate and Mining companies are deliberately throttling the project back because they do not have equity available.


The second reason for not joining the “fright club” is that a number of regulatory institutions which have come to the fore over the past two years will help the Indian economy going forward. The actions of a number of regulators, most notably the CAG and the Competition Commission (CCI) are an obvious antidote to the excesses of the noughties. Whether it be CAG’s pathbreaking report on the 2G maater of the CCI’s landmark action against DLF
for the alleged abuse of its dominant position in Gurgaon, it is hard to blame the Government for these actions.


In the Natural Resources sector almost all the titanic promoters seem have hit a brick wall in New Delhi as they run into an array of opponents in the form of: (a) The CAG which is publishing report after report on different aspects of malfeasance in this sector; (b) The Environment Ministry which is no longer willing to give clearances to projects; (c)
The Supreme Court which is unwilling to let illegal mining continue and which has advocated the use of auctions for all natural resource allocations henceforth; and (d) The relevant Ministry (be it Coal, Petroleum or Mining or Steel) which is unwilling to play ball. It is hard to imagine that our enfeebled Executive is behind such a coordinated blocking of a range of powerful companies.


If the Competition Commission continues its crusade against abuse of dominant positions by market leaders in industries from Real Estate to Cement to Sugar to LPG Cylinders, this should help improve economic efficiency. If the CAG continues its practice of scrutinizing public spending and regulatory decisions in the manner that it has over the past two years, it will revolutionise the way the Indian Government works. Without such interventions from well
meaning regulators and from a powerful judiciary, India could go the way of numerous “banana republics” in Latin America and Africa.



The final reason for not joining the fright club is that our GDP data is so compromised that drawing any conclusions about the state of the economy based on this data could result in poor investment decisions. First and foremost, India’s GDP data is subject to inexplicable retrospective revisions of a material magnitude. For instance, investment demand growth numbers have been revised upwards from 5% YoY and -4% YoY in 1QFY12 and
2QFY12 respectively to 15% YoY and 5% YoY respectively. Secondly, there is limited synchronization between trade data as shown by the national accounts data and the same variables captured by the RBI. And thirdly, the share of ‘discrepancies’ in the CSO’s GDP growth data has risen by 50% from FY05-08 to FY12 (from -9% of the change in GDP to 42% of the change in GDP!).


Clearly, the economy has slowed down sharply. Whilst we were amongst the first to signal such a pronounced slowdown (refer to our macro research from exactly a year ago), we had become more optimistic about the Indian economy in January this year. Our optimism is not being borne out by the current state of the economy but, once
again, this is because the paralytic state of affairs in Europe means that a big swathe of the Indian economy simply does not have equity to fire up the capex cycle. Policy somersaults in New Delhi can’t do much to change that reality.


Investment implications
A significant part of the blame for the dramatic slowdown of the Indian economy lies not with domestic factors but with the freezing of risk appetite in the wake of the European crisis. Our economist, Ritika Mankar, estimates that at least a third of the collapse in India’s growth can be attributed to the slowdown in investment growth which in turn is most profoundly affected by the global risk environment given India’s capital scarce nature. Whilst investment growth accounted for 50% of India’s GDP YoY growth over FY05-08, this share has now fallen to 20% in 4QFY12. Our own modeling process suggests that the global risk environment is the most important determinant of India’s growth engine (30x times more powerful than the repo rate).


This “blame attribution” is important. If investors pull out of India believing that there is something “systemically” or structurally wrong with the country, they will lose a great opportunity to participate in the Indian recovery which will come when global risk appetite recovers. This is main reason why we at Ambit refuse to join the “fright club” of brokers who are sounding dire warnings about what will happen to India if the Government does not do X, Y or Z.
We reiterate that this is a good time to invest in India as valuations are the most attractive that they have been in a decade leaving aside the quarter following the Lehman bankruptcy. We note that over the past decade the 12 month returns from investing in India when valuations are as low as they are now have always been strongly positive - see table below.

We also believe that by focusing on “Good & Clean” (G&C) companies investors can comprehensively outperform the sagging Indian indices. Since inception in March 2011, our G&C portfolios have outperformed the BSE500 by over 20% (on a free float market cap weighted basis). Our latest G&C portfolio (has outperformed the BSE200 and the BSE500 by 52bps and 48bps respectively since publication on 3rd May.

>MARKET STRATEGY: Retrospective May 2012 – Murky May

 Retrospective in Summary


• MSCI India underperformed the MSCI EM marginally, by 20bp.


• India’s performance rank improved to 12th position.


• Mid-cap performed in broadly in line with the narrow market; small cap index underperformed.


• INR fell to a record low during the month, down 6% MoM, but was down 0.3% against the EUR.


• Implied volatility rose while inter-day volatility fell MoM.


• Oil prices fell 7% in INR terms while gold prices were flat MoM.


• M&A transactions remained steady.


To read report in detail: MARKET STRATEGY


RISH TRADER

>STRATEGY: India looks oversold

With sellside economists’ GDP estimates being cut regularly (our estimate remains above 7%), with the INR in a free (our target INR/US$56-58), India's star appears to be fading. However, as shown by a series of long term charts in this note, the Indian market is unquestionably ‘cheap’ now. Whilst given the scale of the European crisis and given India's comatose Government, it is easy to be bearish on India, these charts suggest that now is almost as good a time as any to BUY India. The country will rarely look as attractive on valuations when the world economy perks up and when India's growth hits its cyclical peak (v/s the cyclical trough that it is at now).


India appears oversold on long term metrics
India appears significantly oversold on a comprehensive set of relative valuation metrics based on book value, national income and cyclically adjusted earnings (refer to the right hand margin). In fact, India has appeared cheaper than it is at present only once or twice in the last ten years:


 ■ P/B: The Sensex was significantly cheaper compared to current levels only in the year after 9/11 and in the wake of the Lehman crash (exhibit 1).


 ■ P/GDP: BSE500 was significantly cheaper only until 2005. Since then, with the exception of the post-Lehman period, the market has never been this cheap relative to underlying national income. Even in the depths of the Lehman crisis, the market was only 10% cheaper than it is today (exhibit 2).


 ■ CAPE: On CAPE (i.e. cyclically adjusted real P/E), India has only once traded at lower multiples than the current 15x. This rare outcome materialized in the post-Lehman months when it hit 12x (see exhibit 3).


 ■ Even relative to the nominal CAPE for MSCI EM, India has never looked this cheap v/s its peers post CY05 (with the exception of the post Lehman months) with its premium currently crunched to 38% v/s the long term average of 51%.


Investment Implications: Buy Good & Clean stocks
Given that India appears oversold on long term metrics, unless you believe that there is another Lehman on the way, it makes sense to take a bolder approach to buying high-quality, sensibly-valued companies in India. Fifty such companies were highlighted in our "Good & Clean 4.0: the Great 50" note published on May 03, 2012.


Furthermore, leaving our charts aside, it is worth considering the three upcoming catalysts highlighted in our email last week (India Strategy: Blinkered by all the doom & gloom", May 16, 2012) in case your spirit is willing to buy India but the flesh is weak:


1.Change in FM: With the current FM likely headed for a more prestigious but more titular role, the three candidates who appear to be in the frame for the FM’s role appear to be more progressive candidates than the incumbent.


2.More QE from the West: We have seen the QE playbook being rolled out repeatedly by the ECB and the Fed. Given the potential risks to the European banking system and given a pro-growth (hence anti-austerity) leader heading France, it would be very strange if the ECB did not use the monetary fire hose to calm the markets down eventually.


3. Oil: India's oil import bill amounts to 7% of our GDP. Therefore, a 10% fall in the price of oil (from US$110/Brent barrel to US$100) will reduce our current account deficit by 40bps. We are not oil experts but looking at the weakening Chinese economy and listening to the Saudis talk about how they will work proactively to push Brent to US$100, we cannot but feel optimistic.

RISH TRADER

>FII's INVESTMENT AND DISVESTMENT IN MARCH 2012

FIIs invested in HDFC, ITC and Tata Motors.

FIIs divested in Bharti Airtel, Patni Computer and United Spirits.

To read report in detail: STRATEGY

>STRATEGY: The flipside of policy inertia – rising FCF yields

■  Sensex PER valuations belie the bottom-up pain. Though Sensex PER (12.5-13.0x) seemingly has more downside given (1) FY12-14E earnings CAGR of only 12%, (2) the still negative spread of earnings yield vs. risk free rate and (3) avg. Sensex PER of 11.5x during the GFC, we expect the rising FCF yields (focus of this report) to begin supporting valuations. The top-down market PER, however, has been supported by the increased weights in FMCG, IT and Pharma and the sustained premiums thereof, thus understating the severe de-rating in other sectors. It is also interesting to note that the India weight in benchmarked funds relative to MSCI EM has remained stable at an Overweight of ~1% during the past two years. Even the absolute India weight has declined only 190bps from the peak of 9.5% two years ago, suggesting significant sector rotation even as relative Over/Underweight has been stable.


■  FCF yield at 2SD to provide downside support, identify stocks. Meanwhile, the flip-side of the collapse in the capex cycle is the rising FCF yields; the Sensex fwd FCF yield is now at 4.5%, higher than 2008-09 levels and almost at 2SD. We believe this could provide material downside support to market valuations notwithstanding the regulatory/policy overhangs. Continuing with our thesis, we map stocks based on the (1) FCF yield (FY13/14E avg.) and (2) the delta in FY13/14E yield vis-à-vis FY12. Stocks that stand out on both parameters are Apollo, Cairn, HZL, Crompton, M&M and TAMO. Stocks with high FCF yields but low deltas are HCLT, Ambuja, ACC, Infy, Bajaj Auto and BHEL. In the model portfolio, we reduce Staples to UW from EW and increase weight on Industrials (OW vs. EW), Financials (EW vs. UW, mainly through PSU banks) and Energy (Reliance). We also reduce weights in Pharma/Healthcare and Materials.


■  FY12-14E earnings CAGR of 12% below nominal GDP growth now: Meanwhile, earnings have continued to slide – Sensex FY13/14E EPS stands at Rs1,216/1,338 (Rs1,247/1,372 in end-Feb). We don’t see too much further downside as margin expectations are low and gains from a weak rupee will start flowing through FY13 earnings. The Earnings Revision Index (ERI) for India has also declined from -0.5 in Sep-11 to -0.1 and has been stable in the past 3 months.


■  Top picks: ACC, HCL Tech, DLF, ICICI Bank, Dr. Reddy’s. We replace Cipla with Dr. Reddy’s and drop HUVR, Tata Motors and Bharti from the top picks. Top Midcap Picks: Apollo, PLNG, Adani Ports, Sobha, YES Bank.


To read report in detail: INDIA STRATEGY
RISH TRADER

>INDIA STRATEGY: A brave new India

A brave new India: We see some of the recent actions of the Indian executive, judiciary and regulators as an attempt to restore the primacy of law and democratic institutions in India. We hope for an equitable, inclusive and transparent development model after eradication of a system based on corruption, cronyism and dysfunctional systems. It may have resulted in strong economic activity but it is also extracted very high invisible costs from the indian economy and society. 


To read report in detail: INDIA STRATEGY
RISH TRADER

>INDIA STRATEGY- ECONOMY: Growth should be the focus of RBI/government

CRADLE OF PESSIMISM



FY12 turned out to be a year of reckoning for most countries. India witnessed rapid slowdown in growth, coupled with near double-digit inflation. Accordingly, we also had to tone down many of our optimistic assumptions. With the uncertainties persisting, we now focus more closely on the coming quarter (1QFY13), while annual projections would remain a critical input for our forward-looking assessment.


■  We estimate inflation at 6.5% for March 2012 and at 6.2% for 1QFY13. These estimates have seen some upward revision in the last couple of months, led by global crude prices, budget proposals, electricity tariff hikes and pending fuel price hikes. These factors have also led us to revise our average inflation estimate to 6.8% for FY13 from 5.6% earlier. We believe inflation would remain within the 6.5% level for a major part of FY13 and will inch above 7% only after December 2012. This presents a reasonable 8-month window of opportunity for the RBI to first ease rates and then pause, as inflation begins rising once again in December 2012. We expect the RBI to cut rates by 100bp in CY12.



■ The liquidity deficit persisted through FY12, but became aggravated during 2HFY12. The government/RBI has also scheduled a larger part (65% of gross and 59% of net) of borrowing for 1HFY13. Some softening of the liquidity situation is likely in April-May 2012, but should firm up once again due to large net borrowings, slowing money supply growth and stress from the external situation. To tide over the liquidity problem, we expect the RBI to undertake open market operations (OMOs) totaling INR1.8t during FY13.


■ The latest BoP data indicates significant stress on the external situation. While merchandise trade volume has declined in 3QFY12, invisibles have been failing to grow for some time. Trade and current account gaps are reaching their record levels at 10% and 4%, respectively. The scenario is unlikely to improve much in FY13 due to multiple headwinds, including weakness in the western economies, high oil prices, etc. Additionally, the INR is vulnerable to inflation. Considering these factors, the exchange rate should hover at INR50-52/USD barring  unexpected developments in balance of payments (BoP) or inflation.


■ Policy flip-flops in many key areas of reform coupled with the coming together of various macroeconomic risks have heightened uncertainties prevailing in the market. While many factors such as coalition politics, political bickering, strained relationship between the government and the judiciary and general lack of governance has been held responsible for this, the combined impact of these events has taken a toll on the investment cycle and attractiveness of India as a destination for foreign capital. We believe meaningful progress in some of these areas is necessary to restore investors’ confidence.


To read report in detail: INDIA STRATEGY
RISH TRADER

>INDIA STRATEGY: 4QFY12 Earnings Preview: V are in a U

■ V Market, U Earnings — India’s market recovery was fairly V shaped in the quarter (+12.6% in 4Q): but you should expect a more U shaped recovery in earnings: +7% yoy (Sensex-ex Oil), 7.5% (CIRA ex-energy), and largely in sync with the earnings performance over the first 3 quarters of the year. We do not believe there are big bottom up expectations for the quarter, but it should have greater skews, bigger surprises and an elevated focus on management guidances. We also believe you should expect only modest earnings revisions post the results, with FY13 earnings growth estimates remaining in the 14-15% level.


■ Margins over sales should continue — Sales should continue to moderate (17% yoy, CIRA ex-Reliance) while margins should continue their qoq rise (after reversing a falling trend in 1HFY12). This trend, we believe, is a reflection of slowing demand, and a combination of easing cost pressures/rising profit focus of corporates. This trend (profit over growth – almost alien to corporate India over the last decade) will need a catalyst – mix of lower rates, higher confidence in government and strong global markets, to reverse. This quarter’s results are unlikely to be that change/catalyst.


■ Bigger sector and stock skews — Over 50% of CIRA coverage companies will report a +/- 20% growth in the quarter; there will be a high share of one-offs (in this qtr or in the base), and big sectors (Banks/Mining) and big stocks (SBI/Coal India/Reliance) will drive these swings. The Banks, Automobiles, Consumer and Pharma sectors should lead while Metals, Media, Telecom and Real Estate should lag.


■ Quarters' question, Stock Selection — Will the quarter meaningfully alter market direction? We think not (the Credit policy with rising rate cut expectations probably more decisive, and will have a bearing on management commentary). We maintain our 18,400 Sensex Target for December 2012. We see potential upside surprises for SBI, Bharti and HCL Tech, and downside ones for Coal India, TCS and Grasim.


To read full report: INDIA STRATEGY
RISH TRADER