India- 2011 Outlook -Daiwa

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India
Despite its richer valuation than the China market currently in terms of one-year
forward PERs, we believe that India is likely to see further upside over the next two
quarters and outperform its Asia ex-Japan peers on the back of abundant global
liquidity inflows. Furthermore, India is forecast by both Daiwa analysts and the IBES
consensus to record one of the better regional EPS-growth rates for the coming year.
We forecast market EPS to rise by 18% YoY for FY12, outpacing the region’s forecast
EPS-growth rate of 17.7% YoY. Hence, we see a strong rebound in the Sensex’s ROE,
driven by the auto and metals sectors. We remain Overweight on the India market.
At the macro level, we think the India Government has done a good job of raising
funds under various programmes, such as the 3G telecom spectrum auction and the
record US$3.5bn disinvestment of Coal India (CIL) (Not listed). Increased revenue
should open up more resources to fund further infrastructure investment in India,
an area where foreign investors have remained unconvinced so far that the country
will see a breakthrough. Apart from the improving government finances, our
economics team continues to expect private-consumption growth to remain robust
on the back of good rainfall during the recent monsoon season, and the improving
employment outlook for the IT outsourcing sector.



So, even with the India market trading currently at a PER of 13.6x for FY12 based
on Daiwa’s EPS forecasts, above its past 10-year average PER of 14.4x, we expect
India’s strong economic-growth outlook for FY11 and FY12 to continue to attract
foreign portfolio inflows. We have seen the market’s forward PER influenced
favourably by inflows from foreign institutional investors (FII) and we expect its
forward PER to be sustained or to expand depending on risk perception and
expectations of further FII fund inflows.
That said, large India corporates are expected to use the IFRS standard from the
next financial year, and that should influence the earnings outlook and forward
valuations from FY12, which may dampen investor interest. In addition, further
appreciation of the Rupee could put pressure on the earnings of the IT outsourcing
sector. Any weakness in the employment outlook for the sector would probably be
a drag on India’s private-consumption growth.
Going into FY12, we expect the main drivers of earnings to be metals, energy,
automotives and financials. We think that the oil and gas sector in India will benefit
from an increasingly positive regulatory environment over the next 12 months.
Deregulation of gasoline was the first step, followed by a price hike in gas. We believe
upstream companies like Oil & Natural Gas Corp (ONGC) and GAIL India are
well-positioned to increase their earnings on back of these changes. Also, gas demand
and supply in India is a multi-year growth story, and we like plays on the gas story
such as Gujarat State Petronet (GSPL) and Petronet LNG (Petronet).
Regarding the financials, we expect banks’ non-performing-loan (NPL) recoveries to be
the main theme. We expect net-interest margins (NIMs) to be stable for next two quarters,
but we may start to see some pressure from 1Q FY12 onwards, especially at state-owned
banks. We believe that liquidity in the banking system will ease as the 3G money comes
back into the system and deposit growth should come closer to loan growth of around
20% YoY for FY12 in the banking system. Overall, we expect the banks sector’s
performance to remain strong in FY12, driven by low provisioning requirements.
Although global IT budgets should not increase much in 2011 in our view, in our
base-case scenario, we still see the demand outlook for India IT companies as
strong. Sequential US-Dollar revenue growth in excess of 8% YoY for FY12 looks
possible to us, given the strong deal pipeline. The blended billing rates are showing
the first signs of reversal and should probably go on to show a mild improvement.
In the event that the Rupee shows some signs of depreciating relative to the US
Dollar, there could be 10-12% upside potential to our FY12 EPS forecasts.