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STOCKS to BUY After Recent Correction (click on name for detail report)
Automobiles: Buy Maruti
Stocks Still a SELL: ENAM view (click on name for detail report)
Enam's SECTOR OVERVIEWS (click on Sector for details)
Auto
Cement
Risk-Reward unfavourable
The Sensex at 15x FY12 is below its 5 year mean valuations.
However, there are risks to earnings growth (21% in FY12 with RoE of
16%, after 33% growth in FY11 on consol basis), in case of delayed
capex and rising costs & subsidies – eg in BFSI, Oil, engg/ infra, etc
Base case India macro assumptions for FY12 avg (vs FY11E) are for a
GDP growth of 8.8% (8.6%), inflation of 6.5% (8.5%), policy rate of
6.75% (6.25%), avg USD/ INR of 44.1 (45.3), Fisc deficit of 5% (5.5%)
and Current a/c deficit of 3.2% (2.9%) – refer Macro-Eco section for
our rationale for these. Key variations to these could be due to:
The main Positive surprise could be that of aggressive quantitative
easing (QE) by the Fed in 2011, easing pressure on our twin-deficits
and INR. US Retail sales in December have been just satisfactory –
not providing any forward clues yet
However, there are massive headwinds, both domestic and global.
Hence, risk-reward for the Sensex is unfavourable this year, with the
base case being a highly volatile but effectively flat Sensex
Downside Risks
Europe: Problems could lead to volatility as well as a flight to safety to USD again. India is particularly vulnerable to
appreciating USD due to its twin deficits and the fact that most Fx inflows are USD denominated. However, global
biggies ie IMF, EU & ECB stand committed to step in to avert any sovereign default. Moreover, in a couple of years
Basel III will ensure that banks are well capitalized to absorb losses
Resurgence of US economic growth, esp given that US Cos are relatively cheap vs other major global markets, may
drive FII flows back to the USA. However:
While the Fed has unleashed massive liquidity, credit growth has failed to pick up as pvt demand is still to make a comeback and
lenders are risk averse. Demand thus far has remained govt induced
While the US has been able to halve its CAD on the back of a weakening USD, hirings are up and pvt savings have also inched up,
unemployment remains high
India is particularly vulnerable due to our twin deficits to Crude oil prices which have nearly doubled in the past
12 months. When such surges have been due to demand side factors, it has not always affected our markets.
However, any QE-induced crude surge in 2011 could be very adverse, given the range of other vulnerabilities at this juncture, with
some impact on metal prices too
Tightening of Chinese interest rates is also threatening world-growth and metal prices, leading to some risk-aversion. Note in
calendar 2010, of the Net Indian market inflows of ~$ 27 bn, FIIs accounted for ~$29 bn, ie domestics were a net outflow
The Parliament has not been able to function last month due to the 2G deadlock. Given that 2011 is very important
to the reforms program in diverse areas such as GST, DTC, Sectoral FDI, etc, until the Govt and other political parties
sort their tangles out, markets could remain nervous of its ability to translate its progressive intent
The large size of issuances of Govt & some pvt sector issues (ref slide 15) this year is also cause for concern
How to Position oneself
Positioning: With massive current headwinds, the Base case is for Sensex to be flat this year, with natural growth
offsetting any PE de-rating for this year. Yet the possibility of further Fed QE due to US not recovering as per
expectations, makes a Bar-bell risk profile in India with large potential upside/ downside, depending largely on liquidity
inflows & thus their effect on twin-deficits/ INR/ availability of capital to fund infrastructure
Possible Sensex range in this volatile period: At the higher end, IF liquidity bulldozes fears, investors would look at
1 yr fwd exit multiples for FY 13: using a median PE of 16 and consensus ests for FY 13 eps of just over Rs 1500, this
translates to a peak Sensex of 24000 (ignoring SoTP valuations). At the lower end, using the current 10 yr G-Sec yield
of 8.2% as the earnings yield (ie no growth) on the FY 12 eps of Rs 1277, this translates to a Sensex of 15600
Thus, portfolio positioning will need to be bottom-up, based on what individual concerns/ triggers are already factored
in in current valuations of stocks. Separately we have also released over the last week, a series of sectoral reports
which provide individual sectoral outlooks, and for each covered stock, the key sensitivities to various vulnerabilities
Sectoral stance: OW Engg, UW FMCG, Cement, Oilngas, Telecom.
Sectoral stance changes vs Dec 10: Moving Banking & IT from UW to slightly OW, Oilngas neutral to UW, Engg/ Infra
neutral to OW, Auto OW to Neutral, Telecom neutral to UW
Top Large-cap Buys (mkt cap> $3 bn): Maruti, ICICI, Canara, L&T, Mundra, CIL, PGCIL
Top Large cap Sells (mkt cap> $3 bn): ACC, HUL
Please see Model Portfolio updated for Jan 11, provided as the last section of this report before the database; and
Sections on Sectoral Outlook and Best Buys/ Sells for greater details
Fundamental Drivers remain intact…
GDP growth buoyant
Corporate and HH B/S remain healthy and hence India growth is not leveraged
to that in G7 and not susceptible to stimulus withdrawal
Fiscal policy remains simulative: The govt has chosen to spend the one-off
revenue gains (~1% of GDP) from Telecom spectrum auctions, thereby hinting
that it remains pro growth despite risks of higher inflation and CAD
Drivers: ~2/3rd of the GDP growth in FY11 was driven by consumption
(both govt & pvt) while investments lagged behind. We believe in FY12,
Consumption & Investments are likely to contribute ~50% each
We expect consumption to grow at ~7% YoY despite a fall in govt consumption
due to a steady addition to the working population and wage growth of ~15%
We expect ~13% YoY growth in investments with higher capacity utilization and
increased credit flow
But risks remain on downside:
Delay in investment cycle: A slippage of 1% in Gross Fixed Capital (GFCF)
growth could shave ~35 bps from GDP growth
Crude prices > $90/bbl: GDP growth gets impacted by 10-20 bps for every $10
rise in oil after a lag of 9-12 mths
Monsoon failure
Scam-hit govt = Policy paralysis?
Govt Reforms: The recent scams show that while the
continuity of reforms is irreversible, their timing is
susceptible to the vagaries of coalition politics. Various
important reforms ie GST, FDI and several other bills are
pending in Parliament. Any further delays will be viewed
negatively
However, we believe as CY11 & 12 are the most
important mid-cycle years for the ruling UPA , we expect
Parliament deadlock to be resolved quickly
India Inc: Some of the recent scams involved housing
finance cos, banks and realty cos. These have raised the
hackles of corporate governance standards in India
We believe these are cases of bribery and individual
culpability and there are no systemic risks involved and
India Inc corporate governance standards by and large
remain healthy
Inflation to remain sticky and Oil adds to worry
Headline inflation to soften YoY from ~8.5% in FY11 due to RBI action
thus far, the base effect and a bumper agri output
However, we expect inflation to average an uncomfortable ~6.5% in
FY12 due to strong pvt demand and higher oil prices
Food inflation: So far inflation has remained high due to supply disruptions,
inclement weather and there is a structural upward bias in prices of proteinrich
food. However, with an expected bumper crop in FY11 (~231 mn tons), a
record 26 mn tons as buffer stock and govt initiatives to ease supply, we
expect food prices to ebb on a YoY basis unless monsoon fails
Fuel: Oil: US$10 per barrel increase in oil prices (assumed crude avg at $90
for FY12)
Raises CAD, and if not passed on (ex petrol), oil under-recovery by
Rs 360 bn ($ 8 bn)
Raises fiscal deficit by ~30 bps
Could increase WPI by ~1%
Manufacturing inflation: We expect pressure to rise with stronger growth
induced pvt consumption and higher wage growth
The Yield curve has flattened with the long end remaining stuck ~8% and
rate tightening by ~150 bps on the short end hinting that bond markets are
expecting inflation to moderate
Interest rates: Bulk of tightening behind
We believe bulk of tightening is behind us:
RBI has effectively tightened by ~300 bps in CYTD and has been
one of the most aggressive central banks (see chart below)
It has also severely tightened liquidity conditions which we expect
to persist for some time
And monetary aggregates ie : M3 & M1 have slackened thus
posing lower risk to demand pressures
Going forward, we expect front-loaded ~50 bps of datadriven
tightening (ie fuel price hikes, sudden spikes in WPI)
Importantly, liquidity management will become a bigger
challenge for RBI in CY11 and hence we expect CRR to be
the preferred policy tool
Rising interest rates due to a pick up in economic growth
are not negative. However, it is only when rates become
excessive or restrictive that markets react negatively
Sensex has a high correlation (~68%) with interest rates
>50 bps hike in Repo from current levels will become restrictive
Will high interest rates hurt capex revival?
With interest rates having moved up sharply in FY11, there is
a fear that capex will not take off or will get deferred
Empirical evidence suggests that interest rates have very low
correlation with private capex (27%) or GFCF and we feel that
bulk of the tightening is behind us
For instance, post-Lehman, RBI cut interest rates by 400
bps in a short span f time and infused liquidity worth Rs
4.2 trn, yet capex refused to pick up due to demand
scare
In a complete contrast to India, interest rates have trended
to historic lows in the developed world. Yet, India Inc has
been reluctant to tap the overseas markets for funds due to
gloomy outlook ie it has borrowed only ~$6b in H1 FY11 by
way of ECBs due to demand outlook and sovereign default
scare in Europe
CAD: Concerns to remain
CAD: To remain >3% as policymakers
have a growth bias. So far higher CAD has
enabled absorption of higher cap flows
w/o overheating. Funding of CAD by way
of ST capital flows is a worry
Capital a/c: We expect moderation in FII
flows but FDI flows are expected to rise in
line with global growth. We believe cap
a/c surplus would be just about enough to
cover CAD
INR to have a mild appreciating bias
interspersed with short bouts of USD
reversal triggered by global uncertainties:
Baseline growth of 8.5%+ and relative
growth and interest rate differential vs US
Continuing QE and rising Yuan
Risks: CAD> 4%, any slippage on
divestments & other reforms, flight-to-safety
Fiscal correction highly geared to growth
Fiscal policy to remain stimulative: The govt has chosen to
spend the one-off revenue gains (~1% of GDP) from
Telecom spectrum auctions, thereby hinting that it remains
pro-growth even at the risk of higher inflation and higher
CAD
Absence of one-offs will make fiscal correction tough in
FY12 & highly geared to GDP growth. Though coal auction
is high on agenda, its progress remains mired in problems
Govt expenditures notoriously difficult to curtail and current
impasse over tax reforms will make it difficult for the govt
to initiate any tax reforms
Thus, risks of crowding out remain as economy moves
back to ~9% growth rate. We think the govt will fall short
of its deficit target of 4.8% for FY12
Thus, we expect 10 year G-Sec to remain under pressure
and remain in the range 7.9-8.2% in FY12
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