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UBS Investment Research
India Market Strategy
2011- A year of opportunities
„ Short term headwinds provide excellent opportunity to buy select stocks
We believe the recent nervousness in the Indian equity markets provides an
excellent opportunity for long term investors to pick up attractively priced growth
stocks. Investors are concerned about higher inflation, lack of reforms in the wake
of several state elections, rising crude oil prices and fiscal discipline going forward.
If oil prices sustain US$100 in FY12, India’s inflation and fiscal position could
dampen investor sentiment. We believe the state elections are unlikely to hinder
reforms as recent electoral trends in Bihar indicate that the Indian electorate has
become more objective in terms of rewarding good governance.
„ India's structural story is compelling
We believe India's structural story is intact and compelling. While sentiment and
liquidity may impact the markets in the short term, we believe India provides an
attractive investment opportunity based on its demographics and low penetration of
products/services. We believe Indian economy has the potential to grow at a real
rate of 7%-9% per annum in the coming decade
„ Theme for 2011 - Focus on bottom-up single stock ideas
We believe 2011 is a year to focus on bottom up stock ideas as opposed to buying
exposure to the broad market. We make the following changes to our model
portfolio -U/W on Autos (from Neutral), Neutral on Banks (from O/W), Neutral on
IT Services (from U/W), Neutral on Oil & Gas (from U/W) and O/W on Pharma
(from U/W). Our high conviction stock ideas are Idea, Hero Honda, Axis bank,
Asian Paints, Coal India, Lanco, Powergrid and select mid-cap ideas such as Jai
Balaji, Tube Investments & Jindal Saw.
1. What is our view on inflation? Likely to slow
Inflation has been a cause of worry, post the recent spike in food inflation data.
We think weekly data are volatile and can be unrepresentative due to the limited
data sample size.
Q Over the 12 month period we expect inflation to follow a downward trend.
WPI inflation is likely to slow down to 6.5% by FY11 end and then
accelerates to 7.0% by FY12.
Q The increase in FY12 is likely to be driven by
— broad money growth stays subdued
— global PPI rates of inflation stay sluggish, and
— local food inflation slows to 10% and global oil prices trade at $85-90 bbl.
Oil prices present the greatest exogenous shock to this scenario. We have
discussed the impact of oil prices on inflation below.
Oil prices – A worry over US$100
Over the last few months, rising oil prices have raised concerns surrounding the
fiscal position of India and inflation. Though the oil prices are still below their
peak in July 2008, investors are concerned that higher oil prices may impact
inflation and fiscal deficit adversely
Q We believe that government’s FY11 fiscal target of 5.5% of GDP seems
attainable given the windfall revenues from 3G and WMAX license proceeds
(1.4% of GDP) and big ticket disinvestments such as Coal India (0.2% of
GDP).
Q The key question is the impact of rising oil prices on FY12 fiscal deficit. Our
oil and gas analyst, Prakash Joshi, has done scenario analysis to ascertain the
impact of high oil prices on fiscal deficit. The scenario analysis (Table 1)
suggests that if global oil prices fluctuate between $85-$100 bbl in FY12
then the impact of fiscal fuel subsidy could be limited to under 0.4-0.8% of
GDP (assuming government shares 2/3rd of the under-recoveries).
Q However, the impact on FY12 fiscal deficit could increase up to 1.2% of
GDP if the oil prices average between $100-$110 and assuming there is no
hike in diesel, kerosene and LPG prices.
Inflation – Scenario analysis
The impact on FY12 WPI could range from 5.5% to 11% for oil averaging $90-
$110. Our base case of 7% WPI by Mar-12 uses average global oil price
inflation of c.12% (WTI to average c. $97 bbl). We believe that RBI would have
to consider hiking rates more aggressively if oil prices start to sustain above
$100 bbl which could skew WPI above 8%.
Also, our Global emerging market economist, Jonathan Anderson, in his note
(Why does not oil matter? published on 5 January 2011) highlighted that global
energy prices are unlikely to pose a substantial independent threat to emerging
growth.
State Assembly elections
The state assembly elections are due in 5 states during first half of 2011. Out of
these five states, three states – Kerela, Tamil Nadu and West Bengal – are
important from political standpoint
We believe the state elections are unlikely to hinder reforms as recent electoral
trends in Bihar indicate that the Indian electorate has become more objective in
terms of rewarding good governance.
Model portfolio changes
Sector changes
Auto (from Neutral to Underweight)
We turn underweight on Auto sector from neutral as we expect some amount of
slowdown in volume growth for the sector in FY12, given strong growth in the
past 2 years and rising inflation and interest rates. The sector margins are likely
to remain under pressure due to rising commodity prices.
Banks (from Overweight to Neutral)
We turn neutral on banks from overweight as we expect sector to remain under
pressure due to macro headwinds such as high inflation and elevated crude
prices. We assign 23.0% of our model portfolio to Banks vs. 23.5% in Sensex as
on 10 January 2011.
IT Services (from Underweight to Neutral)
We turn neutral on IT services sector from underweight as we add MphasiS to
our model portfolio. We have assigned 2.5% weight to MphasiS and increased
our weight on the sector to 16.5% from 14.1% earlier.
Oil & Gas (from Underweight to Neutral)
We turn neutral on oil & gas sector from underweight as we replace Essar Oil
with ONGC in our model portfolio. We have assigned 3.5% weight to ONGC as
we expect stock to benefit from potential diesel price hike and lower royalty
payment from the Rajasthan fields.
Pharmaceuticals (from Underweight to Overweight)
We turn overweight on pharmaceuticals sector from underweight as we add Dr
Reddy’s to our model portfolio. We remain positive on Dr Reddy’s because of
strong visibility on its potential FY12 and FY13 launches.
Stock additions
Axis Bank (Buy, PT Rs1,600)
We add Axis bank to our model portfolio with a weight of 3.0% as we believe
that Axis bank can surprise positively on quarterly metrics (margins, growth and
asset quality) given the strong credit demand in December quarter and weak
street expectations.
BHEL (Buy, PT Rs2,950)
We add BHEL to our model portfolio with a weight of 3.0%. The stock has
under-performed the Sensex by 10% in the last 3 months and we believe such
underperformance is unwarranted. We think positive catalysts would emerge in
the form of good quarterly performance and large order wins (NTPC bulk
tendering). We remain positive on the stock and maintain BHEL as our key pick
in the India capital goods space.
Coal India (Buy, PT Rs400)
We add Coal India to our model portfolio with a weight of 3.5% as we believe it
provides the best exposure to domestic coal demand. Coal India is one of the
lowest cost coal producers globally (US$16/t compared with the global thermal
coal average of US$33/t) due to advantages such as a high share of open mines
(around 90% of output), and favourable geological conditions including low
stripping ratios, thick flat coal seams and gentle inclines.
Dr Reddy’s Labs (Buy, PT Rs2,100)
We remain positive on Dr Reddy’s because of strong visibility on its potential
FY12 and FY13 launches for shared-exclusivity drugs with Zyprexa and
Geodon and further ramp-up of products that have limited competition (limitedcompetition products) such as Prilosec OTC and Fondaparinux in FY12. We
remain 17%/16% ahead of consensus earnings estimates for FY12/13.
Jindal Saw (Buy, PT Rs305)
We add Jindal Saw to our model portfolio and assign it a 2.0% weight as we
expect the stock to re-rate on mine development, favourable order inflows, new
duct iron (DI) capacity commissioning, and meaningful contribution from Jindal
ITF. We think consensus may not be building in significant impact from
mine/Jindal ITF.
Hero Honda (Buy, PT Rs1,950)
We add Hero Honda to our model portfolio as we expect 2-wheeler demand to
remain strong in FY12 driven by strong rural demand. We expect industry
environment to remain positive and margins to improve for Hero Honda.
Idea Cellular (Buy, PT Rs105)
We replace RCom with Idea cellular in our model portfolio as we believe Idea
will benefit in 2011 from increased asset allocation towards the telecom sector
on the back of regulatory changes as well as improving competitive dynamics.
We have recently, in or note “2011 - Resurrection year” published on 10
January 2011, upgraded the stock to Buy from Sell and raised price target from
Rs75 to Rs105 as we increase our estimates reflecting improving competitive
dynamics.
Mphasis (Buy, PT Rs900)
We add Mphasis to our model portfolio with a weight of 2.5%. MphasiS is our
top pick among mid-cap IT services stocks. We expect revenue and margins to
improve over the next few quarters on the back of volume growth driven by
improvement in demand. We forecast 20.3% sales growth and 11.1% earnings
CAGR in FY09-12 period.
ONGC (Buy, PT Rs1,600)
We add ONGC to our model portfolio with a weight of 3.5%. We believe that
the profitability for the company would improve from the potential hike in the
diesel prices. In addition, we expect the Government to reduce ONGC additional
royalty payment for the Rajasthan fields, so as to make that investment
profitable from a loss/breakeven currently
Power Grid (Buy, PT Rs135)
We add Power Grid to our model portfolio with a 3% weight. The Power sector
underperformed the broader market by ~15% in last three months and we expect
defensive names to do well. We are positive on Power Grid as a defensive
investment. Power Grid is the government-appointed central power transmission
utility and we think it will be a key beneficiary of growth in the transmission
sector; it has more than a 50% market share and we expect this to increase. In
our view, Power Grid’s leadership position in the sector is likely to remain
unchallenged. This combined with the low risk nature of business makes it a
good defensive exposure in Indian Power Sector.
Prestige Estates (Buy, PT Rs220)
We replace Godrej properties with Prestige estates in our model portfolio as we
view Prestige as a quality mid cap and the recent share price weakness as an
attractive buying opportunity. We think Prestige provides investors with the best
exposure to Bangalore’s growth potential. We expect encouraging presales for
the upcoming strong pipeline of 4-5m sqft of launches over the next 6-12
months.
Tube Investments (Buy, PT Rs197)
We add Tube Investments to our model portfolio with a weight of 2.0% as we
believe that the company is well positioned to benefit from the rise in demand in
the auto sector (through its tube/strip/doorframe/chain products) and capex for
the infrastructure/power sector (tubes/wagon sections). We forecast a 55% EPS
CAGR over FY10-12, driven by 22% revenue CAGR and rising margins.
Stock deletions
Bajaj Auto (Buy, PT Rs1,775)
We replace Bajaj Auto with Hero Honda in our model portfolio as we expect
Hero Honda to benefit from strong rural demand. Also, Bajaj has missed it
volume guidance for FY11.
Essar Oil (Buy, PT Rs175)
We replace Essar oil with ONGC in our model portfolio as we are more positive
on upstream oil companies.
Godrej Properties (Buy, Rs890)
We replace Godrej Properties with Prestige Estate as we believe Prestige
provides investors with the best exposure to Bangalore’s growth potential.
Hindalco (Buy, PT Rs200)
We replace Hindalco with Coal India in basic material in the space as we are
more positive on coal theme given the recent increase in coal prices. Hindalco
has been one of our best performing stocks and has outperformed the Sensex by
44.5% since its inclusion on 5 Jul’2010.
Monnet Ispat (Buy, PT Rs730)
We remove Monnet Ispat from our model portfolio as we are adding a large cap
Coal India stock to our model portfolio
Nagarjuna Constructions (Buy, PT Rs210)
We replace Nagarjuna Constructions with BHEL as it has better visibility (due
to an order book which is >3x FY11 revenue), it’s a better defensive and a large
cap in infra/cap goods space.
Reliance Communications (Buy, Rs215)
We replace RCom with Idea in our model portfolio as we believe Idea gives a
better exposure to Indian mobile sector given Idea is a pure play mobile player.
Reliance Industries (Neutral, PT Rs1,150)
We remove Reliance Industries from our model portfolio as the news flows on
the company’s upstream business continues to be negative. The upstream
business constitutes two-third of company’s EBITDA.
UBS India model portfolio performance
As on 11 Jan 2011, our portfolio had generated a return of 119.7%. This
compares with the BSE Sensex’s 98.6%; the Nifty’s 94.0%; and the MSCI
India’s 101.9% (as of 10 Jan’11). Key sectors that have outperformed compared
with the BSE Sensex are Banks (93.4% excess return), IT Services (91.0%),
Auto (59.8%), Metals (40.9%) and Power (24.6%) while Telecom (-115.9%),
Real Estate (-109.1%), Oil & Gas (-92.6%), Petrochemicals (-85.0%) and
Agrochemicals (-79.9%) have underperformed.
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