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Sharekhan Budget Special
Run-up to Union Budget 2011: Low on expectations
Amid rising concerns over the government’s fiscal
position and the sustained inflation pressures, the
Union Budget for 2011-12 is likely to throw some light
on the government’s plans to address the core issues.
However, given that elections are due in five states
(of which four are ruled by the United Progressive
Alliance), the focus may shift to spending in social
sector schemes like the National Rural Employment
Guarantee Act (NREGA), food security and right to
education.
From the perspective of investors, the key thing to
watch would be the government’s guidance on fiscal
consolidation and the means to fill in the fiscal deficit
despite the absence of one-time income like the
income from the auction of third generation (3G)
spectrum and the rising cost of energy (ie crude oil).
Other pending issues relating to tax reforms,
curtailment of subsidies etc are likely to be touched
but the Street does not expect any path-breaking
announcement or initiatives to deal with these issues
in this budget. Given the low expectations the risk of
negative surprises from the budget is limited.
In terms of key changes on the taxation front, there
could be a further rollback of the fiscal stimulus given
during the 2008 crisis in the form of excise duty cut
from 14% to 8% for certain segments. It was partially
rolled back to 10% and could be revised up again in
this coming budget. There is also a possibility of an
increase in the service tax rate to 16% to shore up the
revenues and make up for the expected reduction in
custom duty on crude oil and petroleum products.
Social spending to gain prominence over other
matters
In view of the discontent in the masses due to spiralling
inflation and election in five states, the budget spending
may be inclined towards social sectors. Programmes like
NREGA, right to education and food security bill would
entail increased allocations. We believe there could be
significant allocation for implementing the right to
education and the proposed Food Security Act while more
clarity will emerge on the coverage and implementation
of these schemes. Going by the National Advisory Council's
recommendations on providing guaranteed foodgrain
supply, the food subsidy bill is expected to increase
substantially from the existing Rs56,700 crore to around
Rs1 lakh crore.
In addition, the government may take some necessary
measures to maintain growth in the agriculture segment
in order to ensure economic growth in FY2011. As observed
by the Reserve Bank of India (RBI), the inflation rate has
gained structural character; thus the focus on the
agriculture segment would also take care of the food
inflation. Further, the government is likely to announce
measures to improve the credit facilities at reasonable
rates, irrigation facilities and logistics to increase the
productivity.
Fiscal deficit to be guided mostly by expenditure side
Unlike in FY2011, the government has lesser flexibility to
raise resources in FY2012 as one-time revenue sources
such as 3G and broadband auctions would not be available.
Secondly, the expenditure in FY2012 is likely to be higher
than that in FY2011 due to the increased outlay for the
government’s programmes and its rising subsidy burden
driven by higher oil prices. The budgetary allocation for
schemes like food security is likely to double while there
could be a significant rise in expenses on NREGA schemes.
The oil prices are unlikely to retract significantly and
hence would add to the subsidy bill, thereby keeping the
expenditure high.
Though the tax revenues have been on the rise, the gap
between the government’s revenues and expenditure
would increase mainly led by higher spending. With rising
crude oil prices and high inflation the government is
unlikely to do away with subsidies which will weaken its
fiscal position. However, the government can go selective
and reframe the subsidy structure to streamline its
expenses. We, therefore, believe the expenditure is the
key to fiscal consolidation and would continue to threaten
an increase in the fiscal deficit.
Borrowings to remain at higher levels
The government may announce higher borrowings in the
budget to take care of the increase in its spending. In
FY2011 its borrowing target (net) was reduced to Rs3.5
trillion due to the higher than expected collections from
the 3G and broadband auctions. However, in FY2012 the
net government borrowings are likely to be Rs4 trillion,
which may keep the bond yields at higher levels and add
to the liquidity pressures in the economy.
Clarity on divestment policy
With limited scope to ramp up revenues in order to fund
the fiscal deficit, the government would be dependent
on the proceeds from divestments. Therefore, the
government is expected to announce an aggressive
disinvestment target as a few large public sector
undertakings (PSUs) are likely to hit the market in FY2012.
The budget may throw some light on the list of companies
in which the government’s stake is likely to be divested.
Clarity on tax reforms
In the previous budget the government had touched upon
the subject of tax reforms and given guidance on the
implementation of the Goods and Services Tax (GST) and
the Direct Tax Code (DTC). The government would be keen
on moving ahead on tax issues like the GST and the DTC
to increase the traction in the tax revenues as it seems
the only way to achieve the fiscal targets. Although we
do not expect any major announcement on the tax front,
yet the budget could throw up some roadmap for the
implementation of the GST and the DTC. The
implementation of the GST is the key to increase the tax
revenues and any step in that direction will increase the
revenue visibility.
Broadly, we do not expect any increase in the tax rates
but some measures could be announced to expand the
tax base.
Widening of the service tax net
As per the service tax framework, more than hundred
services come within its purview. This number is expected
to increase in the coming budget through either the addition
of new services or the expansion of the scope of the existing
services. Certain welfare services such as health and
education services coupled with legal services, postal services
etc could be brought under the ambit of the service tax.
The Minimum Alternative Tax (MAT)—though there is
expectation of an increase in the MAT rate from 18%
currently to about 20%, we expect the rate to remain
unchanged. This is due to the fact that the Software
Technology Park of India (STPI) benefit is likely get over from
FY2012 while the DTC will come into force in the same year.
Capex growth and supply augmentation
Notwithstanding the strong growth in the economy,
concerns have been growing such as inflation, a steep
rise in interest rates etc, which could threaten the demand
for both investment and consumption. To address that
there may be increased allocation for infrastructure
development and social spending, benefitting the
construction and consumer sectors. The government may
come up with a suitable, legitimate model for promoting
public-private joint ventures and boosting foreign direct
investment (FDI) in the domains of infrastructure
development and insurance.
Sectoral wish-list/expectations
Automobile
Sector outlook: Globally the automobile sector forms about 10% of a country’s gross
domestic product (GDP). During recession, all major economies of the world gave a
boost to their automobile sector to meet their GDP growth objectives. Recently, macro
headwinds such as rising interest rates and surging commodity and fuel prices have
created a challenging growth environment for the domestic automobile sector. We do
not expect any major roll-back of excise duty or curtailment of the incentives given to
the automobile sector earlier.
Banking
Sector outlook: We maintain our neutral stance on the sector due to liquidity issues,
margin pressures and provision expenses that would negatively affect the profits of
banks. Though the non-performing asset (NPA) position is likely to stablise, the public
sector banks (PSBs) will have to provide for pension liabilities while the private banks
will face pressure from the rising employee cost. However, since bank stocks have
corrected significantly, the comfort has increased on the valuation front. Our top picks
from the sector are Axis Bank, Yes Bank, Bank of Baroda and Punjab National Bank
(PNB).
Capital goods and engineering
Sector outlook: In view of the robust investment expected in the Indian infrastructure
sector, particularly the power sector, the demand outlook for the capital goods sector
remains bright. However, various infrastructural bottlenecks, political scams and
organisational inertia have slowed down the pace of awarding of orders in recent
times. Nonetheless, most of the companies have revenue visibility for more than two
years in terms of their book-bill ratio. We also remain positive on the sector for its
attractive valuations. However, concerns on Chinese competition would persist unless
the government intervenes by withdrawing import incentives. Our top picks from the
sector are Larsen and Toubro (L&T), Bharat Heavy Electricals Ltd (BHEL), Thermax and
V-Guard Industries.
Cement
Sector outlook: Given the poor execution of infrastructure projects, the overall volume
growth of the cement industry is unlikely to meet the guidance of 9% (anticipated by
the large cement players) for FY2011 and will be in the range of 7-8%. However, the
supply discipline followed by the manufacturers so far has resulted in a strong cement
realisation in H2FY2011, particularly in the southern region. Going ahead, we believe
a pick-up in the cement offtake could break the supply discipline and bring the prices
under pressure. In addition, the key concerns remain an oversupply of cement due to
capacity addition and cost pressure in terms of higher coal prices and increased freight
cost because of an increase in fuel prices and the lead distance. Hence, we maintain
our negative stance on the sector.
Education
Sector outlook: The government is focused on improving the literacy rate and the
quality of education in the country. The spending on education is expected to rise 12-
fold per household between 1995 and 2025 due to an increase in the income levels of
the Indian middle class. However, the sector is un-organised with regional content and
a large number of regional players are dependent on government spending. The quality
of education in the rural areas remains poor. Though private players are entering the
sector, the sector would still remain dependent on government spending. Any delay in
government programmes to boost education and red-tapism could delay the growth of
the sector.
FMCG
Sector outlook: The Indian fast moving consumer goods (FMCG) sector with a market
size of Rs130,000 crore is the fourth largest sector in the Indian economy. The sector
has grown at a CAGR of 11% over the last decade and is expected to sustain the strong
growth on the back of strong domestic consumption in the long run. However, the high
food inflation and the surging input cost are likely to affect its growth in the near
term. Hence, we expect the government to provide some support to the sector in the
upcoming budget. We maintain ITC as our top pick from the sector in view of the strong
visibility of its long-term earnings. We like Godrej Consumer Products Ltd (GCPL) in
the mid-cap FMCG space.
Information Technology
Sector outlook: The information technology (IT) sector has outperformed the broader
market over the last few months on the back of a strong revival in the sector’s
fundamentals, especially on the demand side. For the upcoming Union Budget FY2011-
12, we remain optimistic about the extension of the STPI benefits for another year till
the time the DTC comes into force. However, in the event of non-extension of the STPI
benefits, we do not expect much impact on investor sentiments as the Street has
already factored in a higher tax rate for FY2012. We remain positive on the IT sector
with a longer-term perspective. Our top picks from the sector are Infosys Technologies,
HCL Technologies, Polaris Software and NIIT Technologies.
Infrastructure
Sector outlook: Given the heavy investment required in the infrastructure space, we
believe the government’s thrust on infrastructure spending will continue. Even in the
last budget the government had increased fund allocation across sectors. However,
due to various scams, political issues and high inflation the government’s focus had
shifted from infrastructure spending over the past few months. Thus, the project award
activity and the execution of projects have been very slow recently, resulting in lower
infrastructure spending. However, going ahead, we believe the project awarding activity
should pick up once again after the budget. Moreover, since the stocks have corrected
significantly, the comfort has increased on the valuation front. Our top picks from the
sector are IL&FS Transportation Networks (India) Ltd (ITNL), IRB Infrastructure Developers
(IRB Infra) and Pratibha Industries.
Media
Sector outlook: According to the FICCI KPMG 2010 report, the Indian media &
entertainment industry is expected to grow at a compounded annual growth rate (CAGR)
of 13% over 2009-14 to reach Rs109,100 crore. This along with the structural changes
in the industry, eg digitisation, and the improving spending trend of the urban and
rural Indians augurs well for the growth of the sector in the coming years. Our top pick
from the sector is Eros International Media
Oil & Gas
Sector outlook: The Indian oil & gas space has witnessed significant reforms in the
form of petrol price de-regulation. However, the recent spike in crude oil prices and
the mounting inflation pressure have resulted in uncertainty regarding the timing of
diesel price de-regulation. The burden of the rising fuel under-recoveries would remain
an overhang on the oil marketing companies (OMCs) and upstream companies (Oil and
Natural Gas Corporation [ONGC], Oil India Ltd [OIL] and GAIL India). Reliance Industries
Ltd (RIL) would benefit from improving refining margins but the declining gas production
from the Krishna-Godavari D-6 block is a concern. Our top pick from the sector is GAIL
India due to its strong earnings growth visibility.
Power
Sector outlook: During the April-January FY2011 period, India generated about 669
billion units of power and its energy deficit remained in the range of 8%. Against a
target of 21,441MW India has added fresh capacity of about 10,210MW in the year till
date, taking its total capacity to 170,228MW. This deficit is attributed to several
challenges at the execution level and the government could address the same to boost
the company’s power generation capacity. The delay from the leading power equipment
suppliers is likely to be resolved soon as new players are rolling up their sleeves and
would continue to get some kind of support from the government. On the other hand,
the shortage of coal in India is another issue at present. To add to that, the deteriorating
financial health of the distributing companies (discoms) remains a concern. We remain
mildly positive on the sector in view of these opportunities and challenges.
Pharma
Sector outlook: The growth trajectory in the key markets of Indian pharma remains
robust. Hence, we maintain our positive view on the sector. Exports still hold significant
promise as Indian pharma has a low market share of 10% in the USA and a 5% share in
the emerging markets. The large first-to-file (FTF) opportunities and strong abbreviated
new drug application (ANDA) pipeline make us believe that the US opportunity remains
attractive. With product-specific opportunities and scaling up in niche segments, the
Indian pharmaceutical (pharma) companies appear to be better prepared to address
the growth opportunities. The price/earnings (P/E) expansion over the past two years
has been backed by strong fundamentals. We expect the sector’s current multiple of
20x FY2012E P/E to sustain with a positive stance on the pharma sector. Our top picks
from the sector are Lupin, Glenmark Pharmacueticals and JB Chemicals.
Retail
Sector outlook: The Indian modern retail segment is at a nascent stage with penetration
of less than 6%, in an overall retail industry size of $350 billion. A favorable demographic
profile and an increasing purchasing power coupled with a changing mindset towards
an organized retail format augurs well for the modern retail players. Along with a
strong revenue momentum, the players’ efforts towards front end as well as back end
cost rationalisation and optimisation will start bearing fruits in time to come. We
remain positive on Indian retail as a structural domestic play
Telecom
Sector outlook: The telecom (wireless) industry has grown by leaps and bounds.
Currently with ~ 750 million subscribers, it still stands at an all India penetration level
of ~60%, and rural penetration of as low as ~30%, thus providing ample growth
opportunity. Of late the sector had witnessed high competition, impacting players’
earnings profile. With the completion of the 3G auction process and stabilizing
competition we believe the domestic environment remains strong. But high level of
regulatory uncertainty (recommendations/ proposals relating to one time excess
spectrum charge, high payments towards license renewal fee) coupled with spectrum
shortage still plague the industry, and hence we remain cautious on the sector.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Sharekhan Budget Special
Run-up to Union Budget 2011: Low on expectations
Amid rising concerns over the government’s fiscal
position and the sustained inflation pressures, the
Union Budget for 2011-12 is likely to throw some light
on the government’s plans to address the core issues.
However, given that elections are due in five states
(of which four are ruled by the United Progressive
Alliance), the focus may shift to spending in social
sector schemes like the National Rural Employment
Guarantee Act (NREGA), food security and right to
education.
From the perspective of investors, the key thing to
watch would be the government’s guidance on fiscal
consolidation and the means to fill in the fiscal deficit
despite the absence of one-time income like the
income from the auction of third generation (3G)
spectrum and the rising cost of energy (ie crude oil).
Other pending issues relating to tax reforms,
curtailment of subsidies etc are likely to be touched
but the Street does not expect any path-breaking
announcement or initiatives to deal with these issues
in this budget. Given the low expectations the risk of
negative surprises from the budget is limited.
In terms of key changes on the taxation front, there
could be a further rollback of the fiscal stimulus given
during the 2008 crisis in the form of excise duty cut
from 14% to 8% for certain segments. It was partially
rolled back to 10% and could be revised up again in
this coming budget. There is also a possibility of an
increase in the service tax rate to 16% to shore up the
revenues and make up for the expected reduction in
custom duty on crude oil and petroleum products.
Social spending to gain prominence over other
matters
In view of the discontent in the masses due to spiralling
inflation and election in five states, the budget spending
may be inclined towards social sectors. Programmes like
NREGA, right to education and food security bill would
entail increased allocations. We believe there could be
significant allocation for implementing the right to
education and the proposed Food Security Act while more
clarity will emerge on the coverage and implementation
of these schemes. Going by the National Advisory Council's
recommendations on providing guaranteed foodgrain
supply, the food subsidy bill is expected to increase
substantially from the existing Rs56,700 crore to around
Rs1 lakh crore.
In addition, the government may take some necessary
measures to maintain growth in the agriculture segment
in order to ensure economic growth in FY2011. As observed
by the Reserve Bank of India (RBI), the inflation rate has
gained structural character; thus the focus on the
agriculture segment would also take care of the food
inflation. Further, the government is likely to announce
measures to improve the credit facilities at reasonable
rates, irrigation facilities and logistics to increase the
productivity.
Fiscal deficit to be guided mostly by expenditure side
Unlike in FY2011, the government has lesser flexibility to
raise resources in FY2012 as one-time revenue sources
such as 3G and broadband auctions would not be available.
Secondly, the expenditure in FY2012 is likely to be higher
than that in FY2011 due to the increased outlay for the
government’s programmes and its rising subsidy burden
driven by higher oil prices. The budgetary allocation for
schemes like food security is likely to double while there
could be a significant rise in expenses on NREGA schemes.
The oil prices are unlikely to retract significantly and
hence would add to the subsidy bill, thereby keeping the
expenditure high.
Though the tax revenues have been on the rise, the gap
between the government’s revenues and expenditure
would increase mainly led by higher spending. With rising
crude oil prices and high inflation the government is
unlikely to do away with subsidies which will weaken its
fiscal position. However, the government can go selective
and reframe the subsidy structure to streamline its
expenses. We, therefore, believe the expenditure is the
key to fiscal consolidation and would continue to threaten
an increase in the fiscal deficit.
Borrowings to remain at higher levels
The government may announce higher borrowings in the
budget to take care of the increase in its spending. In
FY2011 its borrowing target (net) was reduced to Rs3.5
trillion due to the higher than expected collections from
the 3G and broadband auctions. However, in FY2012 the
net government borrowings are likely to be Rs4 trillion,
which may keep the bond yields at higher levels and add
to the liquidity pressures in the economy.
Clarity on divestment policy
With limited scope to ramp up revenues in order to fund
the fiscal deficit, the government would be dependent
on the proceeds from divestments. Therefore, the
government is expected to announce an aggressive
disinvestment target as a few large public sector
undertakings (PSUs) are likely to hit the market in FY2012.
The budget may throw some light on the list of companies
in which the government’s stake is likely to be divested.
Clarity on tax reforms
In the previous budget the government had touched upon
the subject of tax reforms and given guidance on the
implementation of the Goods and Services Tax (GST) and
the Direct Tax Code (DTC). The government would be keen
on moving ahead on tax issues like the GST and the DTC
to increase the traction in the tax revenues as it seems
the only way to achieve the fiscal targets. Although we
do not expect any major announcement on the tax front,
yet the budget could throw up some roadmap for the
implementation of the GST and the DTC. The
implementation of the GST is the key to increase the tax
revenues and any step in that direction will increase the
revenue visibility.
Broadly, we do not expect any increase in the tax rates
but some measures could be announced to expand the
tax base.
Widening of the service tax net
As per the service tax framework, more than hundred
services come within its purview. This number is expected
to increase in the coming budget through either the addition
of new services or the expansion of the scope of the existing
services. Certain welfare services such as health and
education services coupled with legal services, postal services
etc could be brought under the ambit of the service tax.
The Minimum Alternative Tax (MAT)—though there is
expectation of an increase in the MAT rate from 18%
currently to about 20%, we expect the rate to remain
unchanged. This is due to the fact that the Software
Technology Park of India (STPI) benefit is likely get over from
FY2012 while the DTC will come into force in the same year.
Capex growth and supply augmentation
Notwithstanding the strong growth in the economy,
concerns have been growing such as inflation, a steep
rise in interest rates etc, which could threaten the demand
for both investment and consumption. To address that
there may be increased allocation for infrastructure
development and social spending, benefitting the
construction and consumer sectors. The government may
come up with a suitable, legitimate model for promoting
public-private joint ventures and boosting foreign direct
investment (FDI) in the domains of infrastructure
development and insurance.
Sectoral wish-list/expectations
Automobile
Sector outlook: Globally the automobile sector forms about 10% of a country’s gross
domestic product (GDP). During recession, all major economies of the world gave a
boost to their automobile sector to meet their GDP growth objectives. Recently, macro
headwinds such as rising interest rates and surging commodity and fuel prices have
created a challenging growth environment for the domestic automobile sector. We do
not expect any major roll-back of excise duty or curtailment of the incentives given to
the automobile sector earlier.
Banking
Sector outlook: We maintain our neutral stance on the sector due to liquidity issues,
margin pressures and provision expenses that would negatively affect the profits of
banks. Though the non-performing asset (NPA) position is likely to stablise, the public
sector banks (PSBs) will have to provide for pension liabilities while the private banks
will face pressure from the rising employee cost. However, since bank stocks have
corrected significantly, the comfort has increased on the valuation front. Our top picks
from the sector are Axis Bank, Yes Bank, Bank of Baroda and Punjab National Bank
(PNB).
Capital goods and engineering
Sector outlook: In view of the robust investment expected in the Indian infrastructure
sector, particularly the power sector, the demand outlook for the capital goods sector
remains bright. However, various infrastructural bottlenecks, political scams and
organisational inertia have slowed down the pace of awarding of orders in recent
times. Nonetheless, most of the companies have revenue visibility for more than two
years in terms of their book-bill ratio. We also remain positive on the sector for its
attractive valuations. However, concerns on Chinese competition would persist unless
the government intervenes by withdrawing import incentives. Our top picks from the
sector are Larsen and Toubro (L&T), Bharat Heavy Electricals Ltd (BHEL), Thermax and
V-Guard Industries.
Cement
Sector outlook: Given the poor execution of infrastructure projects, the overall volume
growth of the cement industry is unlikely to meet the guidance of 9% (anticipated by
the large cement players) for FY2011 and will be in the range of 7-8%. However, the
supply discipline followed by the manufacturers so far has resulted in a strong cement
realisation in H2FY2011, particularly in the southern region. Going ahead, we believe
a pick-up in the cement offtake could break the supply discipline and bring the prices
under pressure. In addition, the key concerns remain an oversupply of cement due to
capacity addition and cost pressure in terms of higher coal prices and increased freight
cost because of an increase in fuel prices and the lead distance. Hence, we maintain
our negative stance on the sector.
Education
Sector outlook: The government is focused on improving the literacy rate and the
quality of education in the country. The spending on education is expected to rise 12-
fold per household between 1995 and 2025 due to an increase in the income levels of
the Indian middle class. However, the sector is un-organised with regional content and
a large number of regional players are dependent on government spending. The quality
of education in the rural areas remains poor. Though private players are entering the
sector, the sector would still remain dependent on government spending. Any delay in
government programmes to boost education and red-tapism could delay the growth of
the sector.
FMCG
Sector outlook: The Indian fast moving consumer goods (FMCG) sector with a market
size of Rs130,000 crore is the fourth largest sector in the Indian economy. The sector
has grown at a CAGR of 11% over the last decade and is expected to sustain the strong
growth on the back of strong domestic consumption in the long run. However, the high
food inflation and the surging input cost are likely to affect its growth in the near
term. Hence, we expect the government to provide some support to the sector in the
upcoming budget. We maintain ITC as our top pick from the sector in view of the strong
visibility of its long-term earnings. We like Godrej Consumer Products Ltd (GCPL) in
the mid-cap FMCG space.
Information Technology
Sector outlook: The information technology (IT) sector has outperformed the broader
market over the last few months on the back of a strong revival in the sector’s
fundamentals, especially on the demand side. For the upcoming Union Budget FY2011-
12, we remain optimistic about the extension of the STPI benefits for another year till
the time the DTC comes into force. However, in the event of non-extension of the STPI
benefits, we do not expect much impact on investor sentiments as the Street has
already factored in a higher tax rate for FY2012. We remain positive on the IT sector
with a longer-term perspective. Our top picks from the sector are Infosys Technologies,
HCL Technologies, Polaris Software and NIIT Technologies.
Infrastructure
Sector outlook: Given the heavy investment required in the infrastructure space, we
believe the government’s thrust on infrastructure spending will continue. Even in the
last budget the government had increased fund allocation across sectors. However,
due to various scams, political issues and high inflation the government’s focus had
shifted from infrastructure spending over the past few months. Thus, the project award
activity and the execution of projects have been very slow recently, resulting in lower
infrastructure spending. However, going ahead, we believe the project awarding activity
should pick up once again after the budget. Moreover, since the stocks have corrected
significantly, the comfort has increased on the valuation front. Our top picks from the
sector are IL&FS Transportation Networks (India) Ltd (ITNL), IRB Infrastructure Developers
(IRB Infra) and Pratibha Industries.
Media
Sector outlook: According to the FICCI KPMG 2010 report, the Indian media &
entertainment industry is expected to grow at a compounded annual growth rate (CAGR)
of 13% over 2009-14 to reach Rs109,100 crore. This along with the structural changes
in the industry, eg digitisation, and the improving spending trend of the urban and
rural Indians augurs well for the growth of the sector in the coming years. Our top pick
from the sector is Eros International Media
Oil & Gas
Sector outlook: The Indian oil & gas space has witnessed significant reforms in the
form of petrol price de-regulation. However, the recent spike in crude oil prices and
the mounting inflation pressure have resulted in uncertainty regarding the timing of
diesel price de-regulation. The burden of the rising fuel under-recoveries would remain
an overhang on the oil marketing companies (OMCs) and upstream companies (Oil and
Natural Gas Corporation [ONGC], Oil India Ltd [OIL] and GAIL India). Reliance Industries
Ltd (RIL) would benefit from improving refining margins but the declining gas production
from the Krishna-Godavari D-6 block is a concern. Our top pick from the sector is GAIL
India due to its strong earnings growth visibility.
Power
Sector outlook: During the April-January FY2011 period, India generated about 669
billion units of power and its energy deficit remained in the range of 8%. Against a
target of 21,441MW India has added fresh capacity of about 10,210MW in the year till
date, taking its total capacity to 170,228MW. This deficit is attributed to several
challenges at the execution level and the government could address the same to boost
the company’s power generation capacity. The delay from the leading power equipment
suppliers is likely to be resolved soon as new players are rolling up their sleeves and
would continue to get some kind of support from the government. On the other hand,
the shortage of coal in India is another issue at present. To add to that, the deteriorating
financial health of the distributing companies (discoms) remains a concern. We remain
mildly positive on the sector in view of these opportunities and challenges.
Pharma
Sector outlook: The growth trajectory in the key markets of Indian pharma remains
robust. Hence, we maintain our positive view on the sector. Exports still hold significant
promise as Indian pharma has a low market share of 10% in the USA and a 5% share in
the emerging markets. The large first-to-file (FTF) opportunities and strong abbreviated
new drug application (ANDA) pipeline make us believe that the US opportunity remains
attractive. With product-specific opportunities and scaling up in niche segments, the
Indian pharmaceutical (pharma) companies appear to be better prepared to address
the growth opportunities. The price/earnings (P/E) expansion over the past two years
has been backed by strong fundamentals. We expect the sector’s current multiple of
20x FY2012E P/E to sustain with a positive stance on the pharma sector. Our top picks
from the sector are Lupin, Glenmark Pharmacueticals and JB Chemicals.
Retail
Sector outlook: The Indian modern retail segment is at a nascent stage with penetration
of less than 6%, in an overall retail industry size of $350 billion. A favorable demographic
profile and an increasing purchasing power coupled with a changing mindset towards
an organized retail format augurs well for the modern retail players. Along with a
strong revenue momentum, the players’ efforts towards front end as well as back end
cost rationalisation and optimisation will start bearing fruits in time to come. We
remain positive on Indian retail as a structural domestic play
Telecom
Sector outlook: The telecom (wireless) industry has grown by leaps and bounds.
Currently with ~ 750 million subscribers, it still stands at an all India penetration level
of ~60%, and rural penetration of as low as ~30%, thus providing ample growth
opportunity. Of late the sector had witnessed high competition, impacting players’
earnings profile. With the completion of the 3G auction process and stabilizing
competition we believe the domestic environment remains strong. But high level of
regulatory uncertainty (recommendations/ proposals relating to one time excess
spectrum charge, high payments towards license renewal fee) coupled with spectrum
shortage still plague the industry, and hence we remain cautious on the sector.
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