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UBS Investment Research
India Market Strategy
Indian stocks may correct further
Several concerns worry investors
Nifty and Sensex have fallen by 10% 2011 ytd on concerns such as high inflation,
high crude oil prices, lack of progress in govt reforms, fear of populist moves by
Indian govt in the wake of 5 state elections scheduled in May. We believe that
while higher inflation may be partly priced, we are yet to see significant selling by
foreign institutional investors yet. FII selling can take markets down by 10%-15%
more, in our view. We will see any decline in stock prices as a buying opportunity
to invest in attractively priced growth stocks.
How low can Sensex and Nifty go?
We believe that earning estimates for Sensex and Nifty could be revised down in
the coming months. Assuming some downward revision of around 5% (implying
12.5% FY12 earnings growth) and applying a 12.5x P/E multiple we feel that
Sensex and Nifty should find support at 15,000 and 4,500 respectively. We believe
if we see US$4-5b of FII selling, then Indian markets can correct another c15%.
What stocks/sectors to invest in a correction?
We are positive on India in the medium term due to (1) Favorable demographics
and (2) Low penetration of products and services (3) Stable government that is
likely to push through reforms in a steady manner over the medium term. We
therefore urge investors to take advantage of market correction to buy high quality
growth stocks at reasonable prices. Our top picks in large cap stocks are ONGC,
L&T, BHEL, Idea, Bharti, Mphasis.
What is priced in?
• Given that RBI has recently raised its Mar’11 inflation projection to 7%
(from 5.5% earlier), the inflation worries are partly priced in.
• What may not be priced in is further rise in crude prices especially given the
recent tensions in Eqypt which could adversely impact Crude oil supply and
hence prices.
The market expectation of inflation (as reflected by 10 year government bond
yield) has been rising since August 2010. The chart below shows the 10 year
government bond yield vs. Nifty since Jan 2010.
Sentiment continues to remain negative
Market sentiment continues to remain weak with one month moving average
advance/decline (A/D) ratio for the BSE 500 below its long term average since
beginning of the year. Also, put call ratio for Nifty has started inching upwards
since Nov 2010.
Liquidity – Bleak short-term prospects
FIIs have been net sellers since the beginning of this year (Jan 2011) after
having invested record US$ 29.4bn in Indian markets during CY2010. Though,
domestic institutional investors (only mutual funds) have turned net buyers, we
believe that markets are likely to fall further if FIIs pull out US$4-5b.
Valuation – De-rating has started
The 12 month forward PE multiple for Nifty and Sensex has contracted by 2x
since Jan’11.
We believe that the markets may continue to remain weak in coming few
months as FIIs could emerge as bigger net sellers in the coming weeks leading
up to the Indian budget (to be presented on Feb 28).
Higher Cost of capital
Given the high interest rate scenario, investors are worried that cost of capital
may go up for companies resulting in depressed earnings. As shown below,
AAA corporate spreads have moved up by ~50bps since October 2010. The
increased spread is likely to result in higher interest expense for companies with
high working capital requirement for the next 2-3 quarters.
As a result, sectors and companies with high leverage may remain under
pressure under the current rising interest rate scenario. High leverage sectors
such as real estate, infrastructure/capital goods, and power have underperformed
significantly on concerns around higher cost of capital. We believe these sectors
will continue to remain under pressure till the concerns on inflation subside.
Earnings Growth – Marginal downside likely
Given high inflation, the key question is the FY12 earnings growth which is
expected to decelerate as the cost of input rises, interest expense increases and
revenue slows down as government tries to cut demand pressure.
As shown, the consensus (IBES) earnings momentum before the start of the
3QFY11 earnings season was positive. However, since the start of the earnings
season the momentum has turned negative. We believe that the negative
momentum may continue in the near term as we are still in the midst of the
earnings season.
The current consensus (IBES) and UBS-e for FY12 Nifty earnings growth is
19.5% and 21.4% respectively. Sectors such as banks, materials, IT services,
autos and Infrastructure are the biggest contributor to Nifty’s & Sensex’s
earnings growth. We believe in a high inflation scenario there may be downside
to banks, infrastructure and autos estimates.
How low can Sensex and Nifty go?
Assuming some downward revision of around 5% (implying 12.5% FY12E
earnings growth resulting in FY12E Sensex EPS of 1,200 and FY12E Nifty EPS
of 360) and applying a 12.5x P/E multiple we feel that Sensex and Nifty should
find support at 15,000 and 4,500 respectively.
Reforms and politics – Slow progress is a concern
Market concerns revolve around
Lack of reforms
Inability to contain inflation and to generate consensus on key policy
decisions
Corruption/scams related newsflow
Concerns on fiscal discipline.
Also, investors are worried that elections in three key states (Tamil Nadu, West
Bengal and Kerela) in May 2011 may further induce the government to follow
populist policies.
The concerns on fiscal deficit are further compounded with the rise in crude
prices. Investors are concerned that higher oil prices may have an adverse
impact on
— Inflation (if the higher prices are passed on) or
— Fiscal deficit (if oil price rise is absorbed by the government as subsidy).
If global oil prices fluctuate between $85-$100 bbl in FY12 then the impact of
fiscal fuel subsidy could be limited to under 0.7- 1% of GDP (assuming no pass
through on diesel, kerosene & LPG prices to the customer). However, the
impact on FY12 fiscal deficit could increase up to 1.2%-1.7% of GDP if the oil
prices average $100-$110 bbl.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
India Market Strategy
Indian stocks may correct further
Several concerns worry investors
Nifty and Sensex have fallen by 10% 2011 ytd on concerns such as high inflation,
high crude oil prices, lack of progress in govt reforms, fear of populist moves by
Indian govt in the wake of 5 state elections scheduled in May. We believe that
while higher inflation may be partly priced, we are yet to see significant selling by
foreign institutional investors yet. FII selling can take markets down by 10%-15%
more, in our view. We will see any decline in stock prices as a buying opportunity
to invest in attractively priced growth stocks.
How low can Sensex and Nifty go?
We believe that earning estimates for Sensex and Nifty could be revised down in
the coming months. Assuming some downward revision of around 5% (implying
12.5% FY12 earnings growth) and applying a 12.5x P/E multiple we feel that
Sensex and Nifty should find support at 15,000 and 4,500 respectively. We believe
if we see US$4-5b of FII selling, then Indian markets can correct another c15%.
What stocks/sectors to invest in a correction?
We are positive on India in the medium term due to (1) Favorable demographics
and (2) Low penetration of products and services (3) Stable government that is
likely to push through reforms in a steady manner over the medium term. We
therefore urge investors to take advantage of market correction to buy high quality
growth stocks at reasonable prices. Our top picks in large cap stocks are ONGC,
L&T, BHEL, Idea, Bharti, Mphasis.
What is priced in?
• Given that RBI has recently raised its Mar’11 inflation projection to 7%
(from 5.5% earlier), the inflation worries are partly priced in.
• What may not be priced in is further rise in crude prices especially given the
recent tensions in Eqypt which could adversely impact Crude oil supply and
hence prices.
The market expectation of inflation (as reflected by 10 year government bond
yield) has been rising since August 2010. The chart below shows the 10 year
government bond yield vs. Nifty since Jan 2010.
Sentiment continues to remain negative
Market sentiment continues to remain weak with one month moving average
advance/decline (A/D) ratio for the BSE 500 below its long term average since
beginning of the year. Also, put call ratio for Nifty has started inching upwards
since Nov 2010.
Liquidity – Bleak short-term prospects
FIIs have been net sellers since the beginning of this year (Jan 2011) after
having invested record US$ 29.4bn in Indian markets during CY2010. Though,
domestic institutional investors (only mutual funds) have turned net buyers, we
believe that markets are likely to fall further if FIIs pull out US$4-5b.
Valuation – De-rating has started
The 12 month forward PE multiple for Nifty and Sensex has contracted by 2x
since Jan’11.
We believe that the markets may continue to remain weak in coming few
months as FIIs could emerge as bigger net sellers in the coming weeks leading
up to the Indian budget (to be presented on Feb 28).
Higher Cost of capital
Given the high interest rate scenario, investors are worried that cost of capital
may go up for companies resulting in depressed earnings. As shown below,
AAA corporate spreads have moved up by ~50bps since October 2010. The
increased spread is likely to result in higher interest expense for companies with
high working capital requirement for the next 2-3 quarters.
As a result, sectors and companies with high leverage may remain under
pressure under the current rising interest rate scenario. High leverage sectors
such as real estate, infrastructure/capital goods, and power have underperformed
significantly on concerns around higher cost of capital. We believe these sectors
will continue to remain under pressure till the concerns on inflation subside.
Earnings Growth – Marginal downside likely
Given high inflation, the key question is the FY12 earnings growth which is
expected to decelerate as the cost of input rises, interest expense increases and
revenue slows down as government tries to cut demand pressure.
As shown, the consensus (IBES) earnings momentum before the start of the
3QFY11 earnings season was positive. However, since the start of the earnings
season the momentum has turned negative. We believe that the negative
momentum may continue in the near term as we are still in the midst of the
earnings season.
The current consensus (IBES) and UBS-e for FY12 Nifty earnings growth is
19.5% and 21.4% respectively. Sectors such as banks, materials, IT services,
autos and Infrastructure are the biggest contributor to Nifty’s & Sensex’s
earnings growth. We believe in a high inflation scenario there may be downside
to banks, infrastructure and autos estimates.
How low can Sensex and Nifty go?
Assuming some downward revision of around 5% (implying 12.5% FY12E
earnings growth resulting in FY12E Sensex EPS of 1,200 and FY12E Nifty EPS
of 360) and applying a 12.5x P/E multiple we feel that Sensex and Nifty should
find support at 15,000 and 4,500 respectively.
Reforms and politics – Slow progress is a concern
Market concerns revolve around
Lack of reforms
Inability to contain inflation and to generate consensus on key policy
decisions
Corruption/scams related newsflow
Concerns on fiscal discipline.
Also, investors are worried that elections in three key states (Tamil Nadu, West
Bengal and Kerela) in May 2011 may further induce the government to follow
populist policies.
The concerns on fiscal deficit are further compounded with the rise in crude
prices. Investors are concerned that higher oil prices may have an adverse
impact on
— Inflation (if the higher prices are passed on) or
— Fiscal deficit (if oil price rise is absorbed by the government as subsidy).
If global oil prices fluctuate between $85-$100 bbl in FY12 then the impact of
fiscal fuel subsidy could be limited to under 0.7- 1% of GDP (assuming no pass
through on diesel, kerosene & LPG prices to the customer). However, the
impact on FY12 fiscal deficit could increase up to 1.2%-1.7% of GDP if the oil
prices average $100-$110 bbl.
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