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India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Lots of headwinds…
High and rising oil prices, uncertain DM world, slowing domestic growth, fragile politics, stubborn inflation, tight domestic liquidity, and rising rates are hurting equities.
…some positives too
Equities have suffered a 17% loss vs. EM since Oct-10.
Valuations are looking attractive, especially on an absolute basis, and for the broader market. The market is pricing in slower near-term growth and implying an attractive 14.5% long-term return.
Interest rates are closer to the peak than before given the recent RBI rate hike.
Earnings growth appears to be nearing a trough given the margin compression that has already happened. ROE, too, is off the bottom.
Politics and policy could surprise positively given how low expectations are.
The market is cautiously positioned if our sentiment indicator is a guide.
Companies and retail continue to be constructive on equities even as FIIs are sellers.
Key Risks
Indian equities may not tolerate a flare up in oil or DM growth surprises. The recent RBI move has levered equities to a DXY rally. Monsoons are still an unknown. VaR suggests that tail risks are not in the price.
Investment Conclusion
•
We remain buyers of Indian equities with a 12- to 18- month view. Our 2011 Sensex target implies 19% upside.
•
The Nifty remains range bound given the current macro in the short run.
•
We are focused on stock picking, since we believe the “macro effect” has peaked.
•
More rewards in small- and mid-caps and stocks down the quality curve.
•
In sector terms, we have shifted from global cyclicals (materials) to domestic consumer cyclicals. We remain overweight industrials but are cognizant of downside to capex.
•
Our favorite large cap names include ADE, COAL, GAIL, INFO, MM, LT
Summary of Our Views
Key Investor Debates
India’s inflation is structural – the fiscal deficit and oil prices worsen matters – this is clearly a downside risk for equities, but getting overly worried ignores how much is in the price.
Equity valuations are rich – our view is equity valuations are okay, especially for the broader market, and ex-financials, ex-tech relative to EM.
Growth is slowing and negative earnings revisions will cap equity upside – we think earnings growth is set for moderate acceleration. ROE is off the trough, too.
Equity returns are overdependent on foreign flows – the current account deficit is a problem. Global winds are critical to outcomes for Indian equities. The RBI move has levered India to a DXY rally.
Politics might play spoilsport. We think expectations are low, and so a positive surprise is possible.
What’s in the Price?
Slowing growth seems to be in the price. The market seems to be looking for slower nominal growth versus our economists’ expectations of a mild acceleration.
Our residual income model for the Sensex implies an ERP of 6.4%, meaning below fair level valuations (relative to our view). At a 10-year bond yield of c8%, this denotes a long-term return of 14.5%. Future growth has been assigned 56% of the MSCI Index value, which is in line with five-year trailing average. Several stocks are implying very low long-term growth rates.
Tail risks are not in the price if our VaR indicator is a guide.
Trades and Themes
Sectors: OW: Energy, Industrials, Telecom, Utilities; UW: Cons Staples, Healthcare, Financials, Materials; Neutral: Technology, Consumer Disc.
Stocks: Favorites include ADE, COAL, GAIL, INFO, MM, LT (see page 4 for Focus List).
Themes
1.
Intense focus on stock picking – macro influence on stock prices has already peaked.
2.
Small- and mid-cap look very attractive.
3.
Look to get more constructive on discretionary consumption as we are approaching closer to a rate peak.
4.
Industrials under threat from slowing capex but share prices look badly hit.
5.
Look to shift style shift to lower quality. The market is pricing these stocks quite cheaply.
Market Outlook: The relative and absolute correction in 2011 has made equities more attractively valued. While we remain in a structural bull market, the market is subject to extreme volatility given the intensity of debates around inflation and growth. In the near term, the market may remain range-bound. Our probability-weighted outcome for the Sensex of 22,100 for YE2011 implies 19% upside.
Base Case (65% probability) BSE Sensex: 21,115
Our base case calls for a “muddle-through” world, some policy initiatives, reasonable capital flows, crude oil prices average around US$100-110/barrel and moderate equity supply (less than US$25bn) with Sensex earnings growth of 22% and 18% in F2011 and F2012.
Bull Case (25% probability) BSE Sensex: 26,727
Our bull case assumes global calm (moderate DM growth), strong domestic policies, lower crude oil prices and moderate equity supply. Sensex earnings growth of 28% and 22% for F2011 and F2012, respectively, and 44% upside to the index.
Bear Case (10% probability) BSE Sensex: 16,773
The bear case consists of two opposite outcomes: strong global growth leading to higher commodity prices or a risk-aversion event causes reticence in capital flows. Both produce a growth scare, causing Sensex earnings growth to fall to 13% for F2011 and 12% for F2012, and 9% downside to the index.
Market Is Range-bound Near Term, but Risk-Reward Favors Longer-term Investors
–
A lot of things have gone wrong for India – from the MENA crisis to the unfortunate earthquake in Japan and India’s domestic political situation saddled with alleged corruption cases.
–
Consequently, the market is only 9% away from our bear case level for 2011, and the upside to our year-end target is now 19%.
–
Near term, we think the market is operating in a range of 17,500 to 21,000.
Has India Underperformed Enough?
–
Since the strong performance in September 2010, India gave up all its outperformance beginning May 2009 vs. emerging markets in a matter of 15 weeks. India is now underperforming by 17% since early October 2010.
–
Effectively, as the bad news on crude oil/Japan/higher inflation/higher interest rates unfolded, a lot of bad news was already in play.
Are Absolute Valuations Cheap?
–
With the implied equity risk premium at 6.4% based on our residual income model, long- term investors are getting slightly better than fair compensation for the risks they are taking.
–
Ex-Financials and Technology, this is cheapest that Indian equities have traded relative to EM since 2003 – almost at the level hit during the financial crisis of 2008.
–
Indeed, the MSCI India index ex-Financials and Technology is trading at 13.3x one-year forward earnings. This is cheaper than it has been on most occasions over the past decade save for 2002 and 2008.
Our residual income for the Sensex implies an ERP of 6.4%, which means long-term valuations are below fair level (relative to our view). At a 10- year bond yield of c8%, this denotes a long-term return of over 14%. Future growth has been assigned 56% of the MSCI Index value, which is in line with the five-year trailing average. Several stocks are implying very low long-term growth rates.
The market seems to have already priced in a slowdown in nominal growth just as it had priced in a pickup in growth in late 2009. Our work shows that the market is expecting nominal IIP growth to drop in the coming months relative to our view of a mild acceleration.
–
India’s biggest tail risk is that the MENA crisis is prolonged and crude oil prices stay higher for longer.
–
The other risks, such as political uncertainty (due to the alleged corruption scandals or adverse state election results), bad monsoons or volatility in DM growth (i.e., large growth surprises), should also be noted.
–
Historical VaR suggests Indian equities remain exposed to tail risks. We identify -12% on the 99%/one month VaR as a level consistent with tail risks being priced in based on historical evidence.
–
The current reading is 9.9%, i.e., the market may not be completely pricing in tail risks. Running a simple simulation, a 10% fall in the next month takes the VaR past 12%.
–
GDP growth in India has not historically explained earnings well enough. Indeed, real GDP growth has an R-squared of 40% with earnings growth (MSCI India index), implying that 40% of the earnings are explained by changes in GDP growth.
–
The other key point to note is that while our economist has reduced his real GDP growth forecast by 100bp since the start of the year, his nominal GDP growth forecast is actually higher by 60bp at 15.9%. What this does is actually drive a higher top-line forecast for Corporates, while creating a debate on margins or, more specifically, gross margins.
–
Of the four macro variables that we use to track earnings growth, real IIP growth appears to have the best explanatory power on earnings growth with an R-squared of 57%.
–
Using the historical relationship between real and nominal IIP growth and earnings growth and our forecasts for real and nominal macro growth, MSCI India EPS growth can range from 10% to 20% for F2012.
–
The pace of downward earnings revisions was higher than what the market experienced in 2008.
–
The response from the sell side has stemmed the possibility of further downgrades.
–
Gross margins are at all-time lows. The bottom line is that Corporate India has not exhibited pricing power. The gap between the CPI for industrial workers and WPI has led gross margins by two quarters. This indicator suggests that the collapse in gross margins may be behind us, although a rise is not imminent.
–
The higher inflation scenario embedded in our macro forecasts may actually be supportive for higher gross margins. Indeed, this lends itself to upside risks to earnings growth rather than downside.
–
It is only the tail that is affected by rising rates if we use the MS coverage universe as our set. Indeed, the stocks in the top interest/EBITDA quintile have been sold quite heavily in the past two quarters, if their performance is any indication.
–
The median interest/EBITDA for F2012 is only 8%.
–
Corporate India’s massive capex cycle over 2005-2008 seems to be key top-down reason for the compression in ROE. It appears from the bottom up data that capacity utilization has not reverted to the levels as in the early part of the previous decade. Another theory is that capital intensity has risen over the past few years, causing an ROE decline.
–
Over the past 12 months, Consumer Staples and Healthcare ROEs have improved relative to their respective EM sectors. Over the longer term, the most compression in ROE gap is in the relatively low capital- intensive Technology sector, followed by Utilities. In the past 12 months, Technology and Materials have contributed the most to India’s ROE underperformance.
–
India’s earnings performance is ahead of its market performance relative to its peer group.
–
The high base effect in earnings is likely waning and growth could improve ever so slightly in the coming months.
The positive correlation with the DXY is not a norm. The trailing three-month correlation is positive even though the trailing 12-month correlation is negative. Indian equities have struggled as the DXY has depreciated.
–
A DXY rally or a slowdown in DM growth (neither are base case scenarios) will likely trigger a correction in global commodities and energy quotes – the key source of inflation pressure in India. Combined with a hawkish RBI, this could form a potent positive force for Indian equities, especially domestic sectors.
–
In judging the impact of oil, it is important to assess capital flows into the country. History shows that if a rising oil price is accompanied by capital flows, Indian equities correlate positively with oil, and vice versa. This is currently in play in the equity markets. Every US$10 average rise in oil needs US$8 billion in flows to be offset.
–
We think there is upside risk to correlations between equity returns in India and elsewhere in the world. Investors should be vigilant to the implications of this to the market (both upside and downside), although it does not form our base case.
–
Macro has been the force du jour, but this is changing. The evidence of how little influence stock picking has had on the behavior of stocks is in the correlation of returns from individual stocks (market effect) with the market, which is just off its all-time high levels.
–
The rise in market effect told us that individual stocks are being influenced more by macro or market performance than by idiosyncratic, stock-related factors.
–
However, we believe that the macro effect has peaked, as we pointed out in mid-February 2011 (see India Strategy Chart Focus: Abandon the Macro Trade, Time for Stock Picking, dated February 16, 2011). To that extent, stock pickers, who are already in the money since mid- February, can continue to burn the midnight oil.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Lots of headwinds…
High and rising oil prices, uncertain DM world, slowing domestic growth, fragile politics, stubborn inflation, tight domestic liquidity, and rising rates are hurting equities.
…some positives too
Equities have suffered a 17% loss vs. EM since Oct-10.
Valuations are looking attractive, especially on an absolute basis, and for the broader market. The market is pricing in slower near-term growth and implying an attractive 14.5% long-term return.
Interest rates are closer to the peak than before given the recent RBI rate hike.
Earnings growth appears to be nearing a trough given the margin compression that has already happened. ROE, too, is off the bottom.
Politics and policy could surprise positively given how low expectations are.
The market is cautiously positioned if our sentiment indicator is a guide.
Companies and retail continue to be constructive on equities even as FIIs are sellers.
Key Risks
Indian equities may not tolerate a flare up in oil or DM growth surprises. The recent RBI move has levered equities to a DXY rally. Monsoons are still an unknown. VaR suggests that tail risks are not in the price.
Investment Conclusion
•
We remain buyers of Indian equities with a 12- to 18- month view. Our 2011 Sensex target implies 19% upside.
•
The Nifty remains range bound given the current macro in the short run.
•
We are focused on stock picking, since we believe the “macro effect” has peaked.
•
More rewards in small- and mid-caps and stocks down the quality curve.
•
In sector terms, we have shifted from global cyclicals (materials) to domestic consumer cyclicals. We remain overweight industrials but are cognizant of downside to capex.
•
Our favorite large cap names include ADE, COAL, GAIL, INFO, MM, LT
Summary of Our Views
Key Investor Debates
India’s inflation is structural – the fiscal deficit and oil prices worsen matters – this is clearly a downside risk for equities, but getting overly worried ignores how much is in the price.
Equity valuations are rich – our view is equity valuations are okay, especially for the broader market, and ex-financials, ex-tech relative to EM.
Growth is slowing and negative earnings revisions will cap equity upside – we think earnings growth is set for moderate acceleration. ROE is off the trough, too.
Equity returns are overdependent on foreign flows – the current account deficit is a problem. Global winds are critical to outcomes for Indian equities. The RBI move has levered India to a DXY rally.
Politics might play spoilsport. We think expectations are low, and so a positive surprise is possible.
What’s in the Price?
Slowing growth seems to be in the price. The market seems to be looking for slower nominal growth versus our economists’ expectations of a mild acceleration.
Our residual income model for the Sensex implies an ERP of 6.4%, meaning below fair level valuations (relative to our view). At a 10-year bond yield of c8%, this denotes a long-term return of 14.5%. Future growth has been assigned 56% of the MSCI Index value, which is in line with five-year trailing average. Several stocks are implying very low long-term growth rates.
Tail risks are not in the price if our VaR indicator is a guide.
Trades and Themes
Sectors: OW: Energy, Industrials, Telecom, Utilities; UW: Cons Staples, Healthcare, Financials, Materials; Neutral: Technology, Consumer Disc.
Stocks: Favorites include ADE, COAL, GAIL, INFO, MM, LT (see page 4 for Focus List).
Themes
1.
Intense focus on stock picking – macro influence on stock prices has already peaked.
2.
Small- and mid-cap look very attractive.
3.
Look to get more constructive on discretionary consumption as we are approaching closer to a rate peak.
4.
Industrials under threat from slowing capex but share prices look badly hit.
5.
Look to shift style shift to lower quality. The market is pricing these stocks quite cheaply.
Market Outlook: The relative and absolute correction in 2011 has made equities more attractively valued. While we remain in a structural bull market, the market is subject to extreme volatility given the intensity of debates around inflation and growth. In the near term, the market may remain range-bound. Our probability-weighted outcome for the Sensex of 22,100 for YE2011 implies 19% upside.
Base Case (65% probability) BSE Sensex: 21,115
Our base case calls for a “muddle-through” world, some policy initiatives, reasonable capital flows, crude oil prices average around US$100-110/barrel and moderate equity supply (less than US$25bn) with Sensex earnings growth of 22% and 18% in F2011 and F2012.
Bull Case (25% probability) BSE Sensex: 26,727
Our bull case assumes global calm (moderate DM growth), strong domestic policies, lower crude oil prices and moderate equity supply. Sensex earnings growth of 28% and 22% for F2011 and F2012, respectively, and 44% upside to the index.
Bear Case (10% probability) BSE Sensex: 16,773
The bear case consists of two opposite outcomes: strong global growth leading to higher commodity prices or a risk-aversion event causes reticence in capital flows. Both produce a growth scare, causing Sensex earnings growth to fall to 13% for F2011 and 12% for F2012, and 9% downside to the index.
Market Is Range-bound Near Term, but Risk-Reward Favors Longer-term Investors
–
A lot of things have gone wrong for India – from the MENA crisis to the unfortunate earthquake in Japan and India’s domestic political situation saddled with alleged corruption cases.
–
Consequently, the market is only 9% away from our bear case level for 2011, and the upside to our year-end target is now 19%.
–
Near term, we think the market is operating in a range of 17,500 to 21,000.
Has India Underperformed Enough?
–
Since the strong performance in September 2010, India gave up all its outperformance beginning May 2009 vs. emerging markets in a matter of 15 weeks. India is now underperforming by 17% since early October 2010.
–
Effectively, as the bad news on crude oil/Japan/higher inflation/higher interest rates unfolded, a lot of bad news was already in play.
Are Absolute Valuations Cheap?
–
With the implied equity risk premium at 6.4% based on our residual income model, long- term investors are getting slightly better than fair compensation for the risks they are taking.
–
Ex-Financials and Technology, this is cheapest that Indian equities have traded relative to EM since 2003 – almost at the level hit during the financial crisis of 2008.
–
Indeed, the MSCI India index ex-Financials and Technology is trading at 13.3x one-year forward earnings. This is cheaper than it has been on most occasions over the past decade save for 2002 and 2008.
Our residual income for the Sensex implies an ERP of 6.4%, which means long-term valuations are below fair level (relative to our view). At a 10- year bond yield of c8%, this denotes a long-term return of over 14%. Future growth has been assigned 56% of the MSCI Index value, which is in line with the five-year trailing average. Several stocks are implying very low long-term growth rates.
The market seems to have already priced in a slowdown in nominal growth just as it had priced in a pickup in growth in late 2009. Our work shows that the market is expecting nominal IIP growth to drop in the coming months relative to our view of a mild acceleration.
–
India’s biggest tail risk is that the MENA crisis is prolonged and crude oil prices stay higher for longer.
–
The other risks, such as political uncertainty (due to the alleged corruption scandals or adverse state election results), bad monsoons or volatility in DM growth (i.e., large growth surprises), should also be noted.
–
Historical VaR suggests Indian equities remain exposed to tail risks. We identify -12% on the 99%/one month VaR as a level consistent with tail risks being priced in based on historical evidence.
–
The current reading is 9.9%, i.e., the market may not be completely pricing in tail risks. Running a simple simulation, a 10% fall in the next month takes the VaR past 12%.
–
GDP growth in India has not historically explained earnings well enough. Indeed, real GDP growth has an R-squared of 40% with earnings growth (MSCI India index), implying that 40% of the earnings are explained by changes in GDP growth.
–
The other key point to note is that while our economist has reduced his real GDP growth forecast by 100bp since the start of the year, his nominal GDP growth forecast is actually higher by 60bp at 15.9%. What this does is actually drive a higher top-line forecast for Corporates, while creating a debate on margins or, more specifically, gross margins.
–
Of the four macro variables that we use to track earnings growth, real IIP growth appears to have the best explanatory power on earnings growth with an R-squared of 57%.
–
Using the historical relationship between real and nominal IIP growth and earnings growth and our forecasts for real and nominal macro growth, MSCI India EPS growth can range from 10% to 20% for F2012.
–
The pace of downward earnings revisions was higher than what the market experienced in 2008.
–
The response from the sell side has stemmed the possibility of further downgrades.
–
Gross margins are at all-time lows. The bottom line is that Corporate India has not exhibited pricing power. The gap between the CPI for industrial workers and WPI has led gross margins by two quarters. This indicator suggests that the collapse in gross margins may be behind us, although a rise is not imminent.
–
The higher inflation scenario embedded in our macro forecasts may actually be supportive for higher gross margins. Indeed, this lends itself to upside risks to earnings growth rather than downside.
–
It is only the tail that is affected by rising rates if we use the MS coverage universe as our set. Indeed, the stocks in the top interest/EBITDA quintile have been sold quite heavily in the past two quarters, if their performance is any indication.
–
The median interest/EBITDA for F2012 is only 8%.
–
Corporate India’s massive capex cycle over 2005-2008 seems to be key top-down reason for the compression in ROE. It appears from the bottom up data that capacity utilization has not reverted to the levels as in the early part of the previous decade. Another theory is that capital intensity has risen over the past few years, causing an ROE decline.
–
Over the past 12 months, Consumer Staples and Healthcare ROEs have improved relative to their respective EM sectors. Over the longer term, the most compression in ROE gap is in the relatively low capital- intensive Technology sector, followed by Utilities. In the past 12 months, Technology and Materials have contributed the most to India’s ROE underperformance.
–
India’s earnings performance is ahead of its market performance relative to its peer group.
–
The high base effect in earnings is likely waning and growth could improve ever so slightly in the coming months.
The positive correlation with the DXY is not a norm. The trailing three-month correlation is positive even though the trailing 12-month correlation is negative. Indian equities have struggled as the DXY has depreciated.
–
A DXY rally or a slowdown in DM growth (neither are base case scenarios) will likely trigger a correction in global commodities and energy quotes – the key source of inflation pressure in India. Combined with a hawkish RBI, this could form a potent positive force for Indian equities, especially domestic sectors.
–
In judging the impact of oil, it is important to assess capital flows into the country. History shows that if a rising oil price is accompanied by capital flows, Indian equities correlate positively with oil, and vice versa. This is currently in play in the equity markets. Every US$10 average rise in oil needs US$8 billion in flows to be offset.
–
We think there is upside risk to correlations between equity returns in India and elsewhere in the world. Investors should be vigilant to the implications of this to the market (both upside and downside), although it does not form our base case.
–
Macro has been the force du jour, but this is changing. The evidence of how little influence stock picking has had on the behavior of stocks is in the correlation of returns from individual stocks (market effect) with the market, which is just off its all-time high levels.
–
The rise in market effect told us that individual stocks are being influenced more by macro or market performance than by idiosyncratic, stock-related factors.
–
However, we believe that the macro effect has peaked, as we pointed out in mid-February 2011 (see India Strategy Chart Focus: Abandon the Macro Trade, Time for Stock Picking, dated February 16, 2011). To that extent, stock pickers, who are already in the money since mid- February, can continue to burn the midnight oil.
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