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Strategy
On the cusp of a turn
Indian markets have underperformed almost all major global
markets in the current calendar year ostensibly due to the twin
macro-concerns of high inflation and interest rates; and now
the key question on the minds of investors is when the rate cycle
will reverse. While the trajectory was a little less certain even a
couple of months back, in our view, various indicators are
signaling that inflation and interest rates are close to peak levels,
with respite likely from the second half.
In our view, external issues such as the Greek crisis can contribute
to near-term uncertainty and volatility, but they are unlikely to
materially impact the overall upward trajectory of the Indian
economy and markets, which are underpinned by strong
structural growth drivers, and even in the near-term are likely
to register GDP growth of 7.5-8%. Hence, we maintain our
positive stance on Indian equities as we believe that valuations
remain fairly attractive, especially in light of the reasonable
earnings visibility over the next two years.
Why broader interest rates are close to peak in our view
Insignificant forex inflows: In this cycle, forex reserves have been
relatively anaemic (up 12% since March 2010 vs. 60% growth
during January 2007 - October 2008), suggesting a peaking
of rates at lower levels in this cycle. In cognizance, the RBI too
has not used the harsher CRR tool much, mainly sticking to
repo hikes.
Cooling domestic demand: Broader interest rates have risen
by 200-225bp and signs of weakening domestic demand are
emerging in interest-sensitive sectors. 1) Real estate and
infrastructure sectors are getting adversely impacted,
2) evidencing this slowing construction activity, cement volumes
are flat on a yoy basis, 3) auto sales are decelerating, with
passenger vehicles growing by just 6.2% yoy and 4) gross capital
formation has been stagnant in 4QFY2011.
Deposit mobilisations up, credit offtake down: There are
broader signs of slowdown in credit offtake, while deposit
mobilisation has picked up significantly only to be largely
deployed at a negative spread into government bonds.
Accordingly, we expect deposit and lending rates to not go up
further even if the RBI hikes the repo rate.
Respite on domestic food prices: With food forming 45-60% of
Indian consumer inflation indices, rising food prices are a
practical concern for policymakers. No doubt rather than hiking
rates we need to improve supply, logistics, subsidy disbursement,
etc., but nonetheless, food inflation cooling off significantly in
recent weeks should reduce policymakers' need to tighten the
policy even symbolically.
Respite also on global commodities, sustainable crude range
US$95-105: Global demand weakness is already leading to
cooling commodity prices. Also, affirming the risk to global
GDP from higher crude, the IEA has decided to release reserves
(third such instance since 1974). Our analysis also indicates
that whenever the global oil bill exceeds 5% of GDP, crude prices
tend to cool off as demand weakens. For CY2011, this gives a
range of US$95-105 for crude.
US Fed still perceives deflationary pressures: Wholesale (PPI)
inflation in the US is as high as 7.3%, largely similar to Indian
WPI levels. The US Fed, on the contrary, is worried about
deflation due to weak unemployment and housing data. It is
dismissive about the current inflation readings, pointing that
they are driven by global commodity price pressures that are
expected to dissipate.
Overweight on sectors with good earnings visibility
Presently, we have a positive outlook on index BFSI stocks, aided
by moderate credit growth, better margin performance and
lower provisioning burden than small banks. Moreover, cooling
of inflation and interest rates from 2HFY2012 is likely to improve
credit growth and asset quality outlook for the overall banking
sector. The infrastructure sector is also likely to benefit from an
imminent cooling of the rate cycle and, in any case, valuations
have become very cheap, offering a margin of safety.
Large-cap metals also offer strong earnings visibility, in our
view, on account of capacity expansion, low-cost integrated
operations and healthy export potential. Incidentally, on the
export front, in the past few quarters, growth in India's exports
has been phenomenal, in our view, aided by the fact that the
rupee has depreciated against the euro and has become more
competitive vis-à-vis the yuan as far as the US and Middle East
are concerned. In the export sector, in case of the IT sector,
we believe valuations factor in the positives; while in case of the
pharma sector, we are overweight on account of a healthy
growth outlook at reasonable valuations.
Overall, in view of the easing headwinds to growth from
2HFY2012, we estimate Sensex earnings to post an 18.4%
CAGR over FY2011-13E. A fair multiple of 15x FY2013E EPS
yields a Sensex target of 21,320, giving a reasonable ~14%
upside from current levels. Hence, we remain positive on the
Indian markets.
Markets decline for second consecutive quarter
Indian markets continued to be under pressure for most of
1QFY2012 primarily due to concerns of higher inflation and
the consequent policy rate hikes by the RBI. Despite the
bounce-back at the very end of the quarter, overall the Sensex
registered losses of 3.1% qoq, continuing the declining trend
witnessed in 4QFY2011.
Inflation and interest rates expected to peak soon
In our view, various indicators are increasingly signaling that
inflation and interest rates are close to peak levels, with respite
likely from the second half. With the RBI hiking rates
10 times since March 2010 and, more importantly, with
demand-supply factors pushing up the broader interest rates
by ~200bp, the demand momentum in the economy has
slowed, as can be observed from the recent incremental credit
offtake, monthly cement and auto sales numbers and almost
stagnant capital formation during 4QFY2011.
Hence, we believe the RBI has largely achieved its objective,
stated in its Monetary Policy Review of May 3, 2011, of reducing
demand-side pressures to contain inflation, and this should lead
to peaking out of inflation from the second half of FY2012.
Lower forex reserve accretion and RBI not hiking CRR
During the last interest rate cycle, our forex reserves had
increased by over US$100bn between January 2007 and
October 2008 alone (representing a 60%+ increase), keeping
the GDP growth momentum high even at higher levels of interest
rates. The demand momentum had remained reasonably strong
even though the RBI had resorted to substantial CRR hikes, which
were far more potent in pushing up domestic interest rates
(at peak levels just before the Lehman crisis, interest rates were
almost 150-200bp higher than those at present).
This time around, forex reserves have been relatively anaemic
(up only 12% since March 2010), suggesting a peaking of
interest rates at lower levels in this interest rate cycle as compared
to the previous one. In cognizance of this, the RBI too has not
really used the harsher CRR tool, sticking to relatively symbolic
repo hikes. In the current scenario, with the CRR prevailing at
6.5% and unlikely to be hiked due to naturally tight liquidity
conditions, broader interest rates are likely to peak at
current levels in spite of repo hikes. This is rightly so, as in
the absence of strong forex inflows, demand too is
accordingly decelerating sooner.
Credit offtake has fallen while deposit accretion has
gained momentum
Prior to December 2010, broader deposit mobilisation was
inevitably lower in light of high inflation and deposit rates even
below NSS rates. Due to the resulting drying up of liquidity,
broader interest rates have already gone up by about 200-225bp.
With the sharp spike in lending rates, credit offtake has declined,
as evident from the incremental CD ratio in FY2012 YTD (up to
June 17) at just 44.9% compared to 247.1% during the same
period in FY2011. A like-to-like comparison between Marchend
and mid-June of FY2011 vs. FY2012 indicates 11% lower
credit mobilisation vs. almost 5x higher deposit mobilisation.
Peak retail FD rates currently hovering at 9-9.5% for major banks
are well above the 8% that NSS offers and well above the
10-year G-Sec yield (8.3%) i.e., deposit mobilisation has picked
up significantly only to be largely deployed at a negative spread
into government bonds. Accordingly, we expect deposit rates
as well as private sector lending rates to not go up further even
if the RBI hikes the repo rate a couple of more times,
as demand-supply dynamics for the banking sector dictate otherwise.
In fact, we expect broader deposit and lending rates to decline
from 2HFY2012, once WPI inflation also starts heading lower
(the near-term uptick due to hike in fuel prices is in our view
already factored in by the RBI and markets).
Even the 1-year and 10-year G-sec yield spread has recently
turned into the negative territory i.e., bond markets are also
signalling that interest rates are closer to peak (as witnessed in
the last interest rate cycle).
RBI's actions for containing demand-side inflationary
pressures are bearing fruits
The RBI in its Annual Review of Monetary Policy for FY2012 had
indicated its intention to contain demand-side pressures on
inflation through continuance of tight monetary policy and to
carry out further rate hikes if needed.
Broader interest rates have risen by 200-225bp and signs of
weakening demand are emerging in interest-sensitive sectors.
1) Real estate and infrastructure sectors are getting adversely
impacted, 2) evidencing this slowing construction activity, cement
volumes are flat on a yoy basis, 3) auto sales are decelerating,
with passenger vehicles growing by just 6.2% yoy in May 2011
and 4) gross capital formation has been stagnant in 4QFY2011.
The interest-sensitive mortgage demand, which has a substantial
negative correlation with interest rates, is also expected to trend
down going forward, as home loan rates have also hardened
by 150-200bp and SBI's teaser rate scheme has been
discontinued. Although sales of 19 large listed real estate
companies have recovered from post-Lehman lows, they are
still barely at the levels before the Lehman crisis even after a
passage of three years and, in our view, higher interest rates
could dampen real estate activity further. Cement dispatches
for April and May 2011 have been almost stagnant on a yoy
basis, providing further evidence of slowing construction activity.
Passenger vehicles’ yoy growth decelerated to a more than
two-year low of 6.2% yoy in May 2011. Another acknowledged
lead indicator of the broader economy – commercial vehicle
sales, which were growing at a healthy rate of 30%+ at the
start of FY2011, have slowed down to below 20% growth rate.
Hence, with the RBI's actions for containment of demand-side
inflationary pressures bearing fruits, we expect the monetary
tightening stance to end sooner than expected by the markets.
Growth in capital formation decelerating sharply
The gross fixed capital formation (GFCF) during 4QFY2011
dipped sharply to almost the same level as in 4QFY2010.
Though the decline in the growth rate in 4QFY2011 has to be
seen in the context of the high base during 4QFY2010, yet broader
trends suggest that capital formation is slowing down, even if not
as drastically as maybe suggested by the latest quarterly numbers.
On a yoy basis, real gross capital formation in FY2011 registered
an 8.6% increase compared to 7.4% in FY2010. However,
yoy growth levels are almost half of what they used to be in the
pre-crisis period; and on a quarterly basis, yoy growth in
capital formation has been falling sharply for the last five
consecutive quarters.
Strategy
Oil burden closer to the peak of historical averages;
other commodities also expected to soften further on
moderating global demand
Global oil prices had risen sharply over the past few months
(from a steady range of US$85-95/barrel at the start of CY2011.
Brent crude rose to the peak of US$125/barrel in April 2011
and has averaged over US$111/barrel in CY2011YTD, thereby
impacting emerging economies like India in particular. However,
looking at the trend in crude oil burden (crude oil consumption
as a percentage of global GDP) over the past decade, we believe
crude prices are closer to their peak levels. Since CY1999, crude
oil burden has averaged 3.1% with a peak of 5.0% in CY2008.
However, with the increase in oil prices, global forecasted crude
oil bill for CY2011 has risen to 5.2%, indicating that
CY2011 YTD average oil prices are closer to their peak levels
based on historical trends. Hence, we expect Brent crude to
continue its recent moderating trend further before stabilising
in the US$95-105/barrel band.
Further, with the signs of recovery in advanced economies like
the US moderating, consumption is likely to be lower than
forecasted, thereby causing a decline in prices. Even the Federal
Reserve in its recent review has revised its estimates downwards
for US' GDP growth for the current as well as next year,
suggesting moderating economic growth.
In order to reduce the impact of disruption in Libyan oil supplies,
the International Energy Agency (IEA), which consists of
28 member countries, recently decided to release 60mn barrels
of oil from its emergency stocks. IEA member countries currently
hold 4.1bn barrels of oil, of which 1.6bn barrels are held
exclusively for emergency use (equivalent to 146 days of net oil
imports as against the legal obligation of 90 days).
Significantly, this is only the third time since 1974 that the IEA
has tapped into its emergency stockpiles, indicating the
willingness to reduce the burden of oil prices on the already
moderating economic growth and carry out further releases if
the situation does not improve. Though the quantum of the
recent release was small at 60mn barrels (2mn barrels/day for
30 days) as compared to global forecasted demand for 2011
at ~88mn barrels/day, the quantum of excess reserves with
IEA is large enough to continue a similar 'stimulus' for ~300
days. The announcement resulted in a sharp fall in oil prices
and is expected to keep them on a downward bias at least in
the short term.
The government recently decided to hike the prices of several
regulated fuels due to the rising under recoveries of OMCs.
However, the recent decline in crude prices is expected to contain
inflationary pressures within comfortable levels going forward.
In case of other commodities, with the recent signs of moderation
in advanced economies and the re-emergence of sovereign
debt crisis in the eurozone, we expect commodities to remain
under pressure at least in the short term, which is expected to
wane inflationary pressures on the Indian economy.
The US Fed also expects pressures from global commodity and
energy prices to dissipate going forward, as it modulates its
accommodative monetary policy. Also, with the second round
of Quantitative Easing (QE-II) ending on June 30, the speculative
money which, to an extent, was fueling the commodity prices
will shrink, thereby putting downward pressure on prices.
Sensex EPS: 18.4% CAGR in FY2011-13E
We expect Sensex EPS to grow by 17.6% to `1,193 in FY2012
and by 19.2% in FY2013 to `1,421, implying an 18.4% CAGR
over FY2011-13E. A fair multiple of 15x FY2013E EPS yields a
Sensex target of 21,320, giving a reasonable ~14% upside
from current levels.
The primary growth drivers of Sensex EPS over FY2011-13E
are expected to be BFSI, oil and gas and metal stocks, with the
BFSI sector expected to contribute 31.6% to overall growth in
Sensex EPS during the period, while contribution from the oil
and gas and metal sectors is estimated to be at 16.8% and
11.9%, respectively. Strong performance by the BFSI sector
highlights the underpenetration of financial services in India,
which would drive credit growth in the years to come.
IT companies are expected to contribute healthy 10.7% to Sensex
EPS growth over FY2011-13E, primarily backed by higher
volumes. On the other hand, sectors such as telecom, power
and FMCG are expected to underperform the others. The
combined contribution of all these sectors to Sensex EPS growth
is expected to be 12.6% over FY2011-13E.
1QFY2012 Sensex earnings outlook
We expect Sensex companies to maintain strong top-line growth
momentum, with projected growth of 21.8% yoy in sales.
However, profit growth is expected to be lower at 14.0% yoy,
mainly on the back of lower operating margins, which are
expected to contract by 124bp yoy during the quarter. Overall,
we expect OPM to come in at 20.9% vis-à-vis 22.1% in the
corresponding period last year. Net profit margin is also
expected to decline to 11.0% from 11.7%, down by 75bp yoy.
We expect strong numbers to be posted by the oil and gas,
BFSI and FMCG sectors in 1QFY2012. The oil and gas sector
is expected to drive growth in Sensex sales and profit, with 18.7%
contribution in Sensex sales growth and 18.4% contribution in
Sensex profit growth, despite operating margin contraction of
116bp yoy. Ex. oil and gas, growth in Sensex sales and earnings
is expected to be at 22.9% and 14.1%, respectively.
IT companies are expected to report 21.2% growth in sales,
driven primarily by volumes, while profit growth is expected to
come in at a relatively lower 13.2% yoy due to a 199bp yoy
margin compression on account of wage hikes. BFSI companies
are expected to report an 18.9% jump in net profit on the back
of similar growth in the top line. Performance of private banks
is expected to remain consistent with ~30% yoy growth in profits.
The regulatory provisioning burden will decline for SBI over the
next couple of quarters, thereby aiding growth in profits.
Ex. BFSI, growth in Sensex profit is expected to be 12.8% yoy.
We expect FMCG companies to post decent 16.4% yoy
growth in sales on the back of higher volumes as well as price
hikes; the increase in profits is expected to be healthy 20.7%
yoy due to an 87bp yoy expansion in operating margins. Power
companies are expected to post a 15.5% increase in sales, while
PAT is expected to grow by healthy 22.8% on the back of OPM
expansion of 262bp yoy.
The auto, capital goods, metals and telecom sectors are
expected to be the major underperformers during this quarter.
Auto stocks are expected to report 12.1% yoy growth in profit,
despite a healthy 22.2% increase in sales, mainly because of
sub-15% growth in earnings for Hero Honda, Tata Motors and
M&M due to stiff pressure on margins on account of high input
costs. Maruti Suzuki is expected to report a 3.7% yoy decline in
profits due to lower volumes as well as margin compression.
Telecom companies are expected to report a decline in profits,
despite substantial top-line growth. The telecom sector is expected
to report a healthy 29.1% yoy increase in the top line, partially
because of the inclusion of Zain's numbers in Bharti Airtel's accounts.
However, due to increased competition and higher interest and
other costs on account of the 3G network rollout, profits are
expected to decline by 2.5% yoy. RCom's earnings are expected to
fall substantially by 72.2% yoy due to operating margin
compression as well as higher interest costs. Ex. telecom, profit
growth in the Sensex is estimated at 14.7% yoy.
Metal companies are expected to witness healthy growth of
27.3% in the top line on the back of stronger commodity prices
as well as volume growth on account of capacity expansions.
However, profits are expected to grow by relatively lower 11.2%
yoy, primarily due to high input costs denting margins by 207bp
yoy. Though the capital goods sector is expected to witness strong
sales growth of 25.8%, margins are estimated to fall by 92bp
yoy, resulting in bottom-line growth of just 5.8%.
In the construction sector, we expect JP Associates to report
moderate performance on the top-line front with strong growth
in adjusted net profit. Sales and adjusted profits are estimated
to grow by 11.6% and 88.4% yoy, respectively, with
margins increasing by 275bp. We expect Cipla to perform
moderately, with 15.5% top-line growth and 9.4% growth
in the bottom line.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Strategy
On the cusp of a turn
Indian markets have underperformed almost all major global
markets in the current calendar year ostensibly due to the twin
macro-concerns of high inflation and interest rates; and now
the key question on the minds of investors is when the rate cycle
will reverse. While the trajectory was a little less certain even a
couple of months back, in our view, various indicators are
signaling that inflation and interest rates are close to peak levels,
with respite likely from the second half.
In our view, external issues such as the Greek crisis can contribute
to near-term uncertainty and volatility, but they are unlikely to
materially impact the overall upward trajectory of the Indian
economy and markets, which are underpinned by strong
structural growth drivers, and even in the near-term are likely
to register GDP growth of 7.5-8%. Hence, we maintain our
positive stance on Indian equities as we believe that valuations
remain fairly attractive, especially in light of the reasonable
earnings visibility over the next two years.
Why broader interest rates are close to peak in our view
Insignificant forex inflows: In this cycle, forex reserves have been
relatively anaemic (up 12% since March 2010 vs. 60% growth
during January 2007 - October 2008), suggesting a peaking
of rates at lower levels in this cycle. In cognizance, the RBI too
has not used the harsher CRR tool much, mainly sticking to
repo hikes.
Cooling domestic demand: Broader interest rates have risen
by 200-225bp and signs of weakening domestic demand are
emerging in interest-sensitive sectors. 1) Real estate and
infrastructure sectors are getting adversely impacted,
2) evidencing this slowing construction activity, cement volumes
are flat on a yoy basis, 3) auto sales are decelerating, with
passenger vehicles growing by just 6.2% yoy and 4) gross capital
formation has been stagnant in 4QFY2011.
Deposit mobilisations up, credit offtake down: There are
broader signs of slowdown in credit offtake, while deposit
mobilisation has picked up significantly only to be largely
deployed at a negative spread into government bonds.
Accordingly, we expect deposit and lending rates to not go up
further even if the RBI hikes the repo rate.
Respite on domestic food prices: With food forming 45-60% of
Indian consumer inflation indices, rising food prices are a
practical concern for policymakers. No doubt rather than hiking
rates we need to improve supply, logistics, subsidy disbursement,
etc., but nonetheless, food inflation cooling off significantly in
recent weeks should reduce policymakers' need to tighten the
policy even symbolically.
Respite also on global commodities, sustainable crude range
US$95-105: Global demand weakness is already leading to
cooling commodity prices. Also, affirming the risk to global
GDP from higher crude, the IEA has decided to release reserves
(third such instance since 1974). Our analysis also indicates
that whenever the global oil bill exceeds 5% of GDP, crude prices
tend to cool off as demand weakens. For CY2011, this gives a
range of US$95-105 for crude.
US Fed still perceives deflationary pressures: Wholesale (PPI)
inflation in the US is as high as 7.3%, largely similar to Indian
WPI levels. The US Fed, on the contrary, is worried about
deflation due to weak unemployment and housing data. It is
dismissive about the current inflation readings, pointing that
they are driven by global commodity price pressures that are
expected to dissipate.
Overweight on sectors with good earnings visibility
Presently, we have a positive outlook on index BFSI stocks, aided
by moderate credit growth, better margin performance and
lower provisioning burden than small banks. Moreover, cooling
of inflation and interest rates from 2HFY2012 is likely to improve
credit growth and asset quality outlook for the overall banking
sector. The infrastructure sector is also likely to benefit from an
imminent cooling of the rate cycle and, in any case, valuations
have become very cheap, offering a margin of safety.
Large-cap metals also offer strong earnings visibility, in our
view, on account of capacity expansion, low-cost integrated
operations and healthy export potential. Incidentally, on the
export front, in the past few quarters, growth in India's exports
has been phenomenal, in our view, aided by the fact that the
rupee has depreciated against the euro and has become more
competitive vis-à-vis the yuan as far as the US and Middle East
are concerned. In the export sector, in case of the IT sector,
we believe valuations factor in the positives; while in case of the
pharma sector, we are overweight on account of a healthy
growth outlook at reasonable valuations.
Overall, in view of the easing headwinds to growth from
2HFY2012, we estimate Sensex earnings to post an 18.4%
CAGR over FY2011-13E. A fair multiple of 15x FY2013E EPS
yields a Sensex target of 21,320, giving a reasonable ~14%
upside from current levels. Hence, we remain positive on the
Indian markets.
Markets decline for second consecutive quarter
Indian markets continued to be under pressure for most of
1QFY2012 primarily due to concerns of higher inflation and
the consequent policy rate hikes by the RBI. Despite the
bounce-back at the very end of the quarter, overall the Sensex
registered losses of 3.1% qoq, continuing the declining trend
witnessed in 4QFY2011.
Inflation and interest rates expected to peak soon
In our view, various indicators are increasingly signaling that
inflation and interest rates are close to peak levels, with respite
likely from the second half. With the RBI hiking rates
10 times since March 2010 and, more importantly, with
demand-supply factors pushing up the broader interest rates
by ~200bp, the demand momentum in the economy has
slowed, as can be observed from the recent incremental credit
offtake, monthly cement and auto sales numbers and almost
stagnant capital formation during 4QFY2011.
Hence, we believe the RBI has largely achieved its objective,
stated in its Monetary Policy Review of May 3, 2011, of reducing
demand-side pressures to contain inflation, and this should lead
to peaking out of inflation from the second half of FY2012.
Lower forex reserve accretion and RBI not hiking CRR
During the last interest rate cycle, our forex reserves had
increased by over US$100bn between January 2007 and
October 2008 alone (representing a 60%+ increase), keeping
the GDP growth momentum high even at higher levels of interest
rates. The demand momentum had remained reasonably strong
even though the RBI had resorted to substantial CRR hikes, which
were far more potent in pushing up domestic interest rates
(at peak levels just before the Lehman crisis, interest rates were
almost 150-200bp higher than those at present).
This time around, forex reserves have been relatively anaemic
(up only 12% since March 2010), suggesting a peaking of
interest rates at lower levels in this interest rate cycle as compared
to the previous one. In cognizance of this, the RBI too has not
really used the harsher CRR tool, sticking to relatively symbolic
repo hikes. In the current scenario, with the CRR prevailing at
6.5% and unlikely to be hiked due to naturally tight liquidity
conditions, broader interest rates are likely to peak at
current levels in spite of repo hikes. This is rightly so, as in
the absence of strong forex inflows, demand too is
accordingly decelerating sooner.
Credit offtake has fallen while deposit accretion has
gained momentum
Prior to December 2010, broader deposit mobilisation was
inevitably lower in light of high inflation and deposit rates even
below NSS rates. Due to the resulting drying up of liquidity,
broader interest rates have already gone up by about 200-225bp.
With the sharp spike in lending rates, credit offtake has declined,
as evident from the incremental CD ratio in FY2012 YTD (up to
June 17) at just 44.9% compared to 247.1% during the same
period in FY2011. A like-to-like comparison between Marchend
and mid-June of FY2011 vs. FY2012 indicates 11% lower
credit mobilisation vs. almost 5x higher deposit mobilisation.
Peak retail FD rates currently hovering at 9-9.5% for major banks
are well above the 8% that NSS offers and well above the
10-year G-Sec yield (8.3%) i.e., deposit mobilisation has picked
up significantly only to be largely deployed at a negative spread
into government bonds. Accordingly, we expect deposit rates
as well as private sector lending rates to not go up further even
if the RBI hikes the repo rate a couple of more times,
as demand-supply dynamics for the banking sector dictate otherwise.
In fact, we expect broader deposit and lending rates to decline
from 2HFY2012, once WPI inflation also starts heading lower
(the near-term uptick due to hike in fuel prices is in our view
already factored in by the RBI and markets).
Even the 1-year and 10-year G-sec yield spread has recently
turned into the negative territory i.e., bond markets are also
signalling that interest rates are closer to peak (as witnessed in
the last interest rate cycle).
RBI's actions for containing demand-side inflationary
pressures are bearing fruits
The RBI in its Annual Review of Monetary Policy for FY2012 had
indicated its intention to contain demand-side pressures on
inflation through continuance of tight monetary policy and to
carry out further rate hikes if needed.
Broader interest rates have risen by 200-225bp and signs of
weakening demand are emerging in interest-sensitive sectors.
1) Real estate and infrastructure sectors are getting adversely
impacted, 2) evidencing this slowing construction activity, cement
volumes are flat on a yoy basis, 3) auto sales are decelerating,
with passenger vehicles growing by just 6.2% yoy in May 2011
and 4) gross capital formation has been stagnant in 4QFY2011.
The interest-sensitive mortgage demand, which has a substantial
negative correlation with interest rates, is also expected to trend
down going forward, as home loan rates have also hardened
by 150-200bp and SBI's teaser rate scheme has been
discontinued. Although sales of 19 large listed real estate
companies have recovered from post-Lehman lows, they are
still barely at the levels before the Lehman crisis even after a
passage of three years and, in our view, higher interest rates
could dampen real estate activity further. Cement dispatches
for April and May 2011 have been almost stagnant on a yoy
basis, providing further evidence of slowing construction activity.
Passenger vehicles’ yoy growth decelerated to a more than
two-year low of 6.2% yoy in May 2011. Another acknowledged
lead indicator of the broader economy – commercial vehicle
sales, which were growing at a healthy rate of 30%+ at the
start of FY2011, have slowed down to below 20% growth rate.
Hence, with the RBI's actions for containment of demand-side
inflationary pressures bearing fruits, we expect the monetary
tightening stance to end sooner than expected by the markets.
Growth in capital formation decelerating sharply
The gross fixed capital formation (GFCF) during 4QFY2011
dipped sharply to almost the same level as in 4QFY2010.
Though the decline in the growth rate in 4QFY2011 has to be
seen in the context of the high base during 4QFY2010, yet broader
trends suggest that capital formation is slowing down, even if not
as drastically as maybe suggested by the latest quarterly numbers.
On a yoy basis, real gross capital formation in FY2011 registered
an 8.6% increase compared to 7.4% in FY2010. However,
yoy growth levels are almost half of what they used to be in the
pre-crisis period; and on a quarterly basis, yoy growth in
capital formation has been falling sharply for the last five
consecutive quarters.
Strategy
Oil burden closer to the peak of historical averages;
other commodities also expected to soften further on
moderating global demand
Global oil prices had risen sharply over the past few months
(from a steady range of US$85-95/barrel at the start of CY2011.
Brent crude rose to the peak of US$125/barrel in April 2011
and has averaged over US$111/barrel in CY2011YTD, thereby
impacting emerging economies like India in particular. However,
looking at the trend in crude oil burden (crude oil consumption
as a percentage of global GDP) over the past decade, we believe
crude prices are closer to their peak levels. Since CY1999, crude
oil burden has averaged 3.1% with a peak of 5.0% in CY2008.
However, with the increase in oil prices, global forecasted crude
oil bill for CY2011 has risen to 5.2%, indicating that
CY2011 YTD average oil prices are closer to their peak levels
based on historical trends. Hence, we expect Brent crude to
continue its recent moderating trend further before stabilising
in the US$95-105/barrel band.
Further, with the signs of recovery in advanced economies like
the US moderating, consumption is likely to be lower than
forecasted, thereby causing a decline in prices. Even the Federal
Reserve in its recent review has revised its estimates downwards
for US' GDP growth for the current as well as next year,
suggesting moderating economic growth.
In order to reduce the impact of disruption in Libyan oil supplies,
the International Energy Agency (IEA), which consists of
28 member countries, recently decided to release 60mn barrels
of oil from its emergency stocks. IEA member countries currently
hold 4.1bn barrels of oil, of which 1.6bn barrels are held
exclusively for emergency use (equivalent to 146 days of net oil
imports as against the legal obligation of 90 days).
Significantly, this is only the third time since 1974 that the IEA
has tapped into its emergency stockpiles, indicating the
willingness to reduce the burden of oil prices on the already
moderating economic growth and carry out further releases if
the situation does not improve. Though the quantum of the
recent release was small at 60mn barrels (2mn barrels/day for
30 days) as compared to global forecasted demand for 2011
at ~88mn barrels/day, the quantum of excess reserves with
IEA is large enough to continue a similar 'stimulus' for ~300
days. The announcement resulted in a sharp fall in oil prices
and is expected to keep them on a downward bias at least in
the short term.
The government recently decided to hike the prices of several
regulated fuels due to the rising under recoveries of OMCs.
However, the recent decline in crude prices is expected to contain
inflationary pressures within comfortable levels going forward.
In case of other commodities, with the recent signs of moderation
in advanced economies and the re-emergence of sovereign
debt crisis in the eurozone, we expect commodities to remain
under pressure at least in the short term, which is expected to
wane inflationary pressures on the Indian economy.
The US Fed also expects pressures from global commodity and
energy prices to dissipate going forward, as it modulates its
accommodative monetary policy. Also, with the second round
of Quantitative Easing (QE-II) ending on June 30, the speculative
money which, to an extent, was fueling the commodity prices
will shrink, thereby putting downward pressure on prices.
Sensex EPS: 18.4% CAGR in FY2011-13E
We expect Sensex EPS to grow by 17.6% to `1,193 in FY2012
and by 19.2% in FY2013 to `1,421, implying an 18.4% CAGR
over FY2011-13E. A fair multiple of 15x FY2013E EPS yields a
Sensex target of 21,320, giving a reasonable ~14% upside
from current levels.
The primary growth drivers of Sensex EPS over FY2011-13E
are expected to be BFSI, oil and gas and metal stocks, with the
BFSI sector expected to contribute 31.6% to overall growth in
Sensex EPS during the period, while contribution from the oil
and gas and metal sectors is estimated to be at 16.8% and
11.9%, respectively. Strong performance by the BFSI sector
highlights the underpenetration of financial services in India,
which would drive credit growth in the years to come.
IT companies are expected to contribute healthy 10.7% to Sensex
EPS growth over FY2011-13E, primarily backed by higher
volumes. On the other hand, sectors such as telecom, power
and FMCG are expected to underperform the others. The
combined contribution of all these sectors to Sensex EPS growth
is expected to be 12.6% over FY2011-13E.
1QFY2012 Sensex earnings outlook
We expect Sensex companies to maintain strong top-line growth
momentum, with projected growth of 21.8% yoy in sales.
However, profit growth is expected to be lower at 14.0% yoy,
mainly on the back of lower operating margins, which are
expected to contract by 124bp yoy during the quarter. Overall,
we expect OPM to come in at 20.9% vis-à-vis 22.1% in the
corresponding period last year. Net profit margin is also
expected to decline to 11.0% from 11.7%, down by 75bp yoy.
We expect strong numbers to be posted by the oil and gas,
BFSI and FMCG sectors in 1QFY2012. The oil and gas sector
is expected to drive growth in Sensex sales and profit, with 18.7%
contribution in Sensex sales growth and 18.4% contribution in
Sensex profit growth, despite operating margin contraction of
116bp yoy. Ex. oil and gas, growth in Sensex sales and earnings
is expected to be at 22.9% and 14.1%, respectively.
IT companies are expected to report 21.2% growth in sales,
driven primarily by volumes, while profit growth is expected to
come in at a relatively lower 13.2% yoy due to a 199bp yoy
margin compression on account of wage hikes. BFSI companies
are expected to report an 18.9% jump in net profit on the back
of similar growth in the top line. Performance of private banks
is expected to remain consistent with ~30% yoy growth in profits.
The regulatory provisioning burden will decline for SBI over the
next couple of quarters, thereby aiding growth in profits.
Ex. BFSI, growth in Sensex profit is expected to be 12.8% yoy.
We expect FMCG companies to post decent 16.4% yoy
growth in sales on the back of higher volumes as well as price
hikes; the increase in profits is expected to be healthy 20.7%
yoy due to an 87bp yoy expansion in operating margins. Power
companies are expected to post a 15.5% increase in sales, while
PAT is expected to grow by healthy 22.8% on the back of OPM
expansion of 262bp yoy.
The auto, capital goods, metals and telecom sectors are
expected to be the major underperformers during this quarter.
Auto stocks are expected to report 12.1% yoy growth in profit,
despite a healthy 22.2% increase in sales, mainly because of
sub-15% growth in earnings for Hero Honda, Tata Motors and
M&M due to stiff pressure on margins on account of high input
costs. Maruti Suzuki is expected to report a 3.7% yoy decline in
profits due to lower volumes as well as margin compression.
Telecom companies are expected to report a decline in profits,
despite substantial top-line growth. The telecom sector is expected
to report a healthy 29.1% yoy increase in the top line, partially
because of the inclusion of Zain's numbers in Bharti Airtel's accounts.
However, due to increased competition and higher interest and
other costs on account of the 3G network rollout, profits are
expected to decline by 2.5% yoy. RCom's earnings are expected to
fall substantially by 72.2% yoy due to operating margin
compression as well as higher interest costs. Ex. telecom, profit
growth in the Sensex is estimated at 14.7% yoy.
Metal companies are expected to witness healthy growth of
27.3% in the top line on the back of stronger commodity prices
as well as volume growth on account of capacity expansions.
However, profits are expected to grow by relatively lower 11.2%
yoy, primarily due to high input costs denting margins by 207bp
yoy. Though the capital goods sector is expected to witness strong
sales growth of 25.8%, margins are estimated to fall by 92bp
yoy, resulting in bottom-line growth of just 5.8%.
In the construction sector, we expect JP Associates to report
moderate performance on the top-line front with strong growth
in adjusted net profit. Sales and adjusted profits are estimated
to grow by 11.6% and 88.4% yoy, respectively, with
margins increasing by 275bp. We expect Cipla to perform
moderately, with 15.5% top-line growth and 9.4% growth
in the bottom line.
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