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UBS Investment Research
Asia Equity Strategy
I ndia and China – what’s in the price?
We remain overweight India and China
Our overweight on India and China is predicated on economies slowing, resulting
in inflation peaking and policy shifting to neutral. And the slowdown being largely
reflected in earnings and valuations. Three weeks back, we looked at the earnings
risk top down in India, today we extend that to include more bottom-up details and
also China – to see to what extent is the risk in the price?
Earnings risk looks muted, especially in India
Earnings estimates have come down by around 5% in India this year. While this is
not the case in China, revenue forecasts have been revised down for the next fiscal
year. Margin forecasts have also come down in both markets and valuations are
broadly reflecting this except in a few defensive sectors. Transport and Autos in
China, and Telecom and Construction in India particularly stand out with
downgrades to both revenues and margins so far this year, and attractive
valuations.
Earnings results in India so far – a positive
So far through the earnings season in India, analysts have cut their estimates (11e
CY) by 1.2% for the companies that have reported. This looks less extreme than
what many investors were anticipating, in our opinion. Prices, with a few
exceptions, have also not reacted badly to the results so far - suggesting that the
market has discounted a large part of the slowing growth already. History also
suggests that equities generally bottom out before earnings find a trough, typically
3-4 months in advance. This gives support to our view that a growth slowdown is
already meaningfully embedded in estimates and share prices.
A few weeks back we moved India to overweight. We also maintained our
overweight on China. Since then we have been asked by many clients about the
risk to earnings in both the markets. We looked at this earlier in India, and today
extend this to China along with more bottom-up details.
First a quick comment on the latest rate hike surprise in India. Our India
economist, Philip Wyatt, believes that there is a chance of the economy slowing
enough to justify a pause in the rate hikes by the next RBI meeting in October,
although the latest statement keeps the doors open for further hikes (‘India- “All
out” for 8%?’ dated 27th July 2011).
Our base case remains that policy will be less of a headwind in China and
liquidity should improve in India, in the second half of this year. Tight monetary
policy in both these markets has led to a slowdown in growth which is likely to
be felt in the coming months. But this slowdown is largely being reflected in
prices, consensus estimates for revenues and margins and valuations today.
Nevertheless, consensus has to generally wait until actual earnings
announcements to start reflecting the impact of a slowdown in their numbers,
and we expect this to become more evident in the coming weeks. Based on the
current earnings season so far in India, analysts have cut their estimates for CY
2011e by around 1.2%, more than the overall market level downgrade, but less
than, in our opinion, what many investors would be anticipating.
We also try answering a more general but related question – when does
deteriorating earnings momentum stop being an impediment for stock
performance? For this, we have looked at stocks across the region over the last
twenty years and studied their performance during earnings downgrades. Our
key takeaway is that equities generally bottom out 3-4 months in advance of an
earnings trough.
Our conclusions –
1. Our overweights on India and China are predicated on policy shifting,
inflation peaking and economies slowing. But we believe the slowdown is
largely reflected in earnings and valuations. Few weeks back, we looked at the
earnings risk in India, and today we extend that to include more bottom-up
details and also China.
2. Earnings estimates have come down by around 5% in India this year. While
this is not the case in China, consensus forecasts for revenues have been revised
down in both markets. Margins have also come down, and valuations are
broadly reflecting this except in a few defensive sectors. Transport and Autos in
China, and Telecom and Construction in India particularly stand out with
downgrades to both revenues and margins so far this year, and in our view
attractive valuations.
3. So far through the earnings season in India, analysts have cut their estimates
(11e CY) by 1.2% for the reported companies. This looks less extreme relative
to what, in our opinion, many investors were anticipating. Prices, with a few
exceptions, have not reacted badly to the results so far - suggesting that the
market has discounted a large part of the slowing growth. History also suggests
that equities generally bottom out before earnings find a trough, typically 3-4
months in advance.
4. Few stocks that look attractive based on our screens and are Buy-rated by
UBS analysts include – Beijing Enterprises, Dongfang Electric, Zijin Mining,
Lenovo, China Unicom (UBS Key Call), Zhejiang Expressway and China
Merchants Holding. Stocks in India include Hero Honda, Exide, Maruti, Bajaj
Auto, JSW Steel, Jai Prakash Associates, BHEL, ONGC, Infosys, Reliance
Comm. and Reliance Infrastructure.
Where are consensus estimates and valuations?
To what extent are the consensus estimates for earnings in China and India
pricing in a slowdown in growth? What about valuations? We look at these two
issues in this section before looking at price performance in the next.
Aggregate earnings estimate for 2011 (calendar year end) have come down by
around 5% in India so far this year. In China, analysts have downgraded their
margin expectations and are expecting hardly any pickup for the next two years,
albeit they have raised their EPS forecasts.
But we believe the recent picture based on these estimates can be a bit
misleading, especially in India where only a handful of companies have reported
so far and analysts are more likely to revise their estimates after the results
instead of before. To overcome this, we have created an earnings index using
data for only the companies that have reported so far to get a more realistic
estimate of earnings downgrades since the beginning of this earnings season.
Chart 3 shows the two indices together – based on reported companies and for
the overall market. While analysts have hardly downgraded earnings at the
market level, around -0.4%, from July beginning, they have cut their estimates
for 2011 for the reported companies by more than 1% since then. Although
higher in this comparison, the absolute level of downgrades for the reported
companies looks to be a positive to us as we think that many investors were
probably anticipating more downside risk.
This picture however varies sector by sector within these markets. While some
have seen more aggressive cuts than others, a few sectors have seen their
revenue and margins forecasts being revised upwards.
One of the reasons why we moved India to overweight (‘Moving overweight
India’ dated 4th July 2011) was because several sectors in the market seemed to
be pricing in a slowdown. Since then we have received many similar questions
about China. In today’s note, we take a detailed look at forecasts for the Chinese
sectors in addition to revisiting India, and also drilling down to stocks within
each of the markets.
China
Leading indicators have been suggesting a revenue slowdown in China since the
beginning of the year. Our China economist Tao Wang estimates that q/q growth
slowed to annualized 8-8.5% on a seasonally adjusted basis, in line with earlier
observations of a moderate slowdown.
To understand the impact of this slowdown on a sector by sector basis, we have
looked at the margin and revenue forecasts for all the companies in the MSCI
universe, and aggregated the data at the sector level. We show this data for the
nine biggest sectors that account for around 50% of the index. These are Energy,
Telecom, Materials, Capital Goods, Retailing, Transport, Autos, Utilities and
Tech. We exclude financials, insurance and property which are around 40% of
the overall index market cap.
Analysts expect the slowdown in China to impact revenues for next year more
materially than current. Revenue forecasts for 2011 have been upgraded across
sectors since January, except in Transport and Autos. Materials stocks,
particularly Cement and Copper, have seen significant upward revisions to
revenue forecasts and look like the biggest driver of revenue growth at the
market level for 2011. For 2012, on the other hand, revenue forecasts at the
market level have come down since January, most significantly for Energy
stocks.
Energy stocks have seen the most significant upward revision to their 2011
numbers, alongside Materials. This has to do with the oil prices remaining high
this year. The lower revenue growth in 2012 is partly because of the expected
higher base of 2011 and partly because of analysts expecting oil prices to come
off. Revenue growth for 2011 looks in line with historical averages and that for
the subsequent years slightly on the lower side.
Telcos have seen upgrades to both 2011 and 2012 growth numbers by
approximately 200 basis points since January. One of the major drivers of this is
strong growth expectations from China Unicom, which is also a UBS Key Call.
Our analyst, Jinjin Wang, expects that 3G technology could lead to very strong
growth in the high-end subscribers for the telecom operator. To us, these
estimates in aggregate look achievable and close to the lower end of the
historical range since 2003.
A similar case is true for Retailing stocks which have seen upgrades of more
than 200 basis points to their estimates for revenue growth both in 2011 and
2012. This is likely driven by strong same-stores-sales (SSS) reported by a
number of department store operators in January-February, many of which also
suggested 2011 SSS targets in the high-teens. However, unlike Telcos, these
estimates look slightly high relative to history. For instance, our analysts also
see difficulty for Belle in maintaining strong momentum in 2H11 due to a
deceleration in the department store space.
While analysts have been aggressive in raising their revenue forecasts for the
Materials sector for 2011, due to higher commodity prices, they have remained
shy of making similar adjustments to the 2012 forecasts. Analysts have more
than doubled their revenue growth estimates for a number of stocks like Anhui
Conch Cement, CNBM and Jiangxi Copper for 2011 since the beginning of this
year, led mainly by higher ASPs and a shortage of supply. Relative to history
2011 growth looks in line with averages and 2012 slightly on the lower side.
Capital Goods have hardly seen any revisions this year for both 2011 and 2012.
Growth estimates looks slightly below historical average for both years. This is
not entirely surprising given the 20% cut in total capex announced by the new
minister for MoR (Ministry of Railways) in the 12th FYP earlier in April this
year.
Transport and Auto stocks have seen downgrades to their revenue forecasts for
the next two years, and their growth estimates look slightly below the average
growth achieved since 2003. In Transport, this is likely due to overcapacity
issues and expectations of soft demand in China and globally. Revisions in
Autos seem to be largely stock specific, and in this case look to be particularly
driven by Dongfeng Motor Group.
Estimates for Utilities and Tech stocks (only 3 companies in the index –
Kingboard, Lenovo and ZTE), have moved in line with the market i.e. they have
been upgraded for 2011 and downgraded for the next year. For both sectors,
they look low compared to the historical average.
Tying this into the overall macro trends, consensus seems to have fully bought
into the idea of the Chinese economy “rebalancing” away from fixed asset
investment into consumption. For example, the pessimism in revenue growth in
Capital goods, with top line CAGR of 15% over the next two years (2011-13), is
more than 10% lower than the historical average since 2003.
Nevertheless, analysts seem optimistic that weaker fixed asset investment
growth should have no bearing on commodity prices and volumes in the
Materials sector and analysts continue to forecasts strong revenue growth for the
sector in 2011.
Conversely the consensus is already optimistic about the revenues for retailers
and forecasting a CAGR of 21% over the next two years. However this is not
extended to Telcos, which although often seen as consumer plays, are negatively
impacted by the high penetration rates and very strong competition in the
Chinese market.
Turning to margins, we start by looking at a crude measure of pricing power at
the market level i.e. CPI – PPI. Companies may not feel margin pressure due to
higher costs if they have the ability to pass these on. The gap between CPI and
PPI has been negative in China since the beginning of 2010, suggesting that
margins for most companies have been under pressure due to higher costs. But
the rising trend and current levels (just below zero) indicate that this is
improving. This probably reflects to some extent in analyst forecasts as they
have been less aggressive in downgrading their 2012 margins forecasts relative
to 2011.
Margin estimates for both 2011 and 2012 have gone down by around 100 and 75
basis points respectively at the market level. It appears that analysts expect
slower economic growth to be reflected more through margin compression than
revenue slowdown for most sectors.
At the sector level, Capital Goods is the only sector out of the nine that we look
at which has seen upward revisions to its margin forecasts, albeit modest, for
both 2011 and 2012. The forecasts do not look too high relative to history for
both years.
Margins for Energy and Materials over the next two years have been
downgraded the most, by more than 100 basis points for each year. Interestingly,
these are the sectors that have seen the biggest upgrades to their revenue
estimates for 2011. While margins are expected to remain flat for Energy stocks
over the next two years, they are expected to rise for the Materials despite cuts
this year.
As we also highlighted earlier, Autos and Transport have seen the least change
to their margin forecasts since January this year. Analysts are now forecasting
flat margins for Autos and a moderate pickup in Transport sector over the next
two years. While, these estimates look close to the top end of their historical
range and the post sub-prime peak for Autos, in Transport they are lower and
look more reasonable.
Both Telcos and Tech have seen cuts to their margin forecasts this year, in line
with the market, and their margins are expected to remain flat over the next two
years. For both these sectors, they look closer to the lower end of their historical
range.
Similarly Retailing and Utilities stocks have also seen their margin forecasts
being downgraded this year. In both sectors, forecasts still look high - close to
post sub-prime peak for Utilities and highest since 2003 for Retailers.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Asia Equity Strategy
I ndia and China – what’s in the price?
We remain overweight India and China
Our overweight on India and China is predicated on economies slowing, resulting
in inflation peaking and policy shifting to neutral. And the slowdown being largely
reflected in earnings and valuations. Three weeks back, we looked at the earnings
risk top down in India, today we extend that to include more bottom-up details and
also China – to see to what extent is the risk in the price?
Earnings risk looks muted, especially in India
Earnings estimates have come down by around 5% in India this year. While this is
not the case in China, revenue forecasts have been revised down for the next fiscal
year. Margin forecasts have also come down in both markets and valuations are
broadly reflecting this except in a few defensive sectors. Transport and Autos in
China, and Telecom and Construction in India particularly stand out with
downgrades to both revenues and margins so far this year, and attractive
valuations.
Earnings results in India so far – a positive
So far through the earnings season in India, analysts have cut their estimates (11e
CY) by 1.2% for the companies that have reported. This looks less extreme than
what many investors were anticipating, in our opinion. Prices, with a few
exceptions, have also not reacted badly to the results so far - suggesting that the
market has discounted a large part of the slowing growth already. History also
suggests that equities generally bottom out before earnings find a trough, typically
3-4 months in advance. This gives support to our view that a growth slowdown is
already meaningfully embedded in estimates and share prices.
A few weeks back we moved India to overweight. We also maintained our
overweight on China. Since then we have been asked by many clients about the
risk to earnings in both the markets. We looked at this earlier in India, and today
extend this to China along with more bottom-up details.
First a quick comment on the latest rate hike surprise in India. Our India
economist, Philip Wyatt, believes that there is a chance of the economy slowing
enough to justify a pause in the rate hikes by the next RBI meeting in October,
although the latest statement keeps the doors open for further hikes (‘India- “All
out” for 8%?’ dated 27th July 2011).
Our base case remains that policy will be less of a headwind in China and
liquidity should improve in India, in the second half of this year. Tight monetary
policy in both these markets has led to a slowdown in growth which is likely to
be felt in the coming months. But this slowdown is largely being reflected in
prices, consensus estimates for revenues and margins and valuations today.
Nevertheless, consensus has to generally wait until actual earnings
announcements to start reflecting the impact of a slowdown in their numbers,
and we expect this to become more evident in the coming weeks. Based on the
current earnings season so far in India, analysts have cut their estimates for CY
2011e by around 1.2%, more than the overall market level downgrade, but less
than, in our opinion, what many investors would be anticipating.
We also try answering a more general but related question – when does
deteriorating earnings momentum stop being an impediment for stock
performance? For this, we have looked at stocks across the region over the last
twenty years and studied their performance during earnings downgrades. Our
key takeaway is that equities generally bottom out 3-4 months in advance of an
earnings trough.
Our conclusions –
1. Our overweights on India and China are predicated on policy shifting,
inflation peaking and economies slowing. But we believe the slowdown is
largely reflected in earnings and valuations. Few weeks back, we looked at the
earnings risk in India, and today we extend that to include more bottom-up
details and also China.
2. Earnings estimates have come down by around 5% in India this year. While
this is not the case in China, consensus forecasts for revenues have been revised
down in both markets. Margins have also come down, and valuations are
broadly reflecting this except in a few defensive sectors. Transport and Autos in
China, and Telecom and Construction in India particularly stand out with
downgrades to both revenues and margins so far this year, and in our view
attractive valuations.
3. So far through the earnings season in India, analysts have cut their estimates
(11e CY) by 1.2% for the reported companies. This looks less extreme relative
to what, in our opinion, many investors were anticipating. Prices, with a few
exceptions, have not reacted badly to the results so far - suggesting that the
market has discounted a large part of the slowing growth. History also suggests
that equities generally bottom out before earnings find a trough, typically 3-4
months in advance.
4. Few stocks that look attractive based on our screens and are Buy-rated by
UBS analysts include – Beijing Enterprises, Dongfang Electric, Zijin Mining,
Lenovo, China Unicom (UBS Key Call), Zhejiang Expressway and China
Merchants Holding. Stocks in India include Hero Honda, Exide, Maruti, Bajaj
Auto, JSW Steel, Jai Prakash Associates, BHEL, ONGC, Infosys, Reliance
Comm. and Reliance Infrastructure.
Where are consensus estimates and valuations?
To what extent are the consensus estimates for earnings in China and India
pricing in a slowdown in growth? What about valuations? We look at these two
issues in this section before looking at price performance in the next.
Aggregate earnings estimate for 2011 (calendar year end) have come down by
around 5% in India so far this year. In China, analysts have downgraded their
margin expectations and are expecting hardly any pickup for the next two years,
albeit they have raised their EPS forecasts.
But we believe the recent picture based on these estimates can be a bit
misleading, especially in India where only a handful of companies have reported
so far and analysts are more likely to revise their estimates after the results
instead of before. To overcome this, we have created an earnings index using
data for only the companies that have reported so far to get a more realistic
estimate of earnings downgrades since the beginning of this earnings season.
Chart 3 shows the two indices together – based on reported companies and for
the overall market. While analysts have hardly downgraded earnings at the
market level, around -0.4%, from July beginning, they have cut their estimates
for 2011 for the reported companies by more than 1% since then. Although
higher in this comparison, the absolute level of downgrades for the reported
companies looks to be a positive to us as we think that many investors were
probably anticipating more downside risk.
This picture however varies sector by sector within these markets. While some
have seen more aggressive cuts than others, a few sectors have seen their
revenue and margins forecasts being revised upwards.
One of the reasons why we moved India to overweight (‘Moving overweight
India’ dated 4th July 2011) was because several sectors in the market seemed to
be pricing in a slowdown. Since then we have received many similar questions
about China. In today’s note, we take a detailed look at forecasts for the Chinese
sectors in addition to revisiting India, and also drilling down to stocks within
each of the markets.
China
Leading indicators have been suggesting a revenue slowdown in China since the
beginning of the year. Our China economist Tao Wang estimates that q/q growth
slowed to annualized 8-8.5% on a seasonally adjusted basis, in line with earlier
observations of a moderate slowdown.
To understand the impact of this slowdown on a sector by sector basis, we have
looked at the margin and revenue forecasts for all the companies in the MSCI
universe, and aggregated the data at the sector level. We show this data for the
nine biggest sectors that account for around 50% of the index. These are Energy,
Telecom, Materials, Capital Goods, Retailing, Transport, Autos, Utilities and
Tech. We exclude financials, insurance and property which are around 40% of
the overall index market cap.
Analysts expect the slowdown in China to impact revenues for next year more
materially than current. Revenue forecasts for 2011 have been upgraded across
sectors since January, except in Transport and Autos. Materials stocks,
particularly Cement and Copper, have seen significant upward revisions to
revenue forecasts and look like the biggest driver of revenue growth at the
market level for 2011. For 2012, on the other hand, revenue forecasts at the
market level have come down since January, most significantly for Energy
stocks.
Energy stocks have seen the most significant upward revision to their 2011
numbers, alongside Materials. This has to do with the oil prices remaining high
this year. The lower revenue growth in 2012 is partly because of the expected
higher base of 2011 and partly because of analysts expecting oil prices to come
off. Revenue growth for 2011 looks in line with historical averages and that for
the subsequent years slightly on the lower side.
Telcos have seen upgrades to both 2011 and 2012 growth numbers by
approximately 200 basis points since January. One of the major drivers of this is
strong growth expectations from China Unicom, which is also a UBS Key Call.
Our analyst, Jinjin Wang, expects that 3G technology could lead to very strong
growth in the high-end subscribers for the telecom operator. To us, these
estimates in aggregate look achievable and close to the lower end of the
historical range since 2003.
A similar case is true for Retailing stocks which have seen upgrades of more
than 200 basis points to their estimates for revenue growth both in 2011 and
2012. This is likely driven by strong same-stores-sales (SSS) reported by a
number of department store operators in January-February, many of which also
suggested 2011 SSS targets in the high-teens. However, unlike Telcos, these
estimates look slightly high relative to history. For instance, our analysts also
see difficulty for Belle in maintaining strong momentum in 2H11 due to a
deceleration in the department store space.
While analysts have been aggressive in raising their revenue forecasts for the
Materials sector for 2011, due to higher commodity prices, they have remained
shy of making similar adjustments to the 2012 forecasts. Analysts have more
than doubled their revenue growth estimates for a number of stocks like Anhui
Conch Cement, CNBM and Jiangxi Copper for 2011 since the beginning of this
year, led mainly by higher ASPs and a shortage of supply. Relative to history
2011 growth looks in line with averages and 2012 slightly on the lower side.
Capital Goods have hardly seen any revisions this year for both 2011 and 2012.
Growth estimates looks slightly below historical average for both years. This is
not entirely surprising given the 20% cut in total capex announced by the new
minister for MoR (Ministry of Railways) in the 12th FYP earlier in April this
year.
Transport and Auto stocks have seen downgrades to their revenue forecasts for
the next two years, and their growth estimates look slightly below the average
growth achieved since 2003. In Transport, this is likely due to overcapacity
issues and expectations of soft demand in China and globally. Revisions in
Autos seem to be largely stock specific, and in this case look to be particularly
driven by Dongfeng Motor Group.
Estimates for Utilities and Tech stocks (only 3 companies in the index –
Kingboard, Lenovo and ZTE), have moved in line with the market i.e. they have
been upgraded for 2011 and downgraded for the next year. For both sectors,
they look low compared to the historical average.
Tying this into the overall macro trends, consensus seems to have fully bought
into the idea of the Chinese economy “rebalancing” away from fixed asset
investment into consumption. For example, the pessimism in revenue growth in
Capital goods, with top line CAGR of 15% over the next two years (2011-13), is
more than 10% lower than the historical average since 2003.
Nevertheless, analysts seem optimistic that weaker fixed asset investment
growth should have no bearing on commodity prices and volumes in the
Materials sector and analysts continue to forecasts strong revenue growth for the
sector in 2011.
Conversely the consensus is already optimistic about the revenues for retailers
and forecasting a CAGR of 21% over the next two years. However this is not
extended to Telcos, which although often seen as consumer plays, are negatively
impacted by the high penetration rates and very strong competition in the
Chinese market.
Turning to margins, we start by looking at a crude measure of pricing power at
the market level i.e. CPI – PPI. Companies may not feel margin pressure due to
higher costs if they have the ability to pass these on. The gap between CPI and
PPI has been negative in China since the beginning of 2010, suggesting that
margins for most companies have been under pressure due to higher costs. But
the rising trend and current levels (just below zero) indicate that this is
improving. This probably reflects to some extent in analyst forecasts as they
have been less aggressive in downgrading their 2012 margins forecasts relative
to 2011.
Margin estimates for both 2011 and 2012 have gone down by around 100 and 75
basis points respectively at the market level. It appears that analysts expect
slower economic growth to be reflected more through margin compression than
revenue slowdown for most sectors.
At the sector level, Capital Goods is the only sector out of the nine that we look
at which has seen upward revisions to its margin forecasts, albeit modest, for
both 2011 and 2012. The forecasts do not look too high relative to history for
both years.
Margins for Energy and Materials over the next two years have been
downgraded the most, by more than 100 basis points for each year. Interestingly,
these are the sectors that have seen the biggest upgrades to their revenue
estimates for 2011. While margins are expected to remain flat for Energy stocks
over the next two years, they are expected to rise for the Materials despite cuts
this year.
As we also highlighted earlier, Autos and Transport have seen the least change
to their margin forecasts since January this year. Analysts are now forecasting
flat margins for Autos and a moderate pickup in Transport sector over the next
two years. While, these estimates look close to the top end of their historical
range and the post sub-prime peak for Autos, in Transport they are lower and
look more reasonable.
Both Telcos and Tech have seen cuts to their margin forecasts this year, in line
with the market, and their margins are expected to remain flat over the next two
years. For both these sectors, they look closer to the lower end of their historical
range.
Similarly Retailing and Utilities stocks have also seen their margin forecasts
being downgraded this year. In both sectors, forecasts still look high - close to
post sub-prime peak for Utilities and highest since 2003 for Retailers.
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