Infrastructure - India Stress test for winter of orders & profits 􀂄BofA Merrill Lynch,

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Infrastructure - India
Stress test for winter of orders
& profits
􀂄 1H’12 stocks to struggle – low business confidence;
leverage; global risk
We remain cautious on Indian Infra sectors as we believe: a) high inflation and interest
rates (12 hikes in 18 months), b) domestic policy paralysis, c) lack of protection for
domestic industry, d) global macro turmoil and e) 2QFY12 business confidence below
2HFY09 could dry-up orders & impact FY13 earnings. Any rate cut in mid-2012 is
unlikely to sink into P&L before 4QFY13 on hidden inflation & delay in transmission.
Consequently, we not only cut our order inflows, EPS & POs to align them to the
deteriorated macro but also present our worst case analysis should the India / world go
into double-dip & business deteriorates. Stay defensive in 1H with MSEZ, ILFT, JPVL
and NTPC, while risk-on investment ideas include JPA, RELI, & SUEL..
Stress-testing risk-reward for E&C, Utilities and Infra developers
We believe leverage has been the single biggest reason for stock declines - 4 of
the 5 worst performing stocks have high leverage. Given the macro gyrations
globally & deteriorating balance sheets in India, we have done a stress-test of the
Infra stocks. Our stress-tests look at both likely downside to our current earnings
estimates, as well as possible contractions in valuations in an environment where
risk premium expands. A summary of our expectations is in Table 2 (see page 3).
Winter of order @ E&C; Cut L&T EPS; earnings CAGR at 6%
(current: 14%)
Expect E&C cos incl. L&T to report YoY decline in 3Q / 2H order inflows on weak
business confidence. We think the custom rebound in capex in 4Q shall be led by PSUs
with good balance sheets as Pvt. developer finances are stretched v/s FY09 (Chart 2)
and equity markets are closed. We cut L&T’s FY12 inflow to -5% v/s 5% on loss of big
ticket orders and fall in Industrial capex. We model an E&C sector FY11-13 EPS CAGR
of 14%. In a stress scenario, the EPS CAGR 6% v/s FY08-10 (Lehman crisis) was 19%.
In sum, we think the problem is in India this time.
Profitless prosperity @ developers
Aggressive bids and a lack of equity will likely increase the leverage of developers
(2x over FY11-14E, Chart 2). Net D/E ~3x, may push them to do value dilutive
assured return (+20%) PE deals with open-ended dilutions (GMR, GVK). So,
while their regulatory leverage is not a worry, we believe their structured debt is.
Stock picks: Stocks which factor-in the worst and ones that don’t
1. In the current risk-averse environment, limited downside risk stocks are MSEZ,
ILFT, JPVL & NTPC. These are defensive/high growth stocks, though not cheap.
2. Stocks with unfavorable risks: rewards are ABB IN, GMRI IN and LANCI IN.
3. In event of interest rate indeed peak, first the quality (LT IN) may move. Highrisk,
high-reward plays are JPA, RELI, LANCI, IVRC and SUEL. While they have
high upside potential, they need a "risk on" environment where investors are more
willing to tolerate their high-gearing. However, not all 0.5x P/BV stocks may go up
equally. We choose these stocks based on a) turn in core business, b) completion
o f large capex and c) stated deleveraging strategy.