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Executive Summary
Indian equity markets were weak even before the global sell-off commenced in August, and have since followed the regional
correction. On a year-to-date basis, this has made India one of the worst performing equity and currency markets in Asia.
While the earlier weakness was as a result of India-specific factors (growth weakness, stubborn inflation, reform paralysis, and
governance scandals), the latest bout of weakness can best be explained by acute global risk aversion. However, despite the
accumulation of headwinds in recent quarters the economy's resilience has been impressive, particularly in the services and
trade sectors. Despite the high inflation and rising interest rates, consumption demand remains stable and India’s rural
economy remains on a solid footing.
However we expect headwinds from global conditions and lagged implications of domestic policy tightening are likely to lead
to slower growth in the quarters ahead. The next couple of quarters will be crucial and any likely pick-up in project execution
(aside from the interest rate dynamics) could be crucially linked to the sentiment factor. The government thus, on its part,
needs to move ahead with reform measures. Nevertheless, we believe that part of the investor concerns in relation to lower
growth and a lack of project execution are now priced in, as evidenced by India’s sustained underperformance versus other
Emerging Markets since the beginning of the year. As such, we expect a combination of monetary and government policy
action to bring some confidence back and to help capex growth momentum into the second half of financial year 2013.
With the exception of a further sharp rise in oil prices and a potential runaway increase in already elevated commodity prices,
we expect to see a gradual recovery in the domestic macro situation as we head into the second half of financial year 2013.
Equity Outlook
In this backdrop, we believe equity markets will mirror the economic recovery. We expect inflation to come down to ~7.5-8%
levels by March 2012, post which we expect Reserve Bank to start the monetary easing which should drive the economic
growth. We expect market recovery to be back ended and should see Sensex inching up only by latter half of the next year.
Fixed Income Outlook
As far as interest rates are concerned, both domestic as well as international factors indicate towards a bullish bias.
Domestically, slower GDP growth combined with fall in inflation may cause RBI to cuts interest rate in Q1 or Q2 of FY2013. At
the same time slower growth in the Emerging Markets along with any shocks coming from the Euro zone countries due to the
sovereign debt crisis may lead to continued lower interest rates of safe haven economies. This presents a very attractive
opportunity for investors in fixed income markets with a time horizon of 6 months or more as there could be a sharp fall in
interest rates in the next 2 to 3 quarters. However, in case fiscal deficit continues to be high or if there is a sharp upwards
movement in commodities prices globally, the fall in interest rates could be moderate.
The Indian Economy
Slowing GDP Growth Trend
India has generated considerable attention as an investment destination driven by its unique domestic consumption model,
attractive demography and low correlation with global GDP growth. Barring the global economic crisis years (2008-2009),
India’s GDP growth has averaged 9% over past 5 years. While we are not forecasting a slowdown in India’s long term GDP
growth trajectory, we believe that policy uncertainties, the conflicting demands of a popular democracy on the government
(particularly during busy state election years) and India Inc’s rising despondency, are increasing the risk of India’s - medium
term - GDP trajectory slowing towards the 7% level from the average 9% over past five years (ex- crisis period).
These concerns can be alleviated and the risk reduced considerably if (1) global commodity prices come off (2) clarity
emerges on coal supply bottlenecks and revision in power tariffs by state electricity boards (3) return of India Inc’s business
confidence and inclination to invest. Currently, consumption from the Indian hinterland is doing the heavy lifting for the Indian
economy. The Government’s politically strategic inclusive growth initiatives are driving prosperity in the Indian hinterland.
Moving away from the path of Fiscal Consolidation
India‘s fiscal situation has deteriorated sharply since the credit crisis. For FY12, we expect India‘s consolidated fiscal deficit
(including off-budget items) to remain high at 5.7% of GDP (excluding state deficits) in the wake of slowing revenue growth
and lack of expenditure management by the government, compared with 5.1% of GDP in FY11 (including auction of telecom
licence). The fiscal situation has been exacerbated by a combination of high crude oil price and a weak rupee leading to
higher subsidy pay outs by the government.
Private corporate capex to remain weak
Investments have slowed sharply over the past few months, owing to (a) weak investor confidence on governance issues, (b)
higher interest rates and higher inflationary pressures, (c) hindrances to project execution, (d) uncertainty about the global
economy and (e) weak global capital markets. During the credit crisis, private corporate capex slowed to 11.5% of GDP in
FY09 from a peak of 17.3% of GDP in FY08. While it recovered to 13.2% of GDP in FY10 and to 14% of GDP (Macquarie
Research estimate) in FY11, it remains way below the peak.
Sector Outlook
Auto:
The macro environment for the Indian Automotive Sector continues to look challenging with a sluggish demand outlook
coupled with intense competition and high cost pressure. Auto Demand in India has been negatively impacted by:
• Monetary action by RBI with a hike in policy rates (200bps since Jan-11) has impacted passenger and commercial vehicle
segment demand
• 20% increase in petrol prices along with a price difference (~Rs25/ltr) between diesel and petrol has impacted demand for
petrol vehicles
Demand for automobiles in the first half of 2012 would continue to remain weak due to a low growth outlook, high interest
rates and fuel prices. Within the automobile space passenger cars and medium and heavy commercial vehicles are likely to
be the worst hit. In the case of cars, lack of major demand catalysts such as 6th pay commission implementation and PSU pay
revision, etc, coupled with rising interest rates and inflationary stress will continue to weigh on demand outlook over the next
few quarters. Demand for Medium and Heavy Commercial Vehicles will be impacted by a slowdown in economic activity,
rising interest rates and pressure on transporters’ profitability. However, LCV (light commercial vehicles) and MPV (multi
purpose vehicles) continue to grow strongly due to structural changes in intra-city goods transport like hub-spoke models and
replacement of three wheeler goods carriers. Two-wheeler sales have continued to remain robust, driven by rural demand.
Going forward we expect sales growth for two wheelers to moderate on account of a demanding base effect.
We expect a recovery in car demand in the second half of CY2012 as interest rates and inflationary pressures begin to
moderate. Improvement in CV typically lags consumer driven sectors such as cars and hence we do not expect any
meaningful improvement in M&H CV demand during CY2012.
Metals
Demand growth for Metals in India has slowed down significantly over the last few quarters amidst growing concerns on
inflation and availability of raw materials. We expect this situation to continue in the near term as inflation is yet to be
controlled and concerns on raw material availability persist. The slowdown in demand is reflected in the form of lower sales
volumes and pressure on prices.
Further, evolving Indian government policies and a highly active judiciary have added to uncertainty for both existing and
upcoming projects. A 26% tax on profits/amount equal to royalty has been proposed to be levied as part of the upcoming
Mining Policy. This has the potential to reduce earnings by 2–10% for most companies. The recent ban on iron ore mining in
Karnataka, enquiries in Goa and efforts to limit the sale of iron ore from Orissa have made near-term projections difficult. The
new land acquisition bill can also increase costs for the company.
We expect a pick up in domestic demand for metals towards second half of FY2013 due to a combination of a recovery in
infrastructure spending and corporate capex and a reduction in interest rates. In the near term we expect prices of metals
continue to be volatile due to an uncertain outlook on the global economy and concerns of a slow-down in China. We would
prefer to be invested in companies with a higher degree of raw material integration to protect against cost pressures.
Cement
While peak capacity addition in the cement industry is behind us, the concern looming in the near term is the low visibility of
demand growth. The Indian cement market remains highly oversupplied and is operating at around 75% capacity utilization.
However, overall prices have held up much higher than can be explained given current low capacity utilization levels in the
industry. Moreover, cement prices continue to increase across most regions in the country without any meaningful increase in
demand. Cement companies have successfully maintained/increased prices by compromising on capacity utilization. Hence it
is supply cuts rather than demand that have driven cement prices higher over the last couple of months. Therefore, in order for
cement prices to sustain, it is critical that supply discipline continues while the overcapacity situation persists. While we do
expect the current down cycle in cement to have better margins than previous down-cycles, supply discipline is a difficult
variable to predict given low utilization rates.
Cost pressures for the cement industry are likely to remain elevated due to higher imported coal prices on account of rupee
depreciation and lower availability of coal from Coal India. However, we expect margins for most cement companies to be
supported by increases in cement prices across most regions. We also expect improved Y-o-Y demand during the 1st half of
CY2012 on likely revival in rural housing and infrastructure segments and a low base effect.
Industrials
2011 has not been a good year for the Industrial sector as the sector has underperformed the broader market indices by a
considerable margin. We expect 2012 to be similar with problems related to high inflation and thus the corresponding high
interest rates to eat up on companies’ net margins and slow down the demand for capital goods. We do not expect the
industrial capex cycle to revive any time soon as fears of global recession coupled with high interest rates and stalling of
government reforms lead companies to rethink their expansion plans.
Power sector capacity addition has been the major growth driver for order inflows of some of the bigger construction and
capital goods companies till mid of 2011, we do not think that this will continue in 2012 due to various bottlenecks encountered
by generation utilities. These bottlenecks in the form of lack of environment clearance, non-availability of coal, poor financial
health of SEBs, non-availability of water, land acquisition and huge surge in the prices of international coal cannot be
addressed in a short span of time. This will impact companies order inflows and future growth.
On the construction sector, there has been some movement in awarding contracts for road construction by NHAI but because
of lack of opportunities in the other sectors, various construction companies have been very aggressive toward bidding for
these projects. We expect some of these projects to generate negative NPV for the asset owner. We expect competition to
remain stiff in the sector till other industrial and commercial projects pick-up which is unlikely in 2012.
Banking and Financial Services
Last year, profitability of public sector banks was mainly driven by robust credit demand and increasing/stable net interest
margins (NIMs). Lending rates were re-priced ahead of the deposit rates in a tightening cycle resulting in higher net interest
margins which helped banks to offset increase in the provisioning costs for non-performing loans as well as the higher
operating costs resulting from pension expense. Profitability of private sector banks was largely driven by declining credit
costs.
Going ahead, we expect that the combination of factors including high interest rates, hindrances to project execution,
deteriorating business confidence and uncertainty about the global economy to negatively impact investment demand and
consequently banking sector will witness slowdown in credit growth. At the same time, asset quality of banks is expected to
deteriorate in next 12 months as debt servicing capability of corporates will be negatively impacted due to high interest rates
and input prices and weak domestic & international demand.
NIMs have peaked & will likely be under pressure next year even if interest rate cycle reverses as deposits generally re-price
with lag effect. Margin pressure coupled with moderation in loan book & rising credit costs will slow down the earnings growth
for the banking sector. Hence, we prefer banks with strong liability franchise and seasoned book with good asset quality which
shall lower risk of earnings downgrade.
Healthcare
Improving healthcare infrastructure, coupled with rising disposable income and increasing penetration of health insurance, will
aid the domestic formulations drug market in India to grow by a CAGR of 13%-14% in the coming years. The growth will
largely stem from chronic ailments like diabetes, cardiovascular and neurology, which are witnessing a sharp rise in disease
instances and longer treatment cycle (with early onsets).
While the Indian market will continue to be the bread and butter for Indian generic companies’ earnings, it is their presence
across the global market—both developed and developing—that will aid companies boost their overall growth momentum
going forward. With drugs worth US$ 80-90bn losing patent over the next 4-5 years the US market remains the primary market
for Indian companies, despite the intensifying competition. US generic market is expected to touch US$ 51.7bn by 2015 from
~US $ 38bn in 2010. Of this the current share of top 6 Indian companies is not more than US $2.5bn. We believe that Indian
companies are well placed to tap this opportunity given that they have healthy pipeline of ANDA filings (30% market share),
including a substantial presence in Para IVs and FTFs, DMF Filings (50% market share) and highest number of US FDA
approved facility outside US (100). Post the patent cliff in the US we expect emerging market to remain a key growth driver in
the longer term with a number of MNCs tie-ups. These markets have strong growth prospects, high profitability, low price
control and high out-of-pocket expenses. Presence in the right market would be important.
On this backdrop of multiple earnings opportunities targeted by the Indian companies, we continue to remain positive on the
sector and believe that the valuation premium that it enjoys is justified. Stock selection would be of utmost important to pick
the winners from the sector.
Oil & Gas
With the world delicately balanced between growth (but at slower growth rates) in China/India, increasing risk-aversion due to
concerns on Euro-zone and the US still struggling to grow sustainably, oil prices have remained range bound and are
expected to moderate going further. Despite crude prices having been range bound and product price hikes/duty cuts in end-
July curtailing losses partially, the under-recoveries on subsidised fuels remain high due to a sharp depreciation of the rupee
which has made imports costlier. A weak government fiscal situation has meant that Rs300bn of cash reimbursements
promised to Oil Marketing Companies are yet to be disbursed, which has caused the working capital requirements (and hence
interest costs) to balloon. While the government has stuck to 33% sharing by upstream firms for H1FY12, with the ONGC FPO
being delayed there is the likelihood of a higher share being borne by ONGC/Oil India/GAIL in H2FY12E, which could hurt net
realizations.
With high distillate cracks (US$13-17/bbl), naphtha/fuel oil cracks also improving due to a few refinery shutdowns in Asia,
Singapore GRMs have jumped to 10 year highs. Indian operational GRMs have risen much lesser due to refineries being
more leveraged to Diesel (vs. Gasoline which in case of Singapore, which has had higher cracks), but with Gasoline cracks
plummeting the situation is set to reverse. However, inventory and forex losses could continue to hurt reported GRMs.
The Comptroller & Auditor General (CAG) issues with Reliance Industries, subsidy concerns due to rupee depreciation, high
inflation and a weak fiscal situation have caused stock valuations to drop; presenting value in a weak market. A push towards
reforms may be the catalyst needed for stocks to re-rate.
Information Technology
The IT sector in India has performed well in 2011 in spite of the global headwinds. The demand has remained resilient and
while margin pressure was quite visible in the first half, significant depreciation of rupee against US$ and GBP in the latter half
of 2011 led to easing of margin pressure. Rupee has depreciated almost 15% against US$ and ~10% against GBP in the last
six months leading to both higher revenue growth in rupee term as well as improvement in margins.
Going forward, a lot would depend on how the global economies shape up. A deeper crisis in Euro zone can lead to significant
pressure for Indian IT services companies. Demand in US has remained strong so far but any macro shock to the slowly
recovering economy will have a detrimental impact on IT demand. While weakening currency will provide some cushion to the
profits, strength in demand will remain the main catalyst. We remain cautious on IT sector given the macro challenges facing
the global economies and expensive valuations relative to the market.
Telecom
Telecom sector has suffered significantly due to the regulatory uncertainties in the past one year and the trend does not seem
to be reversing even in the immediate future. However, easing of competitive intensity has allowed some bit of tariff
rationalisation which should provide much needed relief to most operators reeling under losses. In fact, Telecom will be one of
the few sectors with good earning visibility in the next one year driven by improvement in margins.
We also expect New Telecom Policy to be finalised and implemented in 2012 which should lead to some clarity on the
regulatory stance. However, valuations are expensive and to an extent, already discounting the better earning visibility. In this
backdrop, we are neutral on the sector with a bias towards large operators.
Consumer Staples
2011 will be a formidable base for volume growth of FMCG sector. The price hikes taken during the year on continuously
escalating cost pressures has gone unscathed till now, with minimal down trading. Further rise in crude oil price and a
depreciating rupee, might have limited scope to be passed on.
In 2012, we see under penetrated categories, such as skin care (20% penetration) and Packaged food (10% penetration), to
drive the sector growth. We expect category volume growths to taper off towards their respective long term averages, because
of a higher base. We foresee well diversified players to continue to weather cost pressures through supply chain efficiencies
and Advertising and Promotion (A&P) expense rationing.
Utilities
Power: 2011 saw the beginning of, power distribution reforms in the form of price hikes and, power generation uncertainties
with coal sourcing. We expect 2012, to see policy initiatives on coal sourcing and mining because of immediate coal shortage.
On distribution reforms, we expect more states to announce price hikes. We don’t expect any “Transmission and Distribution
(T&D) loss reduction” initiatives like distribution franchising etc., in 2012, because of its political implications, though they are
very much on the anvil.
Gas: 2011 saw supply exhaustion on imported LNG, with capacity utilization at 115%. Capacity augmentation has already
started, but we expect them to become operational by 2013. Also, with no immediate ramp up in gas output from KG basin, we
expect gas transmission volume growth to remain tepid next year. City Gas transportation can see additional license issue
next year, in Ludhiana, Jalandhar, Asansol-Durgapur, Jamnagar, to name a few.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Executive Summary
Indian equity markets were weak even before the global sell-off commenced in August, and have since followed the regional
correction. On a year-to-date basis, this has made India one of the worst performing equity and currency markets in Asia.
While the earlier weakness was as a result of India-specific factors (growth weakness, stubborn inflation, reform paralysis, and
governance scandals), the latest bout of weakness can best be explained by acute global risk aversion. However, despite the
accumulation of headwinds in recent quarters the economy's resilience has been impressive, particularly in the services and
trade sectors. Despite the high inflation and rising interest rates, consumption demand remains stable and India’s rural
economy remains on a solid footing.
However we expect headwinds from global conditions and lagged implications of domestic policy tightening are likely to lead
to slower growth in the quarters ahead. The next couple of quarters will be crucial and any likely pick-up in project execution
(aside from the interest rate dynamics) could be crucially linked to the sentiment factor. The government thus, on its part,
needs to move ahead with reform measures. Nevertheless, we believe that part of the investor concerns in relation to lower
growth and a lack of project execution are now priced in, as evidenced by India’s sustained underperformance versus other
Emerging Markets since the beginning of the year. As such, we expect a combination of monetary and government policy
action to bring some confidence back and to help capex growth momentum into the second half of financial year 2013.
With the exception of a further sharp rise in oil prices and a potential runaway increase in already elevated commodity prices,
we expect to see a gradual recovery in the domestic macro situation as we head into the second half of financial year 2013.
Equity Outlook
In this backdrop, we believe equity markets will mirror the economic recovery. We expect inflation to come down to ~7.5-8%
levels by March 2012, post which we expect Reserve Bank to start the monetary easing which should drive the economic
growth. We expect market recovery to be back ended and should see Sensex inching up only by latter half of the next year.
Fixed Income Outlook
As far as interest rates are concerned, both domestic as well as international factors indicate towards a bullish bias.
Domestically, slower GDP growth combined with fall in inflation may cause RBI to cuts interest rate in Q1 or Q2 of FY2013. At
the same time slower growth in the Emerging Markets along with any shocks coming from the Euro zone countries due to the
sovereign debt crisis may lead to continued lower interest rates of safe haven economies. This presents a very attractive
opportunity for investors in fixed income markets with a time horizon of 6 months or more as there could be a sharp fall in
interest rates in the next 2 to 3 quarters. However, in case fiscal deficit continues to be high or if there is a sharp upwards
movement in commodities prices globally, the fall in interest rates could be moderate.
The Indian Economy
Slowing GDP Growth Trend
India has generated considerable attention as an investment destination driven by its unique domestic consumption model,
attractive demography and low correlation with global GDP growth. Barring the global economic crisis years (2008-2009),
India’s GDP growth has averaged 9% over past 5 years. While we are not forecasting a slowdown in India’s long term GDP
growth trajectory, we believe that policy uncertainties, the conflicting demands of a popular democracy on the government
(particularly during busy state election years) and India Inc’s rising despondency, are increasing the risk of India’s - medium
term - GDP trajectory slowing towards the 7% level from the average 9% over past five years (ex- crisis period).
These concerns can be alleviated and the risk reduced considerably if (1) global commodity prices come off (2) clarity
emerges on coal supply bottlenecks and revision in power tariffs by state electricity boards (3) return of India Inc’s business
confidence and inclination to invest. Currently, consumption from the Indian hinterland is doing the heavy lifting for the Indian
economy. The Government’s politically strategic inclusive growth initiatives are driving prosperity in the Indian hinterland.
Moving away from the path of Fiscal Consolidation
India‘s fiscal situation has deteriorated sharply since the credit crisis. For FY12, we expect India‘s consolidated fiscal deficit
(including off-budget items) to remain high at 5.7% of GDP (excluding state deficits) in the wake of slowing revenue growth
and lack of expenditure management by the government, compared with 5.1% of GDP in FY11 (including auction of telecom
licence). The fiscal situation has been exacerbated by a combination of high crude oil price and a weak rupee leading to
higher subsidy pay outs by the government.
Private corporate capex to remain weak
Investments have slowed sharply over the past few months, owing to (a) weak investor confidence on governance issues, (b)
higher interest rates and higher inflationary pressures, (c) hindrances to project execution, (d) uncertainty about the global
economy and (e) weak global capital markets. During the credit crisis, private corporate capex slowed to 11.5% of GDP in
FY09 from a peak of 17.3% of GDP in FY08. While it recovered to 13.2% of GDP in FY10 and to 14% of GDP (Macquarie
Research estimate) in FY11, it remains way below the peak.
Sector Outlook
Auto:
The macro environment for the Indian Automotive Sector continues to look challenging with a sluggish demand outlook
coupled with intense competition and high cost pressure. Auto Demand in India has been negatively impacted by:
• Monetary action by RBI with a hike in policy rates (200bps since Jan-11) has impacted passenger and commercial vehicle
segment demand
• 20% increase in petrol prices along with a price difference (~Rs25/ltr) between diesel and petrol has impacted demand for
petrol vehicles
Demand for automobiles in the first half of 2012 would continue to remain weak due to a low growth outlook, high interest
rates and fuel prices. Within the automobile space passenger cars and medium and heavy commercial vehicles are likely to
be the worst hit. In the case of cars, lack of major demand catalysts such as 6th pay commission implementation and PSU pay
revision, etc, coupled with rising interest rates and inflationary stress will continue to weigh on demand outlook over the next
few quarters. Demand for Medium and Heavy Commercial Vehicles will be impacted by a slowdown in economic activity,
rising interest rates and pressure on transporters’ profitability. However, LCV (light commercial vehicles) and MPV (multi
purpose vehicles) continue to grow strongly due to structural changes in intra-city goods transport like hub-spoke models and
replacement of three wheeler goods carriers. Two-wheeler sales have continued to remain robust, driven by rural demand.
Going forward we expect sales growth for two wheelers to moderate on account of a demanding base effect.
We expect a recovery in car demand in the second half of CY2012 as interest rates and inflationary pressures begin to
moderate. Improvement in CV typically lags consumer driven sectors such as cars and hence we do not expect any
meaningful improvement in M&H CV demand during CY2012.
Metals
Demand growth for Metals in India has slowed down significantly over the last few quarters amidst growing concerns on
inflation and availability of raw materials. We expect this situation to continue in the near term as inflation is yet to be
controlled and concerns on raw material availability persist. The slowdown in demand is reflected in the form of lower sales
volumes and pressure on prices.
Further, evolving Indian government policies and a highly active judiciary have added to uncertainty for both existing and
upcoming projects. A 26% tax on profits/amount equal to royalty has been proposed to be levied as part of the upcoming
Mining Policy. This has the potential to reduce earnings by 2–10% for most companies. The recent ban on iron ore mining in
Karnataka, enquiries in Goa and efforts to limit the sale of iron ore from Orissa have made near-term projections difficult. The
new land acquisition bill can also increase costs for the company.
We expect a pick up in domestic demand for metals towards second half of FY2013 due to a combination of a recovery in
infrastructure spending and corporate capex and a reduction in interest rates. In the near term we expect prices of metals
continue to be volatile due to an uncertain outlook on the global economy and concerns of a slow-down in China. We would
prefer to be invested in companies with a higher degree of raw material integration to protect against cost pressures.
Cement
While peak capacity addition in the cement industry is behind us, the concern looming in the near term is the low visibility of
demand growth. The Indian cement market remains highly oversupplied and is operating at around 75% capacity utilization.
However, overall prices have held up much higher than can be explained given current low capacity utilization levels in the
industry. Moreover, cement prices continue to increase across most regions in the country without any meaningful increase in
demand. Cement companies have successfully maintained/increased prices by compromising on capacity utilization. Hence it
is supply cuts rather than demand that have driven cement prices higher over the last couple of months. Therefore, in order for
cement prices to sustain, it is critical that supply discipline continues while the overcapacity situation persists. While we do
expect the current down cycle in cement to have better margins than previous down-cycles, supply discipline is a difficult
variable to predict given low utilization rates.
Cost pressures for the cement industry are likely to remain elevated due to higher imported coal prices on account of rupee
depreciation and lower availability of coal from Coal India. However, we expect margins for most cement companies to be
supported by increases in cement prices across most regions. We also expect improved Y-o-Y demand during the 1st half of
CY2012 on likely revival in rural housing and infrastructure segments and a low base effect.
Industrials
2011 has not been a good year for the Industrial sector as the sector has underperformed the broader market indices by a
considerable margin. We expect 2012 to be similar with problems related to high inflation and thus the corresponding high
interest rates to eat up on companies’ net margins and slow down the demand for capital goods. We do not expect the
industrial capex cycle to revive any time soon as fears of global recession coupled with high interest rates and stalling of
government reforms lead companies to rethink their expansion plans.
Power sector capacity addition has been the major growth driver for order inflows of some of the bigger construction and
capital goods companies till mid of 2011, we do not think that this will continue in 2012 due to various bottlenecks encountered
by generation utilities. These bottlenecks in the form of lack of environment clearance, non-availability of coal, poor financial
health of SEBs, non-availability of water, land acquisition and huge surge in the prices of international coal cannot be
addressed in a short span of time. This will impact companies order inflows and future growth.
On the construction sector, there has been some movement in awarding contracts for road construction by NHAI but because
of lack of opportunities in the other sectors, various construction companies have been very aggressive toward bidding for
these projects. We expect some of these projects to generate negative NPV for the asset owner. We expect competition to
remain stiff in the sector till other industrial and commercial projects pick-up which is unlikely in 2012.
Banking and Financial Services
Last year, profitability of public sector banks was mainly driven by robust credit demand and increasing/stable net interest
margins (NIMs). Lending rates were re-priced ahead of the deposit rates in a tightening cycle resulting in higher net interest
margins which helped banks to offset increase in the provisioning costs for non-performing loans as well as the higher
operating costs resulting from pension expense. Profitability of private sector banks was largely driven by declining credit
costs.
Going ahead, we expect that the combination of factors including high interest rates, hindrances to project execution,
deteriorating business confidence and uncertainty about the global economy to negatively impact investment demand and
consequently banking sector will witness slowdown in credit growth. At the same time, asset quality of banks is expected to
deteriorate in next 12 months as debt servicing capability of corporates will be negatively impacted due to high interest rates
and input prices and weak domestic & international demand.
NIMs have peaked & will likely be under pressure next year even if interest rate cycle reverses as deposits generally re-price
with lag effect. Margin pressure coupled with moderation in loan book & rising credit costs will slow down the earnings growth
for the banking sector. Hence, we prefer banks with strong liability franchise and seasoned book with good asset quality which
shall lower risk of earnings downgrade.
Healthcare
Improving healthcare infrastructure, coupled with rising disposable income and increasing penetration of health insurance, will
aid the domestic formulations drug market in India to grow by a CAGR of 13%-14% in the coming years. The growth will
largely stem from chronic ailments like diabetes, cardiovascular and neurology, which are witnessing a sharp rise in disease
instances and longer treatment cycle (with early onsets).
While the Indian market will continue to be the bread and butter for Indian generic companies’ earnings, it is their presence
across the global market—both developed and developing—that will aid companies boost their overall growth momentum
going forward. With drugs worth US$ 80-90bn losing patent over the next 4-5 years the US market remains the primary market
for Indian companies, despite the intensifying competition. US generic market is expected to touch US$ 51.7bn by 2015 from
~US $ 38bn in 2010. Of this the current share of top 6 Indian companies is not more than US $2.5bn. We believe that Indian
companies are well placed to tap this opportunity given that they have healthy pipeline of ANDA filings (30% market share),
including a substantial presence in Para IVs and FTFs, DMF Filings (50% market share) and highest number of US FDA
approved facility outside US (100). Post the patent cliff in the US we expect emerging market to remain a key growth driver in
the longer term with a number of MNCs tie-ups. These markets have strong growth prospects, high profitability, low price
control and high out-of-pocket expenses. Presence in the right market would be important.
On this backdrop of multiple earnings opportunities targeted by the Indian companies, we continue to remain positive on the
sector and believe that the valuation premium that it enjoys is justified. Stock selection would be of utmost important to pick
the winners from the sector.
Oil & Gas
With the world delicately balanced between growth (but at slower growth rates) in China/India, increasing risk-aversion due to
concerns on Euro-zone and the US still struggling to grow sustainably, oil prices have remained range bound and are
expected to moderate going further. Despite crude prices having been range bound and product price hikes/duty cuts in end-
July curtailing losses partially, the under-recoveries on subsidised fuels remain high due to a sharp depreciation of the rupee
which has made imports costlier. A weak government fiscal situation has meant that Rs300bn of cash reimbursements
promised to Oil Marketing Companies are yet to be disbursed, which has caused the working capital requirements (and hence
interest costs) to balloon. While the government has stuck to 33% sharing by upstream firms for H1FY12, with the ONGC FPO
being delayed there is the likelihood of a higher share being borne by ONGC/Oil India/GAIL in H2FY12E, which could hurt net
realizations.
With high distillate cracks (US$13-17/bbl), naphtha/fuel oil cracks also improving due to a few refinery shutdowns in Asia,
Singapore GRMs have jumped to 10 year highs. Indian operational GRMs have risen much lesser due to refineries being
more leveraged to Diesel (vs. Gasoline which in case of Singapore, which has had higher cracks), but with Gasoline cracks
plummeting the situation is set to reverse. However, inventory and forex losses could continue to hurt reported GRMs.
The Comptroller & Auditor General (CAG) issues with Reliance Industries, subsidy concerns due to rupee depreciation, high
inflation and a weak fiscal situation have caused stock valuations to drop; presenting value in a weak market. A push towards
reforms may be the catalyst needed for stocks to re-rate.
Information Technology
The IT sector in India has performed well in 2011 in spite of the global headwinds. The demand has remained resilient and
while margin pressure was quite visible in the first half, significant depreciation of rupee against US$ and GBP in the latter half
of 2011 led to easing of margin pressure. Rupee has depreciated almost 15% against US$ and ~10% against GBP in the last
six months leading to both higher revenue growth in rupee term as well as improvement in margins.
Going forward, a lot would depend on how the global economies shape up. A deeper crisis in Euro zone can lead to significant
pressure for Indian IT services companies. Demand in US has remained strong so far but any macro shock to the slowly
recovering economy will have a detrimental impact on IT demand. While weakening currency will provide some cushion to the
profits, strength in demand will remain the main catalyst. We remain cautious on IT sector given the macro challenges facing
the global economies and expensive valuations relative to the market.
Telecom
Telecom sector has suffered significantly due to the regulatory uncertainties in the past one year and the trend does not seem
to be reversing even in the immediate future. However, easing of competitive intensity has allowed some bit of tariff
rationalisation which should provide much needed relief to most operators reeling under losses. In fact, Telecom will be one of
the few sectors with good earning visibility in the next one year driven by improvement in margins.
We also expect New Telecom Policy to be finalised and implemented in 2012 which should lead to some clarity on the
regulatory stance. However, valuations are expensive and to an extent, already discounting the better earning visibility. In this
backdrop, we are neutral on the sector with a bias towards large operators.
Consumer Staples
2011 will be a formidable base for volume growth of FMCG sector. The price hikes taken during the year on continuously
escalating cost pressures has gone unscathed till now, with minimal down trading. Further rise in crude oil price and a
depreciating rupee, might have limited scope to be passed on.
In 2012, we see under penetrated categories, such as skin care (20% penetration) and Packaged food (10% penetration), to
drive the sector growth. We expect category volume growths to taper off towards their respective long term averages, because
of a higher base. We foresee well diversified players to continue to weather cost pressures through supply chain efficiencies
and Advertising and Promotion (A&P) expense rationing.
Utilities
Power: 2011 saw the beginning of, power distribution reforms in the form of price hikes and, power generation uncertainties
with coal sourcing. We expect 2012, to see policy initiatives on coal sourcing and mining because of immediate coal shortage.
On distribution reforms, we expect more states to announce price hikes. We don’t expect any “Transmission and Distribution
(T&D) loss reduction” initiatives like distribution franchising etc., in 2012, because of its political implications, though they are
very much on the anvil.
Gas: 2011 saw supply exhaustion on imported LNG, with capacity utilization at 115%. Capacity augmentation has already
started, but we expect them to become operational by 2013. Also, with no immediate ramp up in gas output from KG basin, we
expect gas transmission volume growth to remain tepid next year. City Gas transportation can see additional license issue
next year, in Ludhiana, Jalandhar, Asansol-Durgapur, Jamnagar, to name a few.
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