“Accumulate” India
[Elara Rating Guide: “Accumulate” indicates positive bias in
fundamentals with a five to 15% upside]
2012: Year of turning points
It was on January 10, 2008 that the Indian market hit its all-time high.
Today, 4 ½ years hence and potentially the longest bear market, we
see reason to turn mildly bullish on Indian equities. The cliché - ‘Wall of
Worries’ will get conquered this year and 2012 might well be the year
where the economic variables of the nation will see the maximum
turning points in Peak inflation, Interest rates, Fiscal deficit, Current
account deficit and the lows of GDP, IIP and INR, all of which will likely
turn favorable in 2013.
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INR depreciation: An upshot to growth
We see the INR depreciation, as the biggest reform move (by design or
default) by the current government. We have attempted to model the
Indian economy to check for the exchange rate sensitivity of real
output and our estimates from the long-form model shows that a 10%
devaluation of the currency yields a 90bps direct impact on the
domestic growth. The second round impact on the manufacturing
sector is difficult to quantify but crude estimates suggest ~70bps rise in
overall growth (depends on the corresponding multiplier effect). GDP
growth may well get supported in the above context.
Market capitulation unlikely
Quite contrary to popular belief, the Nifty / Sensex earnings are
positively pre-disposed to a weak rupee. Our bottom-up analyses of
companies suggest that 2013 earnings will get a positive fillip of 3%
from the currency depreciation. Our Nifty target zone shows us a
range of between 5750 and 5950 in the next 18 months.
Market outlook & investment strategy
The INR at 56 is symptomatic a ‘risk off’ trade also indicating that the
Indian market now is at the lowest PE multiple. The INR at 45 is bubble
territory and would indicate risk in terms of expensive multiples. Today,
the market bottom of 4600 / 4800 is getting well established and we
see little risk of this getting breached even if the Euro Zone issues get
exacerbated. Our Nifty target multiple is in the range of 5750 to 5950.
While it might not represent significant upsides for the FY, it does
indicate that it is time to ‘Accumulate’ India. Our Model Portfolio is
long on the $ and a weak INR. Consumption continues to be the flag
bearer and we see little reason to alter our overweight stance. We are
circumspect of four-wheelers and would hide in the two-wheeler
space. We introduce ‘Zee’ into our portfolio as our top pick.
Sector wise breakup o f impact of depreciation on earnings
Sector Comments
Metals In non ferrous, realizations pegged to LME linked pricing, a direct beneficiary of the currency while majority of the costs
denominated in INR, hence EBITDA margins might expand on depreciation. Most of the companies have capex planned within
the country, hence there is little pressure on cash flows on account of currency movements. While, the Indian steel players
would suffer on rupee depreciation as a major component of their costs are denominated in USD (coking coal imports). While
their realizations are denominated in INR and have been decoupled to an extent from the global steel prices, due to lower
capacity utilizations. On a net basis, metals will have a slightly positive impact as far as Nifty composition goes.
Oil and gas Oil and gas has an outright positive impact as all the constituents (barring the PSU OMCs), integrated player RIL, upstream
plays of Cairn and ONGC. If INR averages 55/60 for the whole FY13, the EPS upside can be 13/19%. Weaker INR will also help
in higher gas realisations in INR terms for RIL and upstream PSUs. Cairn will have a positive EPS impact of 16%/30% on FY13
EPS in case of INR55/60. Currently, Cairn is factoring in USD95/bbl LT oil price
For BPCL, the only Nifty oil and gas stock with a negative impact due to weak INR, though the under-recoveries will mount, the
actual impact will be more through the interim stress on the B/S and high interest costs.
On an overall level, the sectoral impact is positive.
Pharma Pharmaceuticals have a general positive impact because of its business model whereby there is foreign currency denominated
exports improve on exchange rate. Cipla and Sun Pharma have the maximum positive earnings impact while other stocks in
the Nifty basket also have a positive impact
Auto Other than Maruti's, it is net importer to the tune of ~22% of net sales and has its FY13E and FY14E exposure largely
unhedged), all other auto stocks in the Nifty have a positive impact from depreciation. While Bajaj Auto has substantial exports
revenues, it has already hedged 70%-85% of its exports at INR51 for FY13E and INR54-55 for FY14E. Tata Motors will impact
from the currency translation.
FMCG The biggest beneficiaries of INR depreciation are Dabur and marginally ITC while losers are HUL and Asian Paints. However,
simultaneous correction in commodities which are $ denominated like crude and its derivatives (palm oil, chemicals) negates
the impact of INR depreciation (Scenario playing out currently). However, FMCG companies often hedge/cover their
payables/receivables and also transactions are across currencies/geographies - not always US$ denominated. Hence, impact
may not exactly play out as illustrated above (have assumed all transactions as US$ denominated for simplicity purpose). Also,
FMCG companies manage such impact via price hikes/ cost efficiencies and hence, the negative transmission of depreciation
will be negated.
IT services Every percentage depreciation on the INR impacts the margins of the IT services Companies anywhere between 25 to 40bps.
Moving the INR USD assumption for FY13 from 50 to 54 impacts the FY13 EPS positively by around 18%, the highest within our
coverage universe. The next highest beneficiary is Infosys is around 12% closely followed by TCS and Wipro. However, there is
a negative impact on the USD revenue reporting as the USD has been strong against corresponding currencies like EUR, AUD,
and GBP. The least amount of positive impact within our coverage universe is on Mphasis (INR denominated rate card billing
and demestic revenue) and Tech Mahindra. Over the longer term however (2 to 4 years), there might be some adjustment in
the billing rates if the depreciation persists, particularly if the poor demand outlook in the developed world remains.
Source: NSE, Elara Securities Research
Elara Model Portfolio
Getting more selective
We hold on to the same set of guideposts for our model
portfolio in the sense that we limit ourselves to non-Nifty
names that are above a certain size in free float market
capitalization. On the macro front, though we are
looking at a mild recovery in 2HFY13, we think that
select financials might just have run ahead of themselves
with RBI having limited headroom to further cut rates.
The only interest sensitive we are keeping in our
portfolio are autos where we are banking on MSIL, Tata
Motors and HMCL. On the domestic demand front, we
have stayed OW on certain media names and
consumption names, select infrastructure names with a
bottom up story rather than banking on a tide that will
lift all.
Autos
In the consumer discretionary segment, we would still
side with the two wheelers ahead of the four wheeler
story as we think that the inflation upcycle has been
pushed out further and given the subsidies number, a
another couple of rounds of fuel price hikes are in order.
Given that 70% of two wheelers are owned in cash, fuel
price hikes will be likely to impact the four wheeler
segment more. However, within this broad macro
overlay, we have a preference for Hero Honda as we
have more comfort with volumes. We see some
pressures on domestic demand for Bajaj Auto. New
launches will drive 76% of the volumes for MSIL in FY13.
Margin levers will work for MSIL and Tata Motors based
on operating levers kicking in while Mahindra and
Mahindra stands to lose on margins as automotive
segment gains in the product mix. MSIL and Tata Motors
also benefits from a weak currency, the base case in our
assumptions. However, we have a negative view on
Europe and with China headline numbers coming off,
we marginally UW Tata Motors. We choose to do away
with Mahindra and Mahindra altogether from the
portfolio as low demand headroom on tractor sales and
peaking out of the drivers put a cap on tractor demand.
Consumption
We do not expect the macro backdrop of high revenue
expenditure and a weak investment cycle to change
course in the next 18 months. The upwards revisions in
MSPs, impending state elections in 2012 and general
elections in 2014 would mean that India’s economic
construct will remain unaltered for some time now
making a bull-case for consumption-led stocks. However,
we note that valuations are full in the three Nifty names
in consumption. From a bottom up view, we play the
consumption story through Berger Paints and Zee.
Berger’s consistent performance, margin improvement
through mix changes and overall market share gain
support the story.
Metals
We choose to stay underweight on the sector as we look
to steer clear of any and all stocks that are a contingent
play on the government getting its act together. On
Hindalco, however, we have visibility on capacity
additions in aluminum which makes us keep a positive
view. In JSP as well, linkages for existing power plants
(13,000 MW) and poor state of power industry in
general, makes us cautious. We have chosen not to keep
SAIL, Sesa Goa and Sterlite in our portfolio. Execution
and regulation and sundry other uncertainties dog these
stocks. While Sesa Goa is facing an export ban, SAIL’s
expansion plans are either delayed or cancelled.
Uncertainty on the Sterlite consolidation will create
visibility issues for the stock. We include Hindustan Zinc
(non Nifty) on strong volume visibility and lower cost of
operations.
Oil and Gas
We stay very close to the index weights in the sector.
While we see incremental hikes in petrol and diesel
prices going forward, any expectations of a big bang
approach are likely to be disappointed. Our UW stance
on Cairn is led by our concerns on global demand led by
Europe and China and we work with a base case of
weak Brent prices. We are UW on RIL as fundamentals of
both E&P and refineries stay weak. Similarly, we maintain
a marginal UW on GAIL on flattish earnings and lack of
volume growth due to stagnant demand. ONGC is also
an UW as concerns on high under-recoveries, underfunding
in the budget and concerns on OVL and the
recent runup. Among the downstream players, we
remain positive on BPCL but based on high potential
E&P block in Mozambique/Brazil which we believe, will
be valued by the Street over an extended period of 4
quarters.
Banking
Since the last three months or so, there has been a major
downgrade in both the growth and monetary policy
expectations. The hope for banks was that asset quality
issues would be offset by growth in the economy which
has been now belied. With the macro looking worse, the
asset cycle turnaround has definitely been pushed out.
We expect a downgrade in the consensus earnings for
FY13 after the Q4FY13 results. On an overall basis, we
stick to our preference for private banks over public ones
on better earnings visibility, limited downside on the
asset cycle and higher risk adjusted spreads (over PSUs).
In the Nifty basket our major OW is ICICI Bank where our
analyst is positive on the return ratios getting back into
double digits for FY13. The bank is trading at the lower
end of the 5 year historical range in terms of valuations.
Among the larger PSUs, SBIN has regained in the last 6
months the underperformance its showed in first half of
the fiscal. The valuations do not completely reflect the
potential risks from continued asset quality deterioration
and related costs. Inspite of its strong franchise HDFC
Bank remains an UW on valuations as we look to add
some beta in the finacials part of our portfolio. Axis Bank
remains another OW with its we expect increasing retail
contribution will help Axis Bank post class-leading RoA’s
of 1.7% in FY13E & FY14E and marked under
performance over Bankex in the last 3 months. We have
chosen to stay out of KMB and IDFC (on their exposure
to power and infrastructure). On the non-Nifty banks
Allahabad Bank and Bank of India are stocks we
introduce in the portfolio. Indusind is a strong
management driven franchise which has effected an
impressive improvement in ROA, a story set to continue
into FY14. Indusind Bank, a play on good asset quality
inspite of negative asset quality cycles, is on our watchlist
and the only reason it is not included for now is its
strong stock price performance lately.
IT Services
IT services is more of a default overweight in our
portfolio for the want of choices. The tepid view in
absolute terms is borne out by current premium
valuations over the market, imminent rhetoric on
outsourcing as the US presidential election campaign
gains momentum and an overall cut in spending in the
key vertical of BFSI. While our negative calls on Infosys
and Wipro have mostly played out, we are confident of
our FY13 estimates and valuations on these estimates do
not warrant a change in stance to bullish one. However,
even in the case of Infosys (the best play on currency),
we stay rather close to market weight given that our
base case is that of a weak currency for some time. We
remain positive on TCS on its cost takeout franchise, low
discretionary exposure and a scale player set to benefit
from Infosys’ woes. However, our OW on TCS is
tempered by current valuations. HCL Tech is however, an
aggressive OW as they look to execute deal wins in the
next two quarters and a see it shifting track to Tier-1
valuations on the lines of CTSH over the next 5 years.
Pharmaceuticals
Pharma remains one of our biggest overweights with a
huge number approvals slated to be coming on in 2012
as a number of blockbuster drugs are going off patent
with a market size of around USD 40bn to USD 50bn.
Cipla remains our biggest overweight though our
analyst expects most of the approvals to come in the
back half of the year. Dr. Reddy’s has run up lately but
we still choose to stay positive on the back of very strong
pipeline. We are equal weight on Sun Pharma as after
the run-up, most positives and approvals are already in
the price. We exclude Ranbaxy from the portfolio as stiff
valuations factor in a recovery in the core segment,
which we believe is going to get pushed out. We include
a non Nifty name in Glenmark, as core business visibility
in US is strong.
Cement
We are OW on cement mainly through our exposure in
Grasim. We find the valuations attractive while VSF
prices have bottomed out. Strong cement demand is also
likely to positively impact the stock. We stay out of
Ambuja on premium valuations. On ACC, we are OW
inspite of high valuations on higher presence in the
eastern region. Demand supply in the eastern segment is
favorable for ACC with a few competitor plants shut for
competitive reasons.
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