INDIA STRATEGY: Fired up?
Policy engine revives| Next challenge: Investment cycle | New earnings cycle?
2QFY13 highlights: Non-cyclicals have a field day in muted quarter
2QFY13 is likely to be a muted quarter in terms of India's corporate sector performance.
- PAT growth of 9% YoY: We expect MOSL Universe (ex RMs, oil refining and marketing companies) to report PAT growth of 9% YoY. This is the lowest 2Q PAT growth in the last 7 years, barring the Lehman-crisis quarter of September 2009.
- Expect Technology, Financials, Healthcare and Consumer to positively dominate the quarter's performance. On the other hand, global commodities (mainly, Oil & Gas and Metals) will pull down aggregate profits.
- Sensex PAT growth is even more muted at just 2% (ex ONGC, the growth is 9%). Six global cyclicals are major drags, ex which Sensex PAT should be up 15%.
- Top five Sensex companies by PAT growth: TCS (+42% YoY), SBI (+31%), HDFC Bank (+30%), Sun Pharma (+29%), and Infosys (+26%).
- Bottom five Sensex companies by PAT growth: Tata Steel (-63% YoY), Maruti Suzuki (-51%), Bharti (-36%), Tata Power (-30%) and Hero MotoCorp (-27%).
From Cradle of Pessimism … came a Ray of Hope. Have things FIRED UP?
For almost 18 months, the Indian economy and markets have been groping through intensifying darkness and concerns, culminating in the Cradle of Pessimism (our 4QFY12 strategy theme). At the beginning of 2QFY13, there were some Rays of Hope (our 2QFY13 strategy theme) with the Presidential elections giving way to new political alignments. While things remained stuck during July-August, the month of September 2012 saw a complete U-turn from policy paralysis to raging reforms. The last few weeks have seen a significant number of policies / announcements / discussions, and the debate has shifted to "whether UPA-2 led by Congress is finally FIRED UP?"
Re-starting the policy engine – FDI in limelight; further growth catalysts – lower deficits, improved flows, monetary easing
With a precipitous fall in the Indian rupee coupled with a rating downgrade staring India, the government finally bit the proverbial bullet with a change in Finance Minister and a series of policy measures, even at the cost of severing ties with the largest ally, TMC. This, in turn, has catalyzed a slew of measures in the last few weeks that have led to an improvement in sentiment: (1) fuel price hike / reforms, (2) opening/relaxing FDI in multi-brand retail, aviation, broadcasting, (3) Cabinet approval to raise FDI in insurance and pension, (4) easing of fund-raising abroad, (4) proposed GAAR deferral, etc. It also appeared to wade through the political fallout of these measures.
While reality will take a lot longer to reflect the first round of reforms, and require several more follow-up initiatives, the perception has undoubtedly started changing for the better. To some extent, this is visible in INR appreciation (a 7% appreciation), revival of flows (FIIs inflows at USD 16b in CY12) and market sentiment (Sensex up 8% in 3QCY12, making India among the best peforming markets in the world). We believe that 3 important drivers for the markets, going forward, are:
(1) Fiscal situation – our FY13 deficit estimate revised down from 5.9% to 5.4%,
(2) Domestic flows into equity markets – base-case USD30b inflows over FY14-17,
(3) Shift towards a more accommodative monetary stance – RBI should cut interest rates / CRR in 4QCY12.
Addressing logjam the next big challenge
The next big challenge is to address the investment logjam. However, unlike the initial set of reforms that have been largely addressed through policy decisions, the investment phase requires a more involved decision-making process, as land, water, resources, etc, are the prerogatives of the state governments. Execution is the key challenge, as several structural issues impacting growth remain unaddressed. We believe that the government will kick-start its efforts towards reviving the investment climate by accelerating public spending. Our action wish list includes:
- Successful resolution of the contentious issues in the Power sector (through SEB debt recast, standard bidding document, and coal price pooling)
- Close monitoring of CPSU capex (FY13 investment target at INR1.8t is double the highest ever - INR931b in FY11)
- Take-off of large public expenditure projects (like Dedicated Freight Corridor, railways, urban transport, etc). Addressing structural issues impacting infrastructure investments has become important.
- Acceleration of financial sector reforms, including corporate bond market and access to Insurance / Pension money for investment projects. Also, an expenditure switching strategy is required that reduces government revenue spending by cutting subsidies and steps up capital expenditure to crowd-in private investments.
- Successful implementation of the National Investment Board that will provide "single window" clearance. The government has identified 89 projects worth USD20b for fast track clearance.
We identify the key structural issues in core segments:
#1 UTILITIES: Initial steps encouraging, but new investments sometime away
#2 METALS & MINING: Huge investments stuck; will require close monitoring
#3 FINANCIALS: Loan growth moderating; revival will ease asset quality concerns
#4 TELECOM: Spectrum pricing and allocation, conducive M&A policy critical
#5 OIL & GAS: Rational product pricing, gas reforms imperative
#6 INFRASTRUCTURE: Creating conducive environment for large scale development
#7 MEGA PROJECTS: DFC, railways, urban transport can accelerate investment spend
Early signs of a rebound in earnings growth; FY14 Sensex EPS to grow 14% to INR1,395
Our bottom-up estimates for the MOSL universe of companies (ex RMs) suggests FY14 EBITDA growth of 15% and PAT growth of 14%. This growth is driven mainly by (1) Bounce back in sectors which were affected in FY13 (Auto, Telecom); and (2) Steady growth in seculars (Consumer, Healthcare, Financials) offsetting low growth in specific sectors like Oil & Gas, Technology and Capital Goods.
For the 5 years ending FY13, Sensex EPS CAGR has been muted at 8%. However, India's long period average (LPA) earnings growth is 15%. Now, our bottom-up earnings estimates for Sensex companies suggest FY14 Sensex EPS growth of 14%, close to the LPA. The key question: Is FY14 the beginning of a new earnings cycle? We believe there are a few early signs that this is a distinct possibility:
1. Earnings downgrade cycle has bottomed out
2. Our FY14 assumptions are not aggressive
3. FY14 earnings mix is less vulnerable than that of FY13 initial estimates
4. More stocks have a bias for earnings upgrade than downgrade.
Valuations below long-term averages; scope to re-rate as growth returns
Combined action of government and RBI could lead to upgrades in FY13 GDP growth estimate (currently at 6.5%). Our earnings estimates for FY13 and FY14 have been stable for the last 2 quarters. We believe the downgrade cycle is now behind us. Recent government measures along with more to come, monetary easing, and stable to declining commodities can drive earnings upgrades, going forward. Valuations remain below historical averages (FY14 P/E of 13.5x v/s 10-year average of 14.8x). We see more upsides in markets from here.
Our top Overweights are Financials (ICICI / SBI / LIC Housing), Infrastructure & related (L&T, Jaiprakash) and Autos (Tata Motors, Maruti). Our key Underweights are Consumer, Technology, Oil & Gas and Utilities. We have a significant allocation to mid-caps too. Our preferred picks are Yes Bank, MCX, CESC, Hexaware, Petronet, Sun TV, JSW Energy and Oberoi.
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