Buying with margin of safety India Strategy :: Axis Capital

Stress Case Exercise for Nifty stocks
♦ Considered worst possible earnings growth assumptions for FY14 & 15 based on critical variables relevant to each
stock (and also referenced their cyclical history)
♦ Worst-case earnings used to determine Stress case Target prices, keeping target P/E (FY15) unchanged*
♦ For eg Reliance Inds has a Stress case target price of 1,010 (v/s Base Case TP of 1,160), which is 14% over CMP.
Hence the least vulnerable stock
♦ Note that multiples can expand/ contract with earnings, resulting in double whammies, which are ignored here
♦ Cumulation of all worst-case TPs provide Nifty downside of just 8%**
♦ Top 5 stocks with the most upside at stress-earnings (unless they de-rate): Reliance Inds, Cairn, NTPC, ICICI Bank,
Tata Motors
♦ Top 5 stocks with the most downside at stress-earnings: BHEL, Ambuja Cement, Bharti, Asian Paints,
Hindustan Unilever
♦ You could use our “short models” to change these variables as you choose, to decide vulnerabilities and reach your
own conclusions

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Top 5 stocks with the lowest risk…
 Cairn India
 Key Growth Triggers: (1) Clarity on ramp up of production to 300 kbpd; (2) reserve accretion from new fields
 Key Risks: (1) Correction in crude oil prices on the back of new supplies from US, Brazil, Canada; (2) production decline if
EOR gets delayed; (3) Inefficient cash utilization (FY13 cash reserve of US$ 1 bn)
 Recommendation: BUY, as even under our stress case (US$ 80/bl long-term crude prices, higher discount rate, higher cess
and no exploration upside), Cairn’s fair value of Rs 312 offers 6% upside. Our Base TP of Rs 430 offers 40% upside
 ICICI Bank
 Key Growth Triggers: Improvement in RoE (~14% in FY14E from 8% in FY09) to be led by: (1) increase in leverage (CAR at
19%), (2) traction in NIM and non-core income, (3) stable credit costs, (4) higher profitability of domestic subsidiaries
(insurance), and (5) repatriation of part capital from international subsidiaries
 Key Risks: Stress in large corporate segment which could lead to increased delinquencies
 Recommendation: BUY with TP of Rs 1,423 [1.9x FY15E ABV (adj. for invest.) + Rs 349 value of invest.]; upside of 37%
from CMP of Rs 1,038. The stock trades at 1.4x FY14E and 1.2x FY15E adj. ABV of Rs 505 and Rs 569 respectively.
 NTPC
 Key Growth Triggers: Faster execution on: under-construction projects and captive coal mine
 Key Risks: Core RoE decline (for tariff period 2014-19) on sharing of station heat rate gains (300 bps contribution to FY13
core RoE) and standardization of construction period for projects implying no approval for cost over-runs
 Recommendation: BUY as even after factoring in delays in execution (2% long term growth vs. 4% base case) and decline in
sustainable core RoE (to 18% vs. 21% current), our Gordon growth-based TP of Rs 155 gives 8% upside from CMP ( plus 4%
dividend yield). Base case TP of Rs 204 (42% upside from CMP)

 Reliance Industries
 Key Growth Triggers: Improvement in RoCE (~19% in FY17E from 12% in FY13) led by (1) new capacity additions
(petchem, petcoke gasification); (2) increased gas prices (US$ 8.4/mnbtu versus US$ 4.2 currently); (3) gas production
volumes (25 mmscmd versus 14 currently); and (4) INR depreciation (INR 62/USD in FY17 versus 54.4 in FY13)
 Key Risks: (1) Margin compression; (2) higher investments in telecom space (vs.our current expectation of US$ 3 bn capex
over next 4 years); (3) Unrelated acquisitions
 Recommendation: BUY as even under stress case (GRM’s at US$ 7.5/bl; gas production at 12 mmscmd; petchem margins at
5-year lows; additional US$ 1 bn spend in telecom) implies 16% upside. TP of Rs 1,160 (upside of 33% from Rs 870 CMP)
 Tata Motors
 Key Growth Triggers: JLR margin can surprise due to: (1) best ever product mix, (2) improved utilization of Jaguar plant and
(3) 20%+ volume growth in China due to dealer expansion
 Key Risks: Currency volatility and engine supply from Ford
 Recommendation: BUY with TP of Rs 373; 31% upside from CMP of Rs 285

Top 5 stocks with the highest risk…
 Ambuja Cements
 Key Risks: a) Near-term earnings disappointment led by weak cement demand and pricing, b) Volume growth post 2014 to
be impacted as Ambuja has not pursued any expansions and c) Further increase in royalty to parent from the current 1%
 Recommendation: SELL with a TP of Rs 152 (7x CY14 EV/EBITDA). Stock currently trading at 11x EV/EBITDA vs 10-year
average of 8x
 Asian Paints
 Key Risks: Repainting demand unlikely to improve in FY14, given weakness in urban disposable income and weak consumer
sentiments. Stress case stand-alone volume growth at 6% in FY14 (<7 and="" crude="" depreciation="" fy13="" in="" inr="" nbsp="" p="" rising="" sharp="">prices is stoking cost inflation. Stress case stand-alone EBITDA margin lowered by 40 bps in FY14 to 16.5%
 Recommendation: SELL (21% downside in stress case). Unfavorable risk-to-reward given 1-yr fw P/E at 36x
 Bharti:
 Key Risks: (1) India Wireless: erosion of pricing power due to entry of RIL, lower MoUs due to lower discretionary spend,
(2) Africa: lower growth due to continuing instability (esp. Nigeria= ~1/3 of Africa) and competition from MTN; margins
decline due to inefficiencies and higher subscriber acquisition cost, and (3) INR depreciation (~USD 9 bn forex loan)
 Recommendation: BUY with TP of Rs 358 based on 6.5x FY15E Ev/EBITDA. Current valuations discount ongoing challenges.
Worst case downside is 21% if : (1) India Wireless: growth in MoUs was 5% /-5% in FY14E / FY15E (vs. our expectations
of 9%/7% ) and nil RPM increase in FY15E and (2) USD revenue growth in Africa was 5% /7% (vs. our expectations of
8%/10%)
BHEL
 Key Risks: Delay in finalization of new orders on clearance issues, financial crunch resulting in low order inflow (6 GW /
7 GW in FY14/15 vs. base assumption of 9 GW / 8 GW) and execution. This would also result in further margin
compression on negative operating leverage due to higher fixed cost of Rs 94 bn (22% of FY14 sales). Rising balance sheet
stress on lower customer advances and rising receivables
 Recommendation: HOLD with TP of Rs 181 based on 13x FY15E of Rs 14. BTG market is unlikely to improve over next 2-3
years and margin decline is structural
 Hindustan Unilever
 Key Risks: (1) Intensifying growth deceleration, especially in discretionary categories (2) Slower pace of premiumization
(3) Increase in pricing promotions and trade offers. Stress case stand-alone volume growth at 5% in FY14E and 6% in
FY15E. Note: Volume growth at 5% in H2FY13 is lowest in last 3 years. Weakening pricing power in the context of growth
deceleration and rising commodity cost can further impact margins
 Recommendation: SELL (18% downside in stress case). Decelerating earning momentum (8% CAGR over FY13-15E vs. 25%
CAGR over FY10-13E) could trigger P/E compression. The 1-yr fwd P/E valuation at 36x is at 10 year peak and higher than
1-standard deviation above mean