J. P Morgan - Indian Equities The Growth Oasis

Indian Equities The Growth Oasis

· Return of risk appetite helped Indian equities last week; limited fundamental support

· 3Q earnings increased 11% yoy; 51% disappoint for our coverage universe

· Parliament session starts; temporary twin deficit comfort for equities

· Monthly prints of inflation likely to support equities; no support from growth print

· DIIs turn buyers; seasonal factor of fiscal year-end buying has diminished over the last two years

· Revenue growth momentum indicates pockets of relative strength; sub-sectors with relatively higher revenue growth are Textiles, Agri Products, Dairy Products, Media and Business Consultancy

Normalizing risk indicator lift. Markets are usually ahead of time; and sometimes ahead in the space also. The global sell-off seen over the last three weeks started with concerns on EM and was later supported by select DM indicators. The pace of positive surprises in DMs seems to have slowed down. In India and EMs, the hope that a stable external backdrop will help the much awaited bottoming out of growth seems to be progressing slower- than-expected. As of now, the net impact of a DM recovery and a calibrated Chinese slowdown on India seems uncertain. Last week’s local factors of earnings, politics and growth indicators were mostly disappointing in India. Mid cap outperformance indicates that the local investor sentiment is relatively better.

Temporary twin deficit comfort for equities. The Parliament session has started and is expected to continue till 21st Feb. The vote-on-account is scheduled for 17^th Feb. Parliamentary proceedings are likely to have a limited impact on Indian financial markets. In a constrictive development, the response to the ongoing telecom spectrum sale has been good. This would further aid near-term fiscal comfort. Also, the expected lower inflation print, the end of the current year borrowing program, recent sharp softening in US long bond yields are all technical supports for long bond yields in India. Money market rates, on the other hand, have been inching up in-line with the seasonal pattern. Medium term outlook on rates and rates sensitive equities remain uncertain given the shift of policy inflation to the CPI. Indian currency has been one the better performing EM currencies suggesting higher investor confidence in India’s BoP situation now.

Inflation support, growth not yet. India’s January PMI manufacturing increased from 50.7 to 51.4. PMI services remains below 50. The monthly increase from 46.7 o 48.3 is encouraging through. These indicators are in sync with the management commentary in quarterly earnings reporting. Consensus expectations from this week’s CPI, WPI and IP prints are 9.2%, 5.6% and (-1.0%) oya respectively.

A disappointing week of 3Q FY earnings reports. After a good start of quarterly earnings, the surprise bias turned disappointing over last two weeks. Companies across the sectors – Financials, Consumers, Telecom, Industrials and Cement - disappointed. See below key highlights:

· Almost 60% of Indian large cap companies have reported earnings

· Adjusted profit for the J.P. Morgan covered large cap companies grew 11% yoy (See sectoral details below).

· IT Services companies (ex TCS) have managed to meet elevated expectations. Company managements indicated an improved demand environment for the year ahead.

· Financials have reported increased asset quality stress and in select cases targeted a slowdown in the credit growth momentum.

· Consumer companies are yet to report a positive surprise. Most companies have reported margin pressures on account of higher RM inflation and higher A&P spending, as revenue growth momentum moderated.

· Companies linked to the investment cycle – Industrials, Utilities, Cement – continue to disappoint on lower expectations.

For our coverage universe, we expect an earnings growth of 14%, ex Energy.

DIIs turn buyers; seasonality not as supportive anymore. DIIs turned buyers of Indian equities last week. The current quarter is seasonally the strongest quarter for DIIs, supported by fiscal year ending and tax savings related investments. The quarter accounts for 36% of annual premium collection for insurance companies. The trend is similar for equity schemes of mutual funds. This seasonal local support for equities has weakened over the last two years as investor preference shifted away from equities.

Oases of growth. The current ruling coalition is about to complete its second term. When the election results were announced in 2004, equities corrected sharply as consensus view was that NDA would fare better. After a disappointing start, equities delivered surprisingly solid returns during 2004-08. The second term of the ruling government was a sharp contrast to the first term, starting with the opening day 17% rally in the Sensex. With lower growth the over last three years, Indian corporate performance have been adversely impacted in most sectors. See below some observations on the current growth picture:

· Aggregate revenue growth for the reported BSE 500 universe (Ex Financials) has been 11% yoy in the first three quarters of the current fiscal. (See chart below). The revenue growth is not very different from the CPI level of ~10%, reflecting the dismal real growth picture.

· Sectorally, export sectors are doing well supported by weaker INR. Industry wise details indicate that there are select pockets of strength. Textiles, Agri Products and Pesticides, Dairy Products, Media and Business Consultancy companies have been growing relatively faster.

· Banks credit growth details indicate an interesting picture. Credit growth has been faster in Micro and Small Industries vs. Large and Mid Cap over the first nine months of the current fiscal. This appears counter intuitive and can be linked to the working capital related stress. Growth rates are also higher in retail trade, commercial real estate, personal loans linked to consumer durables, vehicle and housing.

Investor focus has rightly been on the companies with lower leverage and better capital efficiency. The preference could change, if the confidence returns in growth revival. National elections are expected to have a significant impact on corporate confidence. The last two national elections results had one common feature: surprise.

Table 1: Quarterly Earnings Growth – Large cap companies

Sector	3Q FY13 PAT (INR bn)	3Q FY14 Adjusted PAT (INR bn)	Adjusted PAT Growth (% YoY)
Consumer Discretionary	22	25	10
Consumer Staples	35	40	14
Energy	89	84	(5)
Financials	94	98	4
Health care	6	7	26
Industrials	32	23	(28)
IT Services	86	117	36
Materials	24	32	31
Telecom	8	15	97
Utilities	40	41	4
Total	435	481	11
Ex Energy	346	397	15

Source: J.P. Morgan

Figure 1: 3Q earnings reports vs. J.P. Morgan expectations

Source: J.P. Morgan

Figure 2: BSE 500 companies: Sectoral revenue growth – 9M FY14 (% yoy)

Source: CMIE, J.P. Morgan

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