30 December 2014

Market Strategy Market Strategy 2015 - ICICI Securities Fundamental Picks

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Equity markets, having appreciated 29% this year, have been running ahead
of an economic recovery, which is expected to follow with a lag. The
government has already initiated several confidence building measures and
taken key decisions like allowing FDI in several sectors, railway fare hike,
online environment & forest clearance, etc. However, an economic recovery
is expected only at a gradual pace. After trading around 14x one year
forward EPS for most of the last five years, the Sensex is now trading at
14.6x one year forward EPS (FY16E).
We have already witnessed a bottoming out of the economic growth cycle,
which coupled with a reduction in crude and other commodity prices has
aided lower inflation. This has also led to hopes of a rate cut in the first half
of next year. India is entering a new phase of economic growth that would
be characterised by a multi-year bull run. In this backdrop, we expect four
major themes to play out, which will last for the foreseeable future.
Consumption growth: With a revival in macroeconomic & per capita income
growth, lifestyle based consumption sectors would be direct beneficiaries.
While consumption expenditure has always been the driver of Indian
economic growth, the pace and size of consumption spends is expected to
multiply manifold. With favourable demographics and the largest working
age population, India is set to have largest middle class by 2050,
contributing 32% of global middle class spending. On the one hand, with
more people crossing the poverty line, overall consumption is expected to
increase while on the other, with rising income level, several households
would move up the value chain resulting in premiumisation. Consumption
spending is expected to cross $3.2 trillion by 2025, 3x of US$991 billion in
2010. Consumption driven sectors like branded apparel, communication,
healthcare, housing, consumer durables, FMCG and automobile would
stand out and exhibit accelerated growth in years to come.
Lower cost of capital: Secondly, with an improvement in medium term
economic outlook that would warrant higher foreign inflows in sovereign
and corporate debt, cost of capital would gradually come down. In addition,
a structural shift in retail inflation by almost 400 bps from double digit to
expected sustainable 6% levels is a marked improvement leading to
positive real interest rates, which may prompt the RBI to cut interest rates
by 75-100 bps in the next calendar year. Both these measures would
facilitate capital investments, which would drive growth and enhance
profitability. This, in turn, would be reflected through expansion in valuation
multiples. Our analysis suggests that sectors like auto
ancillaries, capital goods, cement, ceramic products, logistics, packaging
and plastic products would be key beneficiaries of lower cost of capital and
may witness a multiple expansion.
Softening commodity prices: Thirdly, global commodity prices have
corrected significantly led by a demand-supply mismatch as global supply
continued to increase while demand from the largest consumer, China,
tapered down. Going ahead, a commodity slowdown is expected to sustain
led by excess supply in the medium-term and a shift towards renewable
energy sources in the long run. In the backdrop, sectors like aviation, paints,
textiles, auto ancillaries (tyre and battery), logistics, telecom, lubricants and
mining could be major beneficiaries.
Favourable regulatory framework: Finally, the new government has been
effective in breaking the policy deadlock with several decisions on key
policies like increase in FDI limit in insurance, defence & Railway, easing of
environment & forest clearance process, etc. already being taken. Moreover,
there has been considerable progress in other key reforms like
implementation of GST and innovative measures like “Make in India”,
“Digital India” and “Smart cities”. These measures will improve business
sentiments, provide policy stability and an impetus to a revival in capex
cycle. Stalled projects worth | 25 lakh crore could be kick started benefitting
several sectors ranging from oil & gas, defence, banks, railways, metal &
mining, telecom, construction and infrastructure.
Sensex target: Factoring in the fall in inflation, comfortable CAD, improved
sentiments and pick-up in GDP growth, we expect the Sensex EPS to grow
at a CAGR of 17% over FY14-17E. A decline in cost of equity coupled with a
dovish environment will further fuel portfolio flows for India in equities as
well as debt instruments. The Sensex is trading at 15x one year forward P/E
multiple(FY16E), in line with historical mean. However given the
resurrection of corporate earnings cycle, we believe there exists a case for a
re-rating of the Indian markets. We assign a P/E multiple of 15x on FY17E
EPS to arrive at a fair value of 32500 by end CY15, implying an upside of
18.6%. The corresponding Nifty target would be 9750.

Risks: Though the markets seem to have shifted into an higher growth
trajectory, we highlight certain pitfalls that may inhibit index expansion.
• Brent crude oil has fallen sharply by 47% YTD, and is trading below the
fiscal break even price for most oil exporting countries. We have already
witnessed the impact of crash in crude prices on Russian economy. With
the fall in crude prices, sovereign credit default swaps (CDS) of many oil
exporting countries has increased several times, highlighting the global
risk perception. A global contagion could put investors in risk off mode,
impacting global flows in emerging markets.
• While India would indirectly benefit from divergence of FII flows from
such countries in favour of India and may not be directly adversely
impacted with crash in crude prices, our exports could be hampered.
38% of our exports are to commodity based economies, which can face
slower growth as economic variables deteriorate due to falling oil
• Risks will also emanate from the complexity of rate cycles panning out in
various parts of globe. For instance, strong growth prospects for the US
economy will lead to commencement of rate hike cycle in mid 2015
whereas ECB has to be more accommodative to stave of a deflationary
trend in the Eurozone while India is all set to see the easing of rate cycles.
The implications can be humongous and perplexing as interest rate
decisions will have a meaningful impact on Indian rupee vis-à-vis other
global currency and hence on GDP/corporate profitability in 2015.
• Finally, with formation of government with a strong mandate and
reformist outlook, the investor expectations have built up over the period.
While, the government has shown clear intent and has initiated several
reforms, things are yet to start moving on the ground level. There is a
huge risk of the current government falling short of meeting enormous

Stock Picks for 2015

  1. Credit Analysis & Research (CARE) 
  2. Castrol India
  3. Container Corporation of India
  4. Gujarat Pipavav Port
  5. Heidelberg Cement 
  6. Infosys
  7. SKF India
  8. State Bank Of India (SBI)
  9. UltraTech Cement
  10. Voltas Ltd

Sector Outlook
• Since we expect the economy and corporate profitability to make a
meaningful comeback thereby making cyclical sectors the biggest
beneficiary as pick up in utilisation rates, positive operating and financial
leverage will lead to recovery in profitability and improve the quality of
the balance sheet. Hence we are positive on sectors like banking (pick-up
in loans, lower interest to cushion NIMs, lower bond yields to aid
provisioning and NPA cycle peaking), cement (increase in capacity
utilisation and lower input costs to aid profitability), capital goods (revival
in capex cycle to lead to better orders and execution), autos & auto
ancillaries (lower rates to boost pent up demand and lower commodity to
help margin recovery)
• We are neutral on defensives like IT (demand intact, rich valuation),
pharma (rich valuation, tepid domestic growth), oil & gas (earnings
dependent on deregulation, limited volume growth) & media (earnings
visibility intact, rich valuation)
• We remain negative on sectors like Real estate ( High inventory and huge
debt pile up and regulatory hurdles to weigh over positive like lower
interest rates and pick up in demand), Metals( Lower realisations and
levered balance sheets) and shipping ( Highly dependent on global trade
and demand for commodities)

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