12 May 2014

Exit polls predict NDA govt; Another rally tomorrow?

EXIT POLLS NDA UPA Others
Zee News  289 101 153
ABP 281 97 165
Times Now 249 148 146
CNN-IBN 270-282 92-102 ~170
The India Today Group 261-283 110-120 150-162

J.P. Morgan - Indian Equities

Indian Equities
Converging Valuations, Divergent Performance

· Cyclicals back in favor last week; risk indicators suggest increased caution
· Quarterly earnings reported increased 11% yoy; Financials led the positive surprise tally at 52%
· Consumption sector faces dual risk from expectations on sub-par monsoon and electoral hopes
· Electoral hopes have reduced valuation divergence; outlook on growth normalization key to continued trend
· Extent of FII India overweight scales a new high; DII selling continues
· Trading volumes stabilizing at a higher level; retail trading interest increases
Visibility low, drive slow. Each of the three Es (Earnings, Election and Economic outlook) of near-tern equity performance influenced performance last week. Cyclicals outperformance can be linked to better-than-expected earnings from Financials and electoral hopes. Underperformance of Consumer was led by the IMD official forecast of a below-normal monsoon and also disappointing earnings performance. In the current fundamental backdrop of low medium-term visibility, near-term drivers are likely to over-influence equity performance. The upward momentum in indices has stabilized as expectations shift the election result (May 16th). “May” has historically been a month of higher volatility. Besides the election, monsoon and shift of earnings focus to the year ahead seem to be the fundamental reasons for the increased volatility. Also, the recent surge in global crude oil prices (Brent ~ US$ 110 bbl/ US$) is likely to adversely impact investor sentiment for Indian equities.
Figure 1: Average monthly realized volatility (%)
Source: Bloomberg, Data is since CY 2003
Official forecast of a sub-par monsoon. India’s metrological department expects seasonal rainfall to be 95% of the long term average. IMD has assigned a probability of 60% for El-Nino. Monsoon forecasts have had a significant margin of error. A weak monsoon could impact India’s agri production, inflation, consumption and indirectly the rate cycle. India still has over half of its cultivated land dependent on monsoon. One key difference different this time vs. the 2009 is that the RBI governor is more focused on CPI. Monsoon is a direct risk to consumption linked sectors, although the economic impact has reduced over the years given the lower contribution of agriculture to the GDP. Also, food expenditure has become a lesser proportion of a household expenditure. Cement and CV sectors tend to do better in a weak monsoon year.
FII overweight reaches to a new high. The risk indicator suggests increased caution ahead. EMBI spreads widened by 14 bps last week. India, however, remains a preferred destination for FII equity investors and saw net buying last week also. India overweight in FII portfolios reached a new high, as of March-end. DIIs, on the other hand, were net sellers last week. Domestic retail investors’ trading interest has increased as reflected in the trend of non-institutional trading volume.
Figure 2: India weight in EM portfolio relative to MSCI benchmark
Source: EPFR, MSCI
Figure 3: Non-Institutional trade volume proportion
Source: Bloomberg
4Q FY earnings season – Not disappointing. The quarterly earnings season has started on a better-than-expected note. Key highlights:
· ~30% of Indian large cap companies have reported earnings
· Adjusted profit for J.P. Morgan covered large cap companies increased 11% yoy.
· Financial has been the sector with the most favorable beat percentile (56%). Companies have reported better than expected performance on asset quality. Growth in NIMs and fee income has been mixed.
· IT Services companies managed to meet tempered-down expectations. Guidance for the next fiscal has been mixed. Company managements seem to be more focused on margin performance.
· In Materials, only Cement companies have reported so-far. Two out of three large cap companies have reported better than expected operating earnings, despite a challenging demand environment.
· Only one large cap consumer company has reported so-far with expected disappointment.
· RIL reported in-line earnings supported by better refining margin and weaker INR. .
For our coverage universe, we expect earnings growth of 14% (Ex Tata Steel). Sectoral earnings revision breadth has been favorable for only Financials and Materials over the last month.
Table 1: Quarterly Earnings Growth – Large cap companies under J.P. Morgan coverage
Sector
4Q FY13 PAT (INR bn)
4Q FY14 Adjusted PAT (INR bn)
Adjusted PAT Growth (% YoY)




Consumer Discretionary
12
8
(35)
Consumer Staples
0
0
NA
Energy
82
87
6
Financials
79
90
14
Health care
0
0
NA
Industrials
32
16
(50)
IT Services
88
123
39
Materials
14
16
11
Telecom
3
5
68
Utilities
0
0
NA




Total
310
344
11
Ex Energy
229
257
13
Source: Bloomberg, J.P. Morgan
Figure 4: Quarterly Earnings: Meet/ Beat expectations composition
Source: J.P. Morgan
Figure 5: MSCI India sectoral FY 15 earnings revision breadth – Last one Month
Source: Datastream, IBES
Convergence in valuations. Hope and fear tends to have polarizing effects. Since the start of political hope in early November, “Value” companies have been outperforming. Industrials, Materials and Financials sectors have re-rated. Consumer Staples and IT Services have seen marginal de-rating. For a relatively broad index- BSE 200 index constituents, changing valuation distribution indicates:
· The number of companies trading below a 12 month fwd PE multiple of 10 has reduced (Chart below)
· The number of companies trading above a multiple of 25 has reduced marginally.
· The trend is a reflection of normalizing outlook. Whether the trend continues or reverses will be dependent on post election growth trajectory. What's certain is there will be a change in direction on the macro outlook post the national election, but the slope of the new road and its bumpiness seems uncertain (as it was in May 2009).
Figure 7: Valuation Distribution of BSE 200 Companies: 12 M fwd PE Now and October-end 2013
Source: Datastream, J.P. Morgan
Figure 6: Valuation convergence – Change in proportion of companies and valuation band BSE 200 (Now vs. October)
Source: Datastream, J.P. Morgan
Figure 8: MSCI India Sectoral valuations – Current 12 month forward PE vs. last ten years average
Source: MSCI, Datastream, IBES