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India Equity Research Reports, IPO and Stock News
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Conclusion: We are staying overweight industrials – corporate activity is picking up at the margin, utilization rates are creeping higher, share prices have fallen further – the sector is now down c50% (ex-LT) relative to the to the Sensex since Jan-08, peaking interest rates are good for the sector, valuations are attractive – industrials is the cheapest non-global sector in India with only 9% implied EPS growth (vs. 13% for the market).
Our strategy is to pick stocks: Stock selection an overarching theme in industrials. The correlations across stocks in the sector are 0.65 standard deviations above average only exceeded by financials. Our key stock picks: ADE (Rs729.5), LT (Rs1810.70), IRB (Rs185.8) and JPA (Rs77.65) – all in our focus list.
Key risk to our call: Market participants may not have capitulated on the sector, and global & domestic growth uncertainties could delay capex decisions a lot more.
What’s new: a) Data across sectors which show some are approaching peak utilization rates (page 5), b) companies are starting to put cash to work if recent M&A activity is a guide (page 6), c) industrials are inversely correlated to short rates (page 10), and d) valuations are at multi-year lows (page 9 & 10).
We were wrong: Our view that capex and industrials will be key leaders in 2011 has not worked out well. Our proprietary AlphaWise survey had shown that corporate India was set for a only modest increase in capital spending in 1H/2011. Our sector losses were partly compensated by stock selection within the sector.
Key Debates and our Evidence: a) How much more will capex slowdown? Utilization rates across several sectors is approaching the previous cycle peaks signaling the need to put up capex or an increase in gross margins. The other key evidence emerging is the pick up in M&A which shows willingness to spend their massive cash balances.
Will higher rates impede recovery in capital spending? AlphaWise evidence shows that interest rates are not a key capex driver. It’s all about confidence in growth. Our economist, Chetan Ahya, thinks rates are peaking and usually this leads to a trough in industrial shares.
Are industrials pricing in enough? Industrials are trading at multi-year lows on relative valuations. The 5- year EPS growth embedded in share prices is lower only for Energy and Materials.
Staying O/w Industrials
We have been mostly wrong about capex…
•
At the end of the last year, our view was that private corporate capex would be the biggest theme for 2011. We argued that strong industrial growth, low trailing capex, reasonable cost of capital, improving supply of capital, recovering corporate profits, and healthy corporate balance sheets suggested that a robust capex cycle was likely in 2011. We further opined that falling institutional ownership and poor relative share price performance meant that a lot of bad news is in the price. Hence, we were overweight the sector.
…and industrial shares
•
It has not been a good call. In fact our proprietary AlphaWise survey (Indian Corporate Survey: Discipline is the Mantra, dated December 2, 2010) showed that corporate India was set for a only modest increase in capital spending in the first half 2011 despite capex drivers breaching threshold levels for bigger capex. The events of the past six months have made private capex even more difficult. Consequently, private corporate capex seems to have slowed down rather than accelerate as we had forecast.
Stock picking helped us…
•
Six months into the year, the industrials index has only fallen lower (ex-LT). While the sector position did not do us good, fortunately, we were partly compensated by stock selection.
..and could continue to be a key theme in the sector
•
Incremental evidence makes stock selection within industrials an overarching theme. The correlations across stocks in the sector are about 0.65 standard deviations above average (and among MSCI sectors, the only sector with higher z-score is Financials). The sector (ex-Larsen & Toubro) has underperformed even further, now down nearly 50% relative to the to the Sensex since end-07. Valuations also seem more attractive, institutional ownership is a tad lower and, therefore, we conclude that any recovery in capex would come as a big surprise for the market.
Pick up in M&A shows a positive corporate mindset
•
Even though the interest rates are higher, corporates do not regard them as a key factor in the capex decision. Capex is driven by confidence in growth. Nevertheless, interestingly, companies are putting some of their massive cash balances to work in M&A (which has soared to a post crisis high). Utilization rates are also climbing neutralizing some of the excess capacity created in the previous cycle.
Taking risk given what’s in the price
•
Our next periodical AlphaWise survey will provide more bottom-up evidence on whether companies are set to accelerate capex or not. In the meantime, we continue to focus on picking stocks in the sector. Our favorite names are ADE, LT, IRB and JPA. We remain cognizant of the of downside risk to capex but given what may be in the price it seems like a risk worth taking
Despite rising capacity utilization, companies remain reticent about spending money
•
A combination of slowing growth, policy hiatus, global growth volatility and rising rates may be hurting capital spending, especially greenfield capex.
Indian companies feeling the after-effects of a big capex cycle
•
It is not so apparent that India’s corporate capex cycle between 2005 and 2008 was significantly larger than almost any other part of the world relative to balance sheet size. For example, during 2005-2008, India’s capex to depreciation was more than twice the average in EM.
•
The subsequent slowdown in capex has to be seen in this light. Given, India’s growth rate, it is not going to be long before utilization rates start closing to levels which will force a capex cycle.
Utilization rates are not high across the board
•
Capacity utilization rate data is scant in India. So, we asked our analysts to guide us. At the sector level, several sectors are approaching the peak levels of the previous cycle. This also underpins our point that Corporate India will start gaining pricing power in the coming quarters (notably, gross margins are decade lows) but it also tells us that some amount of capex recovery is in the pipeline.
•
The exceptions include commercial vehicles, cement, real estate and steel where capacity utilization is well below peak implying that we could still be several months away from a full blown capex cycle.
Balance sheets set up for capex
•
Corporate activity is definitely picking up. M&A in both value and volume terms is at a post crisis peak and not too far away from the previous high. Share buy-backs by companies are already at a new high. Companies seem to be putting the high cash balances on the balance sheet to work.
•
As and when confidence in growth comes back, a sharp increase in capex seems likely.
Higher Capital Costs Not a Big Impediment
•
The cost of capital is already higher than what it was on an average during the previous capex cycle (2004- 2008).
•
Investors argue that the rise in interest rates may impede capex. However, history does not show that. Moreover, our proprietary AlphaWise survey ranks interest rates the middle of the pack in terms of drivers of capex. However, to the extent higher rates hurt the growth outlook, capex does get affected
BSE Cap Goods Index Down c50% relative to Sensex since end of 2007
•
The underperformance has accelerated since the beginning of 2010.
•
The divergence with LT is striking. LT is driving the capital goods index relative to the Sensex since the middle of May 2011.
•
The longer term price chart shows the cap goods index ex- LT is now back to its mid-2005 level on a relative basis to the Sensex.
Valuations have contracted significantly from highs
•
The premium for industrial shares has climbed down sharply since the end of 2007. The P/E and P/B multiples, though off recent lows, are at multi-year lows.
•
Indian industrial valuations have nearly halved from the peak relative to the EM sector.
•
Given India’s long-term growth prospects, current valuations may be pricing in a prolonged slowdown in capex.
Industrial stocks priced for very little growth
•
The only two sectors that are pricing in less growth than the industrials sector are energy and materials.
•
The more comparable sectors to industrials are domestic sectors such as discretionary, staples, telecoms, financials and utilities. In terms of growth priced in, industrials stands out as the most inexpensive domestic sector currently.
Our industrial growth and rate cycle forecasts favor industrial shares
•
What’s in the price is borne out by the performance of industrials versus the nominal IIP. The share prices currently discounting a significantly slower industrial growth than what our economist, Chetan Ahya, is predicting.
•
Then again, aside from Consumer discretionary, industrials is the only other sector which is highly negatively correlated to the rate cycle. Our economist is arguing for peaking for rates in India and, concurrently, industrials should be finding a trough.
Earnings estimates appear to be improving at the margin
•
Reported revenue growth for a broad sample of industrial names has stabilized at around 20% but growth is trailing market aggregates at the margin.
•
The consensus seems to be pushing the estimates for the large industrial companies higher. We think that larger industrial companies seem to have a nuanced story and may decouple from the rest of the sector.
At the margin, both investors and the sell-side have sold industrials
•
It seems that our bullish call on industrials at the start of the year was a consensus call.
•
Both the buy- and sell-side remain bullish.
•
The only good news is that at the margin both have been sellers of the sector.
•
Key question is have they sold enough and answer may be in the negative.
•
Along with the possible fall in capex, this remains a key risk to the performance of industrials and underpins our point that investors should remain focused on stock picking.
Sector effects and its impact on stock selection
•
We run intra-sector correlations versus the respective MSCI sector indices. This indicator tells us how much sector factors are influencing stock performance within each sector.
•
The adjoining table tells us that the correlations are very low for Consumer Discretionary, Energy, Telecoms, and Utilities and, to that extent, stocks in both sectors are set for sector- specific moves.
•
Conversely, correlations seem high in Industrials and Financials. These sectors are more amenable to stock selection
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Conclusion: We are staying overweight industrials – corporate activity is picking up at the margin, utilization rates are creeping higher, share prices have fallen further – the sector is now down c50% (ex-LT) relative to the to the Sensex since Jan-08, peaking interest rates are good for the sector, valuations are attractive – industrials is the cheapest non-global sector in India with only 9% implied EPS growth (vs. 13% for the market).
Our strategy is to pick stocks: Stock selection an overarching theme in industrials. The correlations across stocks in the sector are 0.65 standard deviations above average only exceeded by financials. Our key stock picks: ADE (Rs729.5), LT (Rs1810.70), IRB (Rs185.8) and JPA (Rs77.65) – all in our focus list.
Key risk to our call: Market participants may not have capitulated on the sector, and global & domestic growth uncertainties could delay capex decisions a lot more.
What’s new: a) Data across sectors which show some are approaching peak utilization rates (page 5), b) companies are starting to put cash to work if recent M&A activity is a guide (page 6), c) industrials are inversely correlated to short rates (page 10), and d) valuations are at multi-year lows (page 9 & 10).
We were wrong: Our view that capex and industrials will be key leaders in 2011 has not worked out well. Our proprietary AlphaWise survey had shown that corporate India was set for a only modest increase in capital spending in 1H/2011. Our sector losses were partly compensated by stock selection within the sector.
Key Debates and our Evidence: a) How much more will capex slowdown? Utilization rates across several sectors is approaching the previous cycle peaks signaling the need to put up capex or an increase in gross margins. The other key evidence emerging is the pick up in M&A which shows willingness to spend their massive cash balances.
Will higher rates impede recovery in capital spending? AlphaWise evidence shows that interest rates are not a key capex driver. It’s all about confidence in growth. Our economist, Chetan Ahya, thinks rates are peaking and usually this leads to a trough in industrial shares.
Are industrials pricing in enough? Industrials are trading at multi-year lows on relative valuations. The 5- year EPS growth embedded in share prices is lower only for Energy and Materials.
Staying O/w Industrials
We have been mostly wrong about capex…
•
At the end of the last year, our view was that private corporate capex would be the biggest theme for 2011. We argued that strong industrial growth, low trailing capex, reasonable cost of capital, improving supply of capital, recovering corporate profits, and healthy corporate balance sheets suggested that a robust capex cycle was likely in 2011. We further opined that falling institutional ownership and poor relative share price performance meant that a lot of bad news is in the price. Hence, we were overweight the sector.
…and industrial shares
•
It has not been a good call. In fact our proprietary AlphaWise survey (Indian Corporate Survey: Discipline is the Mantra, dated December 2, 2010) showed that corporate India was set for a only modest increase in capital spending in the first half 2011 despite capex drivers breaching threshold levels for bigger capex. The events of the past six months have made private capex even more difficult. Consequently, private corporate capex seems to have slowed down rather than accelerate as we had forecast.
Stock picking helped us…
•
Six months into the year, the industrials index has only fallen lower (ex-LT). While the sector position did not do us good, fortunately, we were partly compensated by stock selection.
..and could continue to be a key theme in the sector
•
Incremental evidence makes stock selection within industrials an overarching theme. The correlations across stocks in the sector are about 0.65 standard deviations above average (and among MSCI sectors, the only sector with higher z-score is Financials). The sector (ex-Larsen & Toubro) has underperformed even further, now down nearly 50% relative to the to the Sensex since end-07. Valuations also seem more attractive, institutional ownership is a tad lower and, therefore, we conclude that any recovery in capex would come as a big surprise for the market.
Pick up in M&A shows a positive corporate mindset
•
Even though the interest rates are higher, corporates do not regard them as a key factor in the capex decision. Capex is driven by confidence in growth. Nevertheless, interestingly, companies are putting some of their massive cash balances to work in M&A (which has soared to a post crisis high). Utilization rates are also climbing neutralizing some of the excess capacity created in the previous cycle.
Taking risk given what’s in the price
•
Our next periodical AlphaWise survey will provide more bottom-up evidence on whether companies are set to accelerate capex or not. In the meantime, we continue to focus on picking stocks in the sector. Our favorite names are ADE, LT, IRB and JPA. We remain cognizant of the of downside risk to capex but given what may be in the price it seems like a risk worth taking
Despite rising capacity utilization, companies remain reticent about spending money
•
A combination of slowing growth, policy hiatus, global growth volatility and rising rates may be hurting capital spending, especially greenfield capex.
Indian companies feeling the after-effects of a big capex cycle
•
It is not so apparent that India’s corporate capex cycle between 2005 and 2008 was significantly larger than almost any other part of the world relative to balance sheet size. For example, during 2005-2008, India’s capex to depreciation was more than twice the average in EM.
•
The subsequent slowdown in capex has to be seen in this light. Given, India’s growth rate, it is not going to be long before utilization rates start closing to levels which will force a capex cycle.
Utilization rates are not high across the board
•
Capacity utilization rate data is scant in India. So, we asked our analysts to guide us. At the sector level, several sectors are approaching the peak levels of the previous cycle. This also underpins our point that Corporate India will start gaining pricing power in the coming quarters (notably, gross margins are decade lows) but it also tells us that some amount of capex recovery is in the pipeline.
•
The exceptions include commercial vehicles, cement, real estate and steel where capacity utilization is well below peak implying that we could still be several months away from a full blown capex cycle.
Balance sheets set up for capex
•
Corporate activity is definitely picking up. M&A in both value and volume terms is at a post crisis peak and not too far away from the previous high. Share buy-backs by companies are already at a new high. Companies seem to be putting the high cash balances on the balance sheet to work.
•
As and when confidence in growth comes back, a sharp increase in capex seems likely.
Higher Capital Costs Not a Big Impediment
•
The cost of capital is already higher than what it was on an average during the previous capex cycle (2004- 2008).
•
Investors argue that the rise in interest rates may impede capex. However, history does not show that. Moreover, our proprietary AlphaWise survey ranks interest rates the middle of the pack in terms of drivers of capex. However, to the extent higher rates hurt the growth outlook, capex does get affected
BSE Cap Goods Index Down c50% relative to Sensex since end of 2007
•
The underperformance has accelerated since the beginning of 2010.
•
The divergence with LT is striking. LT is driving the capital goods index relative to the Sensex since the middle of May 2011.
•
The longer term price chart shows the cap goods index ex- LT is now back to its mid-2005 level on a relative basis to the Sensex.
Valuations have contracted significantly from highs
•
The premium for industrial shares has climbed down sharply since the end of 2007. The P/E and P/B multiples, though off recent lows, are at multi-year lows.
•
Indian industrial valuations have nearly halved from the peak relative to the EM sector.
•
Given India’s long-term growth prospects, current valuations may be pricing in a prolonged slowdown in capex.
Industrial stocks priced for very little growth
•
The only two sectors that are pricing in less growth than the industrials sector are energy and materials.
•
The more comparable sectors to industrials are domestic sectors such as discretionary, staples, telecoms, financials and utilities. In terms of growth priced in, industrials stands out as the most inexpensive domestic sector currently.
Our industrial growth and rate cycle forecasts favor industrial shares
•
What’s in the price is borne out by the performance of industrials versus the nominal IIP. The share prices currently discounting a significantly slower industrial growth than what our economist, Chetan Ahya, is predicting.
•
Then again, aside from Consumer discretionary, industrials is the only other sector which is highly negatively correlated to the rate cycle. Our economist is arguing for peaking for rates in India and, concurrently, industrials should be finding a trough.
Earnings estimates appear to be improving at the margin
•
Reported revenue growth for a broad sample of industrial names has stabilized at around 20% but growth is trailing market aggregates at the margin.
•
The consensus seems to be pushing the estimates for the large industrial companies higher. We think that larger industrial companies seem to have a nuanced story and may decouple from the rest of the sector.
At the margin, both investors and the sell-side have sold industrials
•
It seems that our bullish call on industrials at the start of the year was a consensus call.
•
Both the buy- and sell-side remain bullish.
•
The only good news is that at the margin both have been sellers of the sector.
•
Key question is have they sold enough and answer may be in the negative.
•
Along with the possible fall in capex, this remains a key risk to the performance of industrials and underpins our point that investors should remain focused on stock picking.
Sector effects and its impact on stock selection
•
We run intra-sector correlations versus the respective MSCI sector indices. This indicator tells us how much sector factors are influencing stock performance within each sector.
•
The adjoining table tells us that the correlations are very low for Consumer Discretionary, Energy, Telecoms, and Utilities and, to that extent, stocks in both sectors are set for sector- specific moves.
•
Conversely, correlations seem high in Industrials and Financials. These sectors are more amenable to stock selection
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