Strategy: 2003-07 and 2013-XX:: Kotak Securities

Please Share::

2003-07 and 2013-XX. A comparison of the current market cycle with the 2003-07
one (when the Indian market performed well) shows the different evolutionary path of
the current cycle versus the previous one. We note several differences with respect to
(1) starting valuations of the two cycles, (2) global macroeconomic environment,
(3) domestic economic cycle and investment climate and (4) earnings momentum.
The current one will follow its own dynamics but a comparison is useful, nonetheless.

�� India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details ��

��

-->
2003-07 market cycle—low market valuations in the beginning and constant earnings surprises
The 2003-07 market cycle started in the middle of 2003 with the market (BSE-30 Index) trading
at around 8X 12-month forward P/E and continued until 2007 (see Exhibit 1) driven by constant
earnings upgrades. It reached 16X in the middle of 2007 and peaked at 23X by end-2007 in a
burst of frenzy in 2HCY07. The policy rate was 6% in the middle of 2003 and went up with a
fast-expanding economy (7.75% by end-2007). Finally, the cycle was accompanied by large
skepticism among investors, which resulted in periodic sharp corrections in the market.
Ongoing market cycle—starting at a much higher valuation level, low scope for disappointment
The current cycle started at about 14X 12-month forward P/E in September 2013 and the
market is trading at 16.6X 12-month forward P/E. The policy rate is currently at 7.75% and will
likely decline over the next 12-24 months in conjunction with lower inflation. However,
earnings upgrades may still be some time away and we see downside risks to our FY2016
estimates. Banks and companies’ balance sheets are far weaker compared to 2004 levels with
large reported NPLs, hidden NPLs and restructured loans and leveraged balance sheets. The
government is still in the process of resolving India’s investment challenges while the policy
initiatives in 2000-03 led to a massive increase in private sector capex in 2004-07 (see Exhibit 2),
which contributed to India’s strong GDP (see Exhibit 3) and earnings growth. We think
investments in ‘new’ areas of affordable housing, railways, smart cities, urban infrastructure
(‘new’ infrastructure sectors) will take time (1-3 years) to fructify while investments in the
traditional metals, oil & gas, power, roads and telecom sectors (‘old’ sectors that drove the
2004-09 capex cycle) will not see meaningful growth versus 2004-09 levels.
Global environment—strong GDP momentum in 2003-07 versus low cost of capital this time
The global environment was very supportive in 2003-07 and strong global GDP growth (see
Exhibit 4 for GDP growth of key countries over the past 15 years and projections) led to a large
increase in the net profits of India’s commodity and IT companies (see Exhibit 5). We do not see
global GDP growth being supportive this time with the US appearing to be the sole engine of
global GDP growth. More important, the performance of global equity markets appears to be
driven by low and declining cost of capital, in turn driven by accommodative and
unconventional monetary policies of central banks rather than by earnings momentum (see
Exhibit 6 that shows earnings growth over the past few years for the major global indices).
2013-XX: High faith in India’s medium-term story or low cost of capital for a long time?
We remain positive on India’s medium-term economic story noting (1) the government’s focus
on economic development, (2) India’s favorable demographics and (3) improving
macroeconomic position. However, current market valuations factor a lot of the positives even
before any meaningful pick-up in economic activity or earnings upgrades. We would like to
believe that the market is paying the rich valuations for India’s strong medium-term story and
not for the fact that yields (and perceived cost of capital) are low everywhere.

LINK
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily19012015tn.pdf