The brokerage says India premium valuations will come under pressure as global investors veer towards ‘cheaper, commodity-geared markets”. Its best bets are plays on inflation, high growth and high free cash, like BHEL, Dr Reddy’s, Hindalco, IDFC and M&M
CLSA, one of the region's largest and most highly-rated independent brokerages, says India faces headwinds from renewed rising inflation on stronger global commodity prices and domestic factors like rate hikes, tighter liquidity and a rising current account deficit largely on account of higher oil prices, which is why a bottom-up approach would work better than the top-down this year. The brokerage has set a December 2011 Sensex target of 22,500. At that level, the market is expected to trade at about 16 times, and this it believes is reasonable, given a 19% Sensex EPS growth in FY12 after a 31% growth in FY11.
With the Sensex price-to-earnings ratio at 17% above its 10-year historical average, CLSA expects a de-rating in India's premium valuation multiples. Most of the upgrades, this year, will come in the commodity sectors. It is likely that we will see a correction in this quarter with global investors veering towards "cheaper, commodity-geared markets" and because of a "bunching in government divestment-related equity issuances," it says in a report to clients.
The cheaper commodity-geared markets it refers to are Brazil and Russia. "While the weight of the energy and materials sector in the India benchmark indices is less than 30%, it is (as much as) 50-75% in markets like Brazil and Russia." In addition, there's a risk that foreign equity inflows could be attracted to cheaper markets with strong economic linkages, like Korea and Taiwan, in the event of a strong rebound in the developed economies.
CLSA points out that equity issues in the pipeline are worth almost $30 billion. "The current pipeline of IPOs with SEBI is Rs503 billion ($11 billion). Adding another Rs590 billion ($13 billion) in the proposed government sector offerings and making another $5 billion allowance for other QIPs/offerings that may be under consideration, the overall primary market raising (maximum) would be $29 billion." While the brokerage is not alarmed at the size of the pipeline, it says that bunching up of government offerings could put pressure on the markets. Major government issues in the pipeline include Rs210 billion by IOC, Rs160 billion by SAIL, Rs140 billion by ONGC, and Rs50 billion by HPCL.
In inflationary conditions, the sectors that are likely to outperform include materials, software and energy, while consumer durables and staples will be constrained by competition and rising rates. In its 'visible growth' category, plays such as consumer and pharma stocks riding structural growth drivers, and industrials with strong order books or new capacity additions, should do well, it believes. "The FCF yield screen suggests some opportunities in property stocks too," it says.
"BHEL offers visible near-term growth; fears on competition are overdone. IDFC looks best placed to gain from the huge infrastructure financing opportunity. M&M is well positioned to profitably grow volumes on rising agri incomes. Dr Reddy's huge drug pipeline will drive a surge in profits over FY12-14. Hindalco's new aluminium capacities will drive 23% CAGR in volume, restore high profitability and help deleverage the balance sheet. Our top mid-cap picks are Exide, e-clerx, SR Sugar, Jain Irrigation and Titan," CLSA says.
It expects inflation will correct to about 6% by March 2011, but trend back to 8% by March 2012. This will be mainly because of a rise in global commodity prices (as the percentage of the wholesale price index basket linked to global commodity prices has increased) and rising food inflation.
Inflation has its risks for the stock market, like the potential slowdown in consumer spending, a squeeze in profit margins of corporates, the effect of currency depreciation and monetary policy actions aimed at containing inflation as well as administrative measures by the government to check prices for some commodities that may be deemed to be essential (possibly steel, cement and sugar).
Tightness in liquidity and rising interest rates also do not augur well for the market. "We believe that the RBI (Reserve Bank of India) will be required to hike policy rates during 2011 to curb inflationary pressures." However, a pick up in government spending will help, says CLSA. "Although the government raised $15 billion more than budgeted from the 3G/BWA licence auctions in July 2010, the borrowing programme was not cut back in anticipation of additional expenses. While the additional expenditure (introduced through two supplementary grants aggregating Rs740 billion) has now been approved by parliament, the interim period has seen a build-up in cash balances of the government with the RBI (Rs920 billion in December 2010, versus Rs480 billion in June 2010) and thus a net liquidity drain from the system." (3G/BWA stands for third generation-for GSM-and broadband wireless access-for CDMA.)
CLSA sees some of the strong performers of 2010 coming under pressure. "Stocks in sectors that are incrementally seeing pressures on growth and have been strong performers of 2010 look most at risk for a tactical correction. In this category, we see PSU banks, oil PSUs, airlines and select consumer names."
The brokerage points out that quality will prevail in 2011. The spate of scams that broke out late 2010 have hurt risk perception. It found that after the Satyam scandal stocks that have a dodgy corporate governance record have been slow to bounce back and quality stocks have sustained outperformance. Corporate governance risks will weigh on mid-cap valuations, it says.
Since free cash flow is more valued in periods of rising capital cost, even some property stocks come out strong in this category. "JP Infratech, SR Sugars, Sobha Developers, Cairn India, Sterlite, DLF and Ashok Leyland are our preferred stocks in this basket," the brokerage says.
(This article is based on secondary research. The report is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author's own and may not necessarily represent those of Moneylife.)
The local market is likely to see a cautious opening today on lacklustre global cues. Wall Street closed mostly lower overnight on the strengthening dollar. Markets in Asia were trading with modest cuts in early trade on Wednesday as commodity stocks were hit by lower prices of gold and crude. The SGX Nifty was down 13.50 points at 6,145.50 over its previous close of 6,159.
As indicated in Monday's market closing report, the market fell 62.33 points yesterday. The Sensex opened 56.33 points above its previous close, hitting a high of 20,651.21, which was lower compared to the high of Monday, despite an overnight rally of almost 100 points in the Dow, on improving economic data. Buying in select stocks lifted the key benchmarks into the green in noon trade, but volatility soon pushed them lower again. The market ended its four-day winning streak, ending about a quarter of a per cent lower.
The Sensex declined 0.30% to end at 20,498.72. The Nifty shed 11.25 points (0.18%) at 6,146.35 after touching the day's high-low of 6,181.05 and 6,124.40.
US markets closed mostly lower on Tuesday as the dollar gained strength and as prices of gold and crude declined. Gold declined 3.1% while crude futures shed 2% in trade. The indices pared their losses after the Federal Reserve announced that it would continue with its bond buying programme.
Announcing the minutes of its 14th December meeting, the Fed said a stronger US economy is among the reasons behind the rise in government-bond yields, which may undermine its efforts to keep the recovery going through low interest rates. In economic news, the Commerce Department reported that US factory-goods orders rose 0.7% in November, against analysts’ forecasts of a 0.1% decline.
The Dow gained 20.43 points (0.18%) 11,691.18. The S&P 500 shed 1.67 points (0.13%) to 1,270.20 and the Nasdaq fell 10.27 points (0.38%) to 2,681.25.
Markets in Asia were mostly in the red in early trade today as the strengthening dollar pushed gold and crude lower. Investor sentiment was also hit as they were wary that the US Fed’s plan to continue with bond buying would not be sufficient to boost the economy.
The Shanghai Composite declined 0.48%, the Hang Seng fell 0.34%, the Jakarta Composite lost 0.16%, the Nikkei 225 was down 0.12%, the Straits Times fell 0.13%, the Seoul Composite shed 0.09% and the Taiwan Weighted was down 0.20%. On the other hand, the KLSE Composite gained 0.44% in early trade. The SGX Nifty was down 13.50 points at 6,145.50 over its previous close of 6,159.
Back home, corporate affairs minister Salman Khurshid on Tuesday said the April 2011 deadline for the transition of Indian accounting standards to the International Financial Reporting Standard (IFRS) will be met and all issues, especially those related to tax implications, have been resolved.
Mr Khurshid’s statement comes days after industry body Ficci sought delay in the implementation of the IFRS beyond April 2011, saying the deadline was “highly unworkable” and “unfair”.
The convergence would require minor amendment in the Companies Act, 1956 and some changes in the governing Acts of the three professional institutes—ICAI, ICWAI, and ICSI.
New Delhi: Strong domestic demand will enable the Indian economy to register an average annual growth of 8.4% during next five fiscals, reports PTI quoting ratings firm Crisil.
Crisil said the Indian economy faced five key constraints which if addressed would accelerate growth to 10% annually on a sustained basis.
These involved quantity and quality of physical infrastructure, skill shortages among the workforce, faltering agriculture and high food inflation, less spending on health, education and physical infrastructure, and a governance deficit.
"The inherent strength of India's domestic demand will enable it to maintain 8.4% annual growth over the next five years (2011-12 to 2015-16)," Crisil said in its report 'India-Raising the Growth Bar'.
The report comes at a time when the Indian economy clocked 8.9% growth during the first half of the current fiscal.
Spurred by better-than-expected growth, the government had in its mid-year economic review in December revised upward its forecast for economic expansion in 2010-11 to 8.75%, plus or minus 0.35%, from the earlier estimate of 8.5%.
The Indian economy grew by 7.4% in the last fiscal, showing recovery from the global economic downturn.
It had grown by an average of above 9% for three fiscals before global recession plunged the growth rate to 6.7% in 2008-09.
The report said an increase in discretionary spending by middle class households will boost demand for durables like automobiles and white goods, and services like hotels, restaurants, and tourism.
Financial services such as consumer finance, asset management and insurance will grow briskly to cater to the needs of a growing middle class with increasing disposable income, it added.
The growing income of the middle class segment, which already numbers over 30 crore, will also propel demand for healthcare and education services, particularly in the private sector.
"Domestic demand, spurred by a large growing young population, and robust consumption and investment rates, will support 8.4% economic growth over the next five years," Crisil managing director and CEO Roopa Kudva said.
"The Indian economy is not demand-constrained. Rather, it is the supply-side issues that limit the growth prospects," Crisil said.