India Strategy & Top Ideas

Growth expectations back ended, Headwinds increase, IT majors the best pick

R Sreesankar rseesankar@plindia.com

+91-22-66322214

Click to edit Master title style LilladherPrabhudas June 2015

Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to important disclosures and disclaimers at the end of the report.

LilladherPrabhudas FY16 downgrades started….

• Business confidence still high, despite poor revenue numbers : The fiscal consolidation aimed by the government has resulted in low government spending. The performance of infrastructure companies in Q4FY15 bears a testimony to this. However, the commentaries by the infrastructure companies post the Q4FY15 results was positive and we believe that this should start to yield results from Q2FY16.

• Infrastructure, especially roads seeing a large interest: We expect to see large order flows in the road sector both in terms of EPC, BOT and the hybrid model. This may turn out to be the first push in terms of the capex cycle picking up. We tend to believe that the large capex cycle could be back ended, while the immediate beneficiary could be the infrastructure.

• Politics, Will the standoff on bills be an issue? The Indian equity markets continue to remain volatile. The reasoning for the volatility may vary, but the corporate results for 4QFY15 were of little help to end any volatility. While the domestic economic outlook continues to remain optimistic, the corporate results have continued to be disappointed fraught with demand headwinds. With assembly elections to the Bihar assembly set for October 2015, it is most likely that politics will once again become the hot topic after monsoon.

• Interest rates, will it reduce or have seen the bottom? The repo rates under the Liquidity Adjustment Factor (LAF) was reduced by 25bps from 7.50% to 7.25% in the bi-monthly monetary policy on the 2nd of June 2015. RBI believes that the banks have started to pass on some of the past rate cuts into their lending rates. While we had mentioned last month that the industry has been clamoring and market has been expecting to see a reduction in the domestic interest rates to fuel growth, we believe that with the recent run up in crude prices and the resultant effect off it in the domestic fuel prices and inflation, the chances are that we may not see any sharp reduction in the near term.

• IT Sector, Negatives in the Price: IT sector had faced headwinds and performance of many of the IT companies were below expectations. The recent under performance not withstanding, we believe that the stage is set for a revival in performance, partly aided by a weak Indian Rupee. We expect a 10% return for the sector over the next three months. and we continue to remain optimistic on the sector.

• FMCG companies, Already facing rural slowdown now to face regulatory challenges: The industry has highlighted the narrowing gap between the rural growth and the urban growth. With crude retracing almost 50% from the bottom, it is quite likely that the industry may see withdrawal of many of the discounting schemes which may put pressure on sales. In addition, the recent row over the safety issues with Maggi noodles and the resultant product withdrawal could have far reaching consequence for not only Nestle but also for the entire Food processing and FMCG industry. We expect to see tighter norms ahead for the food products and personal care industry.

• Contracting exports, a cause for worry: The merchandise exports from the country have been seeing a steady decline since July 2014 and have entered into contraction from January 2015 through April 2015. The reduction in current account deficit resulting from decline in oil prices has begun to reverse, though RBI believes that the size of the deficit may be contained at 1.5% of GDP.

6/12/2015 3

LilladherPrabhudas Contd…

• Where should we invest? Private sector banks, the obvious: While we have had a call where we had recommended investors to remain overweight in financials, automobiles and IT, we do not see any reason to change the thought process. While banking as a sector had come under pressure, the private sector banks which we have been recommending had had a relatively better period and has out performed. We continue to believe that structurally, it is the private sector banks which will give a sustained out performance and at best most of the PSU banks will be trading play. Our preferred picks continue to be HDFC Bank, Yes Bank, ICICI Bank, and State Bank of India among the PSU banks.

• Passenger cars and commercial vehicles should do well: We remain optimistic on the outlook for automobiles especially in case of passenger cars and commercial vehicles, while remaining cautious on Motorcycles. Our top picks in the sector continues to be Maruti Suzuki and Ashok Leyland, representing the passenger cars and commercial vehicles respectively. Our call of the headwinds in terms of rural consumption post the un seasonal rains could result in slowdown in demand for two wheelers in rural areas, affecting the off take of motor cycles.

• Tailwinds behind IT stocks: The IT sector has been under pressure and the sector has under performed over the last one month. We believe the sector has tail winds behind them in terms of a weak currency and demand environment continues to look healthy despite the business sentiments in USA not that great due to weakness in energy and telecom sectors.

• Commodities continue to under pressure: The global commodities and the agricultural commodities continue to remain under pressure, which is even more complicated by the easy monetary policies being followed by most economies resulting in weak currencies impacting some of the commodities further. Any further slowdown in growth in the Chinese economy is going to have even a bigger impact in the commodity space. Despite this scenario, we have seen a fuel inflation in India for the fourth consecutive month.

• Market trading range: This has led to the equity markets trading at a one year forward multiple of 16.8X, still at a premium to the long term average despite the market correction as the FY16 earnings have already got revised downwards. We have revised our estimate for the market trading range downwards to 7800-8800 in the near term with no change in the long term estimates with the 12 month outlook at 9500-10000 levels for the NIFTY.

• Our preferred picks continue to be HDFC Bank, SBI, and ICICI bank among the financials, L&T and Ashoka Buildcon among Engineering & Capital Goods and Infosys, TCS, among IT, UltraTech Cement and JK Lakshmi Cement among Basic materials and Ashok Leyland and Maruti Suzuki among Automobiles.

6/12/2015 4

LilladherPrabhudas Global Issues – Growth estimates revised

downwards • 1QCY15 US growth below expectations: US is expected to drive global growth in both 2015 and 2016. The 1QCY15 revised

estimates have shown a contraction of 0.4% in US economy against the general consensus and estimates of a 0.2% growth. The EIU have reduced the growth forecasts for CY2015 to 2.4% from the earlier estimates of over 3.0%. The European economies are expected to be having a better growth mainly on account of benign crude prices, accommodative monetary polices and a weak euro.

• US Non farm pay roll recovers after two months of lower job additions: The non farm payroll additions were at 281,000 after two months of below 200,000 additions. The business sentiments in Energy and Telecom were not that great given the fact that the energy sector saw layoffs were high, as job cuts in energy sector surged, a reflection of the low oil prices.

• Euro zone, better 1QCY15: The Euro zone growth estimates have been revised upwards to 1.5% from the earlier levels of 1.4%. The revised forecasts of 1.5% and 1.8%, for 2015 and 2016 reflects the changed outlook and are above the earlier estimates. Growth is expected to be supported by (i) low oil prices, (ii) continued monetary easing, and (iii) euro deprecation. Bond yield sin both the Euro zone and to some extent in the USA has spiked from the historic low levels due to an expectation of a stronger economic growth in the single currency area and increase in oil prices leading to an expectation of higher inflation.

• Crude oil Prices, have bounced from lows: The Brent crude oil prices have corrected from a low of US$49 before recovering to US$67 at present. Countries like India have been a big beneficiary of lower crude prices and an increasing crude price does not augur well for the CAD as far as India is concerned.

• Global Volatility lower, Indian Volatility higher: The CBOE VIX volatility index, a measure of the cost of equity portfolio protection has have seen lower volatility and trades at 13.22, while the Indian VIX at 17.85 is seeing increased volatility following a weak currency, increased earnings downgrades and FII outflows. We expect to see the market remaining volatile for some time.

6/12/2015 5

LilladherPrabhudas Non oil Non gold imports- Worst in the last 12

months

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• Over the last twelve months, while the exports, total imports and oil imports have seen a significant reduction, the non oil non gold

imports have been on the rise and have reached a 12 month high in April 2015. resulting in the trade deficit of US$10.99bn. The

challenges in an improving domestic economy is an increase in non oil non gold imports and managing the trade deficit with an increase

in crude oil prices will remain a challenge.

External debt break-up between ST and LT

Source: RBI, PL Research * Data revised on exchange rate fluctuation

Trade Deficit

Source: RBI, PL Research

US $ Mn Jun'14 Jul'14 Aug'14 Sep'14 Oct'14 Nov'14 Dec'14 Jan'15 Feb’15 Mar’15 Apr’15

Trailing 12M

Trailing 12M YoY

Exports 26,480 27,728 26,958 28,903 26,094 25,961 25,398 23,883 21,545 23,951 22,055 306,954 314,596

Imports 38,243 39,956 37,797 43,151 39,452 42,822 34,833 32,206 28,392 35,745 33,047 444,875 445,042

- Oil 13,343 14,355 12,839 14,497 12,365 11,716 9,942 8,248 6,101 7,413 7,443 132,727 165,951

- Gold 3,120 1,810 2,040 3,752 4,170 5,610 1,340 1,550 1,980 4,980 3,131 36,052 27,386

- Non Oil Non Gold 21,780 23,791 22,918 24,902 22,916 25,496 23,551 22,408 20,311 23,351 25,604 276,096 250,496

Trade Deficit (11,763) (12,229) (10,839) (14,247) (13,357) (16,861) (9,435) (8,323) (6,847) (11,794) (10,992) (137,921) (130,445)

3.6 2.8 4.7 4.4 17.7 19.5 28.1 45.8 43.3 52.4 64.9 78.2 98.9 98.3 95.4 92.9 86.2 87.8 86.2 85.5

97.7 96.0 100.2 108.2 116.3 119.6

144.3 178.6 181.2

208.5 241.0

267.6 301.4 304.5 307.0 333.1 356.1 362.3 369.7 376.4

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LilladherPrabhudas Inflation is low, but will start to rise?

• The retail inflation corrected for a second consecutive month and the food inflation reached a four month low. correction in food articles saw the overall CPI inflation declining to 4.9% for the month ended April 15, down from the earlier level of 5.3%. The fuel inflation rose for the fourth consecutive month and the inflation expectation remain in high single digits. The fuel inflation though has reached a four month high, reflecting the increase in oil prices.

• 10yr G-Sec Yield is trading at 7.81%, and has been seeing an upward march post the bi monthly monetary policy on 02 June 2015.

• The March 15 IIP data continue to be disappointing, reflected in the quarterly results being published. Source: Bloomberg, PL Research

Source: Bloomberg, PL Research

CPI Inflation

GDP Growth YoY (Quarterly)

Source: Bloomberg, PL Research

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LilladherPrabhudas Disclaimer

6/12/2015 58

BUY : Over 15% Outperformance to Sensex over 12-months

Accumulate : Outperformance to Sensex over 12-months

Reduce : Underperformance to Sensex over 12-months

Sell : Over 15% underperformance to Sensex over 12-months

Trading Buy : Over 10% absolute upside in 1-month

Trading Sell : Over 10% absolute decline in 1-month

Not Rated (NR) : No specific call on the stock

Under Review (UR) : Rating likely to change shortly

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Rating Distribution of Research Coverage PL’s Recommendation Nomenclature

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