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Motilal Oswal

By Motilal Oswal 11-Apr-2012 | 15:02

Second successive quarter of sub-2% PAT growth

MARKET: Indian equities end FY12 with a modest decline of 10%

4QFY12 PREVIEW: Another disappointing quarter; PAT up 6% YoY (1.6% ex SBI)

FY14 ESTIMATES: Expect earnings CAGR of 14% over FY12-14

ECONOMY: Growth should be the focus of RBI/government

TOP PICKS: ICICI Bank / SBI, Maruti / Tata Motors, Wipro / Infosys, Coal India, UltraTech / JP, Lupin




MARKET: Indian equities end FY12 with a modest decline of 10%


The BSE Sensex declined 10% in FY12 and closed at 17,404. The decline would have been higher but for a 13% rally in 4QFY12. During FY12, all emerging markets, led by BRIC nations, faced headwinds on growth and inflation, leading to severe underperformance. India in particular faced additional headwinds of policy inaction. Considering the economic-political-corporate-global headwinds of FY12, a decline limited to 10% appears quite reasonable. As at the end of FY12, Indian markets traded at a P/E multiple of 13.8x, the global average. The P/B multiple, however, remains among the highest in the world, considering the strong RoE of 18%.


In line with the weak sentiment, FII flows plunged from USD25b in FY11 to USD8.5b in FY12, that too after huge inflows of over USD9b in 4QFY12 itself. Domestic mutual funds were net sellers for the third year in a row and insurance companies were net sellers for the first time in several years. While we expect domestic inflows to improve in FY13, the volatility in FII flows would remain the key catalyst for the trend in Indian equities.


4QFY12 PREVIEW: Another disappointing quarter; PAT up 6% YoY (1.6% ex SBI)


We expect MOSL Universe (ex RMs, oil refining and marketing companies) to report PAT growth of 6% YoY in 4QFY12. Here, 4.5 percentage points of growth would be single-handedly led by State Bank of India (SBI); ex-SBI, aggregate PAT growth would be just 1.6%. This would make 4QFY12 the second successive quarter of sub-2% PAT growth and the quarter of lowest PAT growth excluding the global crisis period.


The results would reflect the macroeconomic backdrop of persistent high inflation, high interest rates, and weak currency. Thus, as in the recent few quarters, aggregate revenue growth would be fairly robust at 19%. However, EBITDA margins are likely to be down over 200bp YoY; EBITDA growth would halve YoY to 9%. Further, high interest cost and forex-related losses would drag down PAT growth to 6% YoY.


  • 63 out of 137 companies ex RMs (i.e. 46%) are likely to report PAT de-growth YoY. This is the highest ever in any quarter including the quarters of peak global crisis (3Q and 4QFY09). At the same time, the number of companies with expected PAT growth of over 30% is one of the lowest ever at 26 (19% of Universe).

  • The top-5 PAT growth sectors are: Financials (36% YoY, led by SBI; ex-SBI: 10% YoY), Autos (32%), Consumer (17%), Technology (15%) and Healthcare (13%). The top-5 PAT de-growth sectors are: Infrastructure (-50% YoY), Media (-26%), Metals (-18%), Telecom (-18%), and Real Estate (-13%).

  • Sensex PAT growth would be respectable at 15% YoY. But here too, the SBI factor comes into play; ex-SBI, PAT growth would be just 7% YoY. We expect Sensex sales growth of 21% YoY, EBITDA growth of 11% YoY, and PAT growth of 15% YoY.


FY14 ESTIMATES: Expect earnings CAGR of 14% over FY12-14


We estimate aggregate PAT growth at 14% for FY14, largely in line with 16% in FY13 and significantly above 6% in FY12. Likewise, based on a bottom-up PAT aggregation of Sensex constituents, we arrive at Sensex EPS of INR1,431 for FY14, up 14% (after 14% growth in FY13 and 7% growth in FY12). This is also in line with the 10-year/20-year Sensex earnings CAGR of 15%. Thus, post a moderation in FY12, growth rates in FY13 and FY14 would move towards the long-term average. The key reasons for this sustained growth momentum are 15%+ earnings growth in sectors like Financials, Consumer, Healthcare, Technology and Telecom (these sectors contribute 46% to MOSL Universe).


Earnings growth in FY13/FY14 would be fairly diversified, with key sectors like Financials, Oil & Gas, Autos and Technology contributing 67% / 76% of the earnings growth. The earnings contribution of these sectors to Sensex earnings stands at 70%; earnings growth would be in line with earnings contribution. This is unlike FY12, during which there were sharp swings across sectors, with Financials contributing 48% of earnings growth, while Metals and Telecom witnessed de-growth of 21% and 6%, respectively. We believe the expected diversity in FY13/FY14 earnings growth would provide stability.


ECONOMY: Growth should be the focus of RBI/government


FY12 turned out to be a year of reckoning for most countries. India witnessed rapid slowdown in growth, coupled with near double-digit inflation. Accordingly, we also had to tone down many of our optimistic assumptions. With the uncertainties persisting, we now focus more closely on the coming quarter (1QFY13), while annual projections would remain a critical input for our forward-looking assessment.


  • We estimate inflation at 6.5% for March 2012 and at 6.2% for 1QFY13. These estimates have seen some upward revision in the last couple of months, led by global crude prices, budget proposals, electricity tariff hikes and pending fuel price hikes. These factors have also led us to revise our average inflation estimate to 6.8% for FY13 from 5.6% earlier. We believe inflation would remain within the 6.5% level for a major part of FY13 and will inch above 7% only after December 2012. This presents a reasonable 8-month window of opportunity for the RBI to first ease rates and then pause, as inflation begins rising once again in December 2012. We expect the RBI to cut rates by 100bp in CY12.
  • The liquidity deficit persisted through FY12, but became aggravated during 2HFY12. The government/RBI has also scheduled a larger part (65% of gross and 59% of net) of borrowing for 1HFY13. Some softening of the liquidity situation is likely in April-May 2012, but should firm up once again due to large net borrowings, slowing money supply growth and stress from the external situation. To tide over the liquidity problem, we expect the RBI to undertake open market operations (OMOs) totaling INR1.8t during FY13.
  • The latest BoP data indicates significant stress on the external situation. While merchandise trade volume has declined in 3QFY12, invisibles have been failing to grow for some time. Trade and current account gaps are reaching their record levels at 10% and 4%, respectively. The scenario is unlikely to improve much in FY13 due to multiple headwinds, including weakness in the western economies, high oil prices, etc. Additionally, the INR is vulnerable to inflation. Considering these factors, the exchange rate should hover at INR50-52/USD barring unexpected developments in balance of payments (BoP) or inflation.
  • Policy flip-flops in many key areas of reform coupled with the coming together of various macroeconomic risks have heightened uncertainties prevailing in the market. While many factors such as coalition politics, political bickering, strained relationship between the government and the judiciary and general lack of governance has been held responsible for this, the combined impact of these events has taken a toll on the investment cycle and attractiveness of India as a destination for foreign capital. We believe meaningful progress in some of these areas is necessary to restore investors’ confidence.


STRATEGY:  Top picks – ICICI Bank / SBI, Maruti / Tata Motors, Wipro / Infosys, Coal India, UltraTech / JP, Lupin

Indian markets staged a good recovery in 4QFY12, which limited the decline in FY12 to 10%. There were significant headwinds (global, political, economic and monetary) during the year, which had impacted performance. Our earnings estimates witnessed a period of downgrades during 9MFY12. The two most keenly awaited events of 4QFY12 – the UP elections and the Union Budget also failed to cheer the markets.


Post this dismal performance, Indian market valuations have slipped below historical averages (rolling 12-month forward P/E of 13.8x v/s 10-year average of 14.6x). We believe that a bulk of the earnings downgrades (16% downgrade in FY13 earnings) and the entire rate tightening (13 rate hikes aggregating 375bp) is now behind. However, there is poor visibility of implementation of key reforms. While the monetary cycle has begun to ease (CRR cut by 125bp; rate cuts to follow), any meaningful re-rating of the Indian markets will be preceded either by confidence in the implementation of key reforms or significant correction in global crude prices. We see limited downside in the markets from here, but upsides would be a function of clarity on either of these catalysts. Our model portfolio has sectoral weights similar to the benchmarks, as there is some discomfort on either fundamentals or valuations of most sectors. There is significant divergence in stock weights within the sectors. Our top picks are ICICI Bank / SBI, Maruti / Tata Motors, Wipro / Infosys, Coal India, UltraTech / JP, and Lupin.