India 2010?Watch out for the second half: Indian markets had a lacklustre first half 2010, rising just 1-2%. But the equities could throw up a few surprises in the second half of the year. How the second half plays out for India depends on the interplay of 11 different forces?valuations, global markets, corporate events, monsoons, payouts, consumption, capex boom, interest rates, fund flow, reforms and earnings.
Overall assessment: Earnings should remain steady in Q1FY11 with Sensex PAT (profit after tax) growing 19% YoY (year-on-year). For Indian equities, the second half of 2010 depends on the action of the above 11 drivers. Monsoons and global markets remain the near-term triggers for market direction. If all drivers work in tandem, the Indian market could well be higher from current levels by March 2011.
Our model portfolio is overweight on domestic plays?financials (SBI, ICICI Bank), infrastructure & allied sectors (Bhel, ACC, Unitech) and oil & gas (BPCL, GAIL). Among the global plays, we prefer IT and pharma over cyclicals.
Markets to remain range-bound: Accelerating corporate profit growth will limit the downside in the markets. Yet, above-average valuations cap the upside. Expect benchmark indices to remain in a range of 10% from the current levels. Thus, 2010 will be a year of stockpicking, with market contribution to aggregate performance being the lowest in three years. Stocks in our model portfolio offer growth at reasonable valuations.
The starting line-up: The Sensex has ended the June quarter at 17,700, marking its third consecutive quarter of consolidation, after the sharp approx. 100% appreciation during March-September 2009. For the Indian market, it was a lacklustre first half 2010, with the major indices rising only 1-2%. Yet, in relative terms, India was one of the best performing markets.
Earnings?domestic play: The earnings growth has been the bedrock of Indian equities during the upcycle of FY03-08, with an EPS CAGR (earnings per share compound annual growth rate) of 25%. Post-global financial crisis, Indian earnings flattened for two consecutive years. While H2FY10 marked the beginning of earnings growth, markets need more certainty about the resumption and sustenance of the trend. We estimate EPS CAGR of 25% during FY10-12. Importantly, our FY11 EPS estimate has not witnessed any major changes over the last one year, indicating greater confidence.
Another feature of earnings growth in this cycle would be the rising contribution of domestic sectors. We expect domestic plays to contribute 56% of aggregate earnings in FY12 against 52.6% in FY08. The contribution in FY10 appears high due to insignificant profits and losses in a few cases from global cyclicals. The domestic proportion of earnings would have further risen, if one were to include the gas profits from Reliance, GAIL, ONGC, etc. The rising share of domestic plays provides stability to aggregate earnings growth and will also lead to higher market valuations. We see this as a key source of market re-rating over the next few years.
Correction in valuation underway: With market indices being flat for the last three quarters, growth in earnings has led to a correction in valuations. From a premium of over 20% to 15-year averages in September 2009, the Sensex PE (price-to-earnings) has now corrected as earnings have-grown. Consolidation for another couple of quarters will bring valuations in line with long-term averages.
Key earnings divergence for Sensex stocks in Q1FY11: We expect Sensex Universe to report sales growth of 28%, Ebitda (earnings before interest, taxes, depreciation and amortisation) growth of 21% and PAT growth of 19%. The growth rates in Sensex universe earnings are expected to improve over the next three quarters, with average growth of 22%. The EPS growth will be even higher due to the higher weightage of growth stocks.
Commodity stocks are the biggest contributor to the YoY earnings growth, given the low base of June 2009. This is explained by the loss-to-profit scenario for Tata Steel, 783% earnings growth from Hindalco and 59% for Sterlite. Reliance (contribution of 14%) is expected to report strong earnings growth of 30%, while ONGC would report de-growth of 28% (contribution of 10%). Further, the muted earnings growth of 3% and 6%, respectively, by NTPC and SBI (total contribution at 14%) would bring the overall earnings growth down.
Stock with 25% plus earnings growth include: Tata Motors (+45%), HDFC Bank (+31%), and ICICI Bank (+25%). Stocks with 20-25% earnings growth are Maruti Suzuki (+24%), Bhel (+22%), TCS (+22%), M&M (+21%) and HDFC (+21% YoY). RCom, ONGC and Bharti Airtel would report degrowth of 82%, 28% and 21%, respectively.
