While the recently concluded quarterly result season did not provide much to write home about in general, there were a few bright spots. Commodity price decline-led margin improvements helped cushion softer top-line growth in sectors like automobiles and consumer goods. More encouragingly, the better managed real estate firms? acceleration in new residential launches in cities like Bangalore and Mumbai suggests that realty sector has turned the corner.
More generally, the economic slowdown has also resulted in corporates focusing on operational discipline and, thus, reducing their cost base. That in turn suggests that as the economy recovers in FY14, growth in top line will feed into profit-margin improvements at a fairly rapid rate.
Going forward, we expect the Indian economy to recover over the course of FY14 as the RBI?s monetary easing bears fruit and as the policy initiatives outlined below kick in. Against the background of an economic recovery, both operating and financial leverage should kick in to boost corporate bottom lines as FY14 progresses. We expect the Sensex firms to deliver about 10% earnings growth in FY14 (compared to the 8% earnings growth witnessed in FY13). This, combined with a mild re-rating of the Sensex forward P/E (from 15.5x to 17x), should help the Sensex reach 23,000 by the year-end.
Policy measures to address the economic downturn: A combination of rate cuts, allowance of greater FDI and legislative reform is likely to constitute the Indian government?s toolkit for reviving the economy, ahead of the general elections.
Continuance of below-trend GDP growth and moderating inflation is likely to lead the central bank to cut the repo rate by 50 basis points over the course of the next two monetary policy meetings. The quantum of rate cuts could be more than expected if global commodity prices soften further owing to the decelerating growth in China?the world?s largest consumer of commodities.
Given India?s gaping current account deficit and given its largely structural nature, the government is likely to address India?s precarious balance of payments position by allowing greater foreign direct investment into the country. Defence and insurance seem like the two most likely sectors where the government will increase the FDI limits.
Finally, legislative action in the form of passage of the land acquisition bill is likely to form a critical part of the government?s strategy to lift the growth rates. Besides the massive wealth effect that such a law can generate, corporates too stand to benefit from the institutionalisation of the land acquisition process.
No discussion on the economy is complete nowadays without some hoopla on the extent of India?s current account deficit and the impact this is having on the rupee. Whilst the current account deficit looks likely to stay north of 5% in the short term, this does not necessarily translate into a further slide in the currency. Capital account inflows?both on the FDI and FII fronts?have been healthy for India over the past ten years and the ?base case? scenario is for such flows to
sustain, going forward. Therefore, we do not buy into the view that the rupee is destined to slide to Rs60 a dollar. Whilst such a slide might take place,
it should not be the ?base case? scenario in formulating investment decisions.
Investment opportunities, going forward: Key areas where we see immense value currently are sectors that should be disproportionate beneficiaries in a recovery; cyclical stocks and small-cap stocks. Consumer discretionary sectors like automobiles should revive the fastest in a cyclical turn. Tata Motors,
Bajaj Auto and Maruti are our favourite plays in this universe. Construction stocks, especially those with strong balance sheets like Larsen & Toubro, look well placed too in the wake of rising public sector capital expenditure.
On the flip side banks and financial services should be avoided inspite of their cyclical nature as we believe the structural challenges in that space should outweigh any cyclical benefits. The private banking space looks especially vulnerable with punchy valuations failing to account for balance sheet and accounting quality challenges, Defensives such as consumer staples look priced to perfection and are best avoided, too. A better way to play the structural consumer story in India is through entry level consumption plays like Bata and TTK Prestige.
The Indian stock market promises to be a source of healthy returns of around 15% over the next year or so?the combination of undemanding valuations along with an economic recovery should result in better managed Indian companies posting returns.
The authors are CEO and strategist, respectively, for institutional equities, Ambit Capital
