Market Strategy | September 2013

September 13, 2013

Top Picks
Company ICICI Bank Hindustan Zinc Axis Bank Cipla Tech Mahindra Tata Steel Cadilla United Phosporus Crompton Greaves Aurobindo Pharma CMP (`) 951 130 1,021 438 1,310 303 664 134 88 183 Target (`) 1,126 151 1,190 504 1,531 389 894 225 103 271

Market Strategy
Positive signs emerging
Recent INR appreciation backed by CAD fundamentals
In the last couple of months, the sharp INR depreciation exacerbated by a weak current account position triggered a sharp increase in short-term interest rates by the Reserve Bank of India (RBI). This effectively worsened the GDP growth outlook and held to ransom a key catalyst for revival. But finally, the steep 15% depreciation even in REER terms, not to mention the substantial nominal depreciation vis--vis our major competitors like China of 40%+ over the last couple of years, looks to be bearing fruit in terms of sharp improvement in our exports and curtailing of imports, especially gold. Even adjusting for 60 tonne gold import run rate per month (vs 13 tonne in Aug 2013), the CAD run rate looks to have reduced to a much more manageable 2.6% of GDP. More positively, this is backed by a 13% growth in exports in USD terms for 2 months in a row. This is a very healthy growth and is largely real growth as it is in dollar terms and not just in rupee terms. If exports continue to grow at this run rate, then given the weightage of value-added exports in our economy of at least about 16%, it could potentially add 200bp to overall GDP growth. This would in turn trigger a virtuous GDP upgrade cycle as investments also start picking up. The improvement in CAD is likely to give substantial comfort to the RBI to start rolling back its onerous increase in short-term rates as well. After all, domestically, major drivers of inflation such as incessant food-grain MSP increases are no longer present, while core demand and GDP growth is clearly at decadal lows, creating a case for lowering of rates.

Note: CMP as of September 12, 2013

Rate sensitives and cyclicals to benefit

In the short-term, in our view if the RBI does indeed start rolling back its rate hikes (for which as explained, we believe the odds have improved), it would give a strong signal for kick-starting domestic revival and is likely to result in a sharp immediate rally in beaten down cyclicals including banks and other rate-sensitives irrespective of weak near-term earnings outlook. This would be aided by the fact that these stocks are trading at significantly beaten down valuations, and the absence of visibility of a positive catalyst was the only factor holding them back in our view. Hence, in the near-term we would expect a return of anywhere between 20-30% from stocks in these sectors, not-withstanding other cyclical concerns. We acknowledge that eventual medium-term re-rating of these stocks depends on convincing GDP revival that would have to be supported by pick-up in investments and sustained policy improvements. But given the current low expectations, a 100-200bp benefit to growth from exports alone is no insignificant number and can provide a directional improvement to these sectors. Hence, from the point-of-view of a potential positive trigger from the RBI and beaten down valuations, we believe sectors like banking, auto, cap goods and other high beta cyclicals can be invested into in the near-term. Subsequently, if indeed the broader GDP revival also starts to pan out on expected lines, further re-rating potential can be re-assessed.
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Market Strategy | September 2013

Export-oriented sectors remain positive; metals to benefit

Irrespective of the recent INR appreciation, overall the INR is likely to average lower for the quarter and for the year as a whole, and broadly, we maintain that significant export growth is likely to be the starting point of overall sustainable improvement in our macro fundamentals. As a result, we have maintained higher Sensex earnings growth estimates than consensus given the larger weightage of IT and defensives. We maintain our positive outlook on IT and pharmaceutical sectors. Weaker domestic fundamentals (exhibited in a tepid 3% volume growth in steel) had prevented us from turning positive on metals earlier. However, continued INR depreciation has also improved the competitiveness of Indian metals, both ferrous and non-ferrous. Considering recent capacity additions and meaningful under-utilized capacity in the sector, we believe the same is likely to be utilized for sharp increase in exports going forward, aided by improving global fundamentals as well. Additionally, considering that beaten down valuations are building in the worst case for domestic GDP, improvement on that front would lead to further positives. In any case, unlike in earlier quarters when falling global commodity prices had created downsides to EBITDA estimates, currently Indian companies look on far stronger footing to increase their volume growth and sustain EBITDA margins. As a result, we have upgraded several of the larger high quality names in ferrous and non-ferrous sectors including Tata Steel and Hindustan Zinc to Buy.

Overall positive on more sectors, including cyclicals in the near-term

As mentioned earlier, we maintain a higher EPS growth estimate of 10.8% for FY2014 than consensus. Attributing a 14.5x multiple to our Sensex EPS, we arrive at a target of 22,300 for the Sensex over the next few months, driven by the above-mentioned positives. Moreover, unlike a couple of months back, we have a positive outlook on several more sectors, including not just IT and pharmaceuticals, but also metals. Also, at least from a near-term perspective, we believe the odds are in favor of a rally in banking stocks (especially private banks) and other rate sensitives, cyclicals and high beta sectors as well.

Exhibit 1: Trade deficit positively narrowing...

(USDbn) (5.0) (10.0) (15.0) (20.0) (25.0) Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 (18.3) Trade deficit

Exhibit 2: ...On double-digit export growth

(%) 14.0 12.0 10.0 8.0 6.0 6.6 Export growth 11.6 13.0

(9.8) (12.2) (12.3)

(10.9)

4.0 2.0 (2.0) (0.5)

(20.1)

(4.0) (6.0) Mar-13 Apr-13

(1.1) (4.6) May-13 Jun-13 Jul-13 Aug-13

Source: Ministry of Commerce, Angel Research

Source: Ministry of Commerce, Angel Research

September 13, 2013

Market Strategy | September 2013

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September 13, 2013

Market Strategy | September 2013

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September 13, 2013