DSIJ Mindshare

The Driving Forces

There have been various factors that have been pushing up the market for almost two and a half months now, primarily the government’s actions on the policy front. Shailendra Lotlikar and Prasanna Bidkar take you through some of the driving forces which will keep the overall market in a bullish frame and help some key sectors go higher.

For over six months now, we have  been talking about how the overall economic landscape and the investment climate are set to improve. Our belief in the inherent strength of the Indian economy and conviction in the Indian markets stems from our strong research capability and experience of more than 27 years. This has helped us identify the bottom of the market for you and guide you through some of the roughest phases and emerge unscathed.

Investment gains, particularly in equity, are all about right timing. One wrongly timed decision can lead to enormous wealth erosion, while a small investment at an opportune time can bring in reasonably good profits. It pays to identify the right triggers for the market, whether positive or negative. These very triggers define the success or failure of investment decisions.

Readers of Dalal Street Investment Journal would certainly appreciate the fact that we were first ones to have called the market bottom. We would like to reproduce below the sequence in which we have systematically guided our readers over the past six months. Whether it was reminding the Prime Minister that it was time to act (DSIJ Vol. 27 Issue No. 13, dated 17th June, 2012) or it was the spotting of the silver lining to the dark clouds, (DSIJ Vol. 27 Issue No. 15, dated 15th July, 2012), we have been very forcefully reiterating our experience of reading the markets correctly time and again. “The fundamental strength of the Indian economy has reflected well in the growth numbers that we have cl

After providing ample reasons as to why we thought the Indian economy was well placed in getting past through all the negatives and believed that all that spelled doom was about to vanish (DSIJ Vol. 27 Issue No. 18, dated 26th August, 2012), we went all out to raise that one important question on everyone’s mind – ‘Has The Bull Run Begun?’ We even took an in-depth look at whether the Bull Run has really begun (DSIJ Vol. 27 Issue No. 20, dated 23rd September, 2012). Our optimism and foresight are reflecting well in the way things have shaped up since then. Whether it was about the impending bull run or about how reforms were to drive the markets going forward, our teams have been instrumental in keeping our readers well informed much in advance on what to expect and how to profit from what is coming. Having said that all is well and the only way for the markets forward was on the upside, we are sure readers would want to know what are the factors that will push the markets up.ocked until a couple of years ago. How can any economy which has been on such a sound growth path suddenly find itself struggling to get even its basic parameters right? Is the situation so bad as to warrant so much of pessimism? We, at Dalal Street Investment Journal, do not think so...” is what we said then.

While our macro view on the economy and the markets continues to remain bullish, here are what we think the primary drivers for the markets over the near future will be. The most important factor that will drive growth and in turn the markets is government spending. Government spending has always been that one critical element that spurs growth. Having managed to get past the hurdles in taking the

 reforms process forward, the government is likely to train its guns towards helping boost the economic growth rates further. Of course, while it will make it look like an attempt to better the economic performance, more of the efforts will be directed towards calling the attention of the electorate in preparedness for the general elections due in 2014. Let’s take a look at what is lined up over the near future and the likely impact.
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Direct Cash Transfer: Will It Add Up?

The Direct Cash Transfer of subsidies, which is slated to be brought into effect from January 1, 2013, is the first of the initiatives that will come as a trigger in the markets’ way. The scheme is to be rolled out in 51 districts across 16 states to begin with, and gradually, will cover the whole of the country by the end of 2013.

This is a very ambitious scheme envisaged by the government, wherein subsidies on LPG, kerosene, pension payments, scholarships as well as payments under MGNREGA and other government welfare programmes would be made directly to the beneficiaries. According to estimates, roughly INR 400000 crore will be disbursed directly to families through this scheme.

Not all schemes will come under the direct transfer mode right from the beginning, keeping the overall amount likely to be distributed at a lower level. “Right now this is restricted and is not going to happen in all the sectors. Food and fertilisers are not to be impacted by this immediately. I think it will initiate the use of Aadhar as a mode of transmission. The spends on certain welfare schemes already go into the bank accounts of consumers directly. The implementation of the scheme  from 1st January will prepare the Aadhar platform for other uses like fuel, fertilisers and food subsidy”, says D K Joshi, Chief Economist at CRISIL.

In fact, it is not the quantum of money that we are worried about. What is a greater cause for worry is whether this money will really find its way to the intended purposes. We highly doubt that. Given the general propensity of the middle and lower middle class towards spending rather than conserving for the desired purpose, the money granted by this scheme is likely to be drained off into undesired pursuits. While it is bound to fail to work in the direction envisaged, the flip side of it is that huge money will flow primarily into the Fast Moving Consumer Goods sector, which is closest to the hearts of the class of people for whom the scheme is meant. So, whether the scheme manages to plug leakages and help an efficient disbursement of subsidies or not, it will certainly augur well for the FMCG sector.

Budget: Populism At Its Core 

The next very important factor that will drive the markets over the next quarter or so will be the budget to be announced in the month of February 2013. The UPA, through its various permutations and combinations, has ruled India for almost a decade now. For the last five years, the ruling party has been coming up with very populist budgets. The same is expected without any exception this time too.

There are two ways in which the budget is expected to spur the market and keep it in a good mood. The first is the budgetary allocations to key sectors and the second is populist measures that will probably help put more money into the hands of the populace. According to Joshi, “Social spending has been the fastest growing component in the government spending in the last few years. This phenomenon is not going to reverse”.

Infrastructure, Power (which is sometimes also classified as a subset of the infrastructure sector) and Real Estate are  three sectors that we see in clear favour for budgetary allocations this year.

INFRASTRUCTURE

Infrastructure development has always been a pet project of the government. Developing infrastructure helps spur growth. The focus of the 12th Five Year Plan is also likely to remain on infrastructure development. According to the Planning Commission, in view of the fact that the target of double digit economic growth will be difficult to achieve without infrastructural growth, ambitious plans for investment in various sectors of physical infrastructure are being prepared and the cumulative investment in infrastructure in the 12 Five Year Plan is targeted at around USD 1 trillion. One can  imagine the outcome of the kind of spending that the government is planning undertake in this vital sector.

This has been one sector which has been at the core of the Indian growth story, and whose development mirrors the overall health of the nation’s economy. In fact, this sector itself provides a stimulus for growth. It is said that a single rupee invested in infrastructure generates opportunities worth INR 10. Hence, investment in infrastructure is always a priority. No wonder then, that the Government of India has always been quite forthcoming when it comes to infrastructural upgrades. There has been a strong focus on assuring effective implementation of associated projects though budgetary allocations, tariff policies, fiscal incentives, private sector participation and public-private partnerships (PPPs).
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The past few quarters have seen infrastructure companies witness some issues like non-availability of funding, shrinking capex and contraction of margins on account of the higher interest costs and rising commodity prices. However, the scenario seems to be changing now with the government taking initiatives to boost this sector.

In this regard, K Venkataramanan, CEO & MD, L&T, opines, “The rebounding of industrial production and improved credit demand was seen in many sectors towards the end of the quarter. A few steps taken by the government recently underscore its commitment for accelerating the pace of economic development, which provides positive signals for the prospects for the industry”. 

Amid all the battering that this sector has witnessed over the recent past, there is some good news. First is that the Gross Capital Formation in infrastructure is increasing. The 10th Five Year Plan average was 5.1 per cent of the GDP. This is expected to be 7.22 per cent in the 11th Plan and estimated to go up to 9.15 per cent in the 12th Plan (2012-17). In short, around USD 1 trillion will be invested in the infrastructure sector.

A point worth noting is that the private-public-partnership (PPP) participation is also expected to improve. In the 10th Plan, the investment was USD 220 billion, of which 25 per cent came through PPP. In the 11th Plan, it was almost USD 480-500 billion of which 37 per cent came from PPP, and 50 per cent of USD 1000 billion in the 12th Plan is expected to come from this side. This is a major change in India’s infrastructure development, and is expected to provide much-need- ed impetus to the sector as a whole.

While this is a long-term scenario, there are a few indicators for the medium term too. The order books of leading infrastructure companies have witnessed an upward tick after a long time. Further, the completion of industrial and infrastructural projects is expected to proceed at a brisk pace in the second half of 2012-13. According to the Centre for Monitoring Indian Economy, projects worth INR 3.7 lakh crore are likely to go on stream in this period, which is 32 per cent higher than the value of projects completed in the same period during the preceding year.

The improvement in the scenario is also vindicated from the fact that new highway projects this year have given a boost to the road construction sector, unlike the miserable performance last year. The National Highway Authority of India (NHAI) has awarded new projects under the PPP model and project execution has picked up as compared to last year. About 4375 km of road projects were awarded by the NHAI in the first nine months of 2012, as against a total of 4553 km in 2011, 3338 km in 2010 and just 643 km in 2009. The third quarter of 2012 saw 1898 km of road projects being awarded. This clearly indicates a distinct improvement in the scenario over the recent past.
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In a move to facilitate greater flow of funds to the infrastructure sector, insurance firms have now been allowed to take their exposure to 20 per cent of their total funds in this sector as compared to 10 per cent that was allowed earlier. This will resolve the pressing finance issues and help the sector enter a new orbit. Investors can look at L&T, IL&FS Transportation Networks and Sadbhav Engineering in the infrastructure sector. 

NIB: Will Give That Extra Push

Another very important development that is likely to help the overall economy and in turn the markets is the planned constitution of the National Increasing Investment In Infrastructure As A % Of GDP Investment Board (NIB). The NIB is envisaged as a body that will be given the power to clear large infrastructure projects of over INR 1000 crore delayed in the government machinery. Finance minister P Chidambaram had mooted the formation of this body at the meeting of the full planning commission in mid-September. Though the decision is deferred for now, the NIB is sure to put stalled projects on track. This is the need of the hour and will surely happen over the course of the next three to four months. 

Stocks To Watch

L&T: L&T is the largest engineering company in India and will be the greatest beneficiary of the reforms process currently underway. Its execution cycle has shortened from around 27 months to 23 months, which should help in revenue growth going ahead given its robust order book of INR 158528 crore. With the economic scenario improving, the order inflow is expected to increase significantly. With the margins expected to improve, it is a good long-term buy. 

IL&FS Transportation Networks: The company is all set to ride the benefits emanating from the momentum in NHAI-awarded road projects. It already has a robust order book of INR 12000 crore and an average execution period of 30 months. This clearly provides a clear revenue visibility for the next two and a half years. On the valuations front, the scrip is trading at 14x its trailing four-quarter earnings. 

Sadbhav Engineering: The company is present in the roads and highways, irrigation and mining sectors. Sadbhav Engineering has a sound balance sheet with parent net debt/equity of 0.5x as of FY2012. The company’s working capital position is also much better than its peers. This has insulated its earnings to a great extent in an exorbitant interest rate scenario, which has been the key concern for the sector. 

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POWER

The next sector that is likely to get an impetus from government spending is Power. As mentioned earlier, power is often considered to be a part of infrastructure. However, its importance as an independent sector cannot be undermined by this classification. Of late, the power sector has been facing quite a lot of problems. However, all these are likely to be addressed soon. A higher allocation to this sector based on the overall Five Year Plan will see companies being greatly benefited going forward. The key here will be to develop fuel linkages rather than to set up newer projects.

The central government has taken a few exceptional steps towards improving the business environment of this sector, which showed some signs of revival in the September 2012 quarter itself. During the quarter, the government announced a bailout package of INR 1.9 lakh crore to the state electricity boards (SEBs). Under this, half of the SEB debt will be taken over by the state governments and the other half will be restructured by providing softer repayment terms. This decision has really improved the sentiments for the sector. Besides the bailout package, many state governments have raised the tariffs, which is now reflecting on the financial performance of the power companies.

P P Gupta, Managing Director, Techno Electric & Engineering Company adds, “The constructive developments also include the signing of FSAs with power suppliers and allowing 49 per cent FDI in power exchanges. During the year, the investment interest in the power sector by private sector industries has witnessed a positive trend”.

Given the power shortage and the increasing demand for electricity, the total investment required in the sector for the 12th Plan is projected to be around INR 15 lakh crore (as against INR 8.04 lakh crore in the 11th Plan). Of this, INR 8.02 lakh crore will be public investment and INR 6.98 lakh crore is envisaged to come from private players. After adding around 78700 MW in the 11th Plan, the government is targeting an ambitious addition of another 1 lakh MW in the 12th Plan. 

As mentioned earlier, while the long-term plan is in place, the major worries are on the fuel supply front. With many companies struggling to secure fuel supply, an immediate solution is needed on that front. Coal India, which was asked to sign the fuel supply pact by March 2012, is yet to work out a coal price pooling formula. The SEBs have voiced their concerns saying that pooling will increase the coal prices for domestic players, which casts a question mark on the fuel supply pact.

On the gas front, production remains subdued, with no sign of improvement. Due to this, the PLFs of the gas-based thermal power plants have now declined to below 50 per cent, indicating a severe gas shortage.

Overall, with the government intervening on the coal supply front and imports being allowed through Coal India, the issue of fuel supply is expected to be addressed soon. Going ahead, we expect the positivity to continue in the power sector. 

Stocks To Watch

CESC: CESC has a presence in the power and retail sectors, where reforms are being carried out. In power, while the operational performance of the existing plants is good, two of its underconstruction projects are also expected to start contributing from FY14 and FY15. Secondly, the losses of its retail business (Spencer’s Retail), which was a drag on its consolidated performance, are declining and the management expects a breakeven in FY14. 

Power Grid Corporation: With the power sector generation capacity being expanded, there should be a parallel grid capacity for distribution. With positive factors like aggressive capital expenditure, a guidance of no equity dilution for capex and its robust financial position in terms of margins, dividends and debtor days, we feel that Power Grid is a good stock to look at. 

JSW Energy: JSW Energy has mega plans of taking its capacity to 11770 MW, of which 2600 MW is operational. It is also expecting to commission another 540 MW by the third quarter of the current fiscal. The remaining 8630 MW capacity is under development. Among other businesses, it is into power trading and also has coal and lignite mines.

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REALTY

The third and a very important sector that will remain in the limelight going forward will be Real Estate. This sector too has lagged behind over the past couple of years, following the lack of policy initiatives that could help it come out of the rut. The government will work towards putting it back on track, thereby helping real estate developers and companies which have been struggling particularly on the liquidity front.

Realty is a sector which has a direct correlation with the GDP or economic growth of a country. If the GDP growth declines, the realty sector also gets impacted. This is exactly what has been happening in the realty sector over the past few quarters. The contraction of GDP growth (5.4 per cent in H1FY13 as against over 7.5 per cent in the previous fiscal), rising inflation leading to higher interest rates and reducing sales volumes and last, but not the least, reducing cash flows have been some of the factors that have only added to the woes of the sector.

However, the scenario seems to be changing now. The sector is at a trough, and there are compelling factors indicating towards an improvement in the scenario, with government reforms playing a very crucial role. While the macroeconomic data is getting better, there are early indicators that suggest an improvement in sentiments for the sector. Even the Finance Ministry and the RBI have hinted at shifting the priority from taming inflation to boosting growth by the next quarter.

With relation to bank loans for the realty sector, the Finance Minister has moved from an earlier hawkish stance wherein his message to banks was to coax real estate developers to reduce prices, to a dovish stand of easing lending norms to the ailing housing sector. Similarly, the RBI is indicating an expected decline in inflation and an improvement in GDP growth at least in H2FY13. The apex bank’s indication of a cut in policy rate in the ensuing two quarters would ameliorate the situation. Lower interest costs will benefit the developers and end users alike.

The positive impact is clear from the fact that the housing loan data from HDFC (the largest private sector lender in housing) indicates an improvement in the latest quarter. Loan approvals have witnessed a growth of 19 per cent in Q2FY13 in comparison to that of 15 per cent in the same period last year. Loan disbursals have also seen a growth of 22 per cent in comparison to 18 per cent in the previous year.

We are of the opinion that liberalised FDI norms in multi-brand retail will further help the sector, as it will drive demand from the commercial segment. According to a spokes-person from Omaxe, a leading real estate developer from North India, “The recent policy announcement in single and multi-brand retail will boost demand for commercial space  in the coming times across all regions and a corresponding demand for residential space as well”. The company’s spokesperson further added, “However, the government’s proactive steps towards reform and the two most important bills of land acquisition and real estate regulation bill shall take shape anytime, and this will definitely give an upward push to prices”.

Gautam Mehra, Executive Director, PwC India, supports this view saying, “The recent decision to permit foreign investment in multi-brand retail, for instance, should lend a spark to the dormant retail real estate space. The authorities have also shown the intent to adopt clear, singular stands on contentious tax and regulatory matters, thereby soothing the frayed nerves of foreign investors”. The slide in the sales momentum of the industry has now come to a halt. This can be gauged from the marginal revenue growth trend in the last three quarters, which has improved with each passing quarter. As a result, we expect the cash flow situation to improve for realty companies which were reeling under debt pressures. We are positive on the realty sector as a whole, as we believe that a recovery in demand and reduction in interest rates will bode well for it. Within this segment, investors can look to invest in Oberoi Realty, Sobha Developers and Godrej Properties.
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Stocks To Watch

Oberoi Realty: Factors like liquidity easing and an up-move in the equity market sentiments are beneficial for the company. Most importantly, this is a debt-free company and hence, hardly witnessed any downfall in the difficult phase. Further, it has a consistent dividend paying history. With its debt-free status (as opposed to the debt concerns of other large players), Oberoi Realty will the prime beneficiary of any improvement in the realty market.

Sobha Developers: Sobha Developers sells 40 per cent of its housing projects to IT professionals in Bangalore. The demand in this segment is strong because IT companies are far from slowing down. Further, it has a strong pipeline of seven housing projects (2.5 million sq. ft). We expect the company to pre-sell at least 50 per cent of this in H2FY13, led by a strong demand on the back of an expected decline in interest rates. 

Godrej Properties: Godrej Properties (GPL) has a total land bank of 78 million square feet, of which, 71 million sq. ft. is through joint development agreements. This is to say that rather than purchasing land from the owners, GPL signs a joint development agreement with the owners and gives them a share in revenues, profits or area, depending on the terms decided. This strategy protects the company from huge initial capital outflows. 

The FDI Push 

Another factor that will help the markets is the push that is likely come from the opening up of FDI in certain sectors. While the impact of allowing FDI in retail will come only with a lag, there are certain other sectors that are likely to benefit from the government’s move of allowing FDI or hiking its limits.

The foremost among these will be the aviation sector. The impact is already being felt on the sector, with UAE-based carrier Etihad Airways intending to buy out a 48 per cent stake in the troubled Kingfisher Airlines. This move is likely to help improve the operational efficiency of airline companies as the required support in terms of resources comes to their aid. A healthy aviation sector will also spell a positive for the overall development of the economy by helping to increase business mobility as well as fostering another vital sector, i.e. tourism.

Two other sectors that are likely to see a good move are insurance and pension funds. Both these have been on the government’s development radar. However, there are a few independently listed companies in these sectors. A sum of parts valuation will keep the parent companies like ICICI, Kotak, Max India and HDFC in the limelight.

Brighter Days Ahead

All these factors cumulatively support the view that the Indian economy and the markets are headed for brighter days ahead. We would be watching developments in each of the aforementioned sectors closely. For now, we have presented a short list of stocks in each of the sectors that you should be closely watching so that you are prepared to ride the wave that is likely to come in.  

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