Make Staggered Equity Buys

Pankaj Pandey
Head Research
ICICI Securities

• EARNINGS LOOKING UP
  We believe that there may not be further downgrades in the earnings going ahead. In fact, there could be upgrades in certain cases if the macros start falling into place.
• CRUDE SUPPORT
  The gross under-recoveries on crude have fallen from an estimated Rs 1.7 lakh crore to Rs 1.4 lakh crore, which in itself would help bring down the fiscal deficit by 0.3 per cent of the GDP.

At the start of this calendar year, we had predicted a time-based correction, with the Sensex remaining largely in the range of 15400 (14x FY12 Sensex EPS) to 17800 (14x FY13 Sensex EPS). The first half of 2012 unfolded in line with our expectations, with the markets remaining in the broader range. Recently, we have upgraded our Sensex target range to 16484 (13x FY13E Sensex EPS of 1268) to 20146 (14x FY14E Sensex EPS of 1439) on the back of better-than-expected earnings, muted expectations and rolling forward to the FY14E estimates. The growth rates of other emerging economies have also moderated, which suggests that the slowdown is not India-specific.

Though the earnings growth was dismal in FY12, the last quarter surprised us, with almost 70 per cent of the Sensex companies reporting higher profits than expected, resulting in approximately seven per cent earnings growth for the Sensex versus the flattish expectations. The subdued expectations highlight the amount of pessimism built in around the corporate performance. We believe that there may not be further downgrades in the earnings going ahead. In fact, there could be upgrades in certain cases if the macros start falling into place.

The interest rates seem to be on the higher side right now. However, since the current inflation is supply-driven, the RBI may not look to cut the interest rates immediately. The July 2012 headline WPI inflation print of 6.87 per cent (consensus expectation 7.37 per cent) could provide some comfort to the RBI, which meets on September 17, 2012 next. However, we need to wait for the August 2012 data to come in before confirming any trend. We expect a further 75-100 basis points cut in the repo rate by the end of this fiscal.

The currency has depreciated primarily on account of a declining risk appetite globally and the widening current and fiscal account deficits in India. The import bill growth is likely to slow down with the fall in crude prices and the reduced demand for gold. This was reflected in the June 2012 trade deficit, which came in at USD 10.3 billion, sharply lower than the January-May 2012 average of USD 15.5 billion, and could help to reduce the current account deficit. If thegovernment raises the prices of diesel, it would further help in curbing the ballooning fiscal deficit. The current valuations are already attractive, and the improving macro conditions might induce higher FII inflow into the country. Hence, we believe the rupee could appreciate from here on.

The markets are trading at attractive valuations of approximately 12x the FY14E earnings, factoring in a 13.5 per cent growth for the Sensex earnings (FY14E), well below its long-term average of 14x. In addition to the compelling valuations, an approximately 12.5 per cent fiscal YTD decline in the average price of the Indian crude basket could change the whole equation on the macro-environmental front. The gross under-recoveries on crude have fallen from an estimated Rs 1.7 lakh crore to Rs 1.4 lakh crore, which in itself would help bring down the fiscal deficit by 0.3 per cent of the GDP. The fall in crude prices and declining gold imports could help address the twin deficits problem, and this in turn, could help revive investor confidence.

The global growth and earnings forecasts have been slashed, and the initial optimism has dissipated to some extent. Global concerns such as the Euro break up, the hard landing of emerging economies such as China and India and the anticipated measures for reviving US economic growth have been debated at length. We believe that it is difficult to predict the outcome of these. At the same time, however, the persistent pessimism has largely taken care of most of the concerns.

In terms of sectoral preference, we expect auto (overweight on four-wheelers, underweight on two-wheelers), pharma (earnings visibility), telecom (Bharti) and banking (private banks positive, public sector banks neutral) to outperform, while we are neutral on capital goods (policy inaction), IT (global macro headwinds), FMCG (valuation concerns) and cement. We expect infrastructure & real estate (stretched balance sheets), oil & gas (subsidy burden), power (delay in reforms) and metals (global slowdown) to underperform.

The valuations are looking cheap at this juncture. The declining crude and gold imports could help address both the fiscal and current account deficit issues. We believe that the macro headwinds have started subsiding. Investors can start buying into Indian equities in a staggered manner, with a focus on companies with strong fundamentals. External shocks or outlier events should be taken as an opportunity to buy in bulk, though bottom fishing should be avoided.