ICICIdirect_Strategy2012

Market Strategy2012

ICICI Securities Ltd. | Retail Equity Research

Page ii

Table of Content House View...................................................................... 3

Has anything gone wrong with India’s growth therapy ..............5

Global concerns ............................................................... 9

Euro – Unity in adversity ..........................................................10 US – First among equals ..........................................................14 Japan’s ageing growth & population – a cause for concern ...16 Even BRIC letting us down… ...................................................17

High inflation overwhelms BRIC…...................................................................18 Slowing GDP…................................................................................................18

Indian economy – better or worse ................................. 19

Indian economy – getting better… ..........................................20 Cooling inflationary expectation a key positive…............................................21 Interest rates peaking… ..................................................................................23 Consumption juggernaut again saves the day! ................................................24 Unattractiveness of other investment avenues to help equities.......................26 Rupee depreciation – Impact on trade deficit ..................................................29

Indian economy – getting worse…..........................................31 GDP growth .....................................................................................................31 Fiscal deficit.....................................................................................................32 Current Account Deficit....................................................................................33 Infra spend tapering down ...............................................................................34 Corporate profitability heading southward…...................................................38 Capitulation – Are we close to the bottom?? ...................................................39

Outlook 2012.................................................................. 42

Watch not only valuations but other variables also…..............42 Sectoral Outlook .......................................................................51

Flashback – The year that was ...................................... 80


Market Strategy 2012 December 30, 2011

House View The year 2011 had one theme consistent across various asset classes i.e. safety first. Risk aversion remained at elevated levels forcing investors to dump sovereign bonds of troubled European countries in favour of relatively safer US bonds, thereby driving their yields to historically lower levels. Within commodities, gold remained in a sweet spot due to perceived benefits of hedge. The emerging equity markets including the BRIC brigade slumped with Indian equities at the bottom of the league. CY12 would be an equally challenging year and is likely to be a rollercoaster ride for the investors. Politically, this year would be a mega carnival of leadership changes in major economies such as the US, China and France among others. Policy responses in the US and Europe region would be directed towards applying the liquidity balm to iron out current issues while solvency issue would be postponed. Emerging economies would spend their time and energy towards preservation of growth as higher inflation and interest rates eat up growth. In addition, global growth faces risk from higher crude prices due to Iran-Israel induced tension, political uncertainty in the Arab world, North Korea, Afghanistan and Iraq among others. Commodity markets may crumble under the Chinese slowdown fears. Domestically, the Indian economy could spot relief in terms of interest rate cuts and lower inflation while higher fiscal deficit, currency volatility and crude oil could still knock off a few basis points from our economic growth. In addition, perceived policy paralysis and gloom associated with it would continue to lead to procrastination in our thoughts and capture headlines. We expect the Indian equity markets to witness time based correction. Hence, we expect the Sensex to be boxed in the range of 15442 (14x FY12 Sensex EPS of 1103) – 17822 (14x FY13 Sensex EPS of 1273, upside of 14%) in line with earnings growth of 15% in FY13 and historical average multiples of 14x. The fortunes of equities are also tied to the relative attractiveness of fixed income, gold and real estate. Any deterioration in risk return trade off in these asset classes would be a blessing in disguise for equities else equity markets may continue to be sidelined. In the event of an unlikely global sell off, Sensex multiples could shrink to 10-11x FY13 earnings, implying a downside of ~15%. The long term case for investments in Indian equity markets still remains intact through periodic investments while investors should grab any opportunity arising due to sharp sell off where multiples contract further to 10-11x. Otherwise, investors should look at the next year end as a buying opportunity as by then we would have captured FY13 growth and a likely double digit growth in FY14 on the anvil, which would limit downsides from thereon. Parallel levels on the Nifty are 4637 on the lower side and 5351 on the higher side. We believe that relatively safer sectors would continue to lure investors as the capital preservation despite lower returns theme is unlikely to fade away. Accordingly we continue to prefer IT (rupee to benefit though valuation expensive), pharma (rupee & patent expiry to benefit yet valuation seems expensive), telecom (financials to improve, reducing regulatory uncertainty) and auto (lower base, lower commodity, peaking interest rates).

Investors should lap up either 15% growth in earnings or 15% cut in the Indices whichever is earlier


We are neutral on FMCG (expensive valuation, pressure on margins), banking (NPA concerns mounting, valuation cheap), oil & gas (elevated crude prices, limiting pricing headroom). We have a negative bias on capital intensive sectors such as infra (highly leveraged, valuations a trap), capital goods (order-book growth concerns, valuations attractive), metals (muted demand, Chinese slowdown fears), hospitality (single digit RoEs, demand growth), real estate (heavy leverage, tepid demand), cement (supply overhang, large caps remain expensive while balance sheets of midcaps are leveraged), shipping (long term visibility poor, valuations cheap), aviation (highly leveraged, elevated crude prices). We would be revisiting our view on these in mid 2012 post visibility on rate cuts, cooling of commodity prices, demand revival and other factors.


Has anything gone wrong with India’s growth therapy Indian current economic growth and corporate woes continue to mount and multiply forcing all of us to ponder whether we have digressed from our long term growth trajectory. The world today is more complex and interconnected and every major economy has lost sheen and is staring at limited options to prevent the current downward spiral. There are mountain of worries domestically with alarming decibel levels thereby confusing all of us between a signal and a noise. Domestically blame game has been running smooth and has become a breeding ground for collective pessimism and for everything which is not working in our respective interest. The participating members of this game are politicians, corporates, economist, bureaucrats, intellectuals, analyst and other stakeholders. While these are beyond doubt challenging times for us but the current situation also paints high expectations, misguided assumption, poor due diligence by corporates, hysteria, suspicion, scepticism etc. We attempt revisiting of crucial growth phases, challenges, policy actions which have shaped our growth so far without seeking pointers for future or a silver bullet to all our current woes. We believe the ongoing rough patch is reminiscing of the earlier bumps which our economy had faced in early 90s and early 2000. Marco-Economic woes such as GDP tapering down to 6.9%, WPI inflation hovering above 8%, Fiscal Deficit inkling closer to ~6% and interest rates are at peak have depleted the confidence and investment climate like it did in the past. In addition, usual snail pace of policy responses to current and past concerns is also creating dissonance in our abilities to sustain the long term growth. Elevated criticism over government's decisions like putting FDI in Retail at the back-burner Lokpal Bill, uncertainly over implementation of GST, Land acquisition delays and uproar over mining bill has added to the collective gloom. However, faced with difficult situation earlier, government has taken landmark policy decision in past whether it is opening up the economy in early 90s or aggressive disinvestment in early 2000s, which has proved to be catalyst for the structural long term growth. In early 90s, GDP growth fell below 5%, fiscal deficit was above 7%, Indian rupee devalued by 19% and average inflation was above 9%. Similarly in early 2000s, GDP growth fell below 5% and fiscal deficit shot up above 6%. However, subsequent reforms and policy changes led to the robust GDP growth for the next 4-5 years and concomitantly fiscal deficit going down below 5% and 3% in 1996 and 2007. We believe current concerns about slowdown in GDP, higher fiscal deficit and sticky high inflation, though valid, but overdone.


Exhibit 1: BSE Sensex performance during 1991-1996

0500

100015002000250030003500400045005000

Jan-

91

May

-91

Oct-9

1

Feb-

92

Aug-

92

Jan-

93

May

-93

Sep-

93

Feb-

94

Jun-

94

Oct-9

4

Mar

-95

Jul-9

5

Nov

-95

Mar

-96

Jul-9

6

Nov

-96

BSE Sensex

Source: Bloomberg, ICICIdirect.com Research

Exhibit 2: BSE Sensex performance during 2000-2006

0

5000

10000

15000

20000

25000

Jan-

00M

ay-0

0Oc

t-00

Mar

-01

Aug-

01Ja

n-02

May

-02

Oct-0

2M

ar-0

3Au

g-03

Dec-

03M

ay-0

4Oc

t-04

Mar

-05

Jul-0

5De

c-05

May

-06

Oct-0

6M

ar-0

7Ju

l-07

Dec-

07

BSE Sensex


Exhibit 3: GDP Growth has slowed down due to macro headwinds; very similar to the slowdown in 1991-1992 and 2001-2003

5.3%

1.4%

5.4% 5.7%6.4%

7.3%8.0%

4.3%

6.7% 6.4%

4.4%

5.8%

3.8%

8.5%7.5%

9.5% 9.7%9.0%

6.7%8.0% 8.3%

7.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

1990

-91

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

1996

-97

1997

-98

1998

-99

1999

-00

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

Source: RBI, ICICIdirect.com Research

Exhibit 4: Fiscal Deficit reached above 7%+ levels twice in past two decades

7.8

5.6 5.3

7.0

5.75.1 4.8

5.86.5

5.4 5.76.2 5.9

4.53.9 4.0

3.32.6

6.06.4

5.1

6.0

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

1990

-91

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

1996

-97

1997

-98

1998

-99

1999

-00

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12E


700045

700045

700045


Exhibit 5: WPI Inflation is above 8% presently mirroring similar challenges faced during 1991-1992

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

`̀

Average inflation during 1991-1996 was 9.2%

Average inflation during 2006-2011 was 6.6%

Source: MOSPI, ICICIdirect.com Research

Exhibit 6: Crude Prices have seen Sharp increase in past ( US $ per barrel)

0

20

40

60

80

100

120

140

160

Oct-9

9

Apr-0

0

Oct-0

0

Apr-0

1

Oct-0

1

Apr-0

2

Oct-0

2

Apr-0

3

Oct-0

3

Apr-0

4

Oct-0

4

Apr-0

5

Oct-0

5

Apr-0

6

Oct-0

6

Apr-0

7

Oct-0

7

Apr-0

8

Oct-0

8

Apr-0

9

Oct-0

9

Apr-1

0

Oct-1

0

Apr-1

1

Oct-1

1


Exhibit 7: FDI inflow during FY91-96

185 3261713

13026

16133 16327

0

5000

10000

15000

20000

1990-91 1991-92 1992-93 199-94 1994-95 1995-96

(| c

rore

)

FDI inflow

Source: Ministry of Finance, ICICIdirect.com Research

Exhibit 8: Disinvestment during FY00-06 (| crore)

2125 3646 3151

16953

442415810

5000

10000

15000

20000

FY01 FY02 FY03 FY04 FY05 FY06

Disinvestments during 2000-2006

Source: Department of Disinvestment, ICICIdirect.com Research

700045

past

700045

700045


Exhibit 9: Movement of | vs. US$

20.00

25.00

30.00

35.00

40.00

45.00

50.00

55.00

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

During 1991-1993, rupee depreciated by 39% against US $



Currently rupee depreciatied 14% against US $


Exhibit 10: Important reforms during 1990-1996 D e-reservation of many public reserved areas

D e-licensing, axing general ceiling of 40% foreign equity under F E R A

D oing away with registration under MR T P A

E xpanding the tax base by including services

R educing rates of direct tax for individuals & corporations

Abolishing most export subsidies

L owering import duties

R ationalis ing sales tax & reducing cascading effect of indirect taxes

P rovided tax incentives for infrastructure & export oriented sectors

Introduction of U nited E xchange R ate S ystem (U E R S )

C urrency entered a regime of floating exchange rate

Source: ICICIdirect.com Research

Exhibit 11: Important Bills passed during 2000-2006 T he Madhya P radesh R eorganisation B ill, 2000

T he U ttar P radesh R eorganisation B ill, 2000

T he B iological D iversity B ill, 2000

T he Motor V ehicle (Amendment) B ill, 2000

T he C ompetition B ill, 2001

T he E lectricity B ill, 2001

T he Insurance (Amendment) B ill, 2002

T he P revention of T errorism (Amendment) B ill, 2003

T he S ecurities L aws (Amendment) B ill, 2004

T he R ight to Information B ill, 2004

T he F ood S afety and S tandard B ill, 2005 Source: Parliament of India, ICICIdirect.com Research


Global concerns CY 2011 has been a volatile year where factors such as the ongoing Euro zone sovereign debt crisis, slowdown fears in the US and higher than anticipated jump in inflation in BRIC countries impinged the global growth ecosystem. Also, spike in key commodities such as crude due to political instability in Middle East and Japanese tsunami disrupting global supply chain etc. kept markets on their toes. CY2012 is likely to be an equally challenging year as climax of eurozone issues would toss up volatility across global financial system. US, on the other hand, may attempt laying down steps for bridging the fiscal deficit while BRIC countries would shift gears to strike an optimum balance between managing growth and monetary tightening stance. Key commodities such as crude may gyrate on potential build up of Iran- Israel tension while base/industrial metals may take cues from the vociferousness of slowdown in China. Additionally political calendar, across the globe, is very tight as elections in US, France, Russia, Greece and leadership changes in China would ensure anxiety and nervousness across global markets.


Euro – Unity in adversity The year 2011 saw the 17 member Euro zone bloc desperately working to work out a feasible solution to save the bloc from collapsing even as the sovereign debt crisis shifted to the core from the periphery. While the crisis has been richly debated and suggests a Euro zone break-up could increase the debt liability of peripheral nations by almost 200-250%, we believe predicting the outcome of sovereign default is difficult. Hence, we have analysed key economic indicators of the Euro zone and the US to highlight the advantages that the bloc can reap from remaining a unified entity. On a consolidated basis, the debt/GDP ratio for the Euro zone stands at ~86% for CY10, compared with ~94% for the US. Also, the fiscal deficit for the Euro zone stands at 6% vs. 10.3% for the US. Further, the average 10-year bond yields in the US continue to be 2.8% vs. 5.3% and 5.5% for Italy and Spain. With the backing of the European Central Bank (ECB), similar to the Fed in the US, borrowing costs for the bloc could ease. Note, these steps could only alleviate liquidity concerns but structural or solvency concerns still persist. That said, we believe the likelihood of a default by any peripheral nation followed by the partial or total break-up of the Euro seems limited.

Exhibit 12: Fiscal deficit as a percentage of GDP

-6.0

-4.1-3.1

-10.3 -9.6-7.9

-12

-8

-4

0

2010 2011E 2012E

As %

of G

DP

Euro Zone US

Source: International Monetary Fund (IMF) estimates , ICICIdirect.com Research

Exhibit 13: Debt/GDP ratio for Euro zone is relatively better than the US

8,284.8 9,035.0

85.8

94.4

7,600

8,000

8,400

8,800

9,200

Euro Zone US

$ bi

llion

80

84

88

92

96

%

Central Govt. debt Gross debt to GDP

Source: OECD, IMF, ICICIdirect.com Research Data as of CY10

Exhibit 14: GDP at current prices for Euro Area and the US

12,168

13,355

14,52715,065

10,000

12,000

14,000

16,000

2010 2011E

$ bi

llions

Euro Zone US

Source: IMF estimates, ICICIdirect.com Research

Exhibit 15: Flight to safety kept the US yields artificially low

3.32.7

5.3 5.5

2.8

0.0

2.0

4.0

6.0

France Germany Italy Spain US

%

Avg 10-year bond yields YTD


Euro zone appears better off as a unified entity as the breakup costs could be bigger and unaffordable

700045

the US

700045


Exhibit 16: GDP forecasts continue to be revised downwards

0

1

2

3

4

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

CY11

E

CY12

E

June'11 Sept'11 June'11 Sept'11 June'11 Sept'11 June'11 Sept'11 June'11 Sept'11 June'11 Sept'11

Euro Area France Germany Italy Spain UK

%GDP Growth Forecasts

Source: International Monetary Fund estimates, ICICIdirect.com Research

Exhibit 17: Historical fiscal deficit/surplus and forecast

-3.9

-6.5 -5

.8 -4.5-3

.6

-3.7

-4.0

-2.3

-5.9

-10.

3 -8.9

-7.0

0.6

-5.9

-6.6 -5

.9

-3.3

-1.7

-5.8

-1.0

-3.2

-5.3

-5.8 -5.3

-3.0

-7.8

-9.4

-7.8

-12

-10

-8

-6

-4

-2

0

2

2002-06 avg 2007-11 avg 2011E 2012E

%

Portugal Italy Greece Spain Germany France UK

Source: Reuters, European Commission Estimates, ICICIdirect.com Research

Exhibit 18: Unemployment data for Europe

8.1 6.09.8

7.0 7.0 5.0

22.1

11.08.2

5.0

12.4

2.0

0.0

10.0

20.0

30.0

Unem

ploy

men

tra

te (%

)

Peop

leun

empl

oyed

(mln

)

Unem

ploy

men

tra

te (%

)

Peop

leun

empl

oyed

(mln

)

Unem

ploy

men

tra

te (%

)

Peop

leun

empl

oyed

(mln

)

Unem

ploy

men

tra

te (%

)

Peop

leun

empl

oyed

(mln

)

Unem

ploy

men

tra

te (%

)

Peop

leun

empl

oyed

(mln

)

Unem

ploy

men

tra

te (%

)

Peop

leun

empl

oyed

(mln

)

UK France Germany Spain Italy Portugal


In September 2011, IMF revised its CY11E, CY12E GDP forecast downwards for a majority of countries

Fiscal health deteriorated for most European countries

Implementation of austerity measures seems difficult, given the high rates of unemployment


Exhibit 19: Break up of Euro zone central government debt (~$8.3 trillion)

Other

Other Euro zone6%

Portugal2%

Ireland 2%

Austria 3%

Greece 4%

Belgium 4%

Spain 9%France

21%

Italy 23%

Germany26%

Source: Reuters, European commission, ICICIdirect.com Research

Exhibit 20: Peripheral debt repayment schedule

0

100

200

300

400

500

CY12

E

CY13

E

CY12

E

CY13

E

CY12

E

CY13

E

CY12

E

CY13

E

CY12

E

CY13

E

CY12

E

CY13

E

CY12

E

CY13

E

Germany Spain Italy France Greece UK Portugal

Euro

billi

on

Principal Interest


Though Germany and France have maintained fiscal discipline, French exposure to PIGS’ debt stands at $718 billion while the same for Germany stands at $495 billion. Rising yield spreads could mean that new money would come at a higher cost.

Exhibit 21: Debt exposure by country to PIGS

0.0

100.0

200.0

300.0

400.0

PS Banks NBPS PS Banks NBPS

Germany France

US$

billio

n

Portugal Italy Greece Spain

PS- Public sector, NBPS - Non-Banking Private Sector Source: Reuters, European commission, ICICIdirect.com Research

Exhibit 22: Debt exposure by country to PIGS

0.0

40.0

80.0

120.0

160.0

PS Banks NBPS PS Banks NBPS

UK US

US$

billio

n

Portugal Italy Greece Spain

PS- Public sector, NBPS - Non-Banking Private Sector Source: Reuters, European commission, ICICIdirect.com Research

Portugal, Italy, Greece and Spain (PIGS) countries have combined principal and interest debt payments of € 29.8 billion, € 382 billion, € 57.9 billion & € 169.7 billion respectively in CY12E


Exhibit 23: Yield spreads relative to German Bunds

-1

0

1

2

3

4

5

6

Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11(%

)-5

0

5

10

15

20

25

30

35

(%)

France Italy Spain Greece (RHS)


Exhibit 24: Chronological sequence of downgrades in Europe

Date Country Rating Agency Rating assignedJan-11 Greece Fitch JunkMay-11 Greece S&P B from BB-Jun-11 Greece S&P CCC from BJul-11 Portugal Moody's JunkJul-11 Ireland Moody's JunkJul-11 Spain Moody's Watch for downgradeSep-11 Italy S&P A from A+Oct-11 Italy Moody's A2 from Aa2Oct-11 Spain Fitch AA- Oct-11 Italy Fitch A+Dec-11 15 Euro zone nations S&P Watch for downgrade


Analysing the chronological sequence of events suggests that the European Union (EU) leaders conducted as many as 16 high profile meetings in CY11 to cope with the crisis, which deteriorated substantially. Note, we have seen as many as 11 sovereign rating downgrades and resignations of as many as five country heads (Ireland, Portugal, Greece, Italy and Spain). The Euro zone members agreed upon various measures to tackle the crisis including the formation of European Stability Mechanism (ESM) – to lend €500 billion from 2013, and raising the temporary bailout funds firepower to €1 trillion which could complement European Financial Stability Facility (EFSF) and European Financial Stabilisation Mechanism (EFSM) initiated in 2010. Finally, in December 2011, Euro governments under a new deal called Fiscal Compact added €200 billion to their war chest. The real concern is that these austerity measures suggested by the EU members could be termed as harsh and difficult to implement given the rising levels of unemployment. However, they seem realistic when compared with known and unknown consequences of partial or complete break-up of the Euro zone.

EU leaders continue to initiate multiple damage control steps

EU electoral calendar for 2012

Country Event ScheduleFinland Parliamentary Elections Jan /FebCroatia Referendum Jan /FebGreece Parliamentary Elections FebSlovakia Parliamentary Elections MarchFrance Presidential Elections April /MayFrance Legislative Elections JuneSlovenia Presidential Elections OctLithuania Parliamentary Elections OctCzech Republic Legislative Elections OctRomania Parliamentary Elections NovSource: Bloomberg, ICICIdirect.com Research

Debt issuance schedule in the near term

Country Type of issuances Issuance dateSpain Bills 17-Jan, 24-Jan

Bonds 12-Jan, 19-JanItaly Bills 12-Jan, 27-Jan, 13-Feb

27-Feb, 13-Mar, 28-MarBonds 13-Jan, 26-Jan, 30-Jan,

14-Feb, 24-Feb, 24-Feb28-Feb, 14-Mar, 27-Mar29-Mar

Notes 26-Jan, 24-Feb, 27-MarSource: Bloomberg, ICICIdirect.com Research


US – First among equals CY12 could be a year of anxiety for the US led by elections in November 2012. Note, the November 2010 mid-term elections saw the Republicans gain majority in the House of Representatives with the Democrats maintaining their lead in the Senate. This is the first Congress since the Congress of 2001–2003 in which the House and Senate are controlled by different parties. Noticeably, there continues to be a discomfort over the fiscal policies of the US led by differences in the Congress over key issues such as reducing fiscal deficit or discontinuing existing tax rebates for wealthy Americans. Political gridlock in Washington against this backdrop remains a concern. In CY10, the US government had a fiscal deficit of $1.4 trillion with social security, Medicare, Medicaid and Defence accounting for over 60%. On the positive side, treasury yields continue to be low, led by aggravated global concerns and flight to safety. Further, better-than-expected economic data such as housing starts & retail sales and fall in the unemployment rate to 8.6% vs. CY11 YTD average of 9% suggests a modest recovery. Against this backdrop, we believe, Congressional consensus coupled with economic recovery in the US would bode well for global financial stability.

Exhibit 25: Break up of the US annual income (~USD 2.1 trillion for CY10)

Individual Income Taxes

41%

Corporation Income Taxes

9%

Social Insurance and

Retirement Receipts

40%

Excise Taxes3%

Other7%

Source: whitehouse.goi, ICICIdirect.com Research

Exhibit 26: Break up of the US annual spend (~USD 3.4 trillion for CY10)

Others37%

Social security20%

Medicare15%

Medical aid8%

Defence20%

Source: whitehouse.goi, ICICIdirect.com Research

Exhibit 27: US fiscal health continues to be under pressure

-4.0

-5.0

-4.4

-3.3

-2.2

-2.9

-6.6

-11.

6

-10.

7

-10.

0

-9.3

-15

-12

-9

-6

-3

0

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

E

2012

E

As %

of N

omin

al G

DP

Fiscal Deficit

Source: OECD estimates, ICICIdirect.com Research

Political disagreement in the US could dampen fiscal discipline initiatives


Earlier in the year, US lawmakers had agreed to raise the nation’s USD 14.3 trillion debt ceiling and put in place a plan to enforce USD 2.4 trillion in spending reductions over the next 10 years. Recall, the public debt has increased by USD 500 billion every year since FY03, with increases of USD 1 trillion, USD 1.3 trillion and USD 1.7 trillion each in FY08, FY09 and FY10, respectively. Though the bipartisan committee failed to conclude the quantum of reduction, the built-in clause led to an automatic cut in fiscal spending by as much as USD 1.2 trillion from January 2013.

Exhibit 28: US GDP growth has been revised downwards

2.5 2.7

1.51.8

0

1

2

3

CY11E CY12E CY11E CY12E

June 2011 projections Sept. 2011projections

US

%

GDP Growth Forecasts

Source: IMF, ICICIdirect.com Research

Exhibit 29: Yield spread relative to US treasury

-2-10123456

Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11

(%)

France Germany Italy Spain


Exhibit 30: US unemployment continues to be a cause for concern

8.6

0

5

10

15

20

Jan-

02M

ay-0

2Se

p-02

Jan-

03M

ay-0

3Se

p-03

Jan-

04M

ay-0

4Se

p-04

Jan-

05M

ay-0

5Se

p-05

Jan-

06M

ay-0

6Se

p-06

Jan-

07M

ay-0

7Se

p-07

Jan-

08M

ay-0

8Se

p-08

Jan-

09M

ay-0

9Se

p-09

Jan-

10M

ay-1

0Se

p-10

Jan-

11M

ay-1

1Se

p-11

Percent of civilian labor force unemployed 15 weeks and overUnemployment Rate - Job LosersUmemployment rateAll of U3 plus discouraged workersAll of U4 plus all other marginally attached workersAll of U5 plus total employed part time for economic reasons

Source: Bureau of Labour statistics, ICICIdirect.com Research

Exhibit 31: Euro CLI points towards lackluster economic activity

85

90

95

100

105

110

Dec-

06

May

-07

Oct-0

7

Mar

-08

Aug-

08

Jan-

09

Jun-

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-09

Apr-1

0

Sep-

10

Feb-

11

Aug-

11

Dec-

2011

E

CLI IIP

CLI – Composite lead indicator,, Source: OECD, ICICIdirect.com Research

Exhibit 32: US CLI suggest tepid economic activity

85

90

95

100

105

110

Dec-

06

May

-07

Oct-0

7

Mar

-08

Aug-

08

Jan-

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Jun-

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Nov

-09

Apr-1

0

Sep-

10

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11

Aug-

11

Dec-

2011

E

CLI IIP

Source: OECD, ICICIdirect.com Research

700045


Japan’s ageing growth & population – a cause for concern Japan is ageing faster than any other nation in the world with as high as 23% of the population in the 65 years and above age group. As the share of the working population continues to de-grow, the economic growth of the country has practically stagnated. Consequently, the savings rate is also on a downtrend and the country will have to resort to more external funds, which will weigh on the fiscal position. This will further impact the Japanese stock markets, lower business investment and, thereby, impede economic growth for the nation. Exhibit 33: Percentage of population over 65 years of age

1970 1980 1990 2000 2010 2025E 2040E 2055E% of population over 65 years 7.0 9.0 12.0 17.0 23.1 30.5 36.5 40.5

Source: Japan Statistics Bureau , ICICIdirect.com Research

The Japanese economy has been ageing faster than any other nation in the world and there are predictions that the situation is likely to worsen with the rising share of population over 65 years of age. In Japan, 23% of the population is above the age of 65 (as on 2010) as compared to 20%, 13%, 17% and 17% in Germany, the US, France and the UK, respectively. While the overall Japanese population is expected to de-grow, the only segment in which growth is expected is the 65 years and above segment.

Exhibit 34: Dwindling GDP growth…

17 1818 19 19

20 20 2122 22

2323

24

0.31.4

2.71.9

-1.2-0.5

2.3

2.4

4.1

-6.3

2.9

0.2

2.0

15

17

19

21

23

25

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

E

2012

E

%

-7

-5

-3

-1

1

3

5

%

% of population over 65 years GDP growth (RHS)

Source: Bloomberg, World Bank, IMF, ICICIdirect.com Research

Exhibit 35: …and rising debt to GDP ratio

228200

193

172170178

158164155

150

170

190

210

230

250

2003 2004 2005 2006 2007 2008 2009 2010 2011E

%

Debt to GDP


During 2000-2010, the economy had grown at a CAGR of 0.7% to $5.5 trillion (2010) and is expected to de-grow by 0.5% to $5.4 trillion in 2011. This is primarily due to declining proportion of working population and dwindling productivity. A decreasing birth rate further worsened the Japanese economic situation. Japan's economy is still challenged by rising commodity prices — the country imports most of its food and oil — and a shrinking labour pool, as its population ages. Like the US, much of Japan's debt resulted from efforts to stimulate its economy out of a 20-year deflationary period and recession. Consequently, Japan’s debt to GDP ratio has also risen from 155% in 2003 to 200% in 2010 and is likely to further increase to 228% in 2011 (see Exhibit: 35). With an increasingly aged population and lower economic growth, the household savings rate came down from as high as ~15% in the early 1990s to slightly over 2% in 2010. If the current situation continues for a number of years, there is a risk that rising interest rates and reductions in net savings will bring Japan’s current account surplus to an end. The rising fiscal deficit and debt will make the national savings negative, which would impact business investment and economic growth.

Population over 65 years (as % of total population)

2000 2010Developed NationsJapan 17 23Germany 16 20United States of America 12 13France 16 17United Kingdom 16 17

BRIC NationsBrazil 6 7Russia 12 13India 4 5China 7 8

Source: World Bank, ICICIdirect.com Research

Increasing life expectancy & decreasing birth rate of Japan…

72

7679

8183

14

10 97

19

65

70

75

80

85

1970 1980 1990 2000 2010

Year

s

0

5

10

15

20

Nos

Life ExpectancyBirth Rate (per 1000 people)

Source: World Bank, ICICIdirect.com Research


Even BRIC letting us down… With the financial and debt crisis, the global economy is facing the threat of a recession, far serious than that in the past few years. The BRIC nations represent the growth engines of the global economy and are expected to propel the world out of the claws of the impeding recession. However, all BRIC countries have started to feel the heat of the current slowdown as the world economies have become increasingly interlinked and dependent on each other.

Exhibit 36: Macroeconomic overview of BRIC nations

Inflation (%)

0

5

10

15

Nov-09 May-10 Nov-10 May-11 Nov-11

Interest Rate (%)

4

6

810

12

14


Rising Inflationlead to monetary tightening

High interest rates leading to lower investments and thus IIP contraction

Lower industrial ouput is reflected in GDP slowdown

IIP growth (%)

-10

0

10

20

30

Nov-09 May-10 Nov-10 May-11

GDP growth (%)

-5

0

5

10

15

Dec-09 Jun-10 Dec-10 Jun-11

Benchmark Indices (indexed)

7075

8085

9095

100105

110115

Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11

All the factors leading to ~20% YoY fall across BRIC

Index 1 year forward PE

0

5

10

15

20

25

Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11

Benchmark indices are trading below their 4 year average

Current A/c Balance ($ Bn)

-20

-100

10

2030

40

Sep-09 Mar-10 Sep-10 Mar-11

Currency depreciation coupled with resilient commodity prices leading to reducing currentA/c surplus in China, Russia and widening deficit in Brazil and India

Currency movement (vs $)

0102030405060


0.5

1

1.5

2

2.5

China Current A/c Balance ($ Bn)

0

100

200

300

400

Dec-09 Apr-10 Aug-10 Dec-10 Apr-11

Commodity Prices (indexed)

0

50

100

150

200


Copper Crude


BRIC nations recovered quickly from the 2008-09 global financial crisis. However, a majority of them are currently subject to inflationary pressures and growth prospects seem dampened by global market instability.


High inflation overwhelms BRIC… Among BRIC nations, we can clearly observe a strong uptrend in inflation among India and China and, to a slightly lesser extent, Brazil and Russia. The current inflation rates viz. Brazil (6.6%), Russia (6.8%), India (9.1%) and China (4.2%) remain an overhang on credit disbursement and economic growth.

Slowing GDP… The slowdown in the world economy has led IMF to downgrade its forecast made in April 2011 for all the BRIC nations in September 2011. The GDP growth rates for Brazil, Russia, India and China were estimated at 4.5%, 4.8%, 9.6% and 8.2% for CY11 and 4.1%, 4.5%, 9.5% and 7.8% for CY12, respectively, in April. These were later downgraded to 3.8%, 4.3%, 9.5% and 7.8% for CY11 and 3.6%, 4.1%, 9.0% and 7.5% for CY12, respectively, in September. The estimated GDP growth rate for Russia in CY11 was further downgraded in December to 4.1% Exhibit 37: Real GDP forecasts Country Actual GDP Growth

2011E 2012E 2011E 2012E Jan- Sep 2011India 8.2 7.8 7.8 7.5 7.5China 9.6 9.5 9.5 9.0 9.4Russia * 4.8 4.5 4.3 4.1 4.1Brazil 4.5 4.1 3.8 3.6 3.2World 4.4 4.5 4.0 4.0

Apr 11 Outlook Sep 11 Outlook

Source: IMF, ICICIdirect.com Research *- Russia’s Real GDP forecast has been again moderated in December 2011

Knowing the third quarter GDP numbers of the BRIC nations, the GDP growth forecast made by the IMF in September seems improbable. During the first nine months of CY11, the GDP growth rate in China was 9.4% while those in India, Brazil and Russia were 7.5%, 3.2% and 4.1%, respectively.

India’s inflation (9.1% YoY in November 2011), grew at a rapid pace during H2FY10 touching a peak of 10.9% in April 2010. China’s inflation rate touched a three-year high of 6.5% in July

Consumer prices had soared in Russia during H2CY10 after a drought damaged Russia’s harvest pushing inflation to 8.8%. However, Russia's inflation rate in November slipped for the sixth consecutive month to 6.8% on the back of a shortage of cash in the economy and weaker food-price growth. Inflation in Brazil was clocked at 6.4% in November 2011 driven by higher food prices. The current inflation rate is significantly higher than the official government target of 4.5%


Indian economy – better or worse India after being the poster boy of the global markets with its decade best performance slumped to the bottom of the performance table in CY11 due to a confluence of domestic and global concerns. Medium term concerns on the domestic front such as high fiscal deficit, slippery GDP growth, currency depreciation, mounting NPAs, evaporating infra spend and corporate confidence, high interest rates and lack-luster policy responses in addressing these issues is sending vibes that we may have digressed from our long term growth trajectory. In all this overwhelming negatives there are few bright spots such latest food inflation coming down to six year lows of 0.42%, consumption still resilient, currency depreciation benefiting the export sector, domestic consumption centric economy, gold imports dipping in Q3 CY11 providing cushion to current account deficit, improved rate cuts prospects among others etc.


Indian economy – getting better… Indian economy after clocking 8-9% economic growth under its belt in the past 5 years is witnessing medium term turbulence in its growth equilibrium. We believe the long term growth trajectory would remain intact due to its unique consumption model, favourable demographics, less dependency on exports (15.7% of nominal GDP in FY11), lower credit to GDP ratio (~52%) besides others. Medium term concerns such as high fiscal deficit, low growth, higher inflation & interest rates may get self addressed in the event of rate cuts, lower crude and commodity prices to a great extent. Better monsoons, a key ingredient for the prosperity of rural India has remained favourable since last year. This also had its positive ruboff on food inflation which has seen a sharp dip to a four year low of 1.8% on a weekly reading in December 2011. The series of rate hikes of 375 bps done in last 21 months is expected to achieve its desired effect of moderating demand side inflation as already experienced in slowing IIP and GDP numbers. But while walking the tight rope of balancing inflation and GDP growth various monetary policy actions had been taken, now inflation fear seems to be cooling off and growth concerns have risen. This may lead to a strong case for interest rate cuts coming around Q1FY13E. Also, India’s consumption story has weathered the current slowdown in economy quite strongly. This is evident from the fact that private final consumption expenditure (PFCE) has remained relatively strong contributor to H1FY12 GDP growth at 6.1%. PFCE contribution to GDP has remained stable while Gross Fixed Capital Formation (GFCF) has fallen by ~| 50,000 crore on a quarterly basis from Q2FY09 (370 bps dip in contribution to GDP). Thereby we believe, with consumption remaining the strength area of the country, the government would have to boost PFCE, GFCF through monetary policy tools as the room for Government final consumption expenditure (GFCE) has become limited with already high fiscal deficit. Also GFCF reaching near its six year low of 30.5% of GDP is also a indicator of an imminent rate cut, which may turn beneficial for FY13E GFCF, PFCE growth. Widenening of trade deficit due to depreciating rupee is experienced in the short term as India remains to be a net importer. Crude is the major concern which constituted ~58% of trade deficit in FY11. However, sectors like IT and pharma, smaller export oriented units tend to benefit from rupee weakness. We remain believers of school of thoughts of Indian economic growth to revive faster than estimated and interest rate cuts to start by Q1FY13.


Cooling inflationary expectation a key positive… Inflation has been a cause for concern for the last two calendar years, hovering over 9%. In 2010, it was food inflation, which led the price rise while in 2011 it is fuel and manufactured products inflation, which remains high. With better monsoons, favourable base effect and decelerating demand, inflationary expectations have started to taper down. Exhibit 38: Food trending down, manufactured goods moderating and fuel still high

-13.0-10.0

-7.0-4.0-1.02.05.08.0

11.014.017.020.023.0

Nov

-06

Mar

-07

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7

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Jul-1

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-11

(%)

WPI Primary A rtic les Fuel G roup Manufatcured goods

Source: CSO, Bloomberg, ICICIdirect.com Research

Food inflation to correct on the back of good harvest In the current year, south-west monsoon being 1% above the LPA (long period average), Kharif produce during 2011-12 is estimated to be 3.1% higher than record produce of 120.2 million tones achieved during 2010-11. With increase in supply, as the Kharif produce is getting marketed and on account of high base effect of last year, food inflation has started to decline. Exhibit 39: Food inflation dips to four year low in first half of December…

-4.0-2.00.02.04.06.08.0

10.012.014.016.018.020.022.0

Nov

-06

Mar

-07

Jul-0

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Mar

-08

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Mar

-11

Jul-1

1

Nov

-11

(%)

Food Articles Mfg. Ex Food

Sharp fall in food inflation seen in first

half of December

Source: CSO, Bloomberg, ICICIdirect.com Research

Exhibit 40: Hike in MSPs has been very high which also has contributed to the food inflation

MSP* 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Rice 590 600 610 675 880 980

Wheat 640 650 750 1000 1080 1100 Source: Ministry of Agriculture, ICICIdirect.com Research * | per quintal

Food inflation for the week ended December 10, declined sharply to a four-year low helped by better monsoons and as seasonal decline in vegetables and food grain prices.


Exhibit 41: Relation between south-west monsoon and food inflation

-20-15-10-505

10152025

Jan-

06

May

-06

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May

-07

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(%)

-20-15-10-50510152025

(%)

SW % Departure from LPA (RHS) Food articles (%) (LHS)

Food inflation reaching normal scenario followed by normal rainfall

Severe drought condition fueling food inflation

Source: IMD, ICICIdirect.com Research

Fuel group inflation continues to remain beyond control… Fuel group contribute 25% to the headline inflation. 58% of the total fuel index is decontrolled which is now driven by the rising crude oil prices.

Exhibit 42: Break-up of fuel group inflation Category Weightage Category Weightage Total

Controlled 42% Decontrolled 58% 100%

LPG 6% Coal 14%Kerosene 5% Electricity (domestic) 23%High Speed Diesel 31% Petrol 7%

Aviation turbine fuel 2%

Naphtha 5%Light diesel oil 1%Bitumen 1%Furnace oil 3%Lubricants 1%

Follows international crude oil and coal

prices

Source: Bloomberg ICICIdirect.com Research

Demand side inflation to moderate with slowdown in aggregate demand Manufacturing Ex Food products, i.e. the core inflation to moderate in coming months as demand has started to decline indicated by lower IIP print and declining GDP growth numbers Exhibit 43: Rate hikes to pull down demand side inflation…

-10

-5

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(%)

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(%)

Manufactured Products Inflation IIP(LHS) Interest Rate


With better monsoons in the current year, we believe a further hike in MSPs in CY12 may not be as sharp as in the past, thereby reducing food inflation expectation even in the coming months

During 2010, India witnessed very high food inflation due to a drought in 2009, which led to lower production and hike in MSPs of major produce. In 2010, normal monsoons led to the Kharif and Rabi production getting restored to average levels.

Brent Crude oil prices have remained at elevated levels (averaging more than USD 90/barrel over last couple of years). This has kept fuel inflation higher and beyond the control of the policy makers.

We have seen growth cooling off due to rate hike and thereby pulling down manufactured products inflation…


Interest rates peaking… The Indian economy is walking on a tight rope with inflation and growth being the two major sides to be balanced. We have seen inflation hovering above 9% for nearly two years and repo rate hikes of 375 bps done in the last 21 months resulting in contracting IIP and GDP growth numbers. An increase in the gap between inflation and repo rate leads to the tightening of monetary policies while the reverse results in a gradual cut in repo rates with a lag as depicted in the chart. Thus, we believe that as inflation and expected GDP growth converges near 7% by March 2012, a possibility of rate cuts will emerge must faster and may start in Q1FY13 or even earlier. We analysed the trend of 1yr spreads between AAA corporate bonds and G-Sec and also 5 year spreads between the same, the decline in spreads is quite steep for 1yr as against increase in 5 yr spreads. 1 yr spreads corrected from over 100bps to 74bps in last 2 months, whereas for 5 yr spreads rose from 88 bps to 100 bps during the same period. Foreign investors have shown huge interest in government securities auction paying higher premium for securing right to subscribe to government securiities and they have been net buyers of around |4000 crores in later part of 2011 indicating that they are also seeing current interest rates attractive. Exhibit 44: As gap between inflation and repo rate narrows, interest rates are peaking…..

-6.0

-4.0

-2.0

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(%)

Inflation Gap (Inf - Repo) Repo rate


Exhibit 45: One year spread between corporate bond and G-sec plunges

456789

1011

Feb-

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(%)

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(bps

)

AAA rated Corporated bond Gsec yield

1 Year Spread (R.H.S.)


Exhibit 46: Five year spread is comparatively stable

6789

1011

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(%)

406080100120140160

(bps

)

AAA rated Corporated bond Gsec yield

5 Year Spread (R.H.S.)


As stated by RBI “further rate hikes might not be warranted. In view of the moderating growth momentum and higher downside risks to growth, this guidance is being reiterated. From this point on, monetary policy actions are likely to reverse the cycle, responding to the risks to growth.”

The spread between corporate bonds and government securities have narrowed down across the yield curve indicating that investors are not contemplating rise in yield in corporate segment as they believe that interest rates have peaked and are preferring corporate bonds despite historic low spreads

700045


Consumption juggernaut again saves the day! The Indian consumption “Elephant” has been one of the shining beacons of our monumental rise for long. FY12 has been another challenging year with the GDP growth rate falling below 7% in more than two years. The PFCE (proxy to consumption) has remained steadfast even as the GFCF (proxy to capital expenditure) contribution has fallen by 370 bps in the last 12 quarters. To emphasize its magnanimity, even though in H1FY12 PFCE growth has witnessed a divergence of -210 bps from its last 6-year full year mean however relatively outperformed both GFCF,GFCE growth which witnessed a “free fall” with declines of -590 bps,-690 bps respectively.

Exhibit 47: Consumption continues to bail out GDP in trying times… Growth rateYoY(%)

FY06 FY07 FY08 FY09 FY10 FY11 Full year basis H1 basis H1FY12 Full year basis H1 basisGDP 9.3 9.3 9.8 4.9 9.1 8.6 8.5 8.4 7.6 -0.9 -0.8GFCE 8.9 3.7 9.5 10.7 16.4 4.8 9.0 10.1 3.1 -5.9 -7.1PFCE 8.5 8.3 9.3 7.7 7.3 8.4 8.3 8.8 6.1 -2.1 -2.7GFCF 16.2 13.8 16.2 1.5 7.3 7.5 10.4 10.6 3.5 -6.9 -7.1

6-year mean(%) Divergence of H1FY12 from mean (%)Growth rateYoY (%)

Source: Company, ICICIdirect.com Research

The slowdown in the investment cycle has led GFCF reach worrying close to its six year low contribution levels at 30.5% to GDP. However the slowdown in the investment cycle has been covered for by the strong PFCE and rise in exports during the same period. We believe the government would have to boost PFCE, GFCF through monetary policy tools as the room for GFCE has become limited with already high fiscal deficit.

Exhibit 48: Contribution of PFCE & GFCF towards GDP expenditure side…

34.2

30.5

59.6

59.5

28

29

30

31

32

33

34

35

36

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

FY06 FY07 FY08 FY09 FY10 FY11 FY12

(%)

50

52

54

56

58

60

62

64

(%)

GFCF (LHS) PFCE (RHS)

Steep declines in capex cycle, resilience of consumption clearly visible


The Indian consumer class has witnessed a very challenging CY11 with high inflation, interest rates, fuel prices burning a bigger hole in their pockets. However even with higher spends the rise in nominal per capita incomes (8.1%CAGR-FY08-11) across both urban, rural classes has helped maintain the demand growth albeit at a slower pace. This has been reflected through the best segmental IIP performance by consumer segment which upped by 6.1%(till Oct’11CY11) on an average against 3.4% for ex-consumers for the same period. Vindication of demand strength can also be highlighted from the fact that FMCG majors like Hindustan Unilever, Nestle Inc has seen topline rise ~16%,~20% in H1FY12, even discretionary spends like


Automobiles, Air-travel have witnessed volume growth of ~15%,~16% FY12YTD respectively. The growth rates are slightly more tepid than previous years however this should be taken with a “pinch of salt” as this is even after manufacturers kept passing commodity pressures to consumers incessantly. This kind of “gargantuan resilience” indicators in such trying times has provided us enough substance towards reiterating our long term faith on the India consumption story. However we still believe as elucidated above (Exhibit: 48) that the investment cycle would need to be boosted for a more balanced growth.


Unattractiveness of other investment avenues to help equities The year CY2011, saw investments flowing to safer assets like Gold and Fixed income investments yielding higher returns while on other hand equities taking a plunge as risk aversion increased on account of global concerns and deteriorating domestic macro economic conditions. Gold considered as hedge against inflation delivered 34% YTD return in rupee terms while high interest rates led to fixed income investment yielding return of over 9% p.a. As we enter CY2012, incremental returns in these avenues may taper down making risk reward unfavorable for them. Corporate bonds have been issued at over 13% pa interest. Even Bank Fixed deposits and fixed maturity plans have been offering interest rates over 9% p.a and therefore have been preferred investment avenues with HNIs and retail investors. FIIs have also increased their investment in Indian debt market as yield curve shifted upwards.

Exhibit 49: Upward shift in yield curve….

8.59 8.22 8.34 8.38

4.04.55.05.56.06.57.07.58.08.59.0

1yr 3yr 5yr 10 yr

Yiel

d (%

)

Dec-11 Dec-10 Dec-09


Exhibit 50: ...Increased FII debt investment

2425

2704

1160

1005

0

8238

0

2000

4000

6000

8000

10000

12000

2007

2008

2009

2010

2011

Milli

on $


Fixed income investment return to squeeze as interest rates peak out... RBI in its Mid Quarter Monetary Policy Review has indicated a pause in rate hike and stated it will now focus more on growth. With focus shifting to growth RBI may start cutting rates in second half of CY12. If that happens, decline in interest rate will provide an opportunity for existing debt investor to reap capital gains. However, with decline in interest rates the earnings yield gap will be lower making equities more favorable avenue for investment over debt.

Exhibit 51: Yield Gap above its historic average

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Earnings yield differential (%) Sensex


G sec yield curve has been flat and yields across the curve have been over 8% as a result of rate hike by RBI and additional government borrowing to meet the fiscal deficit target. India’s debt quota auction for FIIs was oversubscribed by 30% and FIIs paid a higher premium to secure the right to invest in government securities indicating their strong appetite for Indian debt instruments.

Interest rates may start coming down from Q1FY13, which shall bring down the differential further, making debt investment a less preferred over equities


Gold glitter losing its appeal…. India has been the highest importer of Gold having a major share in gold jewellery demand. As per World gold council report “Gold Demand Trends Q3 2011, Indian demand for gold jewellery on a quarterly basis declined by 22% YoY signifying high prices of gold and increased volatility in the same has started impacting the demand for Gold. Even gold ETFs have seen profit booking in the month of November 2011 as its prices peaked from its all time highs. Exhibit 52: Gold imports

107.2

175.1

271.2

159.6

24.2

164.2 179.6207.9

263.4

180.4

263.9284.9 291.8

248.3203.3

0

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Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

2008 2009 2010 2011

Tonn

es

Total tonnes


Exhibit 53: Incremental inflows in gold ETFs have started to decline

172 111 12525

648

121

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252 234

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2000021000220002300024000250002600027000280002900030000

(|)

Fund Flow Price of Gold (RHS)

Source: AMFI, ICICIdirect.com Research

Real estate prices sky high Given the sharp rise in the property prices (1.5x-2.7x in metro cities (ex-Bangalore)) in last 5 years, the affordability has been impacted significantly. Consequently, the sales volume has declined sharply especially as shown in registration numbers in Mumbai. At these higher price levels, further appreciation in property prices seems capped. This is further accentuated from the slowing demand which warrants a price correction of 10%-15% leaving the real estate investments an unattractive proposition.

Gold ETFs, have gained popularity as alternateavenue for investment in gold signified by asubstantial increase in the fund flows from | 265crore in FY09 to | 2810 crore in FY11. Even YTD theinflow has remained strong at | 4690 crore onaccount of increased risk aversion. However, withan appreciation of 115% in gold prices in last 3years, fresh funds getting into gold ETFs havestarted to decline.


Exhibit 54: Property price index in metro cities

0

50

100

150

200

250

300

Dec-07 Dec-08 Dec-09 Dec-10

Mumbai Delhi Bangalore Chennai Kolkata

Source: NHB Residex, ICICIdirect.com Research

Exhibit 55: Rising un-affordability

5.1

4.7

4.3

4.6

5.05.1

5.0

4.5

4.74.8

4.0

4.2

4.4

4.6

4.8

5.0

5.2

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

(x)

40

45

50

55

60

(%)

Property to income Unaffordability ratio (RHS)

Source: HDFC Q2FY12 Analyst presentation, ICICIdirect.com Research

Exhibit 56: Mumbai registration data

2000

4000

6000

8000

10000

Apr-0

9

Aug-

09

Dec-

09

Apr-1

0

Aug-

10

Dec-

10

Apr-1

1

Units

-100%

-50%

0%

50%

100%

150%

YoY

Source: ICICI Property Services Group, ICICIdirect.com Research

Exhibit 57: Delhi registration data

0

4000

8000

12000

Apr-0

9

Jun-

09

Aug-

09

Oct-0

9

Dec-

09

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct-1

0

Dec-

10

Feb-

11

Apr-1

1

June

-11

Uni

ts

-40

-30

-20

-10

0

10

20

30

40

YoY

Source: ICICI Property Services Group, ICICIdirect.com Research

Unaffordability rising as EMI rising faster than income. Property prices to annual income rose to 4.8x in last three years.

700045


Rupee depreciation – Impact on trade deficit Trade deficit ($118.6 bn in FY11) widens in short term due to rupee depreciation, ceteris paribus, as India is a net importer. However, in the long term, the popular 'inverted J' curve leads us to believe that prolonged rupee weakness initially leads the cost to outweigh the benefits, but the country tends to benefit in long term. Exports are likely to benefit directly as rupee depreciation provides competitive advantage over global peers. Weakening rupee make imports dearer, thereby boosting domestic production avenues and growth.

Electronic goods tend to benefit from rupee weakness in long term Of our total electronic goods import, 44% is from China which has fixed exchange rate system. Hence, these imports directly get costly by ~18% equivalent to rupee depreciation. Domestic producers will now be better placed to compete with cheaper China products. Coupled with this, electronic goods are price sensitive segment and hence rupee depreciation would boost export. Exhibit 58: Electronic goods deficit as a % of total trade deficit continuously declining

1316

2123

21 21

1113

17 16 1512

2 3 47 6

9

0

5

10

15

20

25

30


35

37

39

41

43

45

47

49

|/$

Imports ($ bn) (LHS) Deficit ($ bn) (LHS) Export ($ bn) (LHS)

INR/USD (RHS) As % of total deficit (LHS)

Source: Ministry of Commerce, ICICIdirect.com Research

Exhibit 59: 80% revenue generation from exports to benefit Information Technology

32

4147 50

59

0

10

20

30

40

50

60

70

FY07 FY08 FY09 FY10 FY11

($ b

n)

35

37

39

41

43

45

47

49

(|)

IT exports |/$


India is a net importer of electronic goods worth $ 12.2 bn in 2011

IT receives 80% of revenue from exports, while their major expenses are in rupees. Hence, they tend to be major beneficiary of rupee depreciation. These export revenues, however do not picture in trade deficit but is shown in Invisibles, thereby improving our current account deficit.


Improving exports of engineering goods a positive surprise Exhibit 60: Deficit in Engineering goods narrowing

19.326.5

33.740.5

32.6

59.9

29.137.4

60.2 59.849.9

56.6

-9.8 -10.9

-26.4-19.3 -17.3

3.3

-40-30-20-10

010203040506070

2006 2007 2008 2009 2010 2011 (P)

($ b

n)

Export Import Trade Surplus


Depreciating currency positive for future FDI and FII inflows Exhibit 61: Relation of currency movement with FDI and FII flows

-20000

-10000

0

10000

20000

30000

40000

Jun-

07

Sep-

07

Dec-

07

Mar

-08

June

-08

Sept

-08

Dec-

08

Mar

ch-

June

-09

Sep-

09

Dec-

09

Mar

-10

Jun-

10

Sep-

10

Dec-

10

Mar

-11

Jun-

11

Sep-

11

(| c

rore

)

25

30

35

40

45

50

55

|/$

Net FII Investment FDI INR/USD (RHS)

Source: Ministry of commerce - DIPP, Bloomberg, ICICIdirect.com Research

Looking from foreign funds perspective, markets have become cheaper by ~42% in last 1 year i.e. 24% sensex loss and 18% currency depreciation, hence we could see higher portfolio allocation towards India.

Costly import of machinery, iron & steel, etc. due to rupee weakness could result in technological development for increasing self sufficiency, thereby improving the overall trade deficit in the long term

The rupee had depreciated from 39.4 in January2008 to 51 in March 2009. After this, our countrywitnessed strong FII inflow of | 1111 billion in FY10. We have seen a similar sharp depreciation in rupee from 44.15 in July 2011 to ~53.3 currently in December


Indian economy – getting worse… CY11 saw macro headwinds engulfing the economy on multiple fronts and, thereby, impacting the growth, fiscal position and trade deficit. Adding to the woes, policy paralysis has also impacted the investment environment and is finally percolating to corporate performance. With the GDP growth rate of 6.9% (in Q2FY12) touching a nine-quarter low, high inflation (9%+ throughout CY11) and interest rates and currency (down ~18% in CY11YTD) also playing spoilsport, India Inc. also saw a southward movement in their profitability. This is further accentuated by deteriorating fiscal deficit on account of increase in crude prices (unlikely to come down in near future) and other subsidy bills. However, the current trend in inflation has shown signs of moderation (currently at 9.1% in November, 2011 from the high of 10% in September, 2011). Furthermore, the RBI expects it to come down to 7% by March, 2012 on the back of easing food inflation. This would hold the key for growth coupled with policy reforms and state elections.

GDP growth Exhibit 62: GDP growth at nine quarter low

8.57.8 7.5

6.1 5.86.3

8.6

7.3

9.48.8 8.9

8.37.8 7.7

6.9

0123456789

10

Mar

-08

Jun-

08

Sep-

08

Dec-

08

Mar

-09

Jun-

09

Sep-

09

Dec-

09

Mar

-10

Jun-

10

Sep-

10

Dec-

10

Mar

-11

Jun-

11

Sep-

11

(%)

.


Exhibit 63: GDP growth and Sectoral contribution

FY06 FY07 FY08 FY09 FY10 FY11 Q1FY12 Q2FY12

GDP Growth (at factor cost) 9.5 9.6 9.3 6.8 8.0 8.5 7.7 6.9

Agri, forestry and fishing 18.3 17.4 16.8 15.7 14.6 14.4 13.6 11.1

Industry 28.0 28.6 28.7 28.1 28.1 27.9 28.0 27.6

a Mining 2.6 2.6 2.5 2.3 2.3 2.3 2.2 2.0

b Manufacturing 15.3 16.0 16.1 15.8 15.9 15.8 16.0 15.7

c Electricity Gas Water supply 2.1 2.1 2.0 2.0 2.0 1.9 2.0 2.0

d Construction 7.9 8.0 8.1 8.0 7.9 7.9 7.7 7.8

Services 53.8 54.0 54.5 56.2 57.3 57.7 58.4 61.4

a Trade, Hotels, Transport & Communication 25.1 25.6 26.0 26.1 26.6 27.0 27.6 27.9

b Financing, Insurance, real estate and business services 15.1 15.7 16.1 17.0 17.2 17.4 18.3 18.8

c Community Social 13.5 12.7 12.4 13.1 13.6 13.4 12.5 14.7


India’s GDP growth for Q2FY12, which stood at 6.9%, was the lowest in the last nine quarters. We believe a fall in industrial production, elevated commodity prices and peak interest rates will impact in H2FY12 and pull down the GDP growth for India to ~7%

700045


Fiscal deficit Exhibit 64: Government P&L

Budget Actuals@Acuals Estimates Upto

2010-11 2011-2012* October 2011-2012E2011

| crore | crore | crore Comment1 Revenue Receipts 794,277 789,892 359,712 776,892 2 Tax revenue (Net) 572,790 664,457 291,501 664,457

3 Non-tax revenue 221,487 125,435 68,211 112435Shortfall of | 13000 crore in BWA auction slated in FY12 and no clarity ason date

4 Non-debt capital receipts 35,599 55,020 13,653 17,751 5 Recovery of loans 12,752 15,020 10,922 15,020

6 Other receipts 22,847 40,000 2,731 2,731

Disivestment & other proceed - assumed no further receipt. However,govt. is also planning to pledge its resources like some land & equityholding SUUTI (holdings like L&T, ITC & Axis Bank in order to raiseresources worth | 50,000 crore. This will enable the govt. to bridge thedisinvestment proceeds gap of ~| 37000 crore. Still, we have not builtthe same in our estimates pending time clarity

7 Total receipts (1+4) 829,876 844,912 373,365 794,643 8 Non-plan expenditure 821,569 816,182 479,181 816,182 9 On revenue account 726,767 733,558 431,709 733,558

of which interest payments 234,739 267,986 144,521 267,986 10 On capital account 94,802 82,624 47,472 82,624

of which loans disbursed 6,393 397 15,414 397 11 Plan expenditure 377,350 441,547 201,193 526,547

12 On revenue account 312,363 363,604 171,015 448,604

Additional subsidy burden of | 85000 crore (| 45000 crore for crude & |40000 crore for fertilisers & others. Food subsidy increment has not beentaken as the Food Security Bill has not yet been passed. However, govt.may issue bonds for oil subsidy, thereby taking it as off balance sheetitems

13 On capital account 64,987 77,943 30,178 77,943

of which loans disbursed 18,592 16,754 8,959 16,754 14 Total expenditure (8+11) 1,198,919 1,257,729 680,374 1,342,729

15 Fiscal deficit (14-7) 369,043 412,817 307,009 548,086

Incremental fiscal deficit of ~| 135000 crore comprises extra expenditureon fuel subsidy (| 45000 crore), fertiliser subsidy (| 40000 crore) andshortfall in disinvesment proceed (| 37000 crore) and BWA auctionamount (| 13000 crore)

Fiscal Deficit as % of GDP 5.1 4.6 6.0 16 Revenue deficit (9+12-1) 244,853 307,270 243,012 405,270 17 Primary deficit 134,304 144,831 162,488 280,100

Key upside risk to our forecast of fiscal deficit would be lower than anticipated government expenditure and others.

Source: Budget Documents, ICICIdirect.com Research

Exhibit 65: Crude under recoveries inching up adding to fuel subsidy

(| crore) 46 48 50 52 54

80 97516 101213 104910 108606 112303

90 106967 111075 115182 119290 123398

100 116418 120937 125455 129974 134493

105 121143 125868 130592 135316 140040

110 125869 130799 135728 140658 145587

120 135320 140660 146001 151341 156682

130 144771 150522 156274 162025 167777

Crud

e le

vels

($/b

arre

l)

Exchange Rate |/$FY12E


The major addition on the expenditure side is expected to be in the shape of subsidies. With crude remaining above $100/barrel, the petroleum subsidy is expected to run up to | 70,000 crore vs. an estimate of | 23,640 crore (jump of ~190% over budgeted estimates)

While the government had estimated a fiscal deficit of 4.6% in its budget, subsidy bills and shortfall on the income side (disinvestment target, tax revenues) is expected to inch up the fiscal deficit to 6%


Current Account Deficit

Exhibit 66: Rising crude bill impacting Current Account Deficit (CAD)

9.6

15.8

29.6

38.4

44.3

67.8

0

10

20

30

40

50

60

70

80

FY07 FY08 FY09 FY10 FY11 FY12E

US$

in b

illion

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

(%)

CAD CAD as % of GDP (RHS)

Source: RBI, Ministry of Commerce, ICICIdirect.com Research

Exhibit 67: Elevated crude levels stretch import bill

57.1

79.8

93.7

87.1

105.

3

112.

1

38.4

51.4

66.1

58.9

63.0

68.8

0

20

40

60

80

100

120

FY07 FY08 FY09 FY10 FY11 FY12E

US$

in b

illion

26

29

32

(%)

Crude Import (LHS) Crude Deficit (LHS) Crude as % of total import (RHS)


Exhibit 68: Rise in gold & silver prices further pressurises CAD

14.7

17.7

22.4

29.8

33.8

31.3

0

5

10

15

20

25

30

35

40

FY07 FY08 FY09 FY10 FY11 H1 FY12

US$

in b

illion

6.0

9.0

12.0

15.0

(%)

Gold & Silver Import As % of total import


Import of crude oil at elevated levels (accounting for ~30% of total import bill) has led to expansion in the export bill. Consequently, CAD as a percentage of GDP is expected to increase to ~3.5% in FY12E from 2.6% in FY11

The FY12YTD average for Brent crude oil stands at $113.6/ barrel vs. average of $86.6/barrel in FY11. Consequently, crude import as percentage of total import increased sharply to 32.1% in H1FY12 from 28.5% in FY11. Given the sharp rise in crude oil import bill, crude deficit as percentage of total trade deficit also increased to 61.4% in H1 FY12 vs. 53.1% in FY11

Given the sharp rise in gold & silver prices, gold & silver import (as a percentage of total import) has expanded to 13.6% in H1FY12 from 9% in FY11

FY11 (avg) FY12 YTD (avg) % changeGold (US$/ounce) 1295 1635 26.3Silver (US$/ounce) 22.7 36.7 61.3


Infra spend tapering down Policy paralysis impacting ambitious infrastructure targets… Exhibit 69: Ambitious infra target …

50000

150000

250000

350000

450000

550000

650000

FY05

FY06

FY07

FY08

FY09

FY10

P

FY11

E

FY12

E

(| c

rore

)2

4

6

8

10

(%)

GCF in infrastructure Contribution to GDP (RHS)

Source: Planning Commission, ICICIdirect.com Research

…leading to slowing down of investments in infrastructure…

Exhibit 70: Policy reforms awaited across segments impacting investments Segment Policy ReformsAirports Clarity on tariff fixation - whether single till or dual till method to be adopted

Clarity/issues pertaining to pass through on higher fuel costs, which is currently impacting power sector. Clarity on whether the burden of increased fuel costs would be shared by the beneficiary (upward revision of tariffs) or borne by the developer Further, there is lack of clarity on go & no go area in the mining segmentGradual hike in tariff by SEB, which should improve SEB financials PPP model in distribution sector to reduce AT&C lossesImplementation, timeline and quantum, of import duties on power equipment from abroad (especially Asian countries)

RoadAppointment of NHAI permanent chairman, which should provide stability in terms of target monitoring and ordering process

Across Segments

Land Acquisition Bill and clarity over go and no-go area for environmental clearance across segments

Power


A staggering infrastructure spending (| 20.54 lakh crore) was envisaged in the 11th Plan (FY07-12) led by investment across sectors such as power, roads, telecom, etc. However, policy paralysis has led to a slowing down of activity across segments

Delay in the key policy reforms has led to cost overrun of 20% (on an average) and time overrun of 1-201 months


Exhibit 71: Delay in reforms & land acquisition, environmental clearances has led to 20% cost overrun & 1-201 month time delays#

Sector No. of projectsOriginal cost

(| crore)Anticipated cost

(| crore)No. of proj with cost

overrunNo. of proj with time

overrunTime overrun range

(months)

Atomic Energy 4 29228 34066 2 3 11-41

Civil Aviation 2 3216 3216 0 2 7-9

Coal 7 13075 15940 6 5 24-48

Fertilisers 3 4066 4066 0 1 1-1

Mines 1 4092 4402 1 1 30-30

Steel 5 37769 64101 5 2 25-36

Petroleum 37 138786 147266 10 14 5-120

Power 45 164218 168398 5 22 10-83

Railways 29 36547 71799 23 10 3- 201

Road 13 19910 21090 1 3 1-16

Shipping & Ports 6 10128 10558 3 3 2-25

Telecommunications 3 3637 4190 1 0 0

Urban Development 2 15071 30503 2 2 12-15

Water Resources 1 543 1187 1 1 60-60

Total 158 480285 580782 60 69

Source: MOSPI, ICICIdirect.com Research #List of projects with capex of over | 1000 crore

Consequently, investment activity has slowed down… Exhibit 72: New investment announced (| crore)

375,

254

310,

529

318,

468

309,

939

223,

547

0

100,000

200,000

300,000

400,000

Sep-

10

Dec -

10

Mar

-11

Jun-

11

Sep-

11

| cr

ore

Source: CMIE, ICICIdirect.com Research

Exhibit 73: No of projects announced

1,12

7

1,12

0 1,36

6

1,05

8

845

0

250

500

750

1,000

1,250

Sep-

10

Dec-

10

Mar

-11

Jun-

11

Sep-

11


Exhibit 74: Project shelved (| crore)

2380

2

2313

4

2717

7

2942

2

7552

8

0

25000

50000

75000

100000

Sep-

10

Dec -

10

Mar

-11

Jun-

11

Sep-

11

| cr

ore


Exhibit 75: No of projects shelved

74

56

88

54

81

0

25

50

75

100

Sep-

10

Dec -

10

Mar

-11

Jun-

11

Sep-

11


700045

700045


Power sector – major contributor to infra spending – woes continue…

Exhibit 76: Capacity addition targets revised downwards due to delays & fuel shortage

19666 2224530538

40245 41110

100000

78700

0

20000

40000

60000

80000

100000

120000

VI th Plan VII th Plan VIII th Plan IX th Plan X th Plan XI th Plan (07-12) XII Plan (12-17)

MW

40

50

60

70

80

90

100

(%)

Achieved Target Target achieved RHS

Target for XI Plan was further revised to 62000 MW on account of delay in capacity additions, fuel shortages, etc In terms of target for XII Plan, it now stands at 75000 MW vis-à-vis 100000 envisaged earlier 75000

Source: CEA, ICICIdirect.com Research

Exhibit 77: Coal India production (in million tonnes)

343 361 379 404 431 431

177

440

050

100150200250300350400450500

FY06 FY07 FY08 FY09 FY10 FY11 H1FY12 FY12E

MT


Exhibit 78: International coal prices trend

30

50

70

90

110

130

150

Jan-

09

Apr-0

9

Jul-0

9

Oct-0

9

Jan-

10

Apr-1

0

Jul-1

0

Oct-1

0

Jan-

11

Apr-1

1

Jul-1

1

Oct-1

1

(US

$/to

nne)


Exhibit 79: Tariff of UMPP (| per unit)

2.26

1.3

2.33

1.77

0.0

0.5

1.0

1.5

2.0

2.5

T ariff (| per unit)

Mundra S asan K rishnapatnam T ila iya


Coal production is increasing at a slower pace; Coal India’s production is likely to be around 440 million tonnes in FY12, much below expectations in terms of demand, which has partially only been met through imported coal. Given the sharp rise in imported coal prices, the power producers (particularly for UMPP- Mundra & Krishnapatnam which are on imported coal) may find it difficult to pass on the complete hike in coal prices, which could impact their profitability


Exhibit 80: Roads only segment, which has seen some activity

500

1500

2500

3500

4500

5500

6500

7500

FY07

FY08

FY09

FY10

FY11

FY12

YTD

FY12

E

(km

)

-

1

2

3

4

5

6

7

8

(km

)

Completed Awarded Completed/day (RHS)

While the awarding of ~3865 km vs. 7300 km target is lower, roads have been only segment where activity was seen

Source: NHAI, ICICIdirect.com Research

With the awarding of ~3865 km in FY12 YTD vs. 5083 km in FY11, road is the only segment where activity has been seen. However, NHAI’s target of 7300 km appears to be optimistic. We expect awarding of ~5500-6000 km each year over the next two to three years

Roads – second largest contributor- only segment where activity was seen…


Corporate profitability heading southward… Exhibit 81: Rising input cost and interest costs hurt OPM and NPM, respectively

20.020.521.021.522.022.523.023.524.024.525.0

Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11

9.0

10.0

11.0

12.0

13.0

14.0

15.0

OPM NPM (RHS)

Source: Capitaline, ICICIdirect.com Research *Nifty index companies ex banks

Exhibit 82: Interest costs rising leading to a dent in NPM

1.51.61.71.81.92.02.12.22.3

Sep-10 Dec-10 Mar-11 Jun-11 Sep-11

(%)

Interest Cost as a % of sales


Exhibit 83: …and interest coverage ratio has declined to lowest level

89

101112131415

Sep-10 Dec-10 Mar-11 Jun-11 Sep-11

(x)

Interest Coverage ratio


Exhibit 84: Both GNPA & NNPA in absolute terms on the rise*…

51711 55226 56787 5893264279

75372

2342717349

24061 25744 2727735483

01000020000300004000050000600007000080000

Q1FY

11

Q2FY

11

Q3FY

11

Q4FY

11

Q1FY

12

Q2FY

12

| Cr

ore

GNPA NNPA

Source: Company, ICICIdirect.com Research *I-Direct Banking coverage

Exhibit 85: GNPA & NNPA ratio highest in last 10 quarters*

2.0

2.2

2.4

2.6

2.8

3.0

Q1FY

10

Q2FY

10

Q3FY

10

Q4FY

10

Q1FY

11

Q2FY

11

Q3FY

11

Q4FY

11

Q1FY

12

Q2FY

12

(%)

0.5

0.7

0.9

1.1

1.3

1.5

(%)

GNPA Ratio NNPA Ratio (RHS)

Source: Company, ICICIdirect.com Research *I-Direct Banking coverage

In the September 2011 quarter, the margins of the Nifty Index companies (excluding banking & financial services and oil & gas companies) eroded further and have been in the lowest range since the December 2009 quarter. Additionally, the rising interest cost has also led to the lowest PAT margins since the December 2009 quarter

700045


Capitulation – Are we close to the bottom?? Given the ~23% YTD decline in benchmark indices and building up of a consensus for a further decline, investors are now pondering about the strategy for 2012 and, more importantly, where and when the markets will bottom out. However, it is important to asses “whether the markets have capitulated or not?”

To answer this question, we looked at various widely used parameters such as a massive fall in large caps, M-cap to GDP ratio, spike in CBOE and NSE volatility index, analyst downgrades and media as a misleading indicator. Looking at these parameters, we believe that the markets will oscillate with high bouts of volatility and may then complete the final leg of the current bear leg as the correction, which began with various global and domestic headwinds, and has now gradually skewed towards self inflicted problems. Consequently, investors, especially domestic, are now building in dismal growth rates be it for GDP, corporate earnings, currency movement and have also given up on the reform process.

Exhibit 86: Relative sectoral performances … YTD Return (%)

BSE Realty Index -50.4BSE Metal -46.9BSE Cap Goods -46.3BSE Power -38.9BSE Bankex -30.5BSE Oil -26.0BSE Sensex -23.3BSE Auto -19.8BSE IT Sector -18.3BSE Teck -16.1BSE Consumer durables -15.8BSE Healthcare -13.4BSE FMCG Sector 10.6

Source: Bloomberg, ICICIdirect.com Research Note: Returns calculated as of December 28 , 2011

Exhibit 87: No. of stocks touching 52 week lows substantially higher than that in 2009 crash

128

286

52

421

0

100

200

300

400

500

2008 2009 2010 2011

Source: Capitaline, ICICIdirect.com Research

All sectoral indices (except FMCG) have given negative return in CY11 YTD reflecting the somber mood across market participants (both local and global)

The current market decline is depicting a classical market cycle wherein a group/clutch of sectors is facing steep cuts over the other. Similarly, if one looks at the performance of the constituents of BSE Sensex stocks, sectors that are linked to high gestation, high regulatory & policy sensitivity and global exposure have corrected in the range of 26 - 50% over a period of 12 months. This clearly signifies that though steep corrections get justified due to the above mentioned sectors, sometimes it overreacts

The number of stocks touching 52-week lows has nearly doubled from that of the 2008-09 market crash depicting heightened loss of investor confidence across sectors and stocks


Exhibit 88: Market cap to GDP at multi-year lows…

0.5 0.5

0.7

0.9

1.5

0.5

1.01.1

0.5

-

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

2003 2004 2005 2006 2007 2008 2009 2010 2011

(x)


Exhibit 89: … even India fares worse vis-à-vis its global peers

1.5

1.1

0.8 0.80.7

1.1

0.7

0.4

1.2 1.0 0.6 0.6 0.5 0.5 0.5 0.40.2

0.4

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The impending Euro concern and global macro uncertainty is clearly reflected in the CBOE VIX index, which is currently at the highest levels during CY11. The same has been mimicked by India VIX, where global factors coupled with domestic macro headwinds have led to higher bouts of swings/volatility.

Exhibit 90: High VIX levels reflect global uncertainty

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Source: Times of India dated December 26,2011, ICICIdirect.com Research

Exhibit 91: Falling business confidence index echoes concerns over industrial growth

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Source: NCAER, ICICIdirect.com Research

The NCAER Business Confidence index is at the lowest levels in the last six quarters, thereby echoing the concerns over industrial growth, political deadlock and macro headwinds in the economy


Exhibit 92: Consensus downgrade of Sensex EPS estimate seen in CY11 …

1256 1244 1239 12381197 1187 1174 1175 1161

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)

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Exhibit 93: Our stance on Sensex…

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Exhibit 94: ILLUSIONARY correlation… For Sure!

Source: Times of India dated December 26,2011, ICICIdirect.com Research

Consistent building up of negative domestic cues has led to a steep earnings downgrade cycle wherein the EPS for FY12 and FY13 has been revised down by 7% and 10%, respectively. If the macro issues continue to persist, going ahead, we expect the downgrade cycle to continue for FY13

700045


Outlook 2012

Watch not only valuations but other variables also… During gloomy times, one tends to become oblivious to the fact that post a steep correction markets do start looking very attractive as P/E ratios in relation to market levels keep coming down, presuming earnings to remain constant/face less downgrade. On the contrary, both market levels and earnings growth rates are moving targets. Hence, the end results can be highly contrary to general anticipation. Putting the above theory in the current perspective, the markets may be looking attractive as they are trading at 14.1x and 12.2x their FY12E and FY13E EPS, which is 13% below their historical P/E average of 14x. However, what the markets may be pricing in vis-à-vis the consensus is a higher decline in EPS for FY12 and FY13 given the macro and local headwinds the country and corporates are facing. In such an eventuality, looking at forward P/E multiples in isolation can become hazardous. Rather than only focusing on projected estimates, it is also prudent to watch out for the following factors:

One year and two year forward P/E multiples coupled with standard deviation of the same (looking at variances can cushion the deviation in earnings estimates)

Troughing of market multiples based on Trailing Twelve Months earnings

P/BV multiples based on TTM basis (serves as an effective valuation tool at the time when relatively earnings visibility is not clear, thereby rendering forward P/E multiples less effective)

Interrelation of movement of broader markets with macro variables such as interest rates and industrial production

Correlation of markets with other financial assets like crude oil and currency movement

Attractiveness of debt yields vis-à-vis earnings yield of the BSE Sensex

Apart from the above, we have also observed that whenever earnings growth comes out of two or three year hibernation the markets react sharply to that event. This phenomenon is better explained from FY03-FY11 where the correlation strength between market returns and Sensex earnings is strong as compared to the periods of FY92-FY11 and FY02-FY11. Hence, this time around we believe the earnings growth trajectory would stagnate or at best may produce single digit growth rates. However, at the same time, we expect earnings to catch up by CY13/FY14. Therefore, the markets will also mirror the trend, in our view.


Exhibit 95: Movement in EPS growth and Sensex movement

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(|)

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EPS EPS growth (RHS) Sensex Return (RHS)


Exhibit 96: Correlation matrix of BSE earnings growth vis-à-vis BSE returns

Low corelation

Low corelation

Reasonable correlation

FY92-FY11 28%

FY03-FY11 56%

Comments

19%

Period of Corporate EarningsCorrelation of Sensex EPS growth and

Sensex returns

FY92-FY02


Exhibit 97: Cycles of earnings revision

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1103 1161

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We believe that high correlation between Sensex return and EPS is high in FY03-FY11 vs. FY92-FY02 due to the following: Consistency in GDP growth Robust growth and even disbursement of credit Reasonable cost of borrowings Consistent policy reforms High savings and rise in investment/capex cycle Rise in disposable income Consistent and robust growth in corporate earnings Declining information arbitrage in financial markets Consistent portfolio inflows


Given the higher intensity of adverse macro variables in CY11, we have revised down our FY12 and FY13 EPS thrice and twice, respectively, throughout CY11. Similarly, the consensus is more aggressive and has revised the EPS estimates for FY12 to | 1161, which implies a cut of 7% while the number of revisions stood at five. For FY13 EPS, the cut has been top the tune of 10% from the beginning of FY12 while the number of revisions stood at six. Going ahead, if macro issues persist, we may be in for further consensus downgrades for FY13 EPS. In this case, basing one’s investment thesis on forward multiples becomes less effective. Exhibit 98: Sensex at one year forward P/E multiples

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Sensex 6 9.9 13.8 17.7 21.7

6x = -2 STD 9.9x = -1 STD

13.8x = Mean multiple17.7x = +1 STD21.7x = +2 STD


Exhibit 99: Sensex at two year forward P/E multiple

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12.3x = Mean multiple16.4x = +1 STD

20.6x = +2 STD


The important factor for investors to watch out for in CY12 would be possibilities of steep corrections and opportunities for right levels to buy. India’s fixed capital expenditure, interest rates, commodity prices, inflation and government policy action would be the key variables. Historically, we have seen that Indian markets troughing at 10x-11x trailing 12 M multiples.

Historically, the markets have traded at 13.8x one year forward P/E multiple. Currently, they are trading at 14.1x one year forward P/E multiple. During panic situations, the markets have historically troughed at -1 STD multiples. In euphoric cases, they have even breached +2 STD multiples

Historically, the markets have traded at 12.3x on a two year forward P/E multiple. Currently, they are trading at 12.2x two year forward P/E multiple. We believe that, going forward, the markets will be re-rated on the clear visibility of earnings growth rather than correction in debasement of earnings multiples


Exhibit 100: Sensex on trailing 12M multiples generally troughs at 10-11x during “Black Swans”

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During the 2008 crisis, defaults in the US banking system (which was an unanticipated event) led to a savage sell-off in equities. Indian markets tumbled by 62% from its highs and traded at 10x on P/E multiples at the trough

During Harshad Mehta Scam (1992-94) and Technolgy bust/Ketan Parekh Scam (1999-00), broader market multiples were debased savagely and troughed at 10x-11x on the P/E multiples front

Source: BSE, ICICIdirect.com Research

Exhibit 101: Market price/book value at trailing 12M multiples

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Source: BSE, ICICIdirect.com Research

The Indian markets have bottomed at 10x trailing 12M multiples during the 90s, IT sector bust and 2008 financial crisis. A sharp correction from current levels should be used for buying from a three to five year perspective

The Indian markets are trading at 3.1x TTM price/book value against historical mean valuations of 3.7x


Rate cuts Sticky inflation throughout CY11 impelled the RBI to hike policy rates 13 times throughout CY11. It was only in the last policy meeting that the RBI signalled a pause. Going ahead, we expect the same to start declining from H1CY12, which will be a huge cyclical positive for the economy. Hence, we believe that the impact of rate cuts will be back ended in CY12 and would start exhibiting a positive rub off on consumption and may lead to bottoming out of the capex cycle. Also, historically, it has been observed that a declining rate cycle is a good cyclical catalyst for a market up move.

Exhibit 102: Sensitivity of BSE sectoral indices to change in repo rates

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BANK Capital Goods Auto Metals Repo rate (RHS)


Exhibit 103: Spread of earnings over G-Sec yield vis-à-vis market movement

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G-Se c Y ie ld E arnin gs Y ield

- 12 %

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- 3 8%

2 0 % 81 % 11 %

Source: Bloomberg, ICICIdirect.com Research, Note: Bar Graphs represents the returns delivered by BSE Sensex on YoY basis and are not scaled to any of the axis.

Sensitivity of policy rates and growth in consumerdurable segment is significantly high. A steep YoYgrowth rate in the consumer durable segmentfrom February 2009 to January 2010 waswitnessed post interest rate cuts from September2008 - April 2009. Going by the last policymeeting and steep decline in food inflation, weexpect consumer durables growth to be back ontrack once interest rate easing commences

Interest rate cuts by the RBI would be positive for rate sensitive sectors like banks, capital goods, auto, etc

The period of FY03-FY08 witnessed the BSE Sensex delivering a CAGR of 38% during which the spread of earnings yield over G-Sec yield averaged ~2%

The above average moved into the negative zone of -1.1% over FY08-09 (overvaluation of markets in early FY08 followed by a spike in bond yields due to global financial crisis coupled with a short-term spook in crude oil prices in 2009) However, in FY10 and FY11, contrary to belief, negative spreads have persisted between the earnings yield and G-sec yield as lot of monetary easing by western world and developing nations resulted in a rise in inflationary levels while subsequent tightening resulted in negative spreads However, given the correction that Indian markets have witnessed in CY11, spreads are again converging. Hence, equities are again entering the fair valuation zone


Exhibit 104: Implied P/E (inverse of G-sec yield) and trailing P/E a good market timing indicators

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Exhibit 105: |/$ exchange rate depicts strong correlation with movement in BSE Sensex

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Sensex tops out at 21206 levels in early 2008

The dollar exchange rate bottoms at | 39/$

The dollar exchange rate peaks at | 52/$

Sensex bottoms out at ~ 8000 levels in March 2009

Sensex again tops out at 20664 levels in November 2010

The dollar exchange rate rallies after consolidating at | 43 levels


700045


Exhibit 106: Trends in FII flows and market performance

4806137603

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One significant risks that market faces at this point in time is the FII redemption. If such a scenario materializes than markets may face deeper cuts, going ahead into CY12


Investors in catch-22 situation; expensive getting more expensive, cheap getting cheaper… Going into CY12, a classic dilemma that investors will face in terms of stock picking is to determine whether underperforming stocks would continue to do the same or there will be a reversal in their fortunes and whether the stocks that have remain resilient in CY11 will repeat their performance. Our sense is that due to heightened volatility and uncertainty, outperforming sectors of CY11 will continue to shine at least in H1CY12 and it will be the second half that will decide, with turn of events, whether worst is over for the CY11 underperforming sectors.

Exhibit 107: Performance of top 5 and worst 5 stocks in FY11 and TTM (Q2FY12) on basis of P/E ratios, Stock returns and RoE’s

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FY11

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TTM

Source: Bloomberg, Company, ICICIdirect.com Research Note: Size of the bubble represents the ROE’s generated by the stocks over that period, For TTM Chart returns are calculated on CY11YTD basis.

700045


Exhibit 108: Range of Sensex in CY12

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BSE Sensex (LHS) Bear case

14x FY13E-17822 (Base Case)

14x FY12E-15442(Bear Case)


How to play equities in 2012 ? – The SIP way… We believe the at least H1CY12 will be a volatile one as the markets would witness huge swings to the news emanating from emerging and western world. Also, the markets will react sharply to any surprise coming from within the country on the political/economical front. Such bouts of volatility will provide a platform to accumulate equities in staggered manner as we expect H2CY12 to be more trending one as lot of macro issues might get subsiding. In such a scenario, we recommend buying equities systematically in a staggered manner without bothering about the market levels. Don’t time …rather accumulate quality We expect more of a time based correction and expect the markets to oscillate in a broad trading range till the time reasonable clarity emerges from the various local and global macro headwinds. In case of a negative outlier event, the markets may fall further in the wake of panic selling. However, we do not expect the markets to sustain at such levels. In such an environment, timing the markets would become extremely difficult. We believe that any sharp cuts should be bought into from a three to five years perspective. Buying is recommended in large caps and selective quality mid-caps.


Sectoral Outlook High macro uncertainties will create visibility issues for most of the sectors and we expect CY12 (at least H1CY12) to be the year where stock specific actions will prevail. We may however see some sector specific momentum in the latter half on account of subsiding of macro economic headwinds. For CY12 we are positive on sectors that exhibit high revenue visibility, stable cash flows, exhibit pristine balance sheets (low gearing and marginal exposure to foreign liabilities) and will benefit from cyclical turn of macro variables like interest rates and commodity prices. Hence we are positives on sectors such as Automobiles (Monetary and commodity price reversal to provide earnings and valuation upgrade), Technology (Market share gains and depreciating rupee to aid valuations), Pharma (High growth visibility and players with diversified geo mix to benefit), and Telecom (Improving key metrics and regulatory clarity) On the neutral side, sectors that stack the list include Banking (Asset quality issues to neutralise monetary reversal coupled with low valuations), FMCG (expensive valuations albeit improved realisations), Media (Ad growth to moderate), Oil & Gas (Attractive valuations to get subdued by regulatory uncertainties), Retail & Textile (Inexpensive valuations discounting moderation in consumption). As far as negative sectors are concerned we believe that Murphy’s Law will prevail at least in the H1CY12. Therefore the list include sectors that are more concerned with government actions, Capex intensive sectors and sectors with highly geared balance sheets. Hence we expect Infrastructure/Power & Capital Goods/ Real Estate to underperform (Leveraged balance sheets, Regulatory hurdles; stressed investment cycle to outweigh benefits arising from softening of interest rates and low valuations). The list also includes Metals (Uncertain global environment rendering haziness on demand outlook amidst attractive valuations), Cement (Utilisation rates to remain tepid, Tier 1 companies commanding rich valuations), Hotels (Incremental supply will hurt utilisations rates and ARR’s)

Preferred picks

Sector StocksOutperform Auto Tata Motors

Pharma LupinIT TCSTelcom Bharti Airtel

Neutral Banking HDFC BankFMCG ITCMediaOil & Gas Cairn IndiaTextiles Retail

Underperform Capital GoodsPower NTPCReal EstateInfrastructureMetalsHotelsCementShipping



Auto (Can’t get any worse) Outperform The year gone by has been a mixed tale for the Indian auto-sector marked by CV resilience even as the PV segment cracked under the pressure of higher rates, petrol prices and labour issues. Two-wheelers continued to ride the rural tide aided by deferred demand during the lull period of FY07-09.

Exhibit 109: How FY12 was different from FY09? A historical perspective…

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PV sales (LHS) MHCV sales (LHS) 2-Wheeler (RHS)

PV & MHCV sales witnessed pent up demand in FY10-11 as the decline in fuel prices and interest rates cooled off pior

High interest rates & fuel prices adversely impacted PV & MHCV

segments, 2Ws remain least

Source: Bloomberg, ICICIdirect.com Research The sales volume have been indexed to 100 with Q1FY07 as base

We believe FY13E may not mimic a ‘V–shaped recovery’, as we expect modest ~11-13% growth. The rationale of the assumption on a segmental basis has been elucidated in the exhibit below. On a relative basis, our spectrum is most positive on PV segment while two-wheelers remain the least favoured.

Exhibit 110: Key segmental growth estimates… Major segments Growth est. FY13E FY12YTD growth Assumption rationale

Passenger vehicles 14%-16% 2.7%

In FY13E, we believe PV segment would be a relative outperformer across the segments. The non-existent growth till now is expected to aid FY13E through its low base.Issue of higher interest rates had hit the small car segment the most, which could also rebound in a similar fashion post probable rate cuts. FY12 was also marred by labour issues at market leader Maruti, which has recently been resolved and FY13E could see a higher ramp-up in the same, thereby aiding volume growth

Medium & heavy commercial vehicle

12%-15% 8.4%CY11 marked industrial investment climate at its weakest since "Lehman" in 2008.We believe the segment will continue to rise above the consensus outlook on the back of better monetary policy, rising business confidence and improving investment climate

Light commercial vehicle 16%-18% 30.9%

This segment has remained the shining beacon in the automotive space. It hardly witnessed any meaningful impact of rising rates as demand for last mile transportation continued to burgeon with rising rural penetration. We believe, lack of effective govternment transportation services would continue to aid the demand for this segment albeit at a lower pace

Two wheelers 10%-12% 17.9%

We believe the low growth demand phase of FY07-09 for two-wheelers was instrumental in the >20% growth rates since FY10. Two-wheelers could decline to normalised growth as deferred demand seems exhausted. We remain cautious on the segment and expect domestic growth for listed players to slow down significantly with strong capacity expansion by foreign challengers

Source: SIAM, ICICIdirect.com Research

The macro picture looks mixed with inflation seemingly peaking out. Expectations of rate cuts by Q1FY13E are not completely unfounded. However, on petrol prices, the outlook remains uncertain as along with global crude oil prices the INR depreciation has become an additional negative We estimate an outperformance from the PV segment (partially aided by a lower base) along with sentiment boost through rate cuts The MHCV segment has practically braved the “Murphy’s law”- "Anything that can go wrong willgo wrong" with mining bans, interest rate hikes and fuel prices all hurting it. We believe it could see a bump up as macro improves, going ahead The LCV segment will continue to benefit from the last mile requirements of the rising rural India and will remain the outperforming segment. The two-wheeler space though not highly impacted by interest rates and petrol price hikes has shown early signs of a slowdown. We believe the growth rates may taper off, going forward, on a higher base

700045


Exhibit 111: Probable outliers that could impact our estimates…

PV MHCV LCV 2-WAggressive rate cuts of more than ~100 bps in CY12E

Fall in global crude oil prices/sharp appreciation of the rupee leading to a decline in petrol / diesel pricesAdditional diesel duty / tax on passenger vehicles

Clarity on mining clearance across various regions

Segmental impactProbable gamechangers

Source: ICICIdirect.com Research Note: Size of symbol represents degree of impact

Exhibit 112: How demand kept slipping against Siam’s revised forecasts of PV sales

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2nd forecast in July trimmed

growth to 10-12%

Source: SIAM, ICICIdirect.com Research, * refers to YTD sales till Nov and our estimates for Dec-Mar’12

Siam has lowered its growth estimate for the domestic PV segment for the third time in FY12 as sales were heavily suppressed by multiple headwinds. The downward revision from 18-20% growth in April to ~4% growth in October reflects the muted consumer demand. We expect sales to grow by 3% for December-March 2012 and could end the year with a tepid 0.5% YoY growth over FY11. We expect an industry wide growth rate of ~11-13% for FY13E


Banking (Recovery to be elongated) Neutral Banking sector has grossly underperformed the index in CY11. Bankex has underperformed the Sensex by ~7% YTD. Advances break-up dictated the valuation given commanded by banks. Banks with retail exposure were spared while the ones having exposure to troubled sectors like Infra, power, Iron and steel, agriculture and textiles took heavy beating. We expect this trend to continue and valuation divergence to sustain.

Asset quality to be watched…

The industry has seen an increase in GNPA ratio from 2.3% on March, 2011 to 2.8% on September, 2011. In absolute terms, this is a 26% jump during H1FY12 to ~| 1180 billion. We expect asset quality to deteriorate further with fresh slippage ratio staying above 2%. However, net GNPA additions may be lesser due to following three reasons – (a) from hereon most of the large ticket loans are likely to get restructured first (b) shifting 100% accounts to system based NPA recognition completed and (c) recoveries to be slightly higher.

We expect restructuring to stay high in FY13E for banks with exposure to SEBs, textile, iron & steel. Total restructured assets amounted to ~| 107 billion i.e. ~2.7% of outstanding credit as on FY11. Agriculture has been one of the major contributors in slippages with 44% of incremental NPAs for domestic banks in FY11. Even on YTD basis, proportion is high due to expiry of Farm loan waiver scheme term, post which all such accounts were taken to NPA.Total credit by banks to power SEBs / discoms (State Electricity Board) stands close to | 75000 crore (1.8% of total credit). If the same or part of this sum goes for restructuring, the 2% provision impact may not be high but the expected slippage in the asset post restructuring may create further downsides in stocks.

Exhibit 113: Sectoral exposure Sectors

% of advances FY11 FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY11 FY10

BOB 8 8 3 2 4 4 3 3 4 4

BOI 6 6 3 NA 4 4 3 4 5 5

Dena Bank 28 26 20 16 3 3 1 1 4 4

IOB 11 12 7 1 5 5 6 9 6 6

OBC 19 21 11 11 5 5 6 7 6 6

PNB 15 13 7 5 3 3 7 8 7 5

SBI 13 10 4 3 8 7 2 2 7 8

Syndicate Bank 12 11 8 NA 2 2 2 3 3 3

Union Bank 11 5 NA NA 3 4 2 2 4 4

Axis Bank 10 9 4 4 3 3 6 5 5 4

City Union 1 1 NA NA 11 12 6 4 5 4

DCB 0 NA NA 3 2 2 3 2 1 1

Dhanlaxmi 14 23 6 7 2 3 4 2 NA NA

Federal Bank 13 11 NA NA 3 3 2 2 4 NA

HDFC Bank NA NA 2 1 1 1 NA NA 2 2

Kotak Mahindra 7 3 NA NA NA NA 10 8 0 1

South Indian 2 3 0 0 4 4 1 1 3 4

Yes Bank 20 21 7 8 1 1 6 6 4 3

N/A: not available

Iron & steelInfra Power Textiles CRE#

Source: Company Annual Reports, ICICIdirect.com Research #CRE- Commercial Real Estate

QoQ movement of asset quality, credit and PAT growth

2.5 2.4 2.3 2.52.8

0.8 1.0 1.0 1.0 1.3

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12

(%)

-10-5051015202530

(%)

GNPA ratio NNPA ratio

Credit growth YOY (R.H.S) PAT growth YoY (R.H.S)

Source: RBI, Company, ICICIdirect.com Research Asset quality deteriorated drastically in H1FY12

10.78.4

6.6 6.1 6.82.8 3.8

9.1

17.3

50

250

450

650

850

Q1FY

10

Q2FY

10

Q3FY

10

Q4FY

10

Q1FY

11

Q2FY

11

Q3FY

11

Q4FY

11

Q1FY

12

Q2FY

12

(| b

n)

2

7

12

17

22

(%)

GNPA GNPA growth QoQ (R.H.S.)

Source: RBI, Company, ICICIdirect.com Research * ICICI Direct coverage universe


Credit growth to be sluggish …….

Credit growth which stands at 17.8% YoY (December 2nd 2011) is expected to moderate at ~16% for FY12E. With GDP likely to grow at similar pace, FY13 credit growth may mimic FY12 growth.

Exhibit 114: Credit growth at 2.5-3x real GDP, GNPA ratio off from earlier peaks ;uptick seen again

710131619222528313437

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E

(%)

123456789101112

(%)

Credit Growth YoY GDP (R.H.S.) GNPA (R.H.S.) Repo rate (R.H.S.)

GNPA had been 5% if all restructured assets slipped

Source: Bloomberg, ICICIdirect.com Research * For FY12E, GNPA ratio of HYFY12E has been taken

NIM seems to be capped from hereon …….

We believe interest rate cycle has peaked and rate reversal should happen around Q1FY13E. However, slowing growth coupled with high cost term deposits and deregulation of saving rate and NRE interest rates would keep NIM under check. We expect saving rate deregulation to impact margins in the long term for all banks but high CASA banks like SBI, HDFC Bank and Axis Bank will bear a larger hit of 20-30 bps.

Exhibit 115: Analysing impact of saving rate deregulation

FY12E FY13E FY12E FY13ESBI** -14.5 -29.8 -12.1 -21.4BOB -10.0 -20.0 -5.3 -10.4PNB -13.0 -26.0 -7.0 -13.6HDFC Bank -14.0 -29.0 -4.9 -9.7Axis Bank -10.0 -20.0 -3.8 -7.8Yes Bank -1.0 -2.0 -0.4 -0.8

** Standalone*Assuming savings rate hike of 50 bps in FY12E and 100 bps in FY13E

BanksImpact on NIM (bps)* Impact on PAT (%)*


Increase in saving rate also causes the base rate to increase and hence, margins may not deteriorate radically Banks are likely to wait before increasing saving rate as credit offtake is sluggish and interest rate cycle is peaking, thus postponing the impact by a year or so


Valuations and outlook

In the absence of major positive triggers, we believe the sector will be in a consolidation phase from here on as concerns over NPA would persist while interest rate cuts (expected in Q1FY13E) and contraction in multiples would limit downside. Banks with higher exposure to power (SEB), infra, iron & steel and textile like SBI, PNB, IOB, OBC and Dena Bank may continue to take a beating.

Exhibit 116: Higher RoA and better asset quality stay in right bottom quadrant, quality stocks still enjoy premium

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0

P/ABV (x)

NN

PA (%

)

HDFC Bank

Dena Bank

Dhanlaxmi

OBCUBI

IOB

Syndicate

Yes Bank

Axis Bank

SIB BOB

CUB

Federal Bank

PNB

BOI SBI

DCB

Kotak

Source: Company, ICICIdirect.com Research Size of bubble represents RoA

The midcap PSB space marred by asset quality concerns and lower RoA (FY13E) (top left corner of the grid) is trading below 1x FY13E P/ABV. Private banks like HDFC Bank, Yes Bank, City Union Bank and South Indian Bank, which have healthy asset quality and higher RoA, continue to get a premium (although the entire sector is now trading at below one year average multiples).


Capital Goods (Order inflow outlook gets murkier) Underperform The BSE Capital Goods Index has lost ~46% YTD owing to issues like fuel linkages, rising coal prices, regulatory clearances and high interest rates, which has severely impacted capex decisions in the power sector, reckoned to as the biggest order inflow contributor. Order inflows from the process sectors have weakened as well. Hence, as of H1FY12, capital good companies under our coverage (including L&T) have witnessed a decline in order inflows by 17% YoY, which raises questions on revenue visibility of FY14E revenues and have lead to tapering down growth rates in FY13E revenues and profitability. We remain cautious on the sector and prefer owning/buying large cap stocks on dips from a three year perspective as the sector is expected to languish in the medium term.

In terms of performance, we expect CY12 to be disappointing as H1CY12 would see tepid order inflows even though revenue growth would be reasonable, whereas H2CY12 would witness a decline in growth rates as dull order inflows in CY11 would reflect on the financial performance. Also, order inflows in H2CY12 would be a function of how fast interest rates decline, pace of implementation of reforms in power sector (fuel issues & SEB reforms) and movement in policy reforms

We believe order inflows in the transmission sector will be relatively strong as we expect PowerGrid to maintain its awarding momentum, though competition will persist. Order inflows for the generation side and other industrial sectors are expected to remain tepid until macro headwinds recede

Valuations of most of the companies in the capital goods sector are at rock bottom levels but we expect the pain to continue at least in H1CY12, until signs of capex revival are not perceived

Exhibit 117: Gross capital formation and capital goods performance (YoY growth)

3.0

57.0

-52.0

121.0

-7.1

-39.8

33.6 27.410.4 7.1

-17.0

9.9 16.21.5 7.3 3.5

17.4

60.7

-14.2

35.5

7.3

-14.3

7.5

-80

-60

-40

-20

0

20

40

60

80

100

120

140

FY07 FY08 FY09 FY10 FY11 FYTD12

(%)

BSE CG Index Order infow Growth Gross Fixed Capital Formation CG IIP Index

Source: RBI, Bloomberg, Company, ICICIdirect.com Research

A boost in GFCF from FY07 to FY08 pulled the capital goods IIP up, with BSE CG following them With a slowdown in FY09 and new investments drying up, stock prices of major capital goods companies fell sharply. However, with policy stimulus and reduced interest rates, investment demand picked up subsequently in FY10, leading to a steep price appreciation Post FY10, with RBI adopting an anti-inflationary stance and increasing policy rates, coupled with a deteriorating macro environment, new private sector investments slowed considerably, leading to a de rating of the sector At present, with the RBI refraining from further rate hikes and softening inflation numbers, possible rate cuts in FY13 should revive investment demand and PAT margins

Current Valuations mirroring FY08-09

3Y Low 3Y Median 3Y High CurrentLarsen & Toubro 13.0 22.0 33.0 13.9Kalpataru 3.7 20.1 81.8 6.9Jyoti Structures 2.9 12.4 18.7 2.9KEC 6.4 15.0 26.4 8.4BGR Energy 4.0 20.5 35.3 4.2Sterlite Tech 2.8 12.7 32.0 7.4Hindor 3.9 15.3 51.0 4.5Thermax 6.3 22.2 42.0 12.5

Price/Earnings

700045


Exhibit 118: Increasing interest burden…

0

10

20

30

40

50

60

FY07 FY08 FY09 FY10 FY11 FYTD12

(%)

0123456789

(%)

Repo Rate (RHS) Interest/EBITDA* Debt Equity Ratio*

Source: Company, ICICIdirect.com Research * Ex Bhel

Exhibit 119: Outlook matrix for coverage companies in FY13E

Company FY11-FY13E Topline CAGR FY11-FY13E EPS CAGR

FY11 FY13E FY11 H1FY12 FY11 H1FY12 FY11 FY12EBGR Energy -2% 11.3 11.8 11% 24% -8% 1.5 2.2 67% 89%Thermax 7% 11.6 11.3 0% 1% 9% 0.0 0.1 20% 19%KEC International 16% 10.6 9.3 23% 38% 3% 1.5 1.7 55% 49%Jyoti Structures 13% 11.5 11.4 35% 42% -4% 0.8 0.9 46% 47%Kalpataru Power 14% 11.5 11.3 24% 34% 7% 0.5 0.4 50% 49%Sterlite Tech 21% 11.5 11.8 18% 47% 17% 0.5 0.6 28% 31%Hindustan Dorr -1% 9.6 10.3 24% 72% -15% 0.5 1.2 31% 34%

Margins Interest/EBITDA Debt/Equity Debtors/Sales


Rising working capital debts, combined with higher interest rates eat away a significant chunk of EBITDA as interest outgo. From 16% levels in FY10 and FY11, it has risen to around 29% for FYTD12


Cement (Margin pressure to continue) Underperform Cement demand has been sluggish in the past 20 months (growth of 4.4% in FY11 and 4% in YTDFY12) due to muted offtake from construction activities. We find that cement demand growth has a high correlation with gross fixed capital formation (GFCF) growth as it captures the construction activities. GFCF declined 0.6% in Q2FY12 on account of a slowdown in infrastructure investments, keeping cement demand under pressure. We expect cement demand to grow by 4.5% in FY12E and 8% in FY13E.

Capacity utilisation has been low during the current year on account of low demand and stabilisation of newly installed capacities. Effective capacity addition of ~26 MT against incremental demand of ~17 MT would keep the utilisation rate under pressure

All-India average cement prices picked up in YTDFY12 with ~7% YoY increase, mainly because of supply discipline and price hikes post monsoons in anticipation of a pick-up in demand. As the demand remained muted even after monsoons, prices have started showing weakness again. We expect prices to remain under pressure, going forward, on account of pressure on utilisation rates

Increase in input costs has been a major dragger for erosion in operating margins. Shortage of domestic coal with depreciation of the rupee is keeping fuel costs higher. Also, rising railway freight charges adds to the increase in cost structure. Thus, we expect the increase in input costs coupled with subdued realisations would keep margins under pressure in FY12E and FY13E.

Exhibit 120: Premium valuations of Large caps on strong balance sheet…

-20%

0%

20%40%

60%

80%

100%

FY08 FY09 FY10 FY11 FY12E0

2000

4000

6000

8000

10000

| pe

r ton

ne

Mcap Net Debt EV/Tonne (RHS)

Source: Company, ICICIdirect.com Research Note: cumulative of ACC, Ambuja Cement & UltraTech Cement

Exhibit 121: Rise in gearing inflates EV; deflates midcaps valuations

0%

20%

40%

60%

80%

100%

FY08 FY09 FY10 FY11 FY12E

-1,0002,0003,0004,0005,0006,000

| pe

r ton

ne

Mcap Net Debt EV/Tonne (RHS)

Source: Company, ICICIdirect.com Research Note: cumulative of Shree Cement, India Cement, JK Cement, JK Lakshmi, Orient Paper, Heidelberg Cement, Mangalam Cement

Exhibit 122: Peak EBITDA/tonne level of FY10 yet to be achieved

0

1000

2000

3000

4000

FY10

FY11

FY12

EFY

13E

FY10

FY11

FY12

EFY

13E

FY10

FY11

FY12

EFY

13E

FY10

FY11

FY12

EFY

13E

FY10

FY11

FY12

EFY

13E

FY10

FY11

FY12

EFY

13E

FY10

FY11

FY12

EFY

13E

FY10

FY11

FY12

EFY

13E

FY10

FY11

FY12

EFY

13E

FY10

FY11

FY12

EFY

13E

ACC Ambuja Cement Ultratech Cem Shree Cement India Cement JK Cement JK LakshmiCement

Orient Paper MangalamCement

HeidelbergCement

| pe

r ton

ne

EBITDA Total Cost

Source: Company, ICICIdirect.com Research Note: dotted line indicates Q2FY12 average EBITDA/tonne of our cement coverage universe

Capacity surplus & subdued demand to keep utilisation rates under pressure…

8987

77 777575

0

10

20

30

40

50

FY09 FY10 FY11 FY12E FY13E FY14E

Milli

on to

nnes

65

70

75

80

85

90

95

%

Incremental capacity

Incremental demand

Capacity utilisation (RHS)

Source: CMA, ICICIdirect.com Research

700045


FMCG (Price led growth, margins to shrink) Neutral FMCG companies would continue to witness strong topline growth, which would largely be led by price increases. We believe a moderation in volumes in slowing down the economy is inevitable. With the rising cost pressure, margins for companies would remain under pressure. Valuations for the FMCG sector remain stretched and risk-reward is unfavourable. However, in case of a sharper sell-off in markets, FMCG being a defensive sector is not as vulnerable as others.

The key raw materials (palm oil-20%, copra-30%, sunflower oil-5%, titanium dioxide-50%, sugar-12%, and tea-~15/kg) witnessed a significant rise in H1CY11 (YoY), which impacted the gross margins of FMCG companies from Q2CY11 onwards. Hence, the companies undertook calibrated price increases (~15-20%) in H2CY11 and simultaneously reduced their advertisement expenses to ward off the impact of input cost inflation. Though raw material prices have stabilised, the impact of currency depreciation (15%) is playing spoilsport from Q3CY11. With majority of the volumes of raw materials (palm oil, crude linked derivatives-LAB, titanium dioxide) being imported, we believe the margins of companies like Dabur, Marico, Asian Paints and Godrej Consumer Products, would continue to remain under pressure until the currency stabilises and raw materials prices start declining

With the continuous price hikes, the branded FMCG players witnessed a moderation in volume growth since Q3CY11. Topline growth in H2CY11 had been largely price led (~15% YoY in hair oils, 10-12% YoY in soaps & detergents, 8-10% in cigarettes). With the prevailing high inflationary scenario and a second round of price hikes looking inevitable (due to rupee depreciation), we believe a moderation in volume growth in highly competitive and price sensitive sectors (soaps, hair oils, detergents and biscuits) would take place in CY12 also. We believe, volume growth would also take a set back due to down-trading in demand by \consumers at the end of the pyramid (rural consumers) who already face higher inflationary challenges. However, we believe low penetrated categories, specifically in foods or oral care, would be less prone to demand deterioration and margins pressures

Exhibit 123: CNX Nifty vs. CNX FMCG Index

6000

7000

8000

9000

10000

11000

12000

4-Ja

n-11

2-Fe

b-11

3-M

ar-1

1

31-M

ar-1

1

3-M

ay-1

1

31-M

ay-1

1

28-J

un-1

1

26-J

ul-1

1

24-A

ug-1

1

23-S

ep-1

1

24-O

ct-1

1

24-N

ov-1

1

23-D

ec-1

1

4000

4500

5000

5500

6000

6500

CNX FMCG CNX Nifty

Source: Bloomberg,, ICICIdirect.com Research

Raw material cost and EBITDA margins

49.050.051.052.053.054.055.0

Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY1210.012.014.016.018.020.022.0

RM to Sales (%) EBITDA Margins (%)


Rupee depreciation

Rupee / US $

45

47

49

51

53

55

Sep-

11

Sep-

11

Oct-1

1

Oct-1

1

Nov

-11

Nov

-11

Dec-

11

Rupee / US $


Imported Raw material as % of sales Company Imported RM (as % to Sales)ITC 4.2Godrej 9Nestle 5.1Marico 1.9



Hotels (RevPar growth to remain tepid) Underperform Hotel industry witnessed turbulent time in the past two years on account of global economic turmoil, higher inflation and political disturbance in the domestic market. Although, our coverage universe witnessed a topline growth of ~18% YoY in FY11 (mainly backed by new room additions), the growth in RevPAR (revenue per room) remained muted due to excess supply. FTAs (Foreign Tourist Arrivals) that are major revenue contributor for premium hotel rooms recorded 9% YoY jump during FY11. However, due to lower corporate spending on travel as result of economic slowdown and higher room supply, occupancy levels for FY11 (61%) remained lower compared to FY09 (63%). Though, it was up by 300bps YoY due to low base effect. The average room rate (ARR) growth also remained subdued (~1.3% YoY) especially across major business destinations such as NCR, Mumbai, Chennai and Hyderababd mainly due to oversupply of rooms. With increased room supply and moderate demand growth, we expect FY11-13E topline CAGR of 12% of our coverage universe, supported by new room additions and marginal growth in occupancy (by~100 bps YoY in FY13E).

Supply overhang to keep ARR growth under pressure

In CY11, the demand for hotel rooms was primarily driven by both business and leisure travellers on international events such as cricket world cup. As a result, the occupancy level witnessed a 200 bps YoY jump on the back of increase in international tourist arrivals by 11% during H1CY11. However, addition of new rooms across the regions hit the ARR growth, thereby restricting RevPAR growth to the extent of 2-3% during the same period. We believe supply of premium rooms to grow at a CAGR of ~11% in FY11-FY13E, keeping pace with same kind of demand growth during the same period. This would keep the occupancy level under pressure with flat ARR growth.

Margin to remain under pressure

The occupancy led recovery that started from H2CY10 was on account of improving FTA across business and leisure destination followed by international events. However, absence of international events in FY12 and FY13 in India, we expect the ARR growth to remain subdued. Also high fixed costs in FY13E will keep EBITDA margin under pressure (down by ~200 bps from FY11). Despite this financial backdrop, we believe the companies under our coverage are trading at distress valuations (trading at average 1.5x FY13E book value as against five years historical one year forward average book value of 3x).

Exhibit 124: FY07-08 PAT level yet to be achieved

0100200300400500600700800900

F07

FY08

FY09

FY10

FY11

FY12

E

FY13

E

(| c

rore

)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

(x)

Net Profit D/E (RHS)


Exhibit 125: Low return ratios keep valuations at discount

0

5

10

15

20

25

F07

FY08

FY09

FY10

FY11

FY12

E

FY13

E

(%)

0.00.20.40.60.81.01.21.41.61.8

(x)

RoE RoCE P/BV (RHS)


FTA arrivals in India

FTA to grow by ~10% in CY12E

2454

2933 3603

4100 50

82

5283

5134

5606

5420 67

36

010002000300040005000600070008000

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

E

(in '0

00)

Source: MoT, ICICIdirect.com Research

Occupancy and ARR growth to remain subdued

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

FY07

FY08

FY09

FY10

FY11

FY12

E

FY13

E

(|)

0

10

20

30

40

50

60

70

80

(%)

ARR Occupancy

700045


Infrastructure (Structural overhang) Underperform CY11 saw Construction & Infrastructure stocks underperforming the broader indices on account of tightening policy rates, muted order inflows across segments (except roads) & rising commodity prices affecting execution and margins. At the onset of CY12, we are at the cusp of regime where rate cut is expected (impact to be seen from H2CY12 onwards in financials) and commodity may cool off bringing down the project cost for developer & working capital for contractors. However, we maintain our cautious view due to policy stance on various issues such as fixation of aero charges for airports, delay in environment clearance & land acquisition issues.

Exhibit 126: Sector snapshot for CY11

New investments slowing down Projects Shelved

Underperformance of developers Underperformance of contractors

Stretched workingcapital, delay inexecution & delay inorder inflows

Clarity on tariff fixation in airports

Financial charges Impact

RBI has increased the policy ratefrom 6.25% to 8.5% during CY11leading to increase in interestcosts (refer exhibit on next pagefor details)

Policy Reforms Deadlock Commodity prices high

Clarity/issues pertaining to passthrough on higher fuel costs currentlyimpacting economics of powerbusiness

Land Acquisition Bill & clarity over go &no-go area for env. clearance

Delays in Investment decisions

Key raw materials like steel andcement up ~11% & 15%,respectively, in the last 18 monthsleading to cost overruns (refer toexhibit on next page for details)

Rate cut of 50/100 bps by H1CY12E would lead to earnings upgrade of 5-60% purely on interest rate savings. Additionally, it would lead to a pick-up in execution and improvement in working capital cycle

Commodity cool- off on the back of global macro concerns & slowdown holds key for margin improvement

3752

54

3105

29

3184

68

3099

39

2235

47

-

100,000

200,000

300,000

400,000

Sep-

10

Dec-

10

Mar

-11

Jun-

11

Sep-

11

| cr

ore

23802 23134 27177 29422

75528

-25,00050,00075,000

100,000

Sep-

10

Dec-

10

Mar

-11

Jun-

11

Sep-

11

| cr

ore

6

7

8

9

Dec-

10

Feb-

11

Apr-1

1

Jun-

11

Aug-

11

Oct-1

1

(%)

Repo Rate

10

30

50

70

90

110

Dec-

10

Feb-

11

Apr-1

1

Jun-

11

Aug-

11

Oct-1

1

Sensex IVRCLHCC NCCSimplex

25

50

75

100

125

Dec-

10

Feb-

11

Apr-1

1

Jun-

11

Aug-

11

Oct-1

1

IRB Infra JP AssociatesGMR GVKSensex

Source: Company, CMIE, Bloomberg, RBI, ICICIdirect.com Research

We maintain our cautious view on the sector on account of policy stance on various issues which would outweigh the cyclical benefits such as interest rate cut & possible commodity cool off.

700045


Exhibit 127: Rising policy rates leading to rise in interest cost as a % of revenues both for contractors & developers Interest cost as percentage of topline

Cont

ract

ors

Deve

lope

rs

6

7

8

9

Dec-

10

Feb-

11

Apr-1

1

Jun-

11

Aug-

11

Oct-1

1

(%)

Repo Rate 4.2

5.8

6.3

2.9

3.4 3.4

-

1

2

3

4

5

6

7

(%)

12.1

13.7

11.6

9.8

12.9

14.4

8

9

10

11

12

13

14

15

(%)

Source: RBI, Company, ICICIdirect.com Research Contractors universe – IVRCL, NCC, Simplex Infrastructure, Unity Infrastructure & Hindustan Construction Developers universe – JP Associates, GMR Infra, GVK Power & IRB Infrastructure

Exhibit 128: Rising commodity prices & policy paralysis causing delays and cost overruns across projects

Sector No. of projectsOriginal cost

(| crore)Anticipated

cost (| crore)No. of proj with

cost overrunNo. of proj with

time overrunTime overrun

range (months)Atomic Energy 4 29228 34066 2 3 11-41Civil Aviation 2 3216 3216 0 2 7-9Coal 7 13075 15940 6 5 24-48Fertilisers 3 4066 4066 0 1 1-1Mines 1 4092 4402 1 1 30-30Steel 5 37769 64101 5 2 25-36Petroleum 37 138786 147266 10 14 5-120Power 45 164218 168398 5 22 10-83Railways 29 36547 71799 23 10 3- 201Road 13 19910 21090 1 3 1-16Shipping & Ports 6 10128 10558 3 3 2-25Telecommunications 3 3637 4190 1 0 0Urban Development 2 15071 30503 2 2 12-15Water Resources 1 543 1187 1 1 60-60Total 158 480285 580782 60 69

Policy paralysis causing delaysin investments across segments

Rising commodities prices andwage inflation leading to costoverruns


700045

700045


IT (off-shoring market share gains, currency) Outperform The IT sector had a favourable year in CY11 as the year-to-date BSE IT index outperformed the Sensex. BSE IT declined 18.3% vs. a 23.3% decline in the Sensex led in part by INR depreciation, volume growth, a healthy balance sheet and cash flow generation. As for CY12, depreciating rupee, tapering attrition, likely lower wage inflation, steady volume (offshoring market share gains) could be likely positives while macro uncertainty, delay in budgeting cycle, discretionary spending, pricing, expensive valuations could be negatives. During the previous recession, Tier-I IT vendors bottomed at trailing 12 month PE range of 6-13x. Consequently, we assembled likely positives/negatives in our scenario builder. We believe the positives outweigh negatives excluding debt crisis in Europe, the outcome of which is indeterminate. Conversely, the macro remains uncertain and sell-offs triggered due to “Lehman” like events in Europe could offer a buying opportunity in quality names for long-term investors.

Rupee depreciation may lift rupee revenues/operating margins The Indian rupee depreciated ~14% since mid September 2011 and could benefit the topline, operating margin & earnings depending on the hedged positions of respective companies. Table below highlights the likely impact of rupee depreciation on FY12E & FY13E revenue estimate & operating margins Exhibit 129: Analysis of favourable currency movement

|/$ @ 50.8 |/$ @ 52 |/$ @ 50.8 |/$ @ 52|/ $ FY12E FY12E FY12E |/ $ FY13E FY13E FY13E

Infosys 47.0 45.3

Revenues 33,851 34,763 34,980 36,405 40,833 41,789

EBIT 9,688 10,146 10,255 10,129 14,066 14,905

EBIT margin(%) 28.6% 29.2% 29.3% 27.8% 34.4% 35.7%

TCS 45.1 44.7

Revenues 44,670 46,152 46,995 50,513 57,417 58,762

EBIT 12,067 12,972 13,197 13,469 16,833 17,489

EBIT margin(%) 27.0% 28.1% 28.1% 26.7% 29.3% 29.8%

Wipro 45.3 45.3

Revenues 36,116 37,009 37,587 40,823 44,515 45,312

EBIT 6,889 7,478 7,859 7,444 9,781 10,285

EBIT margin(%) 19.1% 20.2% 20.9% 18.2% 22.0% 22.7%

HCL Tech 44.7 44.3

Revenues 19,188 20,188 20,315 21,663 24,875 25,457

EBIT 2,823 3,271 3,328 3,095 4,621 4,898

EBIT margin(%) 14.7% 16.2% 16.4% 14.3% 18.6% 19.2%

Current estCurrent est


Visibility, pricing deteriorate sharply in CY08-CY09 Discussions with Tier I vendors point to unanimous rhetorics such as “no project cancellation yet”, “positive discussions on CY12E budgets but deal signing low”, “uncertainty level high”, “off-shoring could benefit eventually”, no pricing pressure” and “modest decision making delay”. Though we acknowledge that Indian IT vendors gain in offshoring irrespective of increase/decrease in IT budgets and could lead to stable volumes, we highlight that the timing of budget finalisation is crucial. The rationale is management commentary on CY08 IT budgets turned circumspect only in

Scenario build for CY12E

3.Pricing continues to be pressure in CY124.Large deals signing significantly reduces

the current 10-12% offshore and 2-4% onsite

as macro uncertainity concerns alleviate2. Attrition increases. Wage hikes higher than

1. Rupee appreciates with significant FII inflows

2.Discretionary spending remains under pressure

Negatives:

Negatives:1.Likely delay in CY12E IT budgets cycles

Worst case - Macro worsens

Best case - Macro improves

Positives:

Positives:

1.Rupee depreciation will lever the rupee revenues and EBIT margins2.Attrition could be light in FY133.Wage hikes could be subdued

1. CY12E IT budgets are concluded on time 2. Discretionary spending helps lift volumes3. Cost-of-living-adjustments (COLA) price increases4. Deal signing improves & Indian vendors earn market share

Source: ICICIdirect.com Research Hedging details as of Q2FY12

Hedges O/S ($ million)TCS 2,900 Infosys 742 Wipro 1,700 HCL tech 713 Source: Company, ICICIdirect.com Research


April 2008, during the previous recession, despite January-March quarter being the budgeting quarter. Finally, pricing weakness during 2008 makes us cautious despite optimistic management commentary. Exhibit 130: Blended pricing trends

-8.0

-4.0

0.0

4.0

Jun-

08

Dec-

08

Jun-

09

Dec-

09

Jun-

10

Dec-

10

Jun-

11

%

TCS Infosys Blended


Exhibit 131: Onshore/offshore pricing trends

-6.0

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6.0

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Mar

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%

Wipro Onsite Wipro Offshore


Sell-offs from “Lehman” like events present buying opportunities During Lehman crisis, large caps TCS, Infosys bottomed at an average TTM PE multiple of 10x. Though these were one-off cases, we believe, repeat of similar events represents aggressive buying opportunities.


Media (Ad growth to moderate) Neutral CY11 was a year of economic slowdown characterised by a slowdown in ad revenue growth across all sections of the media industry. With corporates curtailing ad spends in the event of rising input costs and subdued economic growth expected in the next few quarters, ad revenue would grow moderately at 10-12% in the next fiscal. Expected rate cuts in mid 2012 would boost economic activity, which may lead to a spurt in ad spends in the second half of the next fiscal.

The government has mandated digitisation with March 31, 2014 set as the sunset date for analogue cable. This opens up a huge opportunity for the digital cable and DTH industry. Broadcasters also stand to gain due to plugging of subscription revenue leakages. Currently, there are ~ 67 million analogue cable households, which will have to move to either digital cable or DTH by March 31, 2014. However, digitisation will need huge upfront investment. The DTH industry is relatively well funded and has the distribution infrastructure in place.

We expect subscriber addition of 13.5 million for the DTH industry and 3.1 million subscribers for Dish TV in FY13E without considering the effect on mandatory digitisation. The company imports set top boxes, which could dampen the profitability in case of currency depreciation. We expect revenue growth of by 23.9% and the company to turn positive PAT in FY13.

CY11 witnessed progressive launches while CY12 would be a year of consolidation wherein companies would focus on gaining further inroads in new markets entered in the last fiscal. Revenue growth would be backed by price hikes and increasing circulation. Margins across the print companies are expected to improve in CY12 due to the absence of cost related to any new launches. Newsprint prices may remain a concern especially with the depreciation of the rupee. However, most companies have increased the proportion of domestic newsprint to counter this. We expect print media companies to grow in revenues by 9.9% in FY13 and in PAT by 25.0% primarily due to improving margins.

CY11 was marked by a very subdued ad revenue growth. National advertisers had initially caught up with their local counterparts but in the latter half of the year they felt the effect of the slowing economy and cut down their ad spends. However, we expect national advertisers to catch up with their local counterparts in CY12.

The radio industry would see Phase III auctions in CY12 wherein over 700 licenses will be up for grabs. Radio companies are operating at peak capacities and revenue growth will primarily be through price hikes until more capacity is created. ENIL, with its huge cash reserve, is in the best position to capitalise on the auctions. We expect 12.9% growth in revenues and 28.4% growth in PAT in FY13 for ENIL without taking into consideration the Phase III auction.

CY11 has seen better occupancy than that in CY10 for multiplexes albeit at slightly lower ATPs. The multiplexes would focus on property additions with stable ATP to maintain revenue growth. We expect 44 screen additions in our multiplex universe in FY13. However, we expect the ATPs to reduce ~ 2% and occupancy to reduce by ~150 bps across multiplexes in FY13 due to expansion in smaller cities. We expect multiplexes revenue to grow by 9.0%.

Ad revenue growth of media companies

3,61

1

4,42

0

4,91

2

5,56

9

11.113.4

22.4

12.4

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FY12

E

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(| c

rore

)

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Total Ad revenue - LHS Growth (RHS)


Dish TV subscriber and ARPU

6.9

13.216.2

10.4

171 162154140

02468

1012141618

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FY11

E

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E

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E

In M

illion

n

0

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|

Subscribers ARPU (RHS)


Households Data of C&S Industry

(Mn Households) CY10 CY11E CY12EC&S 102 112 123Analogue 68 67 66DTH 28 38 48Digital 6 7 9

Source: FICCI report 2011, ICICIdirect.com Research

With mandatory digitisation 68 million analogue cable households will move to either DTH or digital cable ATP and occupancy in Multiplexes

169143 141

173

29

27

30

29

0

50

100

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200

FY10

FY11

E

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E

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E

(|)

2626272728282929303031

(%)

ATP Occupancy



Metals and Mining (Tough road ahead) Underperform CY11 was a challenging year for the metals and mining sector on the back of a muted demand scenario, elevated raw material costs and restriction of mining of iron ore in certain areas. During the first nine months of CY11, prices of key raw materials such as iron ore and coking coal were on an upward trend while in Q4CY11 along with a decline in raw materials costs steel prices also tapered off resulting in no respite for steel companies. As a result, on the back of elevated cost structure the operating margins of steel players remained under pressure for CY11. Going forward, on the back of global uncertainty and a muted demand scenario, we expect global steel demand to remain subdued in CY12.

The ongoing slow down in global economy is expected to keep demand for industrial metals under pressure. The recent decline seen in the base metal prices has brought the prices close to marginal cost of production. Going forward we believe that movement in base metal prices would be a function of global economic factors.

The metal sector is currently facing headwinds in the form of muted demand and elevated cost structure. The ongoing debt concern in Europe coupled with signs of slow down in global economy has adversely impacted the overall demand. On the domestic front the slow down in infrastructure spending & delay in implementation of capex plans has led to domestic steel consumption growing by merely 3.9% during the first 8 months of FY’12, as compared to CAGR of ~9.0% over the last five years . Going forward we believe that the ongoing slow down in global economy is expected to keep demand for metals under pressure. In current scenario, we believe companies having backward integration and better product portfolio are better placed.

Exhibit 132: Bird’s eye view of operating performance of major steel companies (last 5 quarter)

0

20000

40000

60000

Q2FY

11

Q3FY

11

Q4FY

11

Q1FY

12

Q2FY

12

Q2FY

11

Q3FY

11

Q4FY

11

Q1FY

12

Q2FY

12

Q2FY

11

Q3FY

11

Q4FY

11

Q1FY

12

Q2FY

12

Tata Steel SAIL JSW

|/to

nne

RM Costs Power costs Employee cost Other costs EBITDA/Tonne

Contraction seen in EBITDA per tonne of steel players over last couple of quarters on the back of higher operating costs

Source: Company, ICICIdirect.com Research *- Standalone numbers are used for comparison purpose

Prices of steel & primary raw materials

0

100

200

300

400

500

Q2FY

11

Q3FY

11

Q4FY

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Q2FY

12

($/to

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20000

25000

30000

35000

40000

45000

(|/to

nne)

Iron Ore Coking Coal HRC (RHS)


Prices of Copper & Aluminium on LME

5000

7000

9000

11000

Apr-1

0

Jun-

10

Aug-

10

Oct-1

0

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10

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Oct-1

1

Dec-

11

in $

/tonn

e

1000

1800

2600

3400

in $

/tonn

e

Copper (LHS) Aluminium (RHS)

Source: Bloomberg, ICICIdirect.com Research Prices of zinc & lead on LME

800

1550

2300

3050

Apr-1

0

Jun-

10

Aug-

10

Oct-1

0

Dec-

10

Feb-

11

Apr-1

1

Jun-

11

Aug-

11

Oct-1

1

Dec-

11

in $

/tonn

e

Zinc Lead


Steel demand in recent years

0

5

10

15

20

FY08

FY09

FY10

FY11

YTD

FY12

(P)

YoY

(%)

Source: JPC, Ministry of Steel, ICICIdirect.com Research * YTD FY12(P) Provisional


Oil & Gas (Uncertainty of regulatory reforms offsets opportunity from cheap valuations) Neutral The oil & gas sector reported a tepid performance in CY11 on lack of regulatory reforms, uncertainty about government policies and lower domestic gas production. In CY12, we believe elevated Brent crude oil prices on geo-political tensions and remote possibility of petroleum products’ pricing deregulations would continue to remain a drag on the OMCs for H1CY12. We prefer to play the oil & gas sector through the PSU upstream companies on account of lower valuations (BSE oil and gas index has been trading near historical lows of 10-12x PE multiple) and gas utility companies as defensive bets within the sector.

Geo-political tensions would continue to mount upward pressure on crude oil prices and limit the downside in crude oil prices caused by weaker demand forecasts. We have revised our FY12 Brent crude oil price estimate to US$105 per barrel and expect average Brent crude oil prices to remain at US$100 in FY13

We believe that pressure from a depreciating currency and high Brent crude prices would lead to record high under-recovery of ~ | 135000 crore in FY12. With state elections round the corner and crude prices remaining firm at current levels, price reforms remain a remote possibility in the near term. We believe that price controls and delayed payment of subsidy from the government would continue to burden the PSU OMCs for H1CY12 and offsets the positives such as valuations hovering around their 2008 levels

The share of Indian government, downstream and upstream companies w.r.t. crude oil gross under-recoveries stood at 52.5%, 8.8% and 38.7%, respectively, in FY11. We assume the same share in future with total gross under-recoveries remaining at ~|135000 crore and ~|128500 crore, in FY12 and FY13, respectively. Even at 38.7% subsidy sharing, PSU upstream companies are trading at ~10x, ~9x and ~8x FY11, FY12E and FY13E EPS, respectively. We believe current valuations would offer good upsides from the current levels

We expect private upstream companies to benefit from rupee depreciation with Cairn India benefiting from higher realisations and Reliance from refining margins. We believe Singapore Gross Refining Margins (GRMs) would remain at the current levels of ~US$5-8 per barrel in the next year on increased heavy-light crude oil spreads

The Fukushima nuclear disaster in March 2011 led to higher imports of LNG in Japan, thus boosting spot LNG prices in Asia to US$14-18 per mmbtu in the last year. Lower domestic gas production has contributed to increased import of LNG in India, thereby increasing the raw material costs for companies. We believe it would be difficult for companies to continue passing on increase in prices for the second year in a row and, hence, their margins would decline. Nonetheless, the recent correction in prices of gas utility companies offers a defensive investment opportunity

Brent crude oil prices and exchange rates

20

40

60

80

100

120

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12E

US

$

35

40

45

50

55

|C rude oil prices (L H S ) E xchange rate (R H S )


Gross oil under-recoveries at US$ 52/bbl

90012871033

461782

1673

400

20591353

494771

0

500

1000

1500

2000

2500

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12E

FY

13E

(| b

n)

$90 $100 $110 $120

Source: PPAC, ICICIdirect.com Research

Oil under-recoveries subsidy sharing (|)

320144

303524 498

713

260

410

710 676

56

69

119

0113

12871353

782

461

1033

0

250

500

750

1000

1250

1500

FY09 FY10 FY11E FY12E FY13E

| bn

Upstream companies Government OMC's

Source: PPAC, ICICIdirect.com Research Oil under-recoveries subsidy sharing (%)

F Y 09 F Y 10 F Y 11E F Y 12E F Y 13EU pstream 31.0 31.3 38.7 38.7 38.7G ovt. 69.0 56.5 52.4 52.5 52.5O MC 's 0.0 12.2 8.8 8.8 8.8T ota l 100.0 100.0 100.0 100.0 100.0

Source: PPAC, ICICIdirect.com Research Singapore gross refining margins

02468

10

Dec-

99

Dec-

00

Dec-

01

Dec-

02

Dec-

03

Dec-

04

Dec-

05

Dec-

06

Dec-

07

Dec-

08

Dec-

09

Dec-

10

Dec-

11

US$

per b

arre

l

Source: Reuters, ICICIdirect.com Research


Pharmaceuticals (US to remain key growth driver) Outperform In CY11, the BSE Healthcare index outperformed Sensex by ~10%. This, we believe, was on account of the defensive nature of the sector, resilience shown by majority of the players by way of a healthy performance on the back of strong exports growth to advanced countries like the US, EU and Japan and stable growth in the domestic formulation business.

• We expect the domestic formulations market to grow at 13-14% per annum mainly driven by chronic therapies. However, overall growth in the domestic market would be lower as we expect mid single digit growth in acute therapies. We expect pricing pressure in some acute therapies such as anti-infectives and gastrointestinals (GI). The domestic formulation growth in 2012 would be driven by volume rather than price hikes

• The US government’s endeavour to push for more healthcare reforms in order to control healthcare spend augurs well for Indian generic players but more so for integrated players that can fathom the pressure in realisation. On the flip side, increased scrutiny from the USFDA conversant with its zero tolerance policy is likely to delay the approvals. More importantly, it will also compel Indian players to maintain highest quality standards. The count of shortage drugs in the US market has increased in the last couple of months due to regulatory issues at leading global generic players such as Hospira and Teva. This would help Indian players to improve the market share in the US.

• We also see good opportunities in the Pharmerging economies especially Brazil, Mexico and Russia as these economies more or less possess the same market dynamics as India. In the CRAMS space, we see a visible revival in fortunes on account of the pause in de-stocking at the clients end and adoption of more dynamic JIT approach by most of the clients

• On the profitability front, we expect some margin pressure on account of (1) fall in realisations across all geographies and (ii) high attrition rate

• Depreciation of the rupee can improve realisation to some extent. As per our calculation, for every one rupee depreciation vis-à-vis the dollar, there will be margin accretion in the range of 17-55 bps. However, companies like Aurobindo Pharma, Glenmark Pharma and Strides also own foreign currency loans, which limit overall benefits.

Exhibit 133: Domestic formulations-Therapy wise growth in CY11

1112 12 13

1516

15

25

1720

0

5

10

15

20

25

30

Grow

th(%

)

Dermatology

Anti-Infectives

CVS

GI

Vitamins

Pain mgtRespiratory

Gyneacology

Anti-Diabetics

CNS

Industry growth 14.8%

Source: AIOCD database, ICICIdirect.com Research

Exhibit 134: Domestic formulations-expected therapy wise growth in CY12

810

12

18

25

15151518

15

0

5

10

15

20

25

30

Grow

th(%

)

Dermatology

Anti-Infectives

CVS

GI

Vitamins

Pain mgtRespiratory

Gyneacology

Anti-Diabetics

CNS

Expected Industry growth 13.5%


Domestic performance: I-Direct Universe

Company Market Share (%) MAT Nov'11 Gr(%)

Sun Pharma 4.5 23

Cadila Healthcare 3.9 15

Lupin 3.0 20

Glenmark 1.8 17

Ipca Labs 1.7 17

Torrent Pharma 1.5 14

Elder Pharma 1.1 8

Unichem Labs 1.1 3

Indoco Remedies 0.8 7Source: AIOCD data base, ICICIdirect.com Research MAT Nov: TTM numbers as of Nov’11

700045


Key events to watch in 2012 New Pharma pricing policy: We may see some impact on account of the likely implementation of the new PPP, which will increase price control to over 60% of the drugs from the current ~20%. Although the policy is still under discussion, if implemented, we may see some negative impact for some top brands. As per AIOCD data, the impact would be around | 1500 crore. Generic Drug User Fee Act: Approval for Generic Drug User Free Act (GDUFA) in the US would be an important event for Indian companies. Under the act, companies need to pay fees when they are filing ANDA or seeking approval for manufacturing facilities. The USFDA is aiming to collect US$ 1.5 billion for five years from all generic players, which would be used to expedite ANDA approvals and reduce time for inspection of new/existing manufacturing facilities. US guidelines for Biosmiliars: The USFDA will take public comments on Biosmiliar guidelines and user free act for the US market till the middle of January and submit the final agreement to the United States Congress. We remain positive about the outlook for the pharma and healthcare sectors for 2012. Our belief is based on the capabilities that most of the players have developed over the years to cope with challenges in a particular geography. We expect players with optimum geographical mix to perform better than players with focused markets. The US will remain the key market to conquer on account of impending patent cliff and, hence, opportunities in both FTF and generics. Brands worth ~$25-30 billion are expected to lose patent exclusivity in 2012 itself. Although we remain positive about the sector outlook, we may not see outright outperformance of the Healthcare index vis-à-vis the Sensex on account of substantial valuation premium (~30% currently). We may, however, see select pharma companies outperforming the broader index. Exhibit 135: One year forward PE graph

5

10

15

20

25

30

35

Mar

-06

Jul-0

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-06

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-07

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7

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-07

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-08

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Mar

-10

Jul-1

0

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-10

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-11

Jul-1

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-11

(x)

Healthcare Sensex

30% premium

Source: BSE,,ICICIdirect.com Research

Focus on therapies

0 20 40 60 80 100

Sun PharmaCadilaLupin

Glenmark Ipca Labs

TorrentElder

UnichemIndoco

(%)

Acute Chronic

Source: AIOCD database, Company, ICICIdirect.com Research

ANDA approvals from USFDA

37 48 26 46

52 3042

6332 39

30

4933 2430

36

0

50

100

150

200

2008 2009 2010 2011

Q1 Q2 Q3 Q4

Source: USFDA, ICICIdirect.com Research Drugs going off patent in 2012

Drug Therapeutic Brand sales

Plavix Anti-coagulants 6.0

Seroquel CNS 3.7

Singulair Anti -asthma 3.2

Actos Anti-diabetes 3.2

Diovan Anti-hypertensive 2.5

Lexapro CNS 2.3

Avapro Anti-hypertensive 1.2

Viagra Erectile Dysfunction 1.0

Eloxatin Anti-cancer 1.0

Provigil Anti-analeptic 1.0 Sales in US$ billion Source: ICICIdirect.com Research


Power (Too many uncertainties warrant caution) Underperform The power sector in CY11 was characterised by robust capacity addition (12737 MW-taking total capacity to 1,85,496 MW), tariff hikes, fuel shortages, back down by SEBS, change in Indonesian coal law and rise in interest rates. We expect capacity addition to be robust in CY12 (our bottom up analysis suggests that ~ 9400 MW can be added in CY12). We are cautious as structural issues like policy reforms and fuel shortages are more critical than cyclical factors like falling interest rates. One should stick to regulated entities like NTPC, NHPC (regulated players, less fuel risk, high Actual Contract Quantity from Coal India, sustainable earnings growth via capacity addition).

Tepid production growth by Coal India and declining gas output from Reliance (KGD6 basin) has resulted in fuel shortages leading to newly commissioned power capacities operating at 30-50% PLFs. In 2012, we expect policy initiatives on coal sourcing and mining in terms of coal block auctions and clarity on go – no go area in coal blocks to be highly crucial for a revival of interest

Elevated coal prices coupled with rupee depreciation have kept imported coal expensive though thermal coal prices have declined 18% YTD. International benchmarking of coal prices in Indonesia will pose stiff challenges for a pass through as initial bid documents did not account for such law changes- a significant headwind for power utilities that rely on imported coal (PPAs with partial pass through)

Merchant rates are expected to remain at | 4 – 4.5/kwhr in FY13E mainly on account of cost push and rising peak power deficits (> 11% in last 3 months).

Losses of SEB in FY10 have increased to | 62700 crore. In FY12, till date 11 SEBs have announced tariff hikes ranging from 1% - 40%. Rising losses would necessitate tariff hikes, back down and investment in distribution (bringing down AT & C losses) in CY12

We expect M&A in power utilities in CY12 where fuel scarcity and environment clearance forces smaller players to cash out. There have been instances in the past like CESC’s acquisition of Dhariwal Infra and Essar’s acquisition of Navbharat Power project

Exhibit 136: Project announcements have grown 50% YoY while projects under implementation have declined 30% ( | 77973 crore) as on June 2011

020,00040,00060,00080,000

100,000120,000140,000160,000180,000

Jun-

08

Aug

-08

Oct

-08

Dec

-08

Feb

-09

Apr

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Jun-

09

Aug

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Oct

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Dec

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Apr

-10

Jun-

10

Aug

-10

Oct

-10

Dec

-10

Feb

-11

Apr

-11

Jun-

11

(|cro

re)

P rojects Announced P rojects under implementation P rojects Abandoned

S E B L oss : |52623 crore

S E B L oss :|62780 crore

S E B L oss : |68643crore

Source: CMIE, PFC, Govt. documents, ICICIdirect.com Research

Capacity addition – Year wise in 11th plan

0

18000

36000

54000

72000

90000

FY08 FY09 FY10 FY11E FY12E YTD XI th planestmates

MW

01020304050607080

(%)

Achievement Target % achievement (RHS)

Tariff hike by SEBs in FY12 till date

Date (Month) StatePower tariff hike (%) Status

Apr-11 Rajasthan 20% HikedMay-11 Punjab 9% HikedJun-11 Bihar 11% Hiked

Jul-11 Assam 56 paiseHiked , roll back

demandedAug-11 Delhi 22% HikedAug-11 Haryana 1% Hiked

Aug-11 Jharkhand 19% HikedSep-11 Gujarat 4% Hiked

Sep-11 Maharashtra40% / 45

paisa Hiked

Oct-11 Karnataka30 paise

/7% HikedNov-11 Tamil Nadu 40% Proposed

Valuations

FY12E FY13E FY12E FY13E

NTPC 13.4 13.0 2.0 1.8

NHPC 9.2 9.4 0.8 0.8

Neyveli 9.1 10.0 1.0 0.9

Tata Power 11.1 12.3 1.5 1.3

JPVL 20.2 9.8 1.7 0.7

Lanco 6.3 7.1 0.5 0.5

PTC 5.8 5.9 0.5 0.5

RoE(%) P/B


Exhibit 137: Sluggish Coal India production – impacting PLF of thermal power plants

353 377 395 389 396

16099 94 107 128 120 120

7768

76 82 7766

0

100

200

300

400

FY08 FY09 FY10 FY11 FY12 H1FY12

Milli

on to

nne

/ USD

per

to

nne

0

18

36

54

72

90

%

Thermal Coal production by Coal India - Yearly(million tonne)

International Coal price - 6700 kcal (USD/ tonne) (LHS)

Thermal PLFs (%) (RHS)

Source: Coal India, Bloomberg, ICICIdirect.com Research

Exhibit 138: No of plants with coal stock < 7 days have increased in two last months

2124

19 17

2832

24 25 25 27 2724

2732

29 2824

27

1822

31

47 48

0

10

20

30

40

50

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11


Exhibit 139: Outlook for coverage companies

Company Fuel LinkagesExposure to merchant

Business Mix Leverage

Working capital risk

Exposure totroubled SEBs

FY12E FY13ENTPC 3,120 4,160 Higher actual contract quantity (ACQ)

from Coal IndiaNIL Regulated Low Low Medium

NHPC 515 690 No fuel risk since water is fuel source NIL Regulated Low Low MediumNeyveli 250 1,140 Captive mines NIL Regulated Low High HighTataPower

1,325 2,125 Relatively safe in current operational projects but project in Maithon (1050 MW) hinges on coal provided by Coal India and Mundhra UMPP impacted by change in Indonesian coal law

Miniscule Regulated & Merchant

Medium High Low

JPVL 1,250 250 Relatively secure since all operational projects are hydro but future expansion depends on coal given by Coal India

Partial Regulated & Merchant

High Low Low

Lanco 0 670 The company buys coal from e- auction (higher prices). The current and future expansion projects are impacted by falling output from KG D6 basin

Partial Regulated & Merchant

High High High

Capacity commissioning


Falling output from KG D6 basin

6362

58

5451

48

40

45

50

55

60

65

Q1 FY11 Q2 FY11 Q3 FY11 Q4 FY11 Q1 FY12 Q2 FY12

Gas Production (Mmscmd) Monthly average

700045


Real Estate (Leveraged balance sheet) Underperform BSE Realty underperformed the Sensex in CY11 due to drying up of the funding (moderation in bank credit and non conducive capital market). Furthermore, sales volume has slowed down due to rising un-affordability and high home loan rates. Given the challenging macro headwinds & stretched balance sheet in the sector, the property prices could correct sharply. At the same time, wage inflation & higher interest expenses on account of rising gearing would keep their bottom line under pressure. Hence, we expect sector to underperform in CY12.

Exhibit 140: Reeling Realty …

Mumbai reigsteration Delhi Registeration

BSE Realty v/s Sensex

Affordability Measurement

Delhi Registration dataMumbai Registration data

Interest rate

Given the sticky inflation and agrressive ratetightening, home loan rates have inched upsignificantly

Given the muted enviroment in the equitymarket & moderating bank credit, developers arefinding it difficult to hold on to their largeinventories

Bank credit to developersHDFC Floating rate (%) Property price index

Rising property prices Bank Credit

Property prices have risen to 1.5x-2.7x in all metro cities (ex-Bangalore) impacting the overall affordability, especially in Mumbai

Given the bribery scam in November, 2010 andstringent RBI policies towards commercial real estatedevelopers, bank credit (the last funding avenue) forsector is also drying up.

0 10000 20000 30000

Mar-10

Sep-10

Mar-11

Sep-11

(| in crore)

5.1

5 4.5

4.7

4.8

4

4.5

5

5.5

2007 2008 2009 2010 2011

(x)

4045505560

(%)

Property to income Affordability ratio (RHS)

2000

4000

6000

8000

10000

Apr-0

9

Jul-0

9

Oct-0

9

Jan-

10

Apr-1

0

Jul-1

0

Oct-1

0

Jan-

11

Apr-1

1

Jul-1

1

Units

-100

-50

0

50

100

150

YoY

(%)

0

4000

8000

12000

Apr-0

9

Jul-0

9

Oct-0

9

Jan-

10

Apr-1

0

Jul-1

0

Oct-1

0

Jan-

11

Apr-1

1

Units

-40

-20

0

20

40

YoY

(%)

Given the rising interest rate cycle & sharp increase in the property price, the affordability (EMI/net income) has deteriorated and has converged towards 2008 levels

With worsening affordability, the sales volume has been adversely affected, especially in Mumbai

Given the slowdown in the sales volume coupled with drying up of funding avenues, developers are finding difficult to hold on to their inventories. This has led to underpeformance of the sector

-50

100150200250300

Dec-

07

Jun-

08

Dec-

08

Jun-

09

Dec-

09

Jun-

10

Dec-

10

Jun-

11Mumbai DelhiBangalore Chennai

8

9

10

11

Apr-0

9

Aug-

09

Dec-

09

Apr-1

0

Aug-

10

Dec-

10

Apr-1

1

Aug-

11

Dec-

11

(%)

405060708090

100

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Sensex BSE Realty

Source,: Bloomberg, Residex, ICICI Property Service Group, HDFC Q2 FY12 presentation & ICICIdirect.com Research

Higher interest expenses on account of rising gearing would keep their bottom line under pressure. Hence, we expect sector to underperform in CY12

700045


Retail (Upsetting SSSG; FDI to be the game changer) Neutral The year 2011 was an eventful year for the retail sector considering that opening up of the sector was in discussion. The government permitted foreign direct investment in multi-brand retail up to 51% and also raised the limit for single brand retail from 51% to 100% in November 2011. However, due to severe opposition from other political parties the government was forced to put the decision on hold.

Exhibit 141: Favourable demographics

15,8

81

16,1

73

16,7

69

17,1

09

18,3

01

19,3

31

20,8

68

22,5

80

24,2

95 31,8

01

33,7

31

35,9

17

-

10,000

20,000

30,000

40,000

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

|

57

59

61

63

65

%

Per capita income Population in the age 15 - 64


Exhibit 142: BMI expects the sector to grow to $825 billion by 2015

353 422

8255.7 5.5

12.4

-

200

400

600

800

1,000

2010 2011 2015E

$ bi

llion

02468101214

%

Indian Retail Sector Organised Retail Penetration

Source: Business Monitor International, ICICIdirect.com Research

According to Business Monitor International (BMI), the Indian retail sector is expected to grow from $422 billion in 2011 to $825 billion in 2015E. It also expects the organised retail penetration to more than double from 5.5% to 12.4%. While India’s demographics in terms of growing disposable income, larger share of the population in the working age group do work in favour of the India consumption story, concerns on the slowing down of consumption due to higher interest rates and increasing inflation remain. Over the last two quarters, we have seen the same store sales growth (SSSG - revenue growth of stores in existence for a year) for retailers coming down and hovering around the low levels of 2009.

Exhibit 143: Revenue and space trend

2,36

1

3,23

7 5,04

9 6,34

2

8,92

6 11,0

12

0.6 0.8 1.0 1.2 1.6 1.8 2.31.01.9 2.5

5.2

8.09.7

13.0

15.2

-500

1500

3500

5500

7500

9500

11500

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

| cr

ore

-246810121416

milli

on s

quar

e fe

et

SS - Sales PRIL - Sales Shoppers Stop PRIL

Source: Company, ICICIdirect.com Research Note: PRIL refers to Pantaloon Retail; Space for Shoppers Stop is that of the departmental stores only

Exhibit 144: SSSGs are again on a downward trend

-30

-20

-10

0

10

20

30

Sep-

08

Dec-

08

Mar

-09

Jun-

09

Sep-

09

Dec-

09

Mar

-10

Jun-

10

Sep-

10

Dec-

10

Mar

-11

Jun-

11

Sep-

11

%

Shoppers Stop PRIL - LifestylePRIL - Value PRIL - Home

SSSGs - falling to the lows of 2009

Source: Company, ICICIdirect.com Research Note: PRIL refers to Pantaloon Retail

Considering the slowdown in the consumption, retailers are forecasting SSSGs will remain in the range of 8–12% for the coming year, as compared to the highs of 18-22% in December 2010. FDI to be game changer: Opening up of the retail sector to FDI will prove to be a game changer for the sector as it will bring in the much needed capital to fund growth.

Industry experts expect investments to the tune of $8-10 billion, if foreign direct investment in retail sector is opened up. This could also lead to creation of over 80 lakh jobs

BMI expects the Indian retail sector to grow from $422 billion in 2011 to $825 billion in 2015E. As per BMI’s estimates, organised retail penetration is likely to more than double from 5.5% to 12.4%.

Retailers with healthy balance sheets are maintaining their space addition plans. However, players with higher leverage will need to hold their growth plans as revenue growth slows down and the cost of raising fresh capital rises


Shipping (Supply overhang; profitability muted) Underperform The shipping industry is currently passing through a downturn, which is likely to be prolonged. A moderation in demand and substantial increase in supply on account of new vessel additions is expected to keep freight rates subdued.

Global dry bulk fleet capacity is ~ 540 million dwt and an additional 256 million dwt i.e. 47 % of the existing fleet is likely to be added over the next two years. Global tanker capacity is ~ 470 million dwt and an additional 122 million dwt i.e. 26% of the existing fleet is likely to be added over same period. Hence, there will be a substantial overhang from large fleet additions over the next couple of years

China has been the main driver of commodity demand. Though Chinese demand for coal has sustained, with China’s iron ore inventory at an all-time high level of 96.9 million tonne (MT), iron ore demand could see moderation over the next three or four quarters. Any slowdown in the Chinese commodity offtake could lead to subdued demand for dry bulk carriers and thereby keep a tab on the up move in freight rates

The US and Europe are the main drivers of crude and refined oil products demand. As the recovery in both countries is likely to be modest, the demand for crude/product carriers is also likely to be subdued

Freight rates are expected to be under constant pressure on account of demand moderation and supply overhang. Hence, the operating performance of shipping companies is expected to be subdued. Companies with high debt and lower fleet utilisation could also report reduction in profitability

However, the offshore shipping segment offers the best play in the entire shipping space on account of firmness in crude oil prices. In CY11, average crude prices have been at $111/barrel, which should lead to higher expenditure on exploration & processing leading to higher requirement of oil drilling assets and offshore vessels. Utilisation levels for most categories of rigs have sustained above 80% for major part of CY11. Average utilisation during H2CY11 for drillship, semisub and jack up has been 81%, 87%, and 80%, respectively. Sustained high utilisation levels are expected to have a positive impact on vessel day rates

Exhibit 145: ICICIdirect Coverage Universe – Debt/equity and return on networth

1.5

1.5

1.7

1.5

6.2

5.3

6.5

4.3

1.31.41.41.51.51.61.61.71.71.8

FY10 FY11 FY12E FY13E

-

1

2

3

4

5

6

7

Debt/ Equity RoE

Source: Company,, ICICIdirect.com Research

Dry bulk indices

0

2000

4000

6000

8000

10000

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Nov

-11

Inde

x

BDI BCI BPI


Tanker indices

0

500

1000

1500

2000

2500

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Nov

-11

Inde

x

Baltic clean tanker index

Baltic dirty tanker index


BPR Shipbuilding index

0

200

400

600

800

1000

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Nov

-11

Inde

x



Soft commodities (Balance sheet woes) Underperform In the agri-commodity sector, sugar stocks have seen a sharp correction in the last one year due to subdued sugar prices, continuous increase in sugarcane cost and uncertain export policy. On the other hand, tea stocks were holding well throughout the year due to strong export prices. We believe sugar stocks have come to distress valuations levels, close to October-December 2008. Though we believe earning would continue to suffer in FY12 a decline in sugarcane area would result in lower sugar production in SY13, which should firm up sugar prices from current levels

Sugar production in season 2012 is expected to be more than 26 MT. We believe production has peaked out in the current year considering production in Maharashtra is close to the 2008 peak of 9.2 MT and production in UP is also near its peak after a 10% increase in production this year. However, a continuous increase in sugarcane minimum support prices (MSP) has resulted in the cost of production increasing higher than sugar prices. We believe the sugar segment would continue to be in losses until sugar prices increase by 5-8% from current levels. Simultaneously, global sugar prices have fallen from the peak of 36 cents /lb in February 2011 to 22 cents in November 2011 as production in Russia, Thailand and India recouped. We believe prices would remain subdued until March 2012. However, price movements post April would depend on sugar production in 2012 in Brazil

Tea production in 2011 in India has increased from 966 million kg in 2010 to ~1000 million kg led by the recovery in the production in North India. Export prices have been robust throughout the year due to lower production in Kenya. We believe production in Kenya will recover in 2012 above 300 million kg as normal rainfall is expected in the current year. Simultaneously, Indian production would also remain at ~1000 million kg in the current year. This, in turn, would lead to a decline in export prices. Tea companies could face some margin pressure in 2012, though it should still remain as high

Most of the balance sheets of sugar companies is stretched due to very high working capital debt and losses in the current year resulting in low repayments or restructuring on long term debts. Considering the negative margins in the sugar segment, debt levels would continue to remain high even in the current year. On the other hand, balance sheets of tea companies are much better with debt to equity below 0.5x.

Exhibit 146: Global raw sugar prices and domestic white sugar prices

11.0

2.8

-3.5

3.01.7

0.0

10.0

20.0

30.0

40.0

Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

SY08 SY09 SY10 SY11 SY12E

-8.0

-4.0

0.0

4.0

8.0

12.0

World (+/-) Raw sugar (c/lb) Delhi sugar (|/kg)

Source: Bloomberg,, ICICIdirect.com Research

North India and Export Tea Prices

0

50

100

150

200

250

Jan Feb Mar Apr May Jun Jul Aug Sep Oct

Tea Prices (| per kg) Export Prices (| per kg)

Source: Tea board of India, ICICIdirect.com Research

Actual sugarcane cost and SAP

241216

240

95 95107 115 125

140165

205

240

95 97

128 227121

153

0

50

100

150

200

250

300

SY04 SY05 SY06 SY07 SY08 SY09 SY10 SY11 SY12E

Cane cost (|/qtl) (LHS) SAP (|/qtl) (LHS)

c


Debt and EBITDA (| crore)

7363 7085.5

14287 15139

0

5000

10000

15000

20000

FY08 FY09 FY10 FY11

0

1000

2000

3000

4000

Debt EBITDA



Telecom (Improving key metrics & regulatory outlook) Outperform The telecom stocks have largely underperformed since early 2008, when the new licenses were issued, followed by increasing competitive intensity (visible in rising net adds and declining ARPMs). However, they have outperformed the Sensex in the last year, in spite of the continuous downgrade of their EPS (due to higher interest and amortisation cost relating to 3G related debt). The regulatory framework has improved with the new telecom minister assuming office and competitive intensity has declined resulting in stable ARPMs, which is also reflected in the stock price movement.

Exhibit 147: Telecom Performance thus far

250

300

350

400

450

500

Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 May-11 Oct-11

(|)

40

60

80

100

120

140

160

(|)

Bharti Idea

5

7

9

11

13

15

17

19

21

23

25

Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 May-11 Oct-11

Milli

on S

ubsc

riber

s

0.4

0.5

0.6

0.7

0.8

0.9

ARP

M (|

)

Monthly Net adds Bharti ARPM Idea ARPM

Phase 3: 3G auction leads to huge outgo; hyper competitive environment leading to lower tariffs and declines in profitability, Draft of NTP released - damps investor confidence

Phase 4: Regulatory scenario positive than earlier, Investor sentiment returns; slowing competitive intensity relected in lower net subscriber adds per month & tariff hike; 3G launch, stocks rise despite decline in profitability


Going forward, we expect the ARPMs to increase on account of the price hike taken recently, the full effect of which is yet to reflect in the ARPMs and a higher 3G uptake. Exhibit 148: Future projections - 3G and ARPM

FY11 FY12E FY13E FY12E FY13E FY12E FY13EBharti 0.44 0.43 0.46 604.2 1685.8 3.5 7.7Idea 0.43 0.43 0.44 311.5 796.2 1.7 3.8RCom 0.44 0.45 0.45 451.3 918.4 2.3 5.0

Net 3G revenues (| Crore) 3G Subscribers (Mn)ARPM (|)


The stocks have shown a high correlation with the ARPMs of the operators. Going forward, we expect the ARPMs to improve on account of the recent price hike and higher 3G uptake

Falling ARPM and rising monthly net adds signify high competitive intensity. Post December 2010, the net adds have started to decline while ARPM has stabilised. This is also reflected in the stock price movement.

Phase 1: New licenses issued; markets respond to threat of price wars

Phase 2: Stocks recovering from the global meltdown; Slight uptick in ARPM also reflected in the stock price


Moreover, all the incumbents are already past their peak capex cycle and are expected to generate free cash flow in subsequent years. We expect Bharti Airtel to generate sufficient cash flow to repay its debt comfortably in the coming years, resulting in huge savings in terms of interest outgo. Although some of the guidelines of the draft of the NTP 2011 (like one time spectrum fees, spectrum renewal charges, and higher spectrum usage charges) could hurt the profitability of the incumbents in the near term, provisions like liberal M&A norms and spectrum sharing will have a positive bearing on the stocks. Though the draft of NTP looks more balanced, there is still lack of clarity on various fronts and the implementation timeline. The telecom operators have grown by 17.9% in revenues in H1FY12 but de grown by 45.0% in PAT due to high depreciation and interest cost relating to 3G debt. However, going forward, we expect the revenues and PAT to grow by 12.4% and 60.2% in FY13 on account of a decreasing interest cost in FY13 as the companies start repaying their debt. The sector is expected to outperform the broader index on the back of improving ARPMs, 3G uptick and lower capex. We may see further upside dependent on the timing and various aspects of policy announcement. Exhibit 149: Impact of NTP on Incumbents and New operators NTP Guidelines Impact on Incumbents Impact on New Operators

One time spectrum fees Negative Neutral

Higher spectrum usage charges Partially Negative Neutral

License Fee of 8% Neutral Negative

IP1 Licensing Negative Neutral

Liberal M&A Guidelines Positive Positive

Reduction in Termination Charges Negative Positive

Spectrum Sharing Positive Positive

Spectrum refarming Negative NA

Source: TRAI, ICICIdirect.com Research


Textiles (Depreciating rupee - a two sided coin) Neutral The year 2011 was a mixed bag for the Indian textiles sector. While cotton and cotton yarn prices rose in the first half of the calendar year, prices fell substantially in the second half. Textile players incurred heavy inventory losses on account of this. Domestic textile players were struck by a double whammy of lower demand and falling realisations. The year 2012 is also likely to be a lull year for the Indian textile industry. While a depreciating rupee would work in favour of textile companies, they are also facing foreign currency losses due to foreign currency debt on their books. On the back of this, larger domestic players would be more comfortable with the currency staying in the range of |47-48 / dollar.

Exhibit 150: Spreads between cotton & cotton yarn prices (Annual)

-

50

100

150

200

CS01

CS02

CS03

CS04

CS05

CS06

CS07

CS08

CS09

CS10

CS11

| / k

g

-1020304050607080

| / k

g

Cotton Prices Cotton Yarn Prices Spread (|/kg) (RHS)

Spreads at 6 year high


Exhibit 151: Spreads between cotton & cotton yarn prices (Monthly)

-

50

100

150

200

250

Apr-1

1

May

-11

Jun-

11

Jul-1

1

Aug-

11

Sep-

11

Oct-1

1

Nov

-11

| / k

g-

10

2030

40

50

60

| / k

g

Cotton Prices Cotton Yarn Prices Spread (|/kg) (RHS)

Spreads on an up-trend over the last five months


With rising cotton inventories and higher global output, cotton prices are likely to be range bound. However, production in China, the biggest cotton producer, is estimated to be 4% lower as compared to the previous season. Therefore, global cotton prices are likely to hold up at current levels thereby cushioning Indian prices from falling.

Man-made fibres to witness lower demand The ratio of cotton yarn price to polyester oriented yarn price has come down from a high of 2.1x in April 2011 to 1.5x in October 2011. This indicates lower demand for man-made fibre as cotton prices have now corrected. This will lower the substitution demand as manufacturers and customers are again likely to shift to pure cotton fabrics, thereby impacting the margins of these players.

Exhibit 152: Price differential between polyester and cotton yarn

121 110 109 105 105 110 110

254

213180

158 152 156 161

0

50

100

150

200

250

300

Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11

|/kg

POY Prices Cotton Yarn Prices

Narrowing gap between the prices will lead to lower demand for man-made fibres

Source: Tecoya Trend, ICICIdirect.com Research

Domestic textile prices corrected from over~|62,000 per candy in March 2011 to | 34,000 –35,000 per candy (December 2011). Consequently,cotton yarn prices too fell from |260 – 270 per kg to| 163 per kg (December 2011)

India’s cotton closing stock

71.5

40.547.5

78.5

0

20

40

60

80

100

2008-09 2009-10 2010-11(P) *

2011-12(P) *

In la

kh b

ales

Source: Textile Commissioner of India, ICICIdirect.com

Research * Provisional


Flashback – The year that was Exhibit 153: Flashback 2011

Q1CY11 (-5.2%) Q2CY11 (-3.1%) Q3CY11 (-12.7%) Q4CY11 (-2.7%)

Political uncertainty in Middle eastGlobal commodity prices rose on economic recovery in US

US raises debt ceiling limit by USD 2.1 trn amid downgrade and repayment concerns

ECB changed stance and cut rates amid weak data points

Rate hike in India and China on inflation concerns

PIIGS debt concerns rise with CDS spreads rising sharply Moody's downgrade Portugal and Greece

EU announces 50% haircut on Greek debt

Oil rises to USD 115/bbl(38% up in 4 months)

S&P cuts Italy outlook, Moody's sends downgrade warnings for UK banks Greece bailout package of Euro 109bn

EU increases EFSF corpus to Euro 1 tn and announced strengthening of capital base for European banks

DM outperform on EM particularly India on incrementally improved US economic data like GDP, consumer confidence etc.

Risk aversion seen as Gold prices rose close to USD1550/ounce, US 10 year G-Sec yield fell below 3%,

China continues to raise rates to combat record high inflation

Slew of rating cuts for Spain Portugal, Belgium and Hungary

Japan Tsunami acts as a shock to markets slide

Weak domestic data prints viz. lower IIP, high inflation and slowing credit growth

RBI shocks market by raising rates by 50bps

Contagion fears rise as German and French yields spike

Moody cut ratings for Spain and Portugal

Q4FY11 results disappoints as RIL,Infosys and SBI miss estimates. Earnings downgrade concerns emerge IMF cuts global growth forecast for CY11,12

Chinese PMI fell below 49, first time in 3 years, cut rates

FII buying during march end as global markets rebound US Fed lowered GDP outlook for CY11,12

S&P downgrades US AAA rating,Moody and S&P cut Italy rating by 3 notches

Indian IIP fell sharply to -5.1%, lowest since march 2009

ECB raises rates for the first time since 2008-09

Asset quality concerns come to fore in the domestic banking sector

US Fed promises to keep rates low till mid 2013

INR touched 54.24, record low levels against USD

Strong domestic export growth the only major positive

PBOC hikes rates twice in the quarter to arrest inflation expectations

Rupee depreciates sharply by ~7.0% to | 49 levels,corporates face MTM on foreign debt

EU leaders decide on stricter fiscal norms

15000

16000

17000

18000

19000

20000

21000Geo political risk in Egypt, Syria emerge. Oil rises to $115/bbl

Rate hikes Tsunami, Rating cuts hurt

Commodities were on fire. Safe haven demand rose

Markets slide under NPAs concerns, estimates missed

Euro debt concerns. US GDP outlook weakens

China,India- Inflation, rate hikes. Markets shocked INR

slides,MTM losses

Harakiri as S&P cuts US rating

Sovereign ratings cut,weak eco-data spook markets

Greece bailout, US debt ceiling raised

Anticipation of concrete EU summit spurs market

ECB rate cuts,EFSF & greek haircut spur markets

IIP,rate shock

We stumbled at the start line Worst performance in a decadeThe lull before the storm Hoping against "Hope"



Pankaj Pandey Head – Research [email protected] ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC Andheri (East) Mumbai – 400 093 [email protected] Disclaimer The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of ICICI Securities Ltd (I-Sec). The author of the report does not hold any investment in any of the companies mentioned in this report. I-Sec may be holding a small number of shares/position in the above-referred companies as on date of release of this report. This report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This report may not be taken in substitution for the exercise of independent judgment by any recipient. The recipient should independently evaluate the investment risks. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Actual results may differ materially from those set forth in projections. I-Sec may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject I-Sec and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction.

ICICIdirect_Strategy2012

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