We built a portfolio of stocks with the theme as “India 2024” to take advantage of the growth prospects for the companies over the next five years. Near term volatility will be high as May 2019 general elections approaches. There has been a slowdown in demand for automobiles in the second half of 2018 and this is affecting the consumption story in India. Worriea in the NBFC sector on IL&FS default is placing pressure on consumption stocks as lenders go slow on credit growth due to uncertain liquidity condiitons, Banking sector is still facing NPA issues.
Global growth too is looking to slow down with weakness in data emerging from China, Japan and the Eurozone. Risk aversion has been high in markets affecting the Indian Rupee that depreciated in 2018.
On the positive side, inflation has not reared its head globally and in India despite higher oil prices. Lack of inflation coupled with weakening growth outlook will prompt global central banks to stay put on rate hikes. US economy is still strong with low unemployment rate and steady job additions.
RBI is expected to change its monetary stance from calibrated tightening to neutral in its February 2019 policy review.
Post elections in May, whichever government comes to power, markets will look at opportunities given that investments and consumption will pick up as uncertainty passes. Consumption story remains intact for India given demographics, growing middle class and lack of market penetration.
Stick to stocks you know is the theme of Equity Strategy Note 2019.
Markets in Perspective
Sensex & Nifty traded volatile for most part of the trading sessions in the year 2018. In 2018, government bonds outperformed equities as bond yields fell on falling inflation expectations, RBI bond purchases and government lowering its borrowing. The year 2018 was an eventful but disappointing year for global equity markets. The Indian market was among the better performers with 3% & 4% returns achieved by Nifty & Sensex respectively in 2018.
Mid & small cap stocks have seen a sharp correction in prices since January 2018. Even though a correction was warranted due to extremely expensive valuations for many stocks in the midcap and smallcap space. The BSE Midcap and BSE Smallcap Indices have declined 17% and 28% respectively in last one year. The Price to Earnings ratio for the BSE Midcap and BSE Smallcap indices was at 40 and 112 respectively when it reached record high levels in the month of January 2018. The current price to earning ratio for the BSE Midcap and BSE Smallcap indices is 33 and 10 respectively. The extent of decline in the levels of valuation has been drastic for the BSE Smallcap index as compared to the BSE Midcap index.
Select Midcap and Smallcap stocks have shown drastic erosion in the valuation multiples due to fall in the broader market even though the fundamentals such as revenue and profit growth continue to outclass the respective industry average.
Global and Indian equity markets will have to contend with several events in H1CY19. Following factors can derail potential gains and increase market volatility:
- The US Fed’s rate actions linked to the strength of the US economy will be a key variable. US economy continues to display strong momentum and better than expected economic data could surprise the market negatively in terms of the extent of rate increases by the Fed.
- The progress on China-US trade issues will be another variable with the US holding the threat of further increases in tariffs on Chinese imports from 1st March 2019.
- The level of oil prices linked to further US action against Iran’s oil exports (current exemption to eight oil importing countries from Iran ends on 4th May 2019 will matter particularly for India’s macro.
- India will hold national elections in April-May 2019 and the outcome is quite uncertain post the strong performance of the main opposition party in recent state elections, these states contributed handsomely to BJP’s victory in 2014.
On the macro-economic front, India’s GDP growth rate moderated to 7.1% in the September 2018 quarter (Q2) of 2018-19, from 8.2% in the June quarter (Q1), data released by the Central Statistics Office showed. Agriculture growth slowed to 3.8% in the September quarter from 5.3% in June quarter while mining contracted by 2.4% against 0.1% growth in the previous quarter, CSO’s Q2 GDP data showed. The sectors that accelerated include electricity (9.2%) and trade, hotels (6.8%) and public services (10.9%). RBI too is likely to turn policy to neutral from calibrated tightening in its policy review in February 2019. CPI inflation for December 2018 came in at 2.19%, well below target of 4% +/- 2% while IIP growth fell sharply in November 2018. Export’s barely grew in December 2018 indicating global economy weakness.
Gross fiscal deficit for the period – April-October is at Rs. 6.5 trillion against the budgeted amount of Rs.6.2 trillion, appropriate balancing to meet the targets set in the beginning of this year will be the key focus for the rest of the year. On the revenue front, an area of concern has been the GST collections which are lagging behind targets. However, going forward lower prices on account of GST rate cuts and higher compliance should reflect in higher GST revenues. On the expenditure front, hike in minimum support prices (MSPs) along with the increase in budget provision for procurement by Rs. 150.50 billion by the centre and Rs. 100 billion by UP, Haryana, Telangana and Rajasthan will likely impose upside pressures, however the stress on Union excise duties & petroleum subsidies might dissipate with the recent fall in volatility of crude oil prices and INR. India’s current account deficit increased to 2.7% of GDP in H1Fy19 compared to 1.8% in H1Fy18.
OPEC and non-OPEC countries decided to cut oil production by 1.2 million barrels a day from 2019 after a recent meeting. OPEC itself will cut output by 800,000 bpd while Russia agreed to reduce production by 400,000 bpd. Iran has been granted an exemption from the cuts as it is under sanctions from the US. Macro may stay supportive as long as oil prices remain below USD 70 per barrel. We expect India’s macroeconomic conditions to be fairly stable through CY2019 unless oil prices were to surprise negatively on the upside (beyond USD 70). After reaching a four-year high in early October 2018, crude has collapsed more than 30%, marking the worst crash since 2015. While oversupply concerns were fuelled by American exemptions on sanctioned Iranian oil, a trade dispute between the U.S. and China has threatened to hurt demand.
Read our Analysis about Oil can get back into bear market as US Shale Output gains on OPEC Cuts.
Global Central Banks Monetary Policy Decisions:
RBI policy stance was changed from neutral to calibrated tightening, even as it held the repo rate at 6.5% during its December policy – meeting after raising it by 50bps over the two previous policies prior to October policy. In December policy, RBI held rates status quo, lowered inflation projections and yet maintained a calibrated tightening policy.
The Federal Reserve raised the target range for the federal funds rate by 25bps to 2.25%-2.5% during its December policy-meeting and lowered forecasts for interest rate hikes in 2019 amid recent volatility in financial markets and slowing global growth.
The Bank of Japan left its key short-term interest rate unchanged at -0.1% during its January policy-meeting and kept the target for the 10-year government bond yield at around 0%. At the same time, the central bank revised down inflation forecast for fiscal 2019 to average 1.1% from an earlier projection of 1.6%, mainly due to a decline in crude oil prices and worries over global economic outlook.
The People’s Bank of China left its short-term borrowing rates unchanged during its December policy-meeting. The interest rate on seven-day reverse bond repurchase agreements was kept at 2.55%, the 14-day reverse repurchase rate at 2.7% and the 28-day tenor at 2.85%.
The European Central Bank held its benchmark refinancing rate at 0% during its January policy-meeting and reiterated it expects key interest rates to remain at record low levels at least through the summer of 2019. The central bank brought to an end its Euro 2.6 trillion bond purchase scheme last month, but said it will keep reinvesting cash from maturing bonds for an extended period of time.
The Bank of England voted unanimously to hold the Bank Rate at 0.75% during its December policy-meeting, saying that Brexit uncertainty had “intensified considerably” over the last month while inflation is expected to ease below the 2% target amid falling oil prices.
The Hong Kong Monetary Authority raised its base rate by 25 basis points to 2.75% during its December policy-meeting, tracking a similar move by the US Federal Reserve as its currency is pegged to the US dollar.
The Bank of Russia raised unexpectedly its benchmark one-week repo rate by 25 bps to 7.75% during December policy-meeting, saying the decision is aimed at limiting inflation risks that remain elevated, especially over the short-term horizon on the back of the upcoming VAT rate increase. Policymakers expects annual inflation to be 5-5.5% by the end of 2019, before returning to 4% in 2020.
Click here to read our analysis of “Strong Core” Stock from Aviation Sector.
According to International Air Transport Association (IATA), India continued to be the fastest growing domestic aviation market for 3 consecutive years ending 2017. Current domestic market of 117 million passengers traveling in the year 2017 & 126.28 million (till November 2018) and expects to be a market of 442 million passengers by 2035.
Air travel penetration in India stood at 0.10 trips/capita in FY17, which is 59% lower than countries with similar GDP/capita, and 76% lower than BRICS nations (barring India), according to the Directorate General of Civil Aviation (DGCA) and IMF.
Increased focus of the Indian Government in infrastructure expansion is a key catalyst to growth of India’s aviation market. In the Union Budget 2018-19, the Government has proposed to expand India’s airport capacity more than 5 times to handle one billion trips a year under its new initiative – NABH (NextGen Airports for Bharat) Nirman.
2018 started on a negative sentiment for airline companies due to sharp uptick in crude oil prices (which led to rise in ATF-Aviation Turbine Fuel prices) and depreciation of INR had filliped increase in operating expenses. Along with the macro-economic factors, intense competition in this industry also played a significant role in steep fall of profitability. Airline companies couldn’t pass rise in operating expenses to consumers because of significant pricing pressure from peer groups.
It has been a turbulent journey for all airline companies in India till H1Fy19, we expect profitability to return in H2Fy19 (but lower than compared to Fy18) as prices of Brent Crude fell sharply, volatility of INR has come off and robust passenger growth will buoyant market participant sentiment for this industry.
Key Growth Drivers:
- Strong Economic Growth
- Continued Working-age population growth
- Expansion in Aviation Infrastructure
- Strong growth in tourism
- Increasing aircraft penetration
In addition to these, exploring the untapped markets of Tier 2 and Tier 3 cities and the long-haul opportunity provides the added stimulus to the existing levels of opportunity.
The S&P BSE Auto Index declined by 30% in the last one-year time period.
Click here to read our analysis of “Strong Core” Stock from Auto Sector (OEM’s).
Click here on the link below to read our analysis of “Strong Core” Stocks from Auto Sector (Auto Ancillaries).
The industry produced a total 23,861,485 vehicles including passenger vehicles, commercial vehicles, three wheelers, two wheelers and quadricycle in April-December 2018 as against 21,432,030 in April-December 2017, registering a growth of 11.34% over the same period last year.
The sale of Passenger Vehicles grew by 4.37% in April-December 2018 over the same period last year. Within the Passenger Vehicles, the sales of Passenger Cars, Utility Vehicle & Vans grew by 4.34%, 2.63% and 12.89% respectively in April-December 2018 over the same period last year.
The overall Commercial Vehicles segment registered a growth of 25.86% in April- December 2018 as compared to the same period last year. Medium & Heavy Commercial Vehicles (M&HCVs) increased by 24.69% and Light Commercial Vehicles grew by 26.60% in April-December 2018 over the same period last year.
Three Wheelers sales increased by 18.85% in April-December 2018 over the same period last year. Within the Three Wheelers, Passenger Carrier sales registered a growth of 21.02% and Goods Carrier grew by 9.70% in April-December 2018 over April-December 2017.
Two Wheelers sales registered a growth at 9.59% in April-December 2018 over April-December 2017. Within the Two Wheelers segment, Scooters, Motorcycles and Mopeds grew by 4.76%, 12.55% and 4.59% respectively in April-December 2018 over April-December 2017.
In April-December 2018, overall automobile exports grew by 18.53%. While Passenger Vehicles exports declined by (-) 8.47%, Commercial Vehicles, Three Wheelers and Two Wheelers registered a growth of 10.99%, 51.45% and 21.45% respectively in April-December 2018 over the same period last year.
The S&P BSE IT Index gained by 30% in the last one-year time period.
Click here on the link below to read our analysis of “Strong Core” Stocks from IT Sector
The global cyclical upswing that began midway through 2016 continues to gather strength. Business environment is going through fundamental shifts as financial conditions have improved across the world. The positive developments give good cause for greater confidence and have begun creating a marked shift in the BPM market which has been driven by the increasing use of automation and digital transformation.
In 2017, the global IT-BPM industry stood at USD 1.3 trillion (excluding hardware) showing a growth of 4.3% over 2016. According to the Nasscom Report, information technology (IT) services grew a modest 2.4% driven by the continuous need for digital solutions. Business process management (BPM) saw greater implementations of robotic process automation. The banking financial services and insurance and manufacturing sectors lead IT spend with a focus on digital transformation. Going forward, telecom, government, professional services are expected to up IT purchases.
India’s IT-BPM industry is worth USD 167 billion, employing around 4 million people. With a 55% global market share, the Indian IT-BPM industry is estimated to grow 8% – 10% in CY2019. Currently revenue from Digital segment is witnessing double digit growth due faster paradigm shift is happening across every sector towards digitalization.
India is on track to be a trillion-dollar digital economy backed by government’s inclusive approach and private sector participation. Growing access to internet in both urban as well as rural areas, ambitions e-governance projects, continued focus on skill development and growing digital transactions are just some of the indicators of rapid growth of the India’s digital economy.
The S&P BSE Healthcare Index declined by 6% in the last one-year time period.
Click here to read our analysis of “Strong Core” Stock from Pharma Sector.
Indian pharma companies have been going through a tough phase for the past couple of years due to significant competitive intensity and pricing pressure in the US (the largest market) and regulatory hurdles in India in terms of demonetization, GST implementation and lower prices. The pricing environment in the US has largely stabilized, as average price erosion has now come down to single digit from double digits and Indian business should grow in double digits.
Further, the next wave of patent expiry will be among the key growth driver for the big pharma companies operating in U.S. as the upcoming patent expiry includes complex generics and specialty drugs, which are difficult to manufacture and have less competition. Companies have been ramping up capabilities as this shift of focus would be the key to future long-term sustainable growth. The specialty products involving innovation provides an exclusivity period for marketing and hence, offers very high profit margins.
The large Indian companies such as Sun Pharma, Lupin, Dr Reddy’s have already commercialized products in specialty segment.
The diagnostic industry growth rate has come down from earlier high double digit to mid-teens mainly due to severe price competition. Although, the pace of competition has reduced but it is expected that the industry will post moderate 14-15% growth going forward.
The hospitals business has been growing in double digits and it is expected that this growth trend is likely to continue considering increasing lifestyle diseases, higher penetration and rising health insurance coverage.
The S&P BSE Bankex Index gained by 6% in the last one-year time period.
Click here to read our analysis of “Strong Core” Stock from NBFC Sector.
After a long period of stress, the banking sector appears to be on course to recovery as the load of impaired assets reduces; the first half-yearly decline in gross NPA ratio since September 2015 and improving Provision Coverage Ratio, indicating positive signals. The asset quality of banks showed an improvement with the gross nonperforming assets (GNPA) ratio of SCBs declining from 11.5% in March 2018 to 10.8% in September 2018 and expected to be at 10.3% in March 2019. Credit growth of scheduled commercial banks improved in Q2FY19, driven largely by private sector banks. Public-sector banks control nearly 70%of the market share, we expect PSB banks market share to come down gradually replaced by private sector banks and NBFCs. We expect private sector banks to perform better than PSB banks on better Net interest income, margin growth.
Micro-finance sector is posting high growth in loan portfolios and client reach. MFIs have 26.5 mn borrowers and outstanding loan portfolio of Rs. 519 bn as at Q1FY19. In Q2FY19, capital position of MFIs improved, after some deterioration during FY18.
Second half of 2018, NBFCs including housing finance companies have seen sharp fall in equity prices and sharp rise in credit spreads, that has increased their borrowing costs post the IL&FS default. GNPAs of the NBFC sector as a percentage of total advances increased to 6.1% in September 2018 from 5.8% in March 2018. Going forward we expect NBFCs adopting greater prudence in risk-taking,
Government of India is focusing on affordable housing schemes. Housing finance sector has aggressive competition as the market has two categories of players, Housing finance companies with 36% market share and remaining 64% with banks. As banks credit growth is rising, we expect housing finance companies’ growth to be limited.
The Indian non-life insurance size was at Rs 1.28 trillion on a GDPI (gross direct premium income) basis and posted a growth of 17.5% CAGR in the last 17 years and it can grow at CAGR of 15-20% in next 5 years. We expect non-life insurance to perform better on high growth prospects, as currently Indian insurance market is under-penetrated and has low insurance density.
Road Construction -Infrastructure
The S&P BSE Infra Index declined by 26% in the last one-year time period.
We were extremely bullish and overweight on road construction stocks in the past couple of years. However, due to increasing debt levels, fall in order-book growth and corporate governance issues, we had exited from our “Strong Core” stocks with a substantial return. Currently, we are underweight and have a cautious outlook on this sector. After IL&FS fiasco, credit-rating agencies have downgraded credit rating of Jharkhand Road Projects Implementation Company (a subsidiary of IL&FS) to D from BB. This has implications on infrastructure companies on raising funds which are required to sustain projects and execute order books.
Click here to read our analysis on “Infrastructure Leasing & Financial Services Limited (IL&FS) Rating Downgrade – Effects & After Effects”.
Infrastructure sector is a key driver for the Indian economy. The sector is responsible for propelling India’s overall development and enjoys intense focus from Government for initiating policies that would ensure time-bound creation of world class infrastructure in the country.
Infrastructure sector includes power, bridges, dams, roads and urban infrastructure development. The Government of India has made a record allocation of Rs 710 billion for road construction projects in Union Budget 2018-19, which is expected to provide significant boost to Indian infrastructure sector.
Also, the Government on the 24th of October 2017, announced the biggest road construction programme in Indian history to create 84,000 kms of roads over the period of next 5 years with a total investment of Rs 6920 billion. Among the 84,000 kms of total roads, 34,800 kms of National Highways will be built under ‘Bharatmala Pariyojan scheme- Phase I’ with a total investment of Rs 5350 billion.
Government had introduced a Hybrid Model (HAM) to revive PPP (Public Private Partnership) in highway construction. At present, three different models –PPP Annuity, PPP Toll and EPC (Engineering, Procurement and Construction) were followed by the government to encourage private sector participation. Under HAM model, Government will contribute 40% of the project cost in the initial time frame through annual payments. The remaining payment (60%) is chipped in by the road construction company in the form of equity or bank loan. Revenue collection (Toll) would be the responsibility of the National Highways Authority of India (NHAI). Advantage of HAM model is, financial risk is shared by the Government and leaves the road construction company with enough liquidity.
Launch of the new model (Hybrid Annuity Model) is due to the many problems with the existing ones. Large number of stalled projects are blocking infrastructure projects and at the same time adding to NPAs (Non- Performing Assets) of the banking system. In this context, the government of India has introduced Hybrid Annuity Model (HAM) to rejuvenate PPP.
The Ministry of Road Transport and Highways (MoRTH) touched a record 31.87 kilometre per day average of national highway construction in December 2018. However, the average road construction for national highways remained at around 25 kilometres per day till the end of the 9MFy19. The road ministry had fixed a construction target of around 16,420 kilometres for 2018-19. Out of this, 9,700 kilometres were MoRTH’s responsibility, while the National Highways Authority of India (NHAI) and the National Highways & Infrastructure Development Corporation Ltd (NHIDCL) were given targets of 6,000 kilometres and 720 kilometres, respectively.
Infrastructure sector is a key driver for the Indian economy. The sector is responsible for propelling India’s overall development and enjoys intense focus from Government for initiating policies that would ensure time-bound creation of world class infrastructure in the country. We expect government to increase 10%-15% (Y-o-Y) in awarding orders for infrastructure sector during FY 2019-20 but however liquidity factor will be keenly watched.
Oil & Gas
The S&P BSE Oil & Gas Index declined by 26% in the last one-year time period.
Click here on the link below to read our analysis of “Strong Core” Stocks from Oil & Gas Sector
OPEC and non-OPEC countries decided to cut oil production by 1.2 million barrels a day from 2019 after a recent meeting. OPEC itself will cut output by 800,000 bpd while Russia agreed to reduce production by 400,000 bpd. Iran has been granted an exemption from the cuts as it is under sanctions from the US. Macro may stay supportive as long as oil prices remain below USD 70 per barrel.
Read our Analysis about Oil can get back into bear market as US Shale Output gains on OPEC Cuts.
The upside for Brent Crude oil price is therefore expected to remain limited as the decision to cut production by OPEC would make way for higher supply of US shale oil in the international market and decrease prices accordingly.
The Gross Refining Margins (GRM) for the oil industry tend to be declining due to increase in the price of the price of crude oil. GRM is the difference between the total value of petroleum products coming out of an oil refinery and the cost of crude. GRMs has touched its lowest levels in December 2018, USD 2.86 per barrel. In coming quarters, retaining current level of refinery efficiency will be challenging considering current crude oil prices, which may in turn affect the earnings of refiners.
Under the current framework, natural gas is first allocated to GAIL, which in turn supplies gas to domestic CGDs. Out of the domestic gas production, gas allocation to CGD is prioritised over the gas allocated to priority sectors such as fertiliser and power. Decrease in Gas prices would marginally put pressure on the profitability and margins for gas distribution companies.
During 9th round of bidding for CNG and piped cooking gas in 22 States Petroleum and Natural gas Regulatory Board has allocated new geographical areas to CGDs for worth Rs. 700 billion. Adani gas has won most of the bids during 9th round and 10th round of bidding is expected during Q4Fy19. Current 9th round of bidding will cover 29% of the population and 24% of the geographical area. In total, 48% of population and 35% of geographical areas will be supplied with gas infrastructure.
The process of addressing environmental concerns is expected to drive the demand for natural gas from industrial users as well as compressed natural gas (CNG) users in the city gas distributor (CGD) segment. Our “Strong Core” stocks from this sector together account for 60% of total sales volume in the gas distribution segment.
Growth in the city gas distribution space is expected to continue going forward and will be positive for established players.
Fast Moving Consumer Goods
The S&P BSE FMCG Index gained by 10% in the last one-year time period.
Results from FMCG companies indicate steady recovery in earnings on the back of double digit volume growth, especially higher growth registered in rural areas and low base effect. Rural sentiments improved aided by recent policy measures and healthy monsoon season. Volume growth of top 10 FMCG companies have posted a 13% (Y-o-Y) growth during Q1Fy19.
During the financial years Fy17 & Fy18, Indian businesses have witnessed major disruptions due to demonetisation in Q3Fy17 and GST roll out during Q2Fy18. These government policies implementation had led to degrowth of volumes in FMCG & other sectors as well during Fy17 & Fy18.
Following table shows growth (%) in volumes Pre-Demonetisation, During Demonetisation & GST Roll Out, Post Gst Roll Out and Current Quarter.
Post Q2FY18, the average volume growth has risen to 11%. In fact, for the leader of the pack, Hindustan Unilever, the growth in Q3Fy19 jumped to 12% from 5% pre-demonetisation and GST and 1% during the quarters of the twin events. Similarly, Godrej Consumer’s domestic volumes grew 14% in Q2Fy19 against the normal average of 9%, for Britannia, it was 13% growth over an average 7% since FY13. Dabur also had a 21% volume growth against long-term average of 8%.
The growth in FMCG is being driven by rural as well as urban demand. Rural wage inflation which fell during 2013 to 2016 has started picking up. An increase in the MSP and good monsoons are supporting the rural income and subsequently the volume growth.
FMCG companies are hinting that supply-related disruptions are behind and that most of them are expanding distribution reach and investing in strategies to optimise the distribution channel.
The S&P BSE Telecom Index declined by 42% in the last one-year time period.
Click here to read our analysis of “Strong Core” Stock from Telecom (optic fiber) Sector.
In calendars the we describe years as “Before Christ (BC) “and “After Christ (AC)”, in the similar manner Indian Telecom industry can be explained in two timelines – “Before Jio” and “After Jio”. After the successful launch of Reliance Jio only three companies are able to survive their business in this industry. High pricing competition has led to tremendous amount of debt and unsuccessful spectrum auctions. ARPUs fell by more than 50% for all major telecos. We are extremely bearish on Indian Telecom operators but however rapid growth in digitisation is creating huge opportunity in high-speed internet segment.
Mobile internet penetration is at 35% and smart phone user’s penetration is at 29% in India and it is estimated to reach 60% by the end of 2019. With increase in number of smart phones, data consumption will lead to higher demand for optic fibres across India. Indian telecom industry has seen incredible growth in terms of expansion of 3G network capacity and rollout of 4G/LTE. Tower capacity in India is around 350000 – 400000 units out of which 40% of them are fiberized.
The demand for optical fibers showed upward trend backed by favourable domestic & international market trends. This sector will benefit from a multi-year global data wave driven by:
(1) Exponential increase in data consumption.
(2) Inevitable replacement of copper wires with optic fiber given more demanding requirements on infrastructure.
(3) Transition to 5G.
(4) Government initiatives (Bharat Net & Smart Cities).
After the recent reversals in state elections, the ruling party is under considerable pressure and is likely to announce populist measures in the interim budget announcement on 1st February 2019. However, this is unlikely to be in the form of loan waivers as the states have already announced waivers of Rs 2.6 trillion in the last two years. Rise in government spending would act as a stimulus for growth momentum in the near term. However, if the government goes overboard, it could put macro stability under pressure because of possible increase in inflation and deficit figures.