The year 2019 turned out to be a good one for markets, with the Sensex and the Nifty delivering 12-14 percent return on a calendar year basis, outperforming the broader markets second time in a row.
But, all this could change in 2020. The trend could reverse in favour of midcaps, Morgan Stanley has said in a note titled India Equity Strategy.
“We opine that growth is likely to improve and that dislocations in price/valuation across sectors, style baskets and market cap cohorts will likely reverse in 2020 since these gaps were created by sluggish growth in the first place,” says the note.
Morgan Stanley backs three themes for 2020: a) domestic cyclical outperform defensives, b) value and growth stocks beat quality stocks, and c) mid-caps lead the large caps.
Quality stocks have had a home run, given the sluggish growth in 2019. Morgan Stanley is of the view that the growth is likely to recover in 2020, and the style bias in India could shift towards value and growth stocks.
Midcaps could well outperform largecaps in 2020 and that is why Morgan Stanley in its focus list has a quarter of the stocks. The midcap calls are sector agnostic since the damage in the space has been across the board.
“The exceptions are in the style basket, i.e. high-quality midcaps (companies with high ROE) have been relatively resilient in the midcap bear market of the past 24 months. Our preferred approach is to buy domestic cyclical midcap value stocks,” the report says.
Here is a list of 20 stocks from Morgan Stanley’s focus list for 2020:
Bharat Electronics (BEL)
BEL is the best way to play India's defence indigenisation theme. Its strengths include strong execution record, wide product range, manufacturing footprint, and a large, diversified order book. Concerns on margins and working capital deterioration are priced in.
Bharti Airtel has announced an increase in tariff by around 28 percent within the prepaid segment from December, along with Vodafone-Idea (VIL) and Jio.
“We are assuming a 24% ex-IUC ARPU increase by FY21 for Airtel and a possible path to Rs180-200 by FY23,” says the report.
With most of incremental revenues flowing through into EBITDA, Morgan Stanley sees a significant improvement in profitability and leverage ratios.
Moreover, TRAI has initiated consultation for bringing rationality in pricing by introducing a floor tariff/rate. Any such price regulation that propels tariffs higher than the current price is a further positive.
DLF recently restructured its business model and the balance sheet and has become a more focused development and rental company. Its balance sheet has strengthened, with net debt of Rs4.5 billion as of September 2019 (vs Rs 20.5 billion as of August 2017).
Morgan Stanley expects significant free cash flow (FCF) generation over the ensuing quarters, driven by completed unsold inventory (~10msf valued at Rs 100 billion) and new rental completions.
The new asset creation cycle provides mid-term growth visibility. Valuations seem reasonable at a 30 percent discount to our Mar'21 NAV of Rs359/sh.
With global LNG prices down 50 percent compared to the last decade, Gujarat Gas is the most levered play with +75% volume exposure to industrial and commercial customers.
As we enter 2020, Morgan Stanley expects LNG prices to decline further by ~11 percent, making gas more competitive vs alternative industrial fuels like furnace oil.
An increase in demand from the tiles industry (driven by regulations and recovery in domestic demand) along with expansion in new geographies and CNG demand should help Gujarat Gas demand rise by 13 percent in F21.
Morgan Stanley expects the loan growth at HDFC to pick up over the next 12 months as competition from other NBFCs and HFCs continues to ease and terms for stronger lenders improve further.
“We forecast F20-25 EPS CAGR of 22% for the core lending business. We forecast core ROE to improve from ~13% in F20 to ~15.5% in F22 and to ~18.5% in F25, driven both by higher underlying profitability and a pickup in leverage as HDFC's excess capital gets deployed,” says the report.
HDFC Bank has been aggressively gaining market share across loans and deposits. Being already dominant in retail lending, the most profitable pool of Indian banking, with multiple products holding over 25 percent market share, the bank is now accelerating its growth in corporate banking as well. Pricing power is strong and, coupled with low competition, it should enable the bank to sustain strong overall growth, given its low-single-digit market share.
A key driver of ICICI's strong performance over the last two years has been a steady improvement in asset quality. Slippages have come down and total impaired loans are now around 10 percent of loans against about 15 percent in F1Q19.
The bank has also kept increasing coverage, with total coverage at around57 percent on all impaired loans. Although there can be additions to BB & below loans in the 2H-F20 given weaker macro, Morgan Stanley expects credit costs to continue to decline.
India's hotel industry is just emerging from a long downcycle in which occupancies sank from 73 percent at the peak of the previous upcycle (F08) to 59% at the bottom of the cycle.
The industry is in the early stages of an upcycle in which occupancies have improved to 67 percent. Morgan Stanley expects pricing growth to commence next with key micro markets at 70 percent plus occupancies.
IHCL has intensified its focus on adding new properties and the global investment bank expects the 5,000 plus rooms in the pipeline to be commissioned over the next 24 months.
India is likely to be one of the world’s fastest-growing major economies over the next four years, as per Morgan Stanley's forecasts. Revenue Passenger Kilometers (RPK) growth has exceeded real GDP growth by an average of 2.3x over the last 15 years.
India still has one of the lowest air-travel penetration rates in the world, as defined by seats per capita. India’s penetration is low relative to other emerging markets such as Brazil, Turkey, Indonesia and China, where penetration is between approximately three and seven times India’s rate.
The past two years have seen flat cigarette taxes, which led to a recovery in volume growth as relative price affordability for cigarettes improved. India is a distinctive market for tobacco–cigarettes contribute <12% to overall tobacco consumption.
“A sharp cut in the corporate tax rate suggests a further drop in cigarette volume elasticity, as ITC has the flexibility to defer cigarette price hikes by 2-3 quarters, in our view, and still deliver 19% earnings growth in F20,” said the report.
Morgan Stanley thinks that capex will be back as a strong theme in CY20. While macro looks weak and the construct for industrial stocks appear less favourable, the government's thrust on investing in infra and creating jobs remains high.
L&T is a best-in-class EPC company and it dominates the domestic EPC market. It also stacks up well against its top global peers, driven by consistent revenue growth, large room to grow in absolute revenue terms, business diversification, and operating profitability.
Mahindra & Mahindra's (M&M) business has been hit by a slowdown in both autos and tractors; negative leverage has also affected margins. The new SUV (XUV300) has done well, but legacy models have slowed. Overall, M&M has gained around 270 bps of UV market share since the launch of the Marazzo. But, the downside still remains limited.
M&M Financial Services:
Morgan Stanley like MMFS, as it screens well in its fundamental framework for non-bank lenders, more relevant in the aftermath of the IL&FS downgrade in September 2018.
It has a strong parentage and/or business vintage, the latter being more important. It has a differentiated business model, and the ability to earn ROE > COE.
Maruti is a key beneficiary of any upturn in demand. The industry has been through a long downcycle and is showing signs of a turn in growth.
With its strong market share and large distribution presence, MSIL could be a key beneficiary of the upturn in demand and should continue to gain share in the BSVI transition and do well in the CAFE norms transition in 2022.
Motherson Sumi (MSS)
MSS is a brand-agnostic way to play the Indian auto cycle. The business has the opportunity to improve content per car as electrification and premiumisation of the car market plays out.
Morgan Stanley estimate that MSS’s top line can grow at ~2x the underlying car market over F19-30e – and thus, the business can command high multiples.
In a tough macro environment, especially for levered businesses and financials, MCX with free cash flow, balance sheet light and a ~90% dividend payout, screens attractively and could command premium multiples.
At 30x one-year forward P/E, the stock is trading close to one standard deviation below its long-term mean. Morgan Stanley expects the stock price to double over three years as the one-year forward P/E of 30x re-rates to the long-term mean of 33x, if not higher, driven by strong earnings compounding.
Fixed cost under-recovery is reducing, and the impact of regulations is known, while the potential government stake sale remains an overhang. Risk-reward is attractive, as two of the three concerns are either reversing or known. Steady commissioning should drive earnings.
With higher telecom tariffs, RIL's ROCE should rise above 10 percent and be maintained at that level. As chemical margins rise from current troughs in 2020 and gas production begins, Morgan Stanley sees a path to 200bps return expansion becoming de-risked by F22.
RIL is trading at 16.9x F22e P/E, a ~33% premium to average past decade multiple but still below historical monetisation cycles. With upside risks from higher chemical margins and telecom industry structure, Morgan Stanley sees further upside potential.
Shriram Transport Finance
Shriram Transport presents a compelling risk-reward for investors looking for beaten-down midcap stocks from a medium-term perspective, and it could also be a good play on a gradual economic recovery.
Reasonable and diversified funding access– able to attract money from institutional, retail and also from the international bond market–should ensure business sustainability. It also is a meaningful provider of priority sector loans to the banking sector via sell down of loans and on balance-sheet borrowing.
There are early signs of revival in the cement demand cycle and Ultratech is well-positioned for that. Over the last two quarters, realisations have declined cumulatively.
After two-quarters of decline, Morgan Stanley expects volume growth by 6-7 percent. Recently, cement companies have announced price increases across regions.
Morgan Stanley expects stickiness in pricing this time better than the last few months, given expectations of improving volume trends.
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