Prabhudas Lilladher handpicks 19 stocks for investment

Prabhudas Lilladher's report on "India strategy & top ideas - August 2013"

• Services contracting, slowing manufacturing & plunge in core sector growth
• India’s biggest risk: Sudden stoppage & reversal of foreign capital flows. Deterioration in most external vulnerability indicators
• RBI in classic ‘impossible trinity’ dilemma, stringent measures to tighten liquidity to shore up plunging Rupee
• Governments foremost agenda: How to finance the large CAD
• FDI regime liberalised. Monsoon Session: Insurance/Pension Bills unlikely to be cleared

Indian Markets

We estimate the free-float EPS for NIFTY companies in FY13, FY14, FY15 at Rs356.6, Rs395.2 and Rs461.6, respectively, representing a YoY growth of 1.4 percent, 10.8 percent and 16.8 percent, respectively. Technology (21.1 percent YoY growth), Telecom (88 percent YoY growth on the back of two years of de-growth) and FMCG (13.9 percent YoY growth) are expected to lead the charge in PAT growth in FY14. Metals (0.7 percent YoY growth), Engg & Power (2.4 percent YoY growth) and BFSI (4.4 percent YoY growth) would be the laggards.

NIFTY is currently trading at 15.6x FY13, 14.1x FY14E and 12.1x FY15E estimated free-float earnings. As the chart below indicates, the last ten-year average for NIFTY’s one-year forward PE is at 14.5x. Thus, NIFTY is currently trading at 13.3x one-year forward earnings (EPS for year-ending July 2014 is Rs 417.3) i.e. at 9 percent discount to its last 10-years average of one-year forward multiple.

We compare MSCI India’s premium to MSCI Asia (excluding Japan) over the last ten years. The average of the last 10-year’s premium is 22 percent and the current premium has fallen sharply over the last one month to 11 percent indicating a sharp de-rating of the market due to worsening macro-economic conditions.

Indian Markets: Headwinds-Deteriorating macro-economy & fears of US bond tapering, Tailwinds-Bountiful monsoons & narrowing CAD

RBI’s success in stamping out wild volatility in the currency markets and arresting the slide in Rupee will play a crucial role in determining the future of equity markets. Attempts to restore stability in the currency markets has been achieved by RBI by stringent tightening of liquidity leading to a sharp spike in interest rates across the curve jeopardizing hopes of recovery in economy. RBI’s priority clearly seems to stabilize external sector followed by controlling inflation and then revive growth. A sharp fall in Rupee has lead to a sharp spike in fuel under-recoveries and this would inevitably lead to ballooning of fuel subsidies in the absence of adequate pass-through. This has the potential to upset the government’s resolve to contain FY14’s fiscal deficit to 4.8 percent of GDP. Passage of food security bill may not pose an immediate threat of spike in food subsidies this year as the county-wide roll out may take 6-9 months but would certainly structurally burden the fiscal from FY15 onwards.

RBI has already scaled down GDP estimates for FY14 to 5.5 percent versus the budgetary estimate of 6.5 percent. This is bound to adversely impact the projected revenues for FY14. The government had based its commitment to contain fiscal deficit by cutting revenue expenditure (i.e. subsidies) and not by slashing plan expenditure like it did in FY13. Infact it has budgeted a hefty increase of around Rs1lakh cr in plan expenditure in FY14 versus FY13’s revised estimates. If the revenue projections fall short and subsidies balloon, the only way to contain fiscal deficit would be by cutting plan expenditure. This would have grave implications on an already weak investment demand.

We expect the market to remain vulnerable to any stoppage and reversal of capital flows due to news flow on tapering by the US Fed. Market would need to navigate both domestic and foreign headwinds. Rapid spread of monsoons with substantial increase of area under cultivation is expected to help cool food and consumer inflation post-harvest. Also trade and current account deficit which has narrowed in June is expected to remain benign till August. Although NIFTY may spring a short-term bounce-back as it is trading at 9 percent discount to its 10-year average of one-year forward multiple, we continue to remain cautious.

Top Picks

Large Cap

ITC, Infosys, HDFC Bank, NTPC, Wipro, ICICI Bank, Larsen & Toubro, Mahindra & Mahindra, Hindustan Zinc, Adani Port & SEZ, Titan Industries, Ranbaxy Laboratories, Shree Cement.

Mid-Cap

Britannia Industries, United Phosphorus, Crompton Greaves, Jammu & Kashmir Bank, KSB Pumps, MT Educare.

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