12MF EV/EBITDA India Market Strategy
Transcript of 12MF EV/EBITDA India Market Strategy
DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
15 November 2016 Asia Pacific/India Equity Research
Investment Strategy
India Market Strategy The Ideas Engine series showcases Credit Suisse’s unique
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Research Analysts
Neelkanth Mishra
91 22 6777 3716
Prateek Singh
91 22 6777 3894
Ravi Shankar
91 22 6777 3869
STRATEGY
A long winter before the spring
Figure 1: Sell stocks with high multiples and volume risk, e.g. cement
Source: Company data, Credit Suisse estimates
■ 12-15 months of growth disruption. We expect the market to overlook
significant but short-term growth disruption from demonetisation for most
sectors. However, asset quality impact on Microfinance/Non-Banking
Financiers could last longer. Further, it may take many years for currency
in the black market to replenish, hurting real-estate (RE)/land transaction
volumes and hence prices. Worst affected: NBFCs (LAP/RE), 80% of
construction jobs, 60% of cement demand, and discretionary consumption.
GST start from 1-April also likely to disrupt the economy for 9-12 months.
■ Rising global bond yields to pressure P/E multiples. P/E multiples have
risen steadily across sectors in India for the last five years, in line with a
global re-rating of equities. A steady decline in bond yields driven by easy
monetary policy in developed markets helped. With yields now rising,
exacerbated by the Trump victory, sectors that saw the strongest re-rating
could come under stress: cement, consumer discretionary and NBFCs.
■ Near-term pain to override long-term gains. There are several long-term
gains to look forward to: GST/demonetisation over time should take India
out of the low productivity equilibrium of low taxes/small government.
Interest rates should fall and a decline in real-estate and land prices could
stimulate more activity over time. But markets may focus on volume
disappointments for expensive stocks first. On these counts, we downgrade
cement (Ultra Tech, Ambuja) and discretionary (Asian Paints, Eicher) to
UNDERPERFORM (and Kajaria to NEUTRAL), and maintain
UNDERPERFORM on Bajaj Finance and Bharat Financial Inclusion. We
revert to an OVERWEIGHT on Indian IT (HCL Tech, Tech Mahindra) and
Pharma (Cipla) and Tata Motors. We also believe better liquidity, lower
interest rates and higher metal prices should reduce pressure on private
sector banks (OUTPERFORM: HDFC Bank, ICICI Bank) and benefit
mortgage providers (LIC Housing Finance, HDFC).
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08
FY10
FY12
FY14
FY16
FY18
E
ForecastCement demand Growth
3x
6x
9x
12x
15x
18x
21x
Nov-04 Dec-06 Jan-09 Feb-11 Mar-13 Apr-15
ACC Ambuja Ultratech
12MF EV/EBITDA
15 November 2016
India Market Strategy 2
Focus charts Figure 2: Sector/market P/E up over 1, 3 and 5 years Figure 3: …but rising bond yields may reverse this
Source: RAVE, IBES, Credit Suisse estimates Source: MSCI, Bloomberg, Credit Suisse estimates
Figure 4: 85% of the currency demonetised Figure 5: India has very high cash usage
Source: RBI, Credit Suisse Source: tradingeconomics.com, Credit Suisse estimates
Figure 6: Real-estate large part of black wealth Figure 7: Which is 90%-plus of household wealth
Source: NIFM, Credit Suisse estimates Source: NSSO, Credit Suisse estimates
Figure 8: Real-estate is 60% of cement demand Figure 9: GST to disrupt too, e.g. state finances
Source: RAVE, IBES, Credit Suisse estimates Source: CMIE, Credit Suisse estimates
-20% 0% 20% 40% 60% 80% 100%
ITUtilitiesEnergy
Pvt BankHealth Care
StaplesNBFC
TelecomBSE100
Cons, Disc.Metals
CementIndustrialsPSU Bank
1Y 3Y 5Y
Change in 12MForward PE
-4%
-2%
0%
2%
4%
6%
8%
10%
1996 1997 1999 2001 2002 2004 2006 2007 2009 2011 2012 2014 2016
Diff betn MSCI India Earnings Yield & US 10Yr treasury yield
High diff => Indian equities undervaluedLow diff => Indian equities overvalued
Decelerating growth for India
Financial crisis
9/11; Dot-com aftermath
Coins1%
<1004% 100
10%
50047%
100038%
Split of Rs 16.6tn Currency in Circulation by Value in FY16 0 0.05 0.1 0.15 0.2
India
Mexico
Japan
Netherlands
Brazil
China*
Canada
UK
South Korea
Sweden
M0/M3 Ratio
0 1 2 3 4 5
Cash
Foreign holdings
Assets in business
Stocks in business
Benami fin. investments
Diamonds, Gems
Precious Metals
Land and buildings
Residential real estate
Mean Difference
Highly SignificantMarginally Signifcant
0%
20%
40%
60%
80%
100%
Rural Urban
Land Buildings Deposits OthersSplit of Assets (2013)
Rural housing40%
Urban housing20%
Power3%
Irrigation4%
Roads3%
Railways3%
Others (including
Private capex)27%
-3%
-2%
-1%
0%
1%
2%
3%
4%
MH WB BI HA OR UT JH JK RJ UP PB CG KA KE GU TN AP
Services GDP Share - Sales Tax Share
15 November 2016
India Market Strategy 3
A long winter before the spring
A local growth disruption for 12-15 months
We expect the market to overlook near-term disruption in growth from demonetisation for
most sectors. However, for some Microfinance/Non-Banking Financiers, where borrowers
have thin buffers, it could take longer, exacerbated by lax lending standards of late.
Permanent demand destruction would come from the black wealth kept in currency that
will not be replaced: this could be 2% of GDP. Further, it may take several years for
currency to normalise in the "black" economy. This would slow down transactions, and
hurt prices of real-estate and land. Worst affected from this trend: banks with exposure to
real-estate developers, NBFCs with Loan against Property books, construction jobs (80%
are in real-estate), cement (60% of demand), and discretionary consumption (90%-plus of
household wealth in land and real-estate).
Like demonetisation, GST is also a medium-term positive step that can disrupt the
economy over the near term, possibly for 9-12 months. Malaysia, a much smaller
economy took 3-6 months to stabilise despite there being just one rate, no centre-state
complexity, two years of advance notice, and no organisational change in the government.
The Indian experience may be more chaotic—it is worse on every metric.
Policymakers would respond to such a slowdown. We believe the widely held notion of
RBI transferring gains from cancelled currency to the government as a dividend and thus
provide a fiscal boost is less likely. The problem also is the government's lack of
institutional capacity to spend, and the time lag for the impact to show up.
P/E ratios to fall with rising bond yields
P/E multiples have risen steadily across sectors in India for the last five years. This was a
global phenomenon as India's P/E premium to various benchmarks has not changed. A
primary driver of this global expansion in equity multiples has been a steady decline in
bond yields driven by easy monetary policy in developed markets. Indian equities have no
capital account restrictions—pricing is thus affected by global trends.
However, bond yields are now rising, reasons being: US wage growth, rebounding
commodity prices, positive Chinese PPI inflation, and expectation of policy stimulus
moving from monetary (more demand for bonds) to fiscal (more supply of bonds). Trump's
victory has sharpened the rise. Some sectors that benefited more from the P/E expansion
could correct: cement, consumer discretionary and NBFCs. These had gained from
medium-term growth outlook for India, but also as multiples rose for these sectors globally.
Near-term pain to override long-term gains
Both demonetisation and GST are structural positives that over time should take India out
of the low productivity equilibrium of low taxes/small government. Further, the deflationary
impact of a growth slowdown should help bring down rates in the formal economy, and a
decline in real-estate and land prices could stimulate more activity over time.
However, these positives would take time to show up. Given the concurrent de-rating due
to rising global bond yields, we believe investors would wait for evidence of the positives to
come through before turning constructive on the broader markets: 12-15 months can test
investor patience. We nevertheless reflect medium-term views in the choice of stocks to
take profits on: there was trouble at the bottom even before these disruptions.
We downgrade cement (ULTC, AMBJ) and discretionary (APNT, EICH) to
UNDERPERFORM (and KAJA to NEUTRAL) as growth may disappoint, and valuation is
at 10 year highs. Maintain UNDERPERFORM on BFIN, BHAFIN. We revert to Overweight
on Indian IT (HCLT, TECHM), Pharma (CIPLA) and TAMO. We believe better liquidity,
lower rates and higher metal prices should reduce pressure on private banks (buy
HDFCB, ICICI) and benefit mortgage providers (LICHF).
Demonetisation: near-term disruption should
be ignored, but there are likely to be longer-
term implications. As the black market
currency may take years to replenish,
weak real-estate could hurt NBFCs, cement
and discretionary consumption.
Disruption due to GST could also last 9-12
months: another positive reform that can
hurt momentum near term
Falling bond yields globally had pushed up P/E multiples; as yields rise again (accelerated by the Trump victory),
these may fall. Cement, Consumer
Discretionary and NBFCs score badly
here as well
GST and demonetisation are
medium-term positives but markets to focus on
stocks with high multiples where
volumes may disappoint: we
downgrade Cement and Discretionary stocks
15 November 2016
India Market Strategy 4
Financial summary
Figure 10: Indian GST implementation to be significantly more complex than Malaysia's
Variable Malaysia India Comments
Population (mn, 2016) 32 1,310 India's population is 40x Malaysia's, making supervision complex, and slow response times.
PPP adjusted per capita GDP (US$, 2016) 27,234 6,658 Malaysia is nearly two decades ahead of India in PPP adjusted per-capita GDP, indicating
better organised systems, and greater government capacity.
WB ease of doing business (paying tax rank) 61 172 India brings up the rear on ease of paying taxes: this worsens the impact of this transition.
Number of rates (excluding exempt and 0%) 1 4 Number of rates to map to increases subjectivity in assessments, raising possibility of
confusion among tax payers and supervisors, and increasing friction in the transition.
Tax subsumed (% of GDP) 9% 6% Malaysia started with a US$20 bn estimate for the GST, but ended the first year with US$28 bn.
It is quite possible that once the system stabilises India too would see a higher tax-to-GDP ratio.
Federal/unitary Only Centre Centre + State Malaysian GST was only central. As India has a central as well as state GST, there is likely to
be additional complexity around the inter-state transactions as well as different levels of
preparedness and sophistication across states, and impact on state fiscal capacity.
Announcement 2 Years back 3 months back In Malaysia businesses had two years to prepare for the GST transition, even though rates
were announced on the last day. In India there is barely any time to prepare.
Change to enforcing department(s) None Overhauled Both central and state bureaucracies overseeing the new tax would change. Further, there
would be a re-mapping of enterprises to the tax officials that they need to deal with.
Source: IMF, World Bank, Credit Suisse estimates
Figure 11: Changes to Model Portfolio
Company RIC Rating Mkt
Cap
CMP Target
Price
Upside P/E (x) EPS Growth (%)
$ bn INR INR % FY16A FY17E FY18E FY16A FY17E FY18E
Negatively Affected Stocks/Stocks whose weights are cut in model portfolio
Ultratech Cement Ltd ULTC.BO UNDERPERFORM 15 3,635 2,900 -20% 44 33 29 9% 32% 16%
Ambuja Cements Ltd ABUJ.BO UNDERPERFORM 6 219 180 -18% 42 31 25 -46% 34% 27%
Asian Paints ASPN.BO UNDERPERFORM 14 964 800 -17% 52 47 42 25% 10% 12%
Eicher Motors EICH.BO UNDERPERFORM 9 21,745 18,300 -16% 46 34 27 107% 38% 23%
Maruti Suzuki India Ltd MRTI.BO NEUTRAL 23 5,136 6,000 17% 34 22 19 23% 52% 19%
Bajaj Finance Ltd BJFN.BO UNDERPERFORM 7 858 660 -23% 36 25 20 33% 43% 26%
Bharat Financial Inclusion BHAF.BO UNDERPERFORM 1 691 710 3% 29 13 11 60% 129% 13%
Kajaria Ceramics Limited KAJR.BO NEUTRAL 1 504 525 4% 35 31 27 25% 14% 13%
Positively Affected Stocks/Stocks whose weights are increased in model portfolio
HDFC Bank HDBK.BO OUTPERFORM 48 1,276 1,470 15% 26 22 18 15% 21% 23%
ICICI Bank ICBK.BO OUTPERFORM 24 277 328 18% 17 15 13 -15% 15% 17%
Tata Motors Ltd. TAMO.BO OUTPERFORM 22 507 720 42% 16 10 8 -25% 50% 37%
HCL Technologies HCLT.BO OUTPERFORM 16 764 975 28% 19 13 12 -23% 51% 7%
Tech Mahindra Limited TEML.BO OUTPERFORM 6 430 575 34% 12 13 11 17% -1% 18%
Cipla Limited CIPL.BO OUTPERFORM 7 550 675 23% 29 31 23 27% -6% 34%
LIC Housing Finance Ltd LICH.BO OUTPERFORM 4 520 700 35% 16 12 9 19% 28% 36%
Source: RAVE, Credit Suisse estimates
15 November 2016
India Market Strategy 5
Table of contents
Focus charts 2
A long winter before the spring 3
A local growth disruption for 12-15 months .............................................................. 3
P/E ratios to fall with rising bond yields .................................................................... 3
Near-term pain to override long-term gains ............................................................. 3
A local growth disruption for 12-15 months 6
15-month disruption from de-monetisation and GST ............................................... 6
Impact of RBI's liability reduction far from certain .................................................... 9
Fiscal impetus likely to come with a lag ................................................................. 11
Rising global bond yields to hurt P/E ratios 13
P/E multiples have risen sharply in the last five years ........................................... 13
Rising global bond yields could reverse this trend ................................................. 14
Some sectors more affected than others ............................................................... 16
Near-term pain to override long-term gains 17
GST and demonetisation are structural positives… ............................................... 17
…but create downside to near-term expectations .................................................. 17
Trouble at the bottom even before recent disruptions............................................ 18
Downgrade Cement and Discretionary (APNT, EICH)........................................... 19
Model portfolio changes ......................................................................................... 22
15 November 2016
India Market Strategy 6
A local growth disruption for 12-15 months
15-month disruption from de-monetisation and GST
While the government's de-monetisation of Rs500/1,000 to root out black money is
undoubtedly a step in the right direction, with 85% of the currency in circulation removed
(Figure 12), and the replacement likely to take several weeks, near-term disruption in
growth could be substantial. The potential impact gets amplified by the Indian economy's
high cash dependence (Figure 13), with more than 90% of consumer purchases in cash.
Figure 12: 85% of the currency de-monetised Figure 13: India has very high cash usage
Source: RBI, Credit Suisse estimates Source: Tradingeconomics.com, Credit Suisse estimates
De-monetisation: Significant but short-term disruption for most sectors
The distribution channels of everything from consumer staples and discretionaries, oil
marketing companies, pharmaceuticals to even many two-wheelers operate primarily in
cash. The non-institutional part of the cement and metal value chains also use cash. Truck
operators also work primarily with cash (a driver would be given cash for diesel and tolls).
Anecdotal evidence suggests that economic activity has already slowed in most of these
segments; we believe this disruption may last 1.5-2.0 months. Most of this demand though
can only be postponed, not cancelled, and we should see a revival in the March 2017
quarter.
For all MFIs and some NBFCs, the last-mile transactions involve cash payments—their
collections have been meaningfully disrupted, and with the quarter-end in sight, they may
need some regulatory forbearance in judging which accounts are genuinely stressed and
which only have a liquidity problem. Some of their customers (e.g., dairy farmers) also
have very thin saving buffers, and a month's disruption in income could set them back by
more than a year. Further, lending standards in the past few quarters had become lax, and
it is quite possible that a slowdown in lending growth could unearth unforeseen problems.
Wealth and ‘black’ currency destruction: ‘White’ economy impacted too
It is difficult to estimate how much of the currency in the form of Rs500/1,000 notes
doesn't get exchanged, i.e., was black money. If one assumes 20% of the notes get
destroyed, that is Rs3 tn of wealth destruction, or about 2% of GDP. A survey of Indian tax
officials (the CBDT or Central Board of Direct Taxes) points to currency being the least-
prevalent mode of storing black wealth (Figure 14). Further, as estimates of black money
have ranged from 15-21% of GDP across surveys (Figure 15), it is likely that hard
currency is only a fraction of the black money in the economy. Nevertheless, wealth
Coins1%
<1004%
10010%
50047%
1,00038%
Split of Rs 16.6tn Currency in Circulation by Value in FY16
0% 5% 10% 15% 20%
India
Mexico
Japan
Netherlands
Brazil
China*
Canada
UK
South Korea
Sweden
M0/M3 Ratio
15 November 2016
India Market Strategy 7
destruction of the order of a few percentage points (pp) of GDP can meaningfully impact
demand for high-value items such as real estate/land and jewellery.
More importantly, the currency for black economy transactions is cash. While over the next
two months currency for the ‘white’ economy would get replenished, it may take several
years for the ‘black’ economy to get the quantum of currency it was used to. This would
slow down transactions, as alternatives such as gold would also take time to accumulate.
Particularly for other asset types traditionally used to store black wealth, this could mean
price declines, as an important source of demand disappears for a few years.
Figure 14: Cash is not a large part of black money Figure 15: Black money estimates - 15-21% of GDP
Source: NIFM, Credit Suisse estimates Source: NIPFP, Credit Suisse estimates
Banks with exposure to real estate developers, and NBFCs with loans against property
(LAP) portfolios could see stress as well. If a decline in real estate prices slows down
construction, as appears likely, nearly 80% of construction jobs could get affected (Figure
50). Domestic demand for cement (Figure 16) and metals (Figure 17) could also suffer
over the medium term as housing is 60% of cement and 35% of India's steel demand.
Figure 16: Real estate is 60% of cement demand Figure 17: Real estate is 35% of Indian steel demand
Source: Credit Suisse estimates Source: Ernst & Young, TechSci, IBEF, Credit Suisse estimates
0 1 2 3 4 5
Cash
Foreign holdings
Assets in business
Stocks in business
Benami fin. investments
Diamonds, Gems
Precious Metals
Land and buildings
Residential real estate
Mean Difference
Highly SignificantMarginally Signifcant
10
15
20
25
1975 1980 1983
% of GDPRange of estimates of Black Money under various NIPFP Studies
Rural housing40%
Urban housing20%
Power3%
Irrigation4%
Roads3%
Railways3%
Others (including
Private capex)27%
Construction35%
Infrastructure20%
Automobiles12%
Pipes & Tubes10%
Capital Goods8%
Other15%
15 November 2016
India Market Strategy 8
Further, while the slowdown in real estate and land transaction volumes may revive in a
few months, a drop in prices could have a negative impact on wealth much larger than the
amount of black money destroyed. About 94% of rural household (HH) assets (Figure 18)
and 92% of urban household assets (Figure 19) are land and buildings.
Figure 18: Land+real estate 94% of rural HH assets Figure 19: Land+real estate 92% of urban HH assets
Source: NSSO, Credit Suisse estimates Source: NSSO, Credit Suisse estimates
GST implementation to cause 9-12 months of disruption as well
Like the de-monetisation exercise, the GST is also a significantly positive development
over the medium term. However, also like de-monetisation, it would disrupt the economy
during implementation. We expect this disruption to last 9-12 months. There is no scientific
basis to this estimate, but Malaysia's recent experience, where the much smaller economy
took 3-6 months to stabilise despite there being just one rate, no centre-state complexity,
two years of advance notice, and no organisational change in the government, suggests
that the Indian experience may be more chaotic as it is worse on nearly every metric
(Figure 20).
Figure 20: Indian GST implementation to be significantly more complex than Malaysia's
Variable Malaysia India Comments
Population (mn, 2016) 32 1,310 India's population is 40x Malaysia's, making supervision complex, and slow response times.
PPP adjusted per capita GDP (US$, 2016) 27,234 6,658 Malaysia is nearly two decades ahead of India in PPP adjusted per-capita GDP, indicating
better organised systems, and greater government capacity.
WB ease of doing business (paying tax rank) 61 172 India brings up the rear on ease of paying taxes: this worsens the impact of this transition.
Number of rates (excluding exempt and 0%) 1 4 Number of rates to map to increases subjectivity in assessments, raising possibility of
confusion among tax payers and supervisors, and increasing friction in the transition.
Tax subsumed (% of GDP) 9% 6% Malaysia started with a US$20 bn estimate for the GST, but ended the first year with US$28 bn.
It is quite possible that once the system stabilises India too would see a higher tax-to-GDP ratio.
Federal/unitary Only Centre Centre + State Malaysian GST was only central. As India has a central as well as state GST, there is likely to
be additional complexity around the inter-state transactions as well as different levels of
preparedness and sophistication across states, and impact on state fiscal capacity.
Announcement 2 Years back 3 months back In Malaysia businesses had two years to prepare for the GST transition, even though rates
were announced on the last day. In India there is barely any time to prepare.
Change to enforcing department(s) None Overhauled Both central and state bureaucracies overseeing the new tax would change. Further, there
would be a re-mapping of enterprises to the tax officials that they need to deal with.
Source: IMF, World Bank, Credit Suisse estimates
Land73%
Building21%
Livestock2%
Transport Equipment
2%
Deposits2%
Others0%
2013
Land47%
Building45%
Livestock0%
Transport Equipment
2%
Deposits5%
Others1%
2013
15 November 2016
India Market Strategy 9
Further, state government finances are likely to face significant uncertainty as well. The
Rs9 tn or so of taxes subsumed under the GST should by design not change (Figure 21),
and may in fact turn out to be higher once the system stabilises as compliance improves.
However, the distribution of these between the states will change in unexpected ways,
disturbing the spending pattern at the state level. For example, states that have a higher
share of services GDP may gain if their sales tax contribution is lower than their share of
services GDP currently (Figure 22): see GST Gist #8 for details. As states now spend 65-
70% more than the centre, this can be another source of volatility in the economy.
Figure 21: Split of taxes subsumed under the GST Figure 22: States with more services share to gain
Source: State Budgets, RNR Committee Report, Credit Suisse estimates Source: CSO, CGA, State Budgets, Credit Suisse estimates
Impact of RBI's liability reduction far from certain
If say Rs3 tn (20% of High Denomination Currency Notes) of old currency notes are not
replaced by new notes, the currency in circulation will fall by the same amount. As the
asset side of the RBI's balance sheet stays unchanged, this would accrue to RBI's
reserves (Figure 23).
Two questions follow from this: (1) Can and should the RBI transfer these gains to the
government, and if so, would this be transferred as a dividend to the government or as
debt cancellation? (2) Should the monetary base expand again given at least some of the
cancelled currency was driving economic activity (i.e., was not stuffed in mattresses)?
Figure 23: Balance sheet of the Reserve Bank of India (June 2016, Rs tn)
Total assets 32.4 Total liabilities 32.4
Banking department assets 15.4 Banking department liabilities 15.4
Investments-domestic 7.0 Deposits
Investments-foreign 6.7 CGRA* 6.1
Others 1.6 Contingency fund 2.2
Others/reserves 1.7
Issue department assets 17.1 Issue department liabilities 17.1
Investments-Foreign 16.3 Notes issued 17.1
Others 0.7
* CGRA = Currency and Gold Revaluation Account. Source: RBI
Sales Tax44%
CST6%Entry Tax
6%
Other State Taxes
4%
Service Tax25%
Excise Duty15%
Taxes Subsumed under GST - Rs 7tn (FY2014)-3%
-2%
-1%
0%
1%
2%
3%
4%
MH WB BI HA OR UT JH JK RJ UP PB CG KA KE GU TN AP
Services GDP Share - Sales Tax Share
15 November 2016
India Market Strategy 10
(1) Dividend payout not the most obvious option
Whether these gains should be transferred to the government is too prescriptive an issue,
as such a demonetisation exercise is unprecedented; all options are theoretically open. In
particular, as discussed in the answer to the second question, demonetisation is in fact a
monetary contraction, and policymakers would attempt to counter its effects via a stimulus.
So we assume that the RBI chooses to transfer these gains to the government.
The question is in what form: a debt cancellation would be the most obvious solution, i.e.,
the RBI extinguishes government bond holdings on the asset side and these reserves on
the liability side. While this will bring down the government's debt outstanding, a 2%
reduction in the ratio would have almost no impact on the economy. One must remember
that the interest paid by the government on bonds the RBI holds is paid back to the
government the next year as dividend; so a debt cancellation would be cash flow neutral.
Some observers believe that this accrual to reserves can be transferred to the government
as a dividend. A 2% of GDP fiscal stimulus would indeed be a strong counter to the
deflationary impact of the demonetisation. But as per current laws and regulations a
dividend is not the most likely outcome in our view for two reasons:
■ Clause 47 of the RBI Act ("Allocation of Surplus Profits") says:
"After making provision for bad and doubtful debts, depreciation in assets,
contributions to staff and superannuation funds and for all other matters for which
provision is to be made by or under this Act or which are usually provided for by
bankers, the balance of the profits shall be paid to the Central Government."
Thus, as per the current law, the RBI can only transfer profits. While currency
cancellation is a net gain, it would not be accounted as profits. One approach could
have been the RBI transferring a larger part of its income to the government by cutting
the P&L allocation to the Contingency Fund (CF). However, in the last three years
these allocations have anyway been zero (Figure 24).
Figure 24: Reserve Bank of India's profit and loss statement
(Rs bn, financial year ending 31 Mar) 2012 2013 2014 2015 2016
Income 532 744 646 793 809
Transfers to CF and ADF 270 288 0 0 0
Contingency fund (CF) 247 262 0 0 0
Asset development fund (ADF) 23 25 0 0 0
Net income 262 456 646 793 809
Total expenditure 101 125 119 134 150
Net disposable income 160 330 527 659 659
Surplus transferred to the government 160 330 527 659 659
Surplus /( income - total expenditure) 37% 53% 100% 100% 100%
Source: RBI, Credit Suisse
■ A second reason is that from a cash-flow perspective, the RBI can only transfer money
that it already has. On an annual basis it accrues interest income/coupon payments on
the bonds it holds, as well as capital gains from its open market operations. After
deducting its annual expenses (salaries, currency printing expenses, administrative
expenses, etc.), the rest is transferred to the government as dividend.
Central bank accounting is tricky as it holds the magical right of converting paper into
money. If the RBI prints Rs15 tn in cash, but only has to issue Rs12 tn to the banks, it
can choose to hand over the remaining Rs3 tn to the government as a special
dividend. Current laws may not permit it, but they may be amended. However, if they
move these gains to reserves, and hold on to the paper, then issuing a dividend to the
government later becomes nearly impossible. This is because now it can only buy
assets (i.e., if it issues printed currency, its balance sheet expands, and it has to then
grow on the asset side as well).
15 November 2016
India Market Strategy 11
(2) Difficulty in quantifying how much to expand
The first challenge for the RBI would be in quantifying the gains. This has two reasons:
given that this count would be taken at the end of the financial year (five months from
now), and the economy was in a phase of rapidly growing currency demand, at the end of
the year it may not show a meaningful reduction in currency in circulation even if a lot of
black money had been incinerated. Further, given the large number of fronts on which
currency is being collected, it is quite possible that a meaningful amount of fake currency
gets collected as well. Some of our colleagues got some notes returned by the bank, but it
appears some banks are discovering fake notes after the exchange.
Conversely, people who were generally lazy in keeping cash or dealt in cash due to inertia
would now deposit these in the bank. Thus, the need for currency in the economy would
fall in a good way too: it would be a challenge for the central bank to think through how
much of a dividend to pass through to the government, to expand the monetary base.
Fiscal impetus likely to come with a lag
The expected decline in inflation is likely to trigger some monetary stimulus by the RBI.
Even if it was to provide some fiscal ammunition to the government, we believe the impact
would come through with a big lag. So a slowdown first, and then the fiscal stimulus would
start to show up in growth numbers.
Figure 25: Government capex to GDP Figure 26: Central government spending split
Source: Budget Documents, CSO, RBI, Credit Suisse estimates Source: Budget Documents, Credit Suisse estimates
To start with, the government's role in the economy has shrunk meaningfully, particularly
when it comes to capex (Figure 25). Most of central government expenditure currently is
non-discretionary (Figure 26)—in the form of interest payments, salary, defence
expenditure, etc. Building up a capacity to spend is therefore a challenge, as we are
discovering in the slowing growth in roads ordering (Figure 27), as well as in construction,
as visible from bitumen demand growth (Figure 28).
0%
1%
2%
3%
4%
5%
6%
7%
8%
0
1
2
3
4
5
6
7
8
1991 1994 1997 2000 2003 2006 2009 2012 2015
State Capex Central Capex Total % of GDP (RHS)
Rs tn
Interest30%
Defence15%
Subsidies15%
Salaries18%
Eco. Services3%
Roads3%
Railways3%
Other Central Plan11%
Others2%
FY16 Central Expenditure ex-state transfers: Rs 16.1tn
15 November 2016
India Market Strategy 12
Figure 27: Roads ordering momentum stalling Figure 28: Bitumen demand growth has slowed
Source: NHAI, MoRTH, Credit Suisse estimates Source: PPAC, Credit Suisse estimates
Nevertheless, in the table below (Figure 29) we run through the various options the
government has to spend a one-off gain that may come through from the RBI. We believe
the impact of these would not be visible in the next 12 months.
Figure 29: Options in front of the government to stimulate the economy
FY17b* (Rs bn) Comments
PSU bank recapitalization
250
Government intent doesn't seem to be to give growth capital to PSU banks: it would rather like them to lose share over time. Further, injecting growth capital through banks would have even slower impact on the economy than the government spending directly.
Roads 1,004 Ordering run-rate running significantly lower than target point to capacity constraints within the government.
Railways 1,210 Railways has shown a limited capacity to spend and hence it's unlikely that more budget is allocated to it.
Rural housing 256 There is a pending backlog of 3.2 mn IAY houses. The government has asked the states to finish them first before PMAY.
Tax benefits on Housing
Significant tax benefits are unlikely in the first year, given the uncertainty on tax revenues due to the disruption in the economy, and the first year of GST. Even on housing if the real estate prices are falling, fresh demand could get delayed by a Buyers' strike.
Lower GST
Given that the GST Council is to decide on these rates, the government can only attempt this in FY19, in case GST revenues surprise positively (we believe they should).
Basic Income type Transfer Such a move appears unlikely, but if necessitated politically, only likely in FY19.
*Total spending including extra budgetary resources. Source: Budget Documents, Credit Suisse estimates
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
2010 2011 2012 2013 2014 2015 2016 2017E 1H16 1H17
NHAI MoRTHkm Road awarding
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
Jul-06 Aug-07 Sep-08 Oct-09 Nov-10 Dec-11 Jan-13 Feb-14 Mar-15 Apr-16
3MMA Bitumen Demand Y/Y (%)
15 November 2016
India Market Strategy 13
Rising global bond yields to hurt P/E ratios
P/E multiples have risen sharply in the last five years
P/E multiples have risen almost steadily across sectors in India for the last five years, with
P/E up over nearly all of 1, 3 and 5 years (Figure 30). As a result, the market P/E has been
significantly above its ten-year mean (Figure 31), despite its recent correction.
Figure 30: Sector/market P/E up over 1, 3 and 5 years Figure 31: Market P/E significantly over mean
Source: RAVE, IBES, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates
Indian equities have no capital account restrictions, and pricing is thus affected by global
trends. Rising P/E in India has not resulted in any major expansion in the P/E premium
that India has over both global equities as well as other Emerging Markets as a group
(Figure 32). The increase in P/Es seems to have been a global phenomenon, with most
other markets having seen their multiples expand over the past few years (Figure 33).
Figure 32: India's P/E premium hasn't risen Figure 33: As P/E multiples have risen globally
Source: MSCI, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates
-20% 0% 20% 40% 60% 80% 100%
IT
Utilities
Energy
Pvt Bank
Health Care
Staples
NBFC
Telecom
BSE100
Cons, Disc.
Metals
Cement
Industrials
PSU Bank
1Y 3Y 5Y
Change in 12MForward PE
8x
10x
12x
14x
16x
18x
20x
22x
Jul-05 Sep-06 Nov-07 Jan-09 Mar-10 May-11 Jul-12 Sep-13 Nov-14 Jan-16
BSE100 12MF PE Mean +1 sd -1 sd
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Dec-14
India's P/E prem. wrt World India's P/E prem. wrt MSCI EM
India's PE premium over MSCI World & EM
No major expansion in PE Premiums 2013 onwards
-10% 0% 10% 20% 30% 40% 50%
TR
TW
MX
KR
MY
JP
RU
ID
IN
EM
ZA
CN
BR
WD
US
EU
5Y Change to MSCI 12MF PEs
15 November 2016
India Market Strategy 14
This expansion in multiples for equities globally has not been driven by any change in
global growth expectations, but just a repricing of assets, given a steady decline in global
bond yields (Figure 34) driven by policy easing in most developed markets.
The linkage between global bond yields and the re-rating of Indian markets is visible in the
range-bound behaviour of the gap between earnings yield in India (i.e., the reverse of
P/E), and the US 10-year treasury (Figure 35).
Figure 34: Global bond yields were falling steadily Figure 35: India earnings yield vs US 10-year yield
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates Source: the BLOOMBERG PROFESSIONAL™ service, MSCI, Credit Suisse estimates
Rising global bond yields could reverse this trend
However, bond yields are now rising, and CS global strategist Andrew Garthwaite believes
that yield increases are likely to surprise market expectations on the upside (see "What to
do with bond proxies", 3 November 2016), with the US 10-year treasury yield reaching
2.25% in mid-2017 (vs 1.47% in June 2016, and 2.1% currently).
The expectations of this yield increase are driven by several factors. US wage growth has
broken out of the 2%-growth range it was in since the Global Financial Crisis (Figure 36).
At the same time, Chinese PPI inflation has turned positive (Figure 37), reducing the fear
at least for now that the steady fall in the RMB would mean China exports deflation to the
rest of the world.
-1
0
1
1
2
2
3
-1
0
1
2
3
4
5
6
7
Nov-00 Nov-02 Nov-04 Nov-06 Nov-08 Nov-10 Nov-12 Nov-14 Nov-16
US UK Ger. Fr Jp
Japan (on RHS)
Generic 10 Yr Govt. Bond Yields (%)
-2%
0%
2%
4%
6%
8%
10%
1996 1997 1999 2001 2002 2004 2006 2007 2009 2011 2012 2014 2016
Diff betn MSCI India Earnings Yield & US 10Yr treasury yield
High diff => Indian equities undervaluedLow diff => Indian equities overvalued
Decelerating growth for India
Financial crisis
9/11; Dot-com aftermath
Russian crisis; Pokharan blasts
15 November 2016
India Market Strategy 15
Figure 36: US wage growth breaking out of a range Figure 37: Chinese PPI inflation offsetting RMB fall
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates
In parallel and contributing to this has been the rebound in global commodity prices
(Figure 38). Further, as policymaking moves from monetary to fiscal stimulus, i.e., instead
of central banks buying government bonds (extra demand for bonds) the governments
start issuing more bonds (extra supply: Figure 39), yields are unlikely to fall again.
Figure 38: Global commodity prices rising again Figure 39: Fiscal contraction in DMs may be over
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates Source: IMF, Credit Suisse estimates
It remains to be seen how resilient developed world demand would be in response to this
rise in yields; but Garthwaite believes that the Trump victory has increased the probability
of yields reaching 2.5%. Even at a 2.25% 10-year US government bond yield, assuming
the yield gap with Indian earnings yield remains within range (20-year and a 10-year
average of 3.5%, and a 5-year average of 4.5%), India's P/E multiple could fall to a 15-
handle. This is particularly as a 12-15 months growth disruption in India (more on this in
the second section) could prevent the yield gap from narrowing.
1.5
2
2.5
3
3.5
4
Apr-07 May-08 Jun-09 Jul-10 Aug-11 Sep-12 Oct-13 Nov-14 Dec-15
Average Hourly Wages in US (YoY)
%
-10
-5
0
5
10
15
20
25
30
Feb-93 Oct-95 Jun-98 Feb-01 Oct-03 Jun-06 Feb-09 Oct-11 Jun-14
China PPI (%, YoY)
0
50
100
150
200
250
300
350
400
Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11 Jan-14
Custom Commodity Index(Bloomberg Comm. Index ex-Gold)
-10
-8
-6
-4
-2
0
2
Germany UK France USA Japan India
2013 2014 2015 2016
General Government Fiscal Balance
% of GDP
15 November 2016
India Market Strategy 16
Some sectors more affected than others
Figure 40: 5-year split of performance by sector Figure 41: P/E change in consumer staples globally
Source: RAVE, IBES, Credit Suisse estimates Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates
Some sectors have benefited more than others, with the five-year returns dominated by
P/E expansion rather than earnings growth (Figure 40). While the P/E expansion in PSU
banks and metals is explained by a sharp earnings contraction (businesses have some
intrinsic value; so multiples rise when earnings fall: trough earnings for peak multiples and
vice versa), that for sectors with growing earnings, like cement and consumer
discretionary has been driven mainly by a falling discount rate, and an India premium.
Even approaching the valuations globally by sector, the expansion in multiples was global
for all of Consumer Staples (Figure 41), Consumer Discretionaries (Figure 42) and
Materials (Figure 43), and driven by a falling discount rate. Contrary to the theoretical and
popular approach of using Indian 10-year yields to value Indian equities, given high foreign
ownership and no restrictions on the capital account, we believe global yields are more
appropriate.
Figure 42: Consumer Discretionary P/E re-rating Figure 43: Materials P/E re-rating
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates
-50% 0% 50% 100% 150% 200%
Information Technology
Utilities
Energy
Pvt Bank
Health Care
Consumer Staples
NBFC
Telecommunication Services
BSE100
Consumer Discretionary
Metals
Cement
Industrials
PSU Bank
EPS % PE %5Y Change in 12M Forward -30% -20% -10% 0% 10% 20% 30% 40% 50%
RU
BR
TR
ZA
MX
CN
EM
TW
IN
WD
EU
KR
US
ID
MY
JP
5Y Change to MSCI Staples 12MF PEs
-10% 0% 10% 20% 30% 40% 50% 60% 70%
KR
JP
TW
MX
ID
EU
WD
MY
US
EM
IN
TR
ZA
CN
BR
5Y Change to MSCI Discretionary 12MF PEs
-20% 30% 80% 130% 180%
MX
ZA
ID
KR
US
JP
TW
MY
TR
EM
WD
IN
CN
RU
EU
BR
5Y Change to MSCI Materials 12MF PEs
15 November 2016
India Market Strategy 17
Near-term pain to override long-term gains
GST and demonetisation are structural positives…
A strong vicious cycle that India has been stuck in is that of low equilibrium of a small
government: high informality and tax evasion have kept tax-to-GDP too low despite the
ratio for the formal economy being rather high by global standards (Figure 44). Lack of tax
revenue restricts government size (Figure 45): the inability to provide basic government
services then negatively impacts economic productivity, and thence tax revenues.
Figure 44: Tax-to-GDP for formal economy was high Figure 45: …restricting the size of government
Source: World Bank, Credit Suisse estimates Source: IMF, Credit Suisse estimates
On this count, de-monetisation and the GST significantly improve the medium-term
prospects for India, in our view: the first deals (mainly) with non-compliance on direct
taxes, and the second on non-compliance on indirect taxes. Malaysia, for example, got
US$28 bn in GST receipts in the first year, vs its own expectation of US$20 bn, a 40%
improvement. Once the economy settles down to the GST, India should also see a
meaningful improvement in compliance. Similarly, the absence of currency in the black
economy (it would take a long time for that much black money to regenerate) is likely to
shift activity to the formal economy, and improve government tax revenues.
Similarly, the decline in real-estate and land prices could stimulate more activity over time,
as would lower interest rates. However, these would take time to show up.
…but create downside to near-term expectations
As earnings estimates are adjusted downward to reflect the disruptions discussed earlier
in this report, accompanied by the P/E de-rating that is likely due to rising bond yields,
broader market performance may suffer irrespective of the improvement in the medium
term. It is possible for the market to look through 3-4 months of weakness, but 12-15
months is too long a period for the market to have patience for.
We nevertheless reflect the medium-term views in the choice of sectors to take profits on.
For example, falling (local) interest rates, improving global commodity prices, and rising
formalisation (driven by de-monetisation, smartphones as well as the GST) should benefit
private sector banks and metals. So we would look through any near-term weakness. In
particular, we believe that falling interest rates should improve mortgage growth (Figure
46), especially as India's mortgage penetration remains very low (Figure 47). We,
therefore, stay constructive on these.
10% 20% 30% 40% 50% 60%
Denmark
France
Germany
OECD
UK
Japan
India (Formal)
Turkey
Australia
Switzerland
USA
Korea
Mexico
India
Total Tax to GDP (2014)
0% 5% 10% 15% 20%
USA
France
S Africa
Brazil
UK
Australia
Turkey
Russia
Germany
Argentina
Thailand
Japan
India
Indonesia
Korea
Government Wages as % of GDP (2000-13 Avg)
15 November 2016
India Market Strategy 18
Figure 46: Falling rates to improve mortgage growth Figure 47: India's mortgage penetration low
Source: Bloomberg, RBI, Credit Suisse estimates Source: Credit Suisse estimates
Trouble at the bottom even before recent disruptions
In September we wrote (link) that steadily rising domestic agricultural surpluses and weak
export markets were likely to weaken prices, offsetting the revival in volume growth this
year after two successive monsoon failures. Thus, the growth in the value of agricultural
output was unlikely to reach double digits (Figure 48): this had witnessed a 14% CAGR
between 2005 and 2014, before slowing to sub-5% in FY15 and FY16.
Figure 48: Growth to be subdued even in FY17 Figure 49: Number of people in agriculture still high
Source: CSO, Credit Suisse estimates Source: Employment Surveys, Credit Suisse estimates
For nearly half of the Indian workforce (Figure 49) working in agriculture this can be
painful. Further, construction, which many such workers move to when forced to look out,
is also weak. 75% of all construction jobs are rural (Figure 50), and with the slowdown in
agricultural incomes, given that nearly half the households are agriculture dependent, rural
house construction has weakened too. Rural wage growth is thus languishing, and real
wage growth has been negative since 2014 (Figure 51).
If the urban real-estate market weakens as well, job availability at the bottom of the
pyramid would suffer further.
5%
7%
9%
11%
13%
15%
17%
19%
21%
23%8.0%
8.5%
9.0%
9.5%
10.0%
10.5%
11.0%
11.5%
12.0%
Apr-07 Jul-08 Oct-09 Jan-11 Apr-12 Jul-13 Oct-14 Jan-16
HDFC Housing Loan Rate (Rev) Housing Credit Y/Y (%, RHS)
62%
32%
30%
28%
23%
16%
15%
15%
13%
12%
7%
0% 10% 20% 30% 40% 50% 60% 70%
AU
KR
MY
TW
HK
SG
CN
ID
TH
IN
PH
Housing Loans as % of Total Credit
0%
5%
10%
15%
20%
25%
0
5
10
15
20
25
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Crops + Livestock GVO YoY (RHS)
Rs tnRebound unlikely to reach past highs
40%
45%
50%
55%
60%
65%
70%
75%
150
160
170
180
190
200
210
220
230
240
250
1978 1983 1988 1994 2000 2005 2010 2012 2014
Persons employed in Agriculture (mn) % of Total Workforce
Drought likely reduced agri workmn
15 November 2016
India Market Strategy 19
Figure 50: 75% of construction jobs are rural Figure 51: Real rural wages seeing de-growth
Source: NSS EUS 68th Round, Credit Suisse estimates Source: CMIE, Labour Bureau, Credit Suisse estimates
Downgrade Cement and Discretionary (APNT, EICH)
On the other hand, we are most concerned about sectors where the P/E multiples imply a
pricing to perfection, given the concerns elaborated on in the first section of this report.
Further, trouble at the bottom, in our view, is a structural not a cyclical problem, and the
slowdown in real estate would take many quarters, if not years, to revive.
Figure 52: Expect moderate rise in cement demand Figure 53: Cement EV/EBITDA at 15-yr highs
Source: CMIE, Credit Suisse estimates Source: RAVE, IBES, Credit Suisse estimates
Cement demand slowdown could last: Downgrade Ultratech and Ambuja
With cement demand growth at low levels (Figure 52), but EV/EBITDA at 15-year highs
(Figure 53), we cut weight on the sector. In our view, cement stocks are already pricing in
an 8-9% volume CAGR over next three years: if so this could drive utilisation to 90%+ (ex-
south) by 2020. The bull case in cement, therefore, is pricing power returning to the
industry at that utilisation (as happened in the previous upcycle FY04-09: Figure 54).
However, we expect volume growth to be much lower starting 2H FY17, when current
stock prices build in 7-8% volume growth but we build in 5% and for FY18 we only expect
Rural Buildings59%
Rural Roads/Rail
12%
Rural Utilities4%
Rural Others2%
Urban Buildings20%
Urban Roads/Rail
1%
Urban Others2%
Split of Construction Jobs: Rural 77%, Urban 23%
-5%
0%
5%
10%
15%
20%
25%
Jul-02 Dec-03 May-05 Oct-06 Mar-08 Aug-09 Jan-11 Jun-12 Nov-13 Apr-15
Nominal Rural Agri wage growth (y/y) Real Growth
7%
8%
11%
8%
10%
6%
15%
-1%
9%9%
6%
9%
12%
9%8%
7%
11%
5%
7%8%
3%3%
3%
5%6%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
FY
94F
Y95
FY
96F
Y97
FY
98F
Y99
FY
00F
Y01
FY
02F
Y03
FY
04F
Y05
FY
06F
Y07
FY
08F
Y09
FY
10F
Y11
FY
12F
Y13
FY
14F
Y15
FY
16F
Y17
EF
Y18
E
Forecast
3x
6x
9x
12x
15x
18x
21x
Nov-04 Apr-06 Sep-07 Feb-09 Jul-10 Dec-11 May-13 Oct-14 Mar-16
ACC Ambuja Ultratech
12MF EV/EBITDA
15 November 2016
India Market Strategy 20
6% volume growth. As supply CAGR expected over next three years is 3-4% (Figure 55),
our forecast demand growth would take utilisation only to 85% (ex-south) in 2020,
affecting the industry's ability to take price increases.
Figure 54: Industry has pricing power at 90%+
utilisation Figure 55: Supply CAGR at 3-4% until FY19E
Source: DIPP, Credit Suisse estimates Source: Company data, Credit Suisse estimates
The weakness in 2H FY17 should now be less debatable (1H FY17 cement demand
growth was 4.5%). As October 2016 had seen negative to flattish demand for the industry
even before the demonetisation shock, 3Q17 demand growth should stay weak and 2H
FY17 to grow at best at 5%. While we expect some demand growth improvement in FY18
to 6%, this would still disappoint the market.
Demand improvement should come from (1) higher government spending on rural housing
to offset muted out-of-pocket spending, (2) high government capex on Roads, Irrigation
and Railways. However, we also expect muted trends for (1) urban housing impacted by
demonetisation and (2) the impact of GST implementation on private capex (Figure 56).
Figure 56: Split of cement demand expectation in FY18—we lower growth expectation to 6%
% of cement
demand
FY18 demand Remarks
Rural housing 40% 8% Out-of-pocket spend to grow slowly at 4-5% given surplus in agri output; government support
to rural housing to drive higher demand.
Urban housing 20% -4% Slowdown in real estate activities due to demonetisation impact; Government scheme on
urban housing may have slow ramp-up
Power 3% 7% Based on capacity under construction in the power sector
Irrigation 4% 20% A good monsoon in FY17 to moderate irrigation demand
Roads 3% 20% 1H17 road construction was up 21% and based on road order momentum, we expect 20%
construction growth in roads
Railways 3% 15% Non-locomotive FY17 budget is up 10% and we expect pick up in spend
Others (including Private capex) 27% 5% Impacted by GST implementation
Total 100% 6% Cement demand to accelerate in FY18 but lower than market expects
Source: Credit Suisse estimates
Therefore, we reduce our volume growth and pricing assumptions for cement stocks and
downgrade Ultratech and Ambuja to UNDERPERFORM, with 15-25% cut to FY18-19
estimates (Figure 57), bringing our estimates on Ultratech in particular to 10%-plus below
consensus (Figure 58). We have also reduced estimates for ACC but maintain our
NEUTRAL rating due to low downside.
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
ASP change (RHS) Utilization (LHS)
0%
5%
10%
15%
20%
25%
30%
0
10
20
30
40
50
60
70
FY
94F
Y95
FY
96F
Y97
FY
98F
Y99
FY
00F
Y01
FY
02F
Y03
FY
04F
Y05
FY
06F
Y07
FY
08F
Y09
FY
10F
Y11
FY
12F
Y13
FY
14F
Y15
FY
16F
Y17
EF
Y18
EF
Y19
E
Capacity additions (mn tonnes) Supply growth (RHS)
Forecast
15 November 2016
India Market Strategy 21
Figure 57: Changes to estimates
FY18/CY17 Ultratech Ambuja ACC
New Old Change New Old Change New Old Change
Revenue 330,982 351,217 -6% 105,645 121,620 -13% 133,462 139,831 -5%
EBITDA 70,696 80,073 -12% 17,791 27,466 -35% 19,190 22,768 -16%
PAT 34,875 41,439 -16% 13,728 18,749 -27% 11,432 14,156 -19%
eps 127 151 -16% 9 12 -26% 61 75 -19%
TP 2,900 3,650 -21% 180 220 -18% 1,300 1,400 -7%
Rating UNDERPERFORM Neutral UNDERPERFORM Neutral Neutral Neutral
Source: Company data, Credit Suisse estimates
Figure 58: CS vs consensus estimates
CS vs consensus CS Consensus Change
FY17 /
CY16
FY18 /
CY17
FY19 /
CY18
FY17 /
CY16
FY18 /
CY17
FY19 /
CY18
FY17 /
CY16
FY18 /
CY17
FY19 /
CY18
Ultratech 110.0 127.2 167.9 114.0 145.0 188.0 -4% -12% -11%
Ambuja 7.1 8.9 11.1 7.4 9.7 11.5 -4% -7% -3%
ACC 42.3 60.8 80.4 43.5 62.8 80.2 -3% -3% 0%
Source: Company data, Credit Suisse estimates
Paints demand to be impaired for 12 months, Downgrade Asian Paints
While Asian Paints' long-term story remains intact, there is significant lowering of volume
growth over the next 12 months. Its margins are at life time high levels due to the drop in
input costs in FY16, some of which have started firming up and could put pressure on
margins.
The stock trades at 42x FY18 earnings which is a 15-25% premium over consumer
staples. Therefore, we downgrade Asian Paints to UNDERPERFORM from Neutral.
Figure 59: Stock still above 1 SD on P/E Figure 60: Moderate volume growth going ahead
Source: RAVE, IBES, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Eicher Motors: Volume slowdown to impact multiples as well
The short-term impact of demonetisation would be there for 1-2 months on account of a
shortage of hard cash; with ~60% of vehicles sold on cash, Eicher will have one of the
highest impact within Autos.
10x
20x
30x
40x
50x
Nov-06 Nov-08 Nov-10 Nov-12 Nov-14 Nov-16
12 mnth fwd PE Average +1 SD -1 SD
-5%
0%
5%
10%
15%
20%
25%
FY92 FY95 FY98 FY01 FY04 FY07 FY10 FY13 FY16
Asian Paints volume (% YoY)
Forecast
15 November 2016
India Market Strategy 22
We are more worried about the medium-term wealth destruction impact on the affluent
self-employed households. In our view, households which have been negatively impacted
on their stock of wealth (both cash and property prices) are less likely to indulge in a high
premium bike like Eicher for the next 1-2 years.
Eicher is entering a phase where volume growth would have slowed down because of
capacity constraints. With this we see waiting periods also reducing significantly. We lower
our estimates by ~5% on account of lower volumes but the waiting period going away will
also impact multiples. We reduce our target multiple to 22x Sep-18 for RE and downgrade
the stock to UNDERPERFORM with a TP of Rs18,300.
Figure 61: Volume growth to slow down … Figure 62: … putting pressure on multiples
Source: Company Data, Credit Suisse estimates Source: RAVE, IBES, Credit Suisse estimates
Model portfolio changes
For the third time this year, we change weights. We made some sharp changes in April-
16, where we cut IT to create space for Metals and ICICI (link), and then in September
where we cut Staples to NEUTRAL, and went deeper UNDERWEIGHT on IT and
Healthcare to create space for more mortgage providers and construction companies
given our expectation for interest rate cuts (link). We cut weights on cement, NBFCs and
on consumer discretionary, to add back to Private Sector Banks, IT, Healthcare and
Utilities (Figure 63). We thus have a NEUTRAL position on IT now, and a sharp
OVERWEIGHT on private banks (Figure 64).
0%
10%
20%
30%
40%
50%
60%
70%
80%
CY11 CY12 CY13 CY14 FY16 FY17E FY18E FY19E
Eicher YoY volume growth (%)
5
15
25
35
45
55
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
Eicher 12m forward P/E
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India Market Strategy 23
Figure 63: Our new model portfolio (vs MSCI) Figure 64: Changes to the model portfolio
Source: MSCI, Credit Suisse estimates Source: Credit Suisse estimates
-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0
Cons. Disc.
Telecom
Materials
IT
Health Care
Cons. Staples.
Energy
Industrials
Utilities
Financials
New
Old
Difference in wts. (CS minus MSCI India)
-5 -4 -3 -2 -1 0 1 2
Cons. Disc.
Materials
Industrials
Telecom
Energy
Cons. Staples.
Utilities
Health Care
IT
Financials
Change in Weights inCS Model Portfolio
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India Market Strategy 24
Companies Mentioned (Price as of 14-Nov-2016) ACC Limited (ACC.BO, Rs1398.4) Ambuja Cements Ltd (ABUJ.BO, Rs219.45) Asian Paints (ASPN.BO, Rs963.6) Cipla Limited (CIPL.BO, Rs549.7) Eicher Motors (EICH.BO, Rs21745.4) HCL Technologies (HCLT.BO, Rs763.6) HDFC Bank (HDBK.BO, Rs1275.7) Housing Development Finance Corp (HDFC.BO, Rs1271.5) ICICI Bank (ICBK.BO, Rs277.0) Kajaria Ceramics Limited (KAJR.BO, Rs503.7) LIC Housing Finance Ltd (LICH.BO, Rs520.05) Maruti Suzuki India Ltd (MRTI.BO, Rs5136.15) Tata Motors Ltd. (TAMO.BO, Rs507.4) Tech Mahindra Limited (TEML.BO, Rs429.7) Ultratech Cement Ltd (ULTC.BO, Rs3634.7)
Disclosure Appendix
Analyst Certification Neelkanth Mishra, Prateek Singh and Ravi Shankar each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities
As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractiv e, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin Ame rican and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Cana dian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiv eness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 1 2-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risk s. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, wh ich was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products.
Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.
Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.
Credit Suisse's distribution of stock ratings (and banking clients) is:
Global Ratings Distribution
Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 44% (63% banking clients) Neutral/Hold* 39% (60% banking clients) Underperform/Sell* 15% (56% banking clients) Restricted 3% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, an d Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis . (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.
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Important Global Disclosures Credit Suisse’s research reports are made available to clients through our proprietary research portal on CS PLUS. Credit Suisse research products may also be made available through third-party vendors or alternate electronic means as a convenience. Certain research products are only made available through CS PLUS. The services provided by Credit Suisse’s analysts to clients may depend on a specific client’s preferences regarding the frequency and manner of receiving communications, the client’s risk profile and investment, the size and scope of the overall client relationship with the Firm, as well as legal and regulatory constraints. To access all of Credit Suisse’s research that you are entitled to receive in the most timely manner, please contact your sales representative or go to https://plus.credit-suisse.com . Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-and-analytics/disclaimer/managing_conflicts_disclaimer.html . Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: See the Companies Mentioned section for full company names The subject company (ABUJ.BO, ASPN.BO, HCLT.BO, TEML.BO, TAMO.BO, HDBK.BO, ICBK.BO, HDFC.BO) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (ABUJ.BO, ASPN.BO, HCLT.BO, HDBK.BO, ICBK.BO, HDFC.BO) within the past 12 months. Credit Suisse has managed or co-managed a public offering of securities for the subject company (ABUJ.BO, HDFC.BO) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (ABUJ.BO, ASPN.BO, HCLT.BO, HDBK.BO, ICBK.BO, HDFC.BO) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (ULTC.BO, ABUJ.BO, ASPN.BO, HCLT.BO, TEML.BO, CIPL.BO, TAMO.BO, HDBK.BO, ICBK.BO, LICH.BO, HDFC.BO) within the next 3 months. Please visit https://credit-suisse.com/in/researchdisclosure for additional disclosures mandated vide Securities And Exchange Board of India (Research Analysts) Regulations, 2014 Credit Suisse may have interest in (ULTC.BO, ACC.BO, ABUJ.BO, ASPN.BO, KAJR.BO, EICH.BO, HCLT.BO, TEML.BO, CIPL.BO, TAMO.BO, HDBK.BO, ICBK.BO, LICH.BO, HDFC.BO, MRTI.BO) As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (ASPN.BO, LICH.BO). Credit Suisse beneficially holds >0.5% long position of the total issued share capital of the subject company (ASPN.BO, EICH.BO).
For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683. For date and time of production, dissemination and history of recommendation for the subject company(ies) featured in this report, disseminated within the past 12 months, please refer to the link: https://rave.credit-suisse.com/disclosures/view/report?i=270468&v=7btpdgnxk9kbj3lf41sq6d5m4 .
Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events. Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit https://www.credit-suisse.com/sites/disclaimers-ib/en/canada-research-policy.html. Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (ABUJ.BO, TAMO.BO, HDBK.BO, HDFC.BO) within the past 3 years. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. This research report is authored by: Credit Suisse Securities (India) Private Limited ......................................................................... Neelkanth Mishra ; Prateek Singh ; Ravi Shankar To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse Securities (India) Private Limited ......................................................................... Neelkanth Mishra ; Prateek Singh ; Ravi Shankar
Important MSCI Disclosures The MSCI sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, re-disseminated or used to create and financial products, including any indices. This information is provided on an "as is" basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to, computing or compiling the information hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of
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India Market Strategy 26
the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are services marks of MSCI and its affiliates. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. and Standard & Poor’s. GICS is a service mark of MSCI and S&P and has been licensed for use by Credit Suisse.
For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683.
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India Market Strategy 27
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