India Strategy: Macro headwinds, politics to cap upside

October 1, 2018 STRATEGY India THIS REPORT HAS BEEN PREPARED BY KIM ENG SECURITIES INDIA PVT LTD SEE PAGE 40 FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS India Strategy Macro headwinds, politics to cap upside Prefer bottom-up investing; Few good opportunities The 6.8% retreat in the NIFTY from the peak of 11,739 at end-August has not fully factored in serious macro headwinds that threaten the fragile earnings recovery, we believe. The market has yet to fully price in: a) 4-year high crude prices; b) sharp INR depreciation; and c) rising bond yields in anticipation of a pick-up in the deficit (refer to note Here). The NIFTY is 7% above our base-case target of 10,500 (based on consensus 18x FY19E PER) set in Nov 2017 and is 20% above its long-term average PER of 16.4x. The start of state elections in Nov 2018 and central elections from May 2019 would keep markets range-bound with a negative bias if outcome is unfavourable for the ruling NDA. A mild positive is first signs of an earnings recovery in 1Q (consensus of 22%/20% for FY19/20E). We prefer bottom-up stock selection across sectors, Top Picks: HDFCB, HCLT, MM, UTCEM, PWGR, BJAUT, EDEL, MAHGL, JM, PVRL and CCD. Sectors to avoid are state-owned banks and telecom. Private financiers, autos, exporters remain favourite We like private financiers despite the recent increase in interest rates/slight liquidity squeeze because retail loan growth remains strong and they are gaining market share in corporate loans. Private financiers are structurally better placed than state-owned banks as they have a better credit-underwriting process, higher productivity, effective use of technology and strong top management teams. The auto sector is a beneficiary of the rural demand recovery after a second near normal monsoon. For 5MFY19, overall auto sales volume increased 14.5% YoY (2Ws +11.5%, 4Ws +9.8%, trucks +41.7%); Exporters in the auto, software and industrial sectors are beneficiaries of the 13% INR depreciation YTD. Prominent names under our coverage include BJAUT and SOTL, and all the tech companies (refer note Here). Preferred themes: digital/data, select industrials Digital/data is a multi-year global growth theme. It is accelerating in India, helped by an 83% fall in the data tariff to 2.7 paise/mb since Dec’16. The wave of video consumption and IOT applications has just begun. This theme could be played through companies offering digital infrastructure, cloud and analytics platforms, and digital content, etc. Beaten down print media and cinema exhibition companies provide good opportunities as a recovery should be visible from 2H. Government programmes, such as housing, power for all, renewables, highways and tax rationalization due to GST are creating opportunities to invest in cement, logistics, city gas networks and power trading/transmission. Domestic flows, politics could extend correction The recent correction in the NIFTY could extend further due to a) any outflows from domestic equity funds, b) BJP loss or sharp cut in vote share in Nov 2018 state elections and c) D/g in growth rates and earnings by analysts following higher interest rates and tightening of liquidity in 2HFY19. Key monitoring factors over the next few months would be interest rates, domestic liquidity and INR/USD. Analysts Top picks Jigar Shah(91) 22 6623 2632 jigar@maybank-ke.co.inNeerav Dalal(91) 22 6623 2606neerav@maybank-ke.co.inVishal Periwal(91) 22 6623 2605vishalperiwal@maybank-ke.co.inLarge capsHDFCB IN5,450Buy2,0062,40020HCLT IN1,515Buy1,0881,24014MM IN1,070Buy8611,12030UTCEM IN1,114Buy4,0564,76517PWGR IN986Buy18824027BJAUT IN778Buy2,6873,24521Mid capsEDEL IN177Buy190380100MAHGL IN81Buy8171,07532JM IN73Buy8715073CCD IN59Buy28140042PVRL IN56Buy1,2011,45021Tic kerMc ap(INRb)Rec oCMP(INR)TP(INR)Upside (%) October 1, 2018 2 India Strategy Market Strategy NIFTY at steep premium to historical valuation/peers. Our target is 10,500 (-7%) for the next 6-12 months. YTD, the NIFTY has increased 6.7% vs the NSE Midcap index which has fallen 8%. The rally in the NIFTY puts Indian equities ahead of the rise in global indices and the MSCI EM decline of 12%. In USD terms, Indian equities returned -6% YTD due to the INR depreciation. To sustain the premium valuations, a stronger earnings expansion is needed with more evidence that the entire economy is doing well, and that the growth is sustainable. After seven (FY18 15%) years of just single-digit EPS expansion, this year in 1Q NIFTY ex-bank EPS growth was 14%, which coincided with GDP expansion of 8.2% in the same period. The earnings recovery is still elusive because the industrial and infrastructure sectors need to sustain the green shoots of recovery and need some adjustment period. Eventually, the earnings will catch up but in the