Indian economic recovery will be of U shape with long trough period

Economic recovery instead of V shape will be of U shape with long trough period.  Post 3rd quarter results and this poor GDP numbers, we have made changes in our Sensex EPS and market assumptions. We have reduced our FY14 Sensex EPS assumption by 3% to 1329. Earlier it was 1371. Consequently, this changes our fair value Sensex estimate for calendar year 2013 from 22, 627 to 21,930. Also our bear case assumption of Sensex low for cy2013 changes from 17,978 to 17,400.

Over last two months Indian equity market had to face series of bad news and that has stopped the rally that market was experiencing since middle of 2012. The trends in macro economic growth environment are showing greater signs of deceleration. First it was dismal IIP data which after showing sign of some revival has fallen drastically and then there were series of downward revision of Indian GDP growth rate. Growth in structural sense is the key for removing most of the ills that India and Indian corporate face right now. The state of economy is succinctly expressed in Economic Survey 2013, which says “… India's situation is difficult… recognize that a lot needs to be done… slowdown is a wake-up call for increasing the pace of actions and reforms.”

The Economic survey advocates for (1) shifting expenditure from consumption to investment, (2) removing bottlenecks to investment, growth and job creation, (3) inflation management with monetary and supply-side measures, (4) lowering borrowing cost and (5) measures for savers to get strong real returns.

Policy makers out of the three primary issues -inflation, growth and deficit, have chosen to go hard primarily, on deficit control. And in conventional sense it is a right thing and in fact in an, immediate term sense, it is critically required too, as rising deficit would have invited, rating downgrade, with its subsequent impact on foreign fund flow and currency volatility. Volatile and depreciating rupee in a situation of trade deficit would have made the whole economy unstable.  Now, budget allays, all fears of rating downgrade and that should help in Rupee strengthening and in turn , helping in reducing inflation leading to further monetary loosening. And under current circumstances, that’s very important for some demand revival at least. Some of the analysts are finding budget calculation unachievable, we also think that tax revenue has been over estimated while subsidy has been under estimated, but we think just like FY13 by cutting other spending deficit will be in control.

December 2012 results have largely mirrored macro realities. Sales growth for Nifty companies slowed to 10% and operating profit growth slowed to 5%—both new post Lehman -crisis lows. Fixed costs like wages and interest continued to rise faster than sales, further pressuring margins. As new capacities get commissioned, interest and depreciation costs continue to rise, thus hurting interest coverage. Also, end of December has seen earning upgrade for FY14, first upward revision in earning in last 24 months. But end of January saw consensus once again downgrading FY14 earnings estimates.

Fundamentally more damaging announcement lately had been that of third quarter FY13 GDP number that has fallen below psychological level of 5% to 4.5%.  It clearly shows the dismal picture of economy. Now, economic recovery instead of V shape will be of U shape with long trough period.  Post 3rd quarter results and this poor GDP numbers, we have made changes in our Sensex EPS and market assumptions. We have reduced our FY14 Sensex EPS assumption by 3% to 1329. Earlier it was 1371. Consequently, this changes our fair value Sensex estimate for calendar year 2013 from 22, 627 to 21,930. Also our bear case assumption of Sensex low for cy2013 changes from 17,978 to 17,400.

Sensex currently is at 18,900 and so fall of 4-5% from current levels will make Indian market highly attractive for investments. In fact at current levels too, risk-reward is favorable to equity buyers with one year horizon in mind. This fall, if any, will give opportunity at least similar to end 2011 and middle 2012 from where 20-25% return will come even on a cyclical bounce. Supporting factors that will provide this 20-25 % cyclical bounce in calendar year 2013 if not a runaway bull market are: Absolute price-to-book of Sensex of 2.16 currently compares favorably with 4.9x at 2007 highs and 2.9x at 2010 highs. Secondly, India’s premium relative to the region has dropped to 8% (the lowest since 31 Dec 2011) compared with premiums of 49% and 32% at the 2007 and 2010 highs, respectively. Thirdly and most critically, 2013E India EPS is 93% above the end-2007 level (i.e. Earning has nearly doubled over last 5years). Fourth, inflation is slowing with the 3-month moving average for the WPI running at 1.7% (lower than other Asian peers)

 

 

 

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