Equity markets, having appreciated 29% this year, have been running ahead of an economic recovery, which is expected to follow with a lag. The government has already initiated several confidence building measures and taken key decisions like allowing FDI in several sectors, railway fare hike, online environment & forest clearance, etc. However, an economic recovery is expected only at a gradual pace. After trading around 14x one year forward EPS for most of the last five years, the Sensex is now trading at 14.6x one year forward EPS (FY16E).
We have already witnessed a bottoming out of the economic growth cycle, which coupled with a reduction in crude and other commodity prices has aided lower inflation. This has also led to hopes of a rate cut in the first half of next year. India is entering a new phase of economic growth that would be characterised by a multi-year bull run. In this backdrop, we expect four major themes to play out, which will last for the foreseeable future.
Sensex target: Factoring in the fall in inflation, comfortable CAD, improved sentiments and pick-up in GDP growth, we expect the Sensex EPS to grow at a CAGR of 17% over FY14-17E. A decline in cost of equity coupled with a dovish environment will further fuel portfolio flows for India in equities as well as debt instruments. The Sensex is trading at 15x one year forward P/E multiple (FY16E), in line with historical mean. However given the resurrection of corporate earnings cycle, we believe there exists a case for a re-rating of the Indian markets. We assign a P/E multiple of 15x on FY17E EPS to arrive at a fair value of 32500 by end CY15, implying an upside of 18.5%. The corresponding Nifty target would be 9750.
Since we expect the economy and corporate profitability to make a meaningful comeback thereby making cyclical sectors the biggest beneficiary as pick up in utilisation rates, positive operating and financial leverage will lead to recovery in profitability and improve the quality of the balance sheet. Hence we are positive on sectors like banking (pick-up in loans, lower interest to cushion NIMs, lower bond yields to aid provisioning and NPA cycle peaking), cement (increase in capacity utilisation and lower input costs to aid profitability), capital goods (revival in capex cycle to lead to better orders and execution), autos & auto ancillaries (lower rates to boost pent up demand and lower commodity to help margin recovery)
We are neutral on defensives like IT (demand intact, rich valuation), pharma (rich valuation, tepid domestic growth), oil & gas (earnings dependent on deregulation, limited volume growth) & media (earnings visibility intact, rich valuation)
We remain negative on sectors like real estate (high inventory and huge debt pile up and regulatory hurdles to weigh over positive like lower interest rates and pick up in demand), Metals( Lower realisations and levered balance sheets) and shipping ( Highly dependent on global trade and demand for commodities).
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