J. P Morgan - Indian Equities The Growth Oasis

Indian Equities The Growth Oasis

· Return of risk appetite helped Indian equities last week; limited fundamental support

· 3Q earnings increased 11% yoy; 51% disappoint for our coverage universe

· Parliament session starts; temporary twin deficit comfort for equities

· Monthly prints of inflation likely to support equities; no support from growth print

· DIIs turn buyers; seasonal factor of fiscal year-end buying has diminished over the last two years

· Revenue growth momentum indicates pockets of relative strength; sub-sectors with relatively higher revenue growth are Textiles, Agri Products, Dairy Products, Media and Business Consultancy

Normalizing risk indicator lift. Markets are usually ahead of time; and sometimes ahead in the space also. The global sell-off seen over the last three weeks started with concerns on EM and was later supported by select DM indicators. The pace of positive surprises in DMs seems to have slowed down. In India and EMs, the hope that a stable external backdrop will help the much awaited bottoming out of growth seems to be progressing slower- than-expected. As of now, the net impact of a DM recovery and a calibrated Chinese slowdown on India seems uncertain. Last week’s local factors of earnings, politics and growth indicators were mostly disappointing in India. Mid cap outperformance indicates that the local investor sentiment is relatively better.

Temporary twin deficit comfort for equities. The Parliament session has started and is expected to continue till 21st Feb. The vote-on-account is scheduled for 17^th Feb. Parliamentary proceedings are likely to have a limited impact on Indian financial markets. In a constrictive development, the response to the ongoing telecom spectrum sale has been good. This would further aid near-term fiscal comfort. Also, the expected lower inflation print, the end of the current year borrowing program, recent sharp softening in US long bond yields are all technical supports for long bond yields in India. Money market rates, on the other hand, have been inching up in-line with the seasonal pattern. Medium term outlook on rates and rates sensitive equities remain uncertain given the shift of policy inflation to the CPI. Indian currency has been one the better performing EM currencies suggesting higher investor confidence in India’s BoP situation now.

Inflation support, growth not yet. India’s January PMI manufacturing increased from 50.7 to 51.4. PMI services remains below 50. The monthly increase from 46.7 o 48.3 is encouraging through. These indicators are in sync with the management commentary in quarterly earnings reporting. Consensus expectations from this week’s CPI, WPI and IP prints are 9.2%, 5.6% and (-1.0%) oya respectively.

A disappointing week of 3Q FY earnings reports. After a good start of quarterly earnings, the surprise bias turned disappointing over last two weeks. Companies across the sectors – Financials, Consumers, Telecom, Industrials and Cement - disappointed. See below key highlights:

· Almost 60% of Indian large cap companies have reported earnings

· Adjusted profit for the J.P. Morgan covered large cap companies grew 11% yoy (See sectoral details below).

· IT Services companies (ex TCS) have managed to meet elevated expectations. Company managements indicated an improved demand environment for the year ahead.

· Financials have reported increased asset quality stress and in select cases targeted a slowdown in the credit growth momentum.

· Consumer companies are yet to report a positive surprise. Most companies have reported margin pressures on account of higher RM inflation and higher A&P spending, as revenue growth momentum moderated.

· Companies linked to the investment cycle – Industrials, Utilities, Cement – continue to disappoint on lower expectations.

For our coverage universe, we expect an earnings growth of 14%, ex Energy.

DIIs turn buyers; seasonality not as supportive anymore. DIIs turned buyers of Indian equities last week. The current quarter is seasonally the strongest quarter for DIIs, supported by fiscal year ending and tax savings related investments. The quarter accounts for 36% of annual premium collection for insurance companies. The trend is similar for equity schemes of mutual funds. This seasonal local support for equities has weakened over the last two years as investor preference shifted away from equities.

Oases of growth. The current ruling coalition is about to complete its second term. When the election results were announced in 2004, equities corrected sharply as consensus view was that NDA would fare better. After a disappointing start, equities delivered surprisingly solid returns during 2004-08. The second term of the ruling government was a sharp contrast to the first term, starting with the opening day 17% rally in the Sensex. With lower growth the over last three years, Indian corporate performance have been adversely impacted in most sectors. See below some observations on the current growth picture:

· Aggregate revenue growth for the reported BSE 500 universe (Ex Financials) has been 11% yoy in the first three quarters of the current fiscal. (See chart below). The revenue growth is not very different from the CPI level of ~10%, reflecting the dismal real growth picture.

· Sectorally, export sectors are doing well supported by weaker INR. Industry wise details indicate that there are select pockets of strength. Textiles, Agri Products and Pesticides, Dairy Products, Media and Business Consultancy companies have been growing relatively faster.

· Banks credit growth details indicate an interesting picture. Credit growth has been faster in Micro and Small Industries vs. Large and Mid Cap over the first nine months of the current fiscal. This appears counter intuitive and can be linked to the working capital related stress. Growth rates are also higher in retail trade, commercial real estate, personal loans linked to consumer durables, vehicle and housing.

Investor focus has rightly been on the companies with lower leverage and better capital efficiency. The preference could change, if the confidence returns in growth revival. National elections are expected to have a significant impact on corporate confidence. The last two national elections results had one common feature: surprise.

Table 1: Quarterly Earnings Growth – Large cap companies

Sector	3Q FY13 PAT (INR bn)	3Q FY14 Adjusted PAT (INR bn)	Adjusted PAT Growth (% YoY)
Consumer Discretionary	22	25	10
Consumer Staples	35	40	14
Energy	89	84	(5)
Financials	94	98	4
Health care	6	7	26
Industrials	32	23	(28)
IT Services	86	117	36
Materials	24	32	31
Telecom	8	15	97
Utilities	40	41	4
Total	435	481	11
Ex Energy	346	397	15

Source: J.P. Morgan

Figure 1: 3Q earnings reports vs. J.P. Morgan expectations

Source: J.P. Morgan

Figure 2: BSE 500 companies: Sectoral revenue growth – 9M FY14 (% yoy)

Source: CMIE, J.P. Morgan

Equity Strategy

Vesuvius India Ltd - Initiating Coverage - A red hot lining :Centrum

Rating: Buy; Target Price: Rs630; CMP: Rs486; Upside: 29.6%



A red hot lining



We initiate coverage on Vesuvius India Ltd (VIL) with a Buy (~30%
upside). VIL's strong track record unequivocally establishes its
ability to largely transcend the cyclicality of its customer industry
- steel. We are impressed by the company's strong track record in a
technology driven sector that is getting increasingly concentrated,
balanced product portfolio delivering superlative growth, technology
support from global parent, and debt-free balance sheet with
consistent free cash flow. These attributes could buttress continued
outperformance of the stock as in the recent past. The stock currently
has very limited coverage within the institutional sell-side.

$ Balanced product portfolio delivers superlative growth via
expansions: VIL has a well-balanced product portfolio and has
delivered strong volume CAGR of 16.5%/11.7% for unshaped/shaped
segments during CY05-12. The company is increasing its presence in the
fast growing unshaped segment and has hiked its share in revenues to
~33% in CY12 from 26% in CY06. We expect similar trend ahead with
volume CAGR of 12.5%/6.5% for unshaped/shaped segments during
CY12-16E, and estimate the share of unshaped segment rising to 40.8%
by CY16E.

$ Benefits from changing industry dynamics and world leader parent:
Refractory demand is led by steel industry which has seen changing
dynamics with i) steel production shift towards primary steelmakers
who have customized refractory needs, ii) drop in per tonne
consumption of refractories in steel making and iii) weak rupee
allowing for import substitution. These trends have forced some
consolidation, with established players like VIL scoring over small
players, leading to a volume growth of 50% in the past five years for
VIL vis-à-vis 13% for the industry. Strong support for growth through
technology sharing from VIL's global parent Vesuvius plc has provided
the required competitive edge.

$ Best in its peer group with enviable track record and strong
returns: VIL remains at the top end of margins of domestic as well as
global peers (incl. its parent Vesuvius plc). It has shown consistent
growth with EBITDA/PAT CAGR of 13.6%/11.5% during CY03-12, remaining
largely immune to steel cycles. VIL also enjoys highest ROE (16%+) in
the industry at a global level due to its operational efficiency,
despite being debt-free. It has been able to maintain its strong track
record of growth on account of its healthy balance sheet,
technological edge from the parent and efficient working capital
management.

$ Valuation and risks: deserves premium to peers: We expect the
earnings momentum to continue with an EBITDA/PAT CAGR of 13.8%/15.4%
during CY12-15E led by volume growth and operational efficiency. We
believe that VIL deserves the premium which it commands over global
and local peers, and assign (mean+0.5sd) multiples of 7.5x CY15E
EV/EBITDA and 15x CY15E P/E  to arrive at our TP of Rs630. High
valuations of recent deals in the sector provide possible re-rating
benchmarks. Key risks are a sharp increase in imported raw material
costs and extreme stress in the steel industry.





Thanks & Regards

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IREDA Tranche-1/IIFCL Tranche-III/Ennore Poprt Tax Free Bond Public Issue collection figures at 5.00 p.m. as on 24-02-2014

Dear All,

Thanks & Regards

J. P Morgan - India Budget Preview: admirable fiscal restraint, but...

India Budget Preview: admirable fiscal restraint, but pivot needed from quantity to quality

With general elections expected to commence in less than two months, India’s government will present an interim budget (“vote on account”) to Parliament on Monday, February 17, which will stay in effect till the new government announces a full Budget after assuming office. Like last year, there have been growing concerns about the government missing its budgeted fiscal target. But, like last year, we expect the government will not only meet its budgeted target (4.8% of GDP) but likely beat it, and we expect the FY14 outturn to be closer to 4.7% of GDP. On a cyclically-adjusted basis, after netting out asset sales, this would constitute a consolidation of 0.3% of GDP which – though smaller than last year’s 0.7% of GDP consolidation -- reveals admirable fiscal restraint, given the pressures of an election year. However, the quality of the consolidation remains a concern, with tax revenues continuing to slump, forcing the government to engage in non-tax one-offs, push out expenditures to next year, and run up arrears on the subsidy front. For next year, we expect the government to target a deficit of 4.2% of GDP – per the fiscal road-map, corresponding to a gross issuance of government bonds to the tune of Rs 6-6.3 trn. Interim Budgets cannot amend tax laws, and so conventionally have avoided major tax changes—particularly on direct taxes – and so we expect a series of smaller proposals, particularly on the indirect tax front. Instead, interim budgets have typically been high on intent, focusing more on expenditure allocations – although this is only applicable for a few months – and laying out a vision for the future. All that said, achieving a consolidation of 0.5% of GDP next year – as the budget is expected to propose – will be challenging and need a combination of accelerating growth, a greater mobilization of tax revenues through rationalizing rates or increasing the base, and rationalizing fuel and fertilizer subsidies to accommodate increased food subsidies under the Right to Food Security Act. FY14 deficit to meet – and likely beat – budget estimates It seems like ground hog day all over again, with due apologies to Bill Murray. Six months before the end of last financial year, there was a widespread belief that the government’s ability to meet the fiscal deficit number last year was nigh impossible. The Budget had proposed a deficit of 5.1%of GDP, and half way into the year a 6% handle was looming. To their credit, not only did the government meet their budgeted target, they actually beat it with the actual deficit printing at 4.9% of GDP. This has further been revised down to 4.8% of GDP with nominal GDP recently being revised up. History is about to repeat itself, as a similar cycle of concern-resignation-wonder- relief has played out this year too. Till as recently as December, market participants were convinced of significant fiscal slippage, given that 95% of the budgeted deficit had been exhausted. However, just like last year, we expect the FY14 fiscal deficit --- faced with the external pressures of a sovereign ratings threat -- will stay within budgeted estimates (4.8% of GDP) and is, in fact, likely to over-deliver by printing closer to 4.7% of GDP. A cyclically-adjusted consolidated of 0.3% of GDP On the face of it, an outturn of 4.7% of GDP in FY14 versus 4.8% of GDP in FY13 would suggest barely any consolidation. But this is misleading for at least two reasons: , because it needs to take account of asset sales (which are simply an exchange of assets between the public and private sector and therefore do not result in a withdrawal of stimulus) as well as accounting for where in the business cycle the economy was. With asset sales expected to contribute 0.4% of GDP in FY14, versus 0.5% in FY13, net of asset sales, the consolidation is 0.2% of GDP. At the outset this may appear modest, but remember the adjustments have happened in a period of very low growth: the first time in 26 years that GDP growth has printed below 5% for two consecutive years, with a sharp fall in tax buoyancy as a result. Therefore one needs to adjust for business-cycle conditions to get a true measure of the underlying fiscal stance. On a cyclically adjusted basis, the consolidation was 0.3% of GDP which – while lower than the 0.7% of the previous year – still constitutes admirable fiscal restraint in an election year. Quality of consolidation remains a concern The larger concern, however, is the quality of the compression. Reaching the fiscal deficit target in the previous year (FY13) was a scramble and entailed a sharp compression of Plan expenditures (which are more productive) in the last few months of the year. Against that back-drop, this year’s Budget targeted a more desirable and balanced mode of consolidation. The gross tax-to-GDP ratio was budgeted to rise to 10.9% of GDP from 10.1% the previous year, Plan expenditures were budgeted to rise almost 30% -- so as to make amends for being slashed the previous year – and subsidies were budgeted to be reduced a whopping 0.7% of GDP, from 2.6% to 1.9%. We had always found the tax buoyancy and subsidy rationalization proposals to be ambitious (see, “India’s workmanlike Fy14 budget disappoints markets,” MorganMarkets, February 28, 2013) but if the government had able to achieve the proposed mix, it would have been a balanced, efficient and desirable means to undertake the adjustment. As it turns out, however, the consolidation wasn’t able to be carried out in the aforementioned manner. For starters tax collections have severely disappointed, with the gross tax to GDP ratio expected to print at 10.1% of GDP – a whopping 0.8% of GDP below target, and even lower than the 10.3% of GDP in the previous year. Tax buoyancy has fallen further on weak growth impulses. The government also budgeted a hefty 2.1% of GDP in non-tax revenue, but this appears to be on course to being met, though through a different mix than was originally envisioned. Disinvestment proceeds will end up appreciably below the 0.5% of GDP that was budgeted. But this will be largely offset by higher dividends from public sector enterprises, and a better-than-expected telecom auction. Yet, substituting stake sales with dividends may not be the best mix, as the latter could end up compromising potential investment that would/could have materialized. To compensate for these shortfalls, authorities have adopted the same approach as last year – a sharp squeeze in Plan expenditures towards the end of the year – estimated to be between 0.8- 1% of GDP. In particular, given the current run-rate of capital expenditures, we expect non-military capital expenditures to likely print about 0.3% of GDP below what was budgeted. Separately, the three major subsidies (food, fertilizer, fuel) have already consumed 1.8% of GDP in the first nine months of the year, against a full year budget allocation of 1.9%. Given the current run-rate, we expect subsidies to end the year close to 2.3% of GDP, but we expect the revised budget to reflect a cash subsidy outgo of between 2.0-2.1% of GDP, with the rest being accrued as arrears to be paid in the next financial year. So while authorities deserve credit for the degree of fiscal restraint, the focus must be on improving the quality of the adjustment. Postponing Plan expenditures for a second successive year, running up arrears, and relying on one-off dividends from public sector enterprises cannot be a strategy for sustained consolidation. That said, one can argue that authorities had little choice. Given the concerns around India’s twin deficits, the pressure that currency was under, and the risk of a ratings downgrade, fiscal slippage had to be avoided at all costs. With growth weak and revenues disappointing, the government had limited degree of freedom. All this cries out for more fundamental fiscal reform – more base broadening, a goods and services tax, bringing all subsidies under the gambit of the UID to reap the savings from de-duplication – if the medium term path of fiscal consolidation is to be made sustainable. Interim budgets typically high on intent, but constrained on tax front With this being an election year, the government is not authorized to present a full budget, but instead a “vote on account” whose main purpose is to seek parliamentary approval for expenditures to run the government for the next few months until the next government is in place (in May) and presents a full Budget for the rest of the fiscal year. Given this, the government will not be able to propose major tax changes that entail amending any law on the books (Income Tax Act, Customs Act or Excise Act). But changes to the rate structure of indirect tax, for example, which simply entail a notification in Parliament can be introduced, as was done in the interim budgets of 2004 and 2009. Conventionally, therefore, vote on accounts have avoided major direct tax reforms or changes. However, we believe a number of small changes on taxes and duties are possible, including: A potential change in tax slabs Import duty hikes for telecom equipment End-use specific exemptions in service tax Region-specific tax breaks such as excise duty exemption in hill states (which expires in May 2014) Potential easing of curbs on gold (though this remains controversial and may be deemed to be premature) However, like in previous interim budgets, we expect the focus to be on the expenditure side, with the government likely announcing healthy increases in current programs, even as no new schemes are typically announced. Interim budgets have therefore typically been high on intent, with the incumbent government using it as an opportunity to lay out a vision and road-map for the future, and we expect that to continue this time around too. FY15 fiscal target likely at 4.2% of GDP; will be challenging to achieve In line with the medium-term road-map set out by the government, we expect the FY15 budgeted fiscal deficit to be 4.2% of GDP, which would entail an adjustment of 0.5% of GDP next year But unless growth were to accelerate sharply, significant base broadening measure or tax rate changes are proposed in the budget by the new government, or subsidies are appreciably rationalized it will be challenging to achieve. For starters, some of the burden of the adjustment will have to be borne on the revenue front. In FY14, the gross tax to GDP ratio slumped (to 10.1% of GDP from 10.3%), as tax buoyancy waned further in the face of weak growth and compressed corporate margins. This put disproportionate burden on the expenditure front and has resulted in a meaningful reduction in Plan expenditures for a second successive year. Already, the total expenditure envelope (at 13.9% of GDP) has seen a significant compression over the last three years and is even below the average levels in the three years pre-crisis (14.1% of GDP). So there are limits on how much more expenditure compression can be exercised. This is particularly true because food subsidies are expected to rise in FY15 as the Food security Act gets rolled out, and will pressure the total subsidy bill. We expect the FY15 budget to peg subsidies at 1.75% of GDP – in line with the target set out 3 years ago, and down from an assumed 2% of GDP this year. But for that to happen in an environment of higher food subsidies, fuel and fertilizer subsidies would need to be significantly rationalized. Given all this, some of the burden of the 0.5% adjustment in FY15 will have to be borne by tax revenues (since there are limits as to how much more can be garnered in non-tax revenues), which would need to entail some combination of stronger growth, a broader base, and selective increase in rates in the Budget later this year. All this suggests the need for more fundamental tax reform – especially the goods and services tax (GST) – could not be more urgent. Expect gross borrowing in the range of Rs 6.1-6.4 trillion Under our assumption of a fiscal deficit of 4.2% of GDP in FY15 and the fact that 90% of the deficit is typically funded through government securities (vis-a-vis small savings schemes, drawdown of cash balances etc), we expect a net borrowing requirement of Rs 4.7 trillion. With total redemptions of Rs 1.56 trillion coming due next fiscal, the gross borrowing requirement is expected to be close to Rs 6.3 trillion (see, “FY15 India gov bond supply INR6.25tn, 11% up vs. last year,” MorganMarkets, February 13, 2014) – a number that markets appear primed to expecting. The risks could be slightly skewed to the downside given the government is expected to end the year with large cash balances which it could run-down to finance next year’s deficit. Also, small savings mobilizations have been stronger than budgeted, and if that is assumed to hold next year as well, it could induce authorities to potentially finance a slightly smaller fraction of the deficit through market borrowing. All told, we expect gross borrowing to be in the Rs 6.1-6.4 trillion range. Fiscal balance 2009/10 2010/11     2013/4 2013/4 2014/15 (% of GDP)       Actual Budget RE Budget Total revenue 9.4 10.7 8.8 9.1 9.9 9.2 9.5 Tax revenue 7.0 7.4 7.0 7.3 7.8 7.2 7.4 Gross tax revenue 9.6 10.2 9.9 10.3 10.9 10.1 10.3 corporate 3.8 3.8 3.6 3.5 3.7 3.5 3.5 income 1.9 1.8 1.9 1.9 2.2 2.1 2.1 excise 1.6 1.8 1.6 1.7 1.7 1.5 1.4 customs 1.3 1.7 1.7 1.6 1.6 1.5 1.6 services 1.1 1.1 1.1 1.4 1.6 1.5 1.6 Less states' share 2.3 2.0 2.8 2.9 3.1 2.9 2.9 Non-tax revenue 2.3 3.3 1.8 1.8 2.1 2.0 2.1 Total expenditure 15.8 15.4 14.5 13.9 14.6 13.9 13.7 Current expenditure 14.1 13.4 12.7 12.3 12.6 12.2 11.6 Interest payments 3.3 3.0 3.0 3.1 3.3 3.3 3.3 Wages 1.6 1.2 1.1 1.1 1.1 1.1 1.2 Direct subsidies 2.1 2.1 2.4 2.6 1.9 2.0 1.75 Other 7.1 7.0 6.1 5.5 6.3 5.8 5.4 Capital expenditure 1.7 2.1 1.8 1.7 2.0 1.7 2.0 Civilian 1.0 1.3 1.0 1.0 1.3 0.9 1.2 Military 0.7 0.8 0.8 0.7 0.8 0.8 0.8 Primary balance -3.2 -1.7 -2.7 -1.8 -1.5 -1.4 -0.9 Fiscal balance (GOI) -6.5 -4.7 -5.7 -4.8 -4.8 -4.7 -4.2 Less               Divestment & spectrum sales 0.4 1.9 0.2 0.5 0.7 0.4 0.5 Subsidy bonds 0.2 0.0 0.0 0.0 0.0 0.0 0.0 Fiscal balance (standard) -7.0 -6.6 -5.9 -5.3 -5.5 -5.1 -4.7