18 June 2014

J.P. Morgan - The Hurry and the Hurray for Cyclicals

Indian Equities
The Hurry and the Hurray for Cyclicals

· Internal signals and external noise remain supportive for Indian equities
· RBI's message can be interpreted as a shift from “hike-or-no-hike” to “cut-or-no-cut”; one year OIS has eased a significant 50 bps since the April policy meeting
· Defensive aggregate portfolio positioning is expediting the cyclical-chase; institutional portfolio beta at historic highs
· Capital inflows momentum continues; YTD long bond yields have softened across key economies
· Government in preparatory discussion and signaling mode; Union budget expected to be presented in first week of July
· Improved sentiment could be helping the bottoming out in growth indicators; analysts remain cautious
· Domestic mutual funds turned buyers of equities over the last fortnight; some new fund offerings announced
Signal and Noise confluence. The upmove in Indian equities continued last week. Since the date of election result, MSCI India has gained (6%) led by high beta cyclical sectors. Key supports for the bulls last week were: 1. Market friendly signals by the new government; 2. Interpretation of RBI’s policy message and monthly growth indicators; and 3. External developments, especially the ECB announcement on negative deposit rate and encouraging growth indicators in select key economies supported risk assets. Overall, the combination of expected higher growth, softening in long bond yields and improved risk appetite supported the performance of Indian equities last week.
Figure 1: MSCI India –Sectoral performances since the National election result (%)
Source: MSCI, Bloomberg
The hurry and the hurray for cyclicals. We highlighted in our earlier notes (links below) that if we see a repeat of 2004 to 2008 kind of accelerated growth momentum, the relative outperformance of cyclicals may continue over the medium term. There are fundamental bottlenecks that need to be addressed. Some of the known challenges are: elevated inflation, banking systems’ constrained capacity, a risk averse government machinery and excessive corporate leverage. The new Government’s initial policy signals have been well received by equity investors towards addressing these macro concerns. Translation of these signals into effective execution is the key towards the performance of cyclicals ahead, in our view. The recent outperformance of cyclicals has dimensions besides the fundamentals. Some facts:
1. Last four years of difficult domestic macro environment were relatively less turbulent for Consumer Non-durables and Export sectors. Domestic cyclical sectors consistently disappointed. The trend combined with low risk appetite resulted in a significant polarization in portfolio positioning and index weights in favor of more stable segments of the economy.
Table 1: BSE 500 index weight - Since the start of current cyclical slowdown
(%)
Mar-10
Mar-14
Change
Consumer Staples
5
10
5
Information Technology
9
14
5
Consumer Discretionary
7
9
3
Health Care
4
6
2
Financials
18
19
1
Telecommunication Services
3
4
0
Energy
15
14
(1)
Materials
14
10
(4)
Utilities
9
5
(4)
Industrials
15
8
(6)




Source: Bloomberg, J.P. Morgan
2. FIIs were the primary drivers of Indian equities over the last four years. Within FIIs, flows were concentrated in regional funds and select India dedicated funds. Aggregate FII portfolio positioning indicates that the funds were primarily deployed in relatively defensive sectors.
Figure 2: Change in FII portfolio weights (March 2010 – March 2014)
Source: CMIE, J.P. Morgan. Data for BSE 500 universe
Figure 3: Institutional holding trend – Indian Equities
Source: CMIE, J.P. Morgan. Data for BSE 500 universe
3. Post the bull-surprise in the national election result, the pace of re-balancing seems to have accelerated. Portfolio beta of domestic mutual funds and FIIs has reached historic highs. The extent of optimism/ risk appetite seems to be higher among domestic fund managers. Also, see below valuations for cyclical / SMID, which have not yet turned “optically” prohibitive based on historical trading range (Price to Book ratio).
Figure 4: Domestic mutual fund equity schemes – Beta trend
Source: Bloomberg, J.P. Morgan. Trend of top 40 growth schemes
Figure 5: India dedicated FIIs – Beta trend
Source: Bloomberg, J.P. Morgan. Trend of 15 key India dedicated funds, with aggregate AUMs of US$ 18bn.
Policy ground work. Media reports (Source: PIP) indicate that the new Government is busy in the preparatory work towards the Union budget and the 100-day-plan. The policy signals are on the expected lines of reviving growth through renewed focus on broader infrastructure and more effective / efficient use of Government machinery. Continuing with the fiscal imperative, Diesel price has been hiked by 0.50 Rs/ liter last week. The Union budget, schedule to be presented in the first week of July, is going to be the first comprehensive indication of new Government’s policy priorities.
RBI signal and external noise: The discussion in credit policy seems to have shifted from “hike or no hike” to “cut or no cut”. One year OIS rate has eased a significant ~ 50 bps since the April policy meeting. Cut in the SLR has limited direct implications. But, it’s a welcome signal with implications for fiscal consolidation and credit availability for the private sector ahead. The trend of lower cost of capital is incrementally positive for capital intensive sectors and not as favorable for sectors with higher RoCE/ cash surplus sectors. Separately, the ECB policy announcement on negative deposit rate, better than expected US non-farm pay-roll and better Chinese PMIs, all supported the performance of risk assets. Surprisingly, most key economies have seen long bond yield softening YTD. The risk of reduced global liquidity is not panning out as much as feared earlier this year.
Figure 6: Changes in 10 year treasury yields - YTD, bps
Source: Bloomberg
Search for Green shoots. The search for green shoots has increased here. There are some early signs of improvement in growth outlook. Monthly car sales increased 7.4% oya. PMI services increased from 48.5 to 50.2, the first print above 50 in last 11 months. The change in PMI manufacturing has been more muted. Core sector IP growth revived to 4.2% oya. The growth in core sector is also important as the sector is widely believed to be most impacted by policy issues and is also the source of substantial NPA problem for banks. Equity analysts remain cautious. Earnings estimates were cut across sectors last month.
FII buying, DII selling continues. Aggregate institutional activity indicates that the upmove in equities is still driven by the FIIs. DII participation has been limited. Domestic mutual funds have turned marginal net buyers over the last fortnight. Insurance companies continue to be net sellers. Retail participation has increased and is also reflected in sharp move in small and mid cap stocks. Trading volumes have increased sharply for small and mid cap stocks. Also, a few key mutual funds have announced new fund offerings, reflecting improved retail investor sentiment.
Figure 7: Mid Cap index and trading volume composition
Source: Bloomberg. BSE info – Small Mid Cap is aggregate minus BSE 100 trading value
Valuation Snapshot – Cyclicals / high beta sectors
Figure 8: MSCI India Energy: Price to Book ratio
Source: MSCI, Datastream
Figure 9: MSCI India Utilities: Price to Book ratio
Source: MSCI, Datastream
Figure 10: MSCI India Materials: Price to Book ratio
Source: MSCI, Datastream
Figure 11: MSCI India Financials: Price to Book ratio
Source: MSCI, Datastream
Figure 12: BSE Small Cap Index: Price to Book ratio
Source: Bloomberg
Figure 13: BSE Mid Cap Index: Price to Book ratio
Source: Bloomberg

Election euphoria does not translate into demand growth or PLF improvement in May - JPMorgan

Election euphoria does not translate into demand growth or PLF improvement in May

In May, energy demand was flat yoy (up 7% mom); while peak demand grew by 2.4% yoy. Peak deficit was 4.1%, down 220bps yoy and 80bps mom, while the energy deficit was 3.8% down 190bps yoy and 20bps mom. As per CEA forecasts, power supply is expected to increase by ~6% yoy in FY15, led by the private sector. The generation target implies a thermal PLF target of 65.5%, almost flat compared to FY14; however, on a larger capacity base.
Figure 1: India's Power deficit
%
Source: CEA. Note: May‘14 figures are provisional.
Figure 2: Monthly peak and energy demand growth
%
Source: CEA. Note: May’14 figures are provisional.
Despite May being the last month of the election campaign, thermal PLFs were sedate. National thermal PLF decreased by 140bps mom and 340bps yoy to 68.2% in May. Central Utilities continued to report higher PLFs, up 80bps yoy to 78% led by NTPC (+300bps yoy in coal PLF to 84%). State and IPP PLFs both declined by 580bps and 440bps respectively to 61% / 67% respectively, IPP PLF improved mom by 140bps.
Figure 1: Sector wise All India PLF (in %)
Source: CEA. Note: May 2014 numbers are tentative.
· CIL dispatches are up 6% yoy, but all IPPs didn’t benefit: In May, Coal India’s dispatches increased 6% yoy, while NTPC benefited with a +300bps yoy improvement in its coal plant PLF to 84%, some IPPs still operate at low PLFs. Domestic coal based plants like JPVL’s Bina (70% vs. 33%), Adani (67% vs. 60% for Tiroda and & 77% vs. 54% for Kawai) reported a mom increase in PLF in May. Newly commissioned Indiabulls’ Amravati (44% vs. 28%) and RPWR’s Butibori (76% vs. 59%) fared better, however JSPL’s Tamnar II reported only a 7% PLF and KSK’s Akaltara (51% vs. 62%) reported a decline. Sterlite’s Jharsuguda (39% vs. 52%), CLP (36% vs. 32%), and Lanco’s Amarkantak (49% vs. 44%) continued to report low PLFs while TPWR’s Maithon PLF declined (74% vs. 80%).
Figure 1: Coal India: Production and Dispatch volume
MMT
 Source: Coal India
· NTPC coal PLFs improve, significant capacity to be eligible for incentives in FY15: NTPC reported 84% PLF for its coal based plants in May up 300bps yoy and 87% in April up 940bps yoy. The significant yoy improvement is driven by the Farakka and Kahalgaon plants, which have a new coal transport system in place via inland waterways as well as the Sipat, Simhadri and Talcher plants. In May, 8 of the 16 commercial coal plants totaling 16GW of capacity (50% of total) reported >85% PLF vs. 11 plants totaling 26GW (~80% of total) in April, thus being eligible for incentives in the new regulatory regime. For all gas based capacity (4GW) PLF was <85 p="">
· Imported coal based plants show better PLFs again on the back of benign input costs: Since the beginning of the year, Indonesian coal prices are down 7-8% in US$ terms, while South African coal prices have declined by ~12%. Meanwhile, the INR has appreciated by ~4%, translating into a 11-16% decline in imported coal costs for Indian utilities. Reduced cost of fuel will help power producers like JSW (low fixed costs, merchant tariff) and Adani Power (fuel cost under recovery in PPA) rise up in the merit order of dispatch for cost conscious SEBs thus boosting PLF. JSW’s Ratnagiri (73% vs. 50%), Lanco’s Udupi (79% vs. 80%), RPWR’s Rosa (97% vs. 91%), TPWR’s Mundra (flat at 74%), Adani’s Mundra (89% vs. 85%) and JSW’s Vijaynagar (102% vs. 104%) all reported flat to improving PLFs.
Figure 2: Richards Bay Coal Index (6,000 kcal/kg)
Source: Bloomberg.
Figure 3: Indonesia Ecocoal Index (4,200 kcal/kg)
Source: Bloomberg.
Figure 4: Indonesia Melawan Coal Index (5,400 kcal/kg)
Source: Bloomberg.
· Captive coal based plants: The three units of Sasan reported 65% vs. 75% in April. With a renewed annual mining quota, JSW’s Barmer reported 82% PLF in May up 200bps from April. JSPL’s Tamnar plant reported a mom flat PLF of 99%.
· Hydro season gets off to a slow start for JPVL: For the country, hydro power production is up 9% yoy ahead of the 3% capacity addition implying better PLF in May. However, JPVL’s Baspa (52% vs. 71% in May’13) and Karcham Wangtoo (56% vs. 80%) plants have reported a significant decline in PLF. Post the flood related repairs, the company’s Vishnuprayag hydro project restarted production in April after a gap of 9 months, reporting a PLF of 56% vs. 69% last year.
Table 1: India Power Sector: Monthly PLFs

Production Units (mn units)
PLF

May '13
Jan'14
Feb'14
Mar'14
Apr'14
May'14
May '13
Jan'14
Feb'14
Mar'14
Apr'14
May'14
Torrent Power
438
449
371
472
472
594
36%
37%
34%
39%
40%
48%
AECO (500MW)
244
277
181
267
269
380
66%
74%
54%
72%
75%
102%
Sugen (1147.5MW)
194
172
190
206
203
213
23%
20%
25%
24%
25%
25%
Reliance Power
891
946
1,232
1,491
2,102
2,159
80%
47%
65%
58%
77%
77%
Rosa (1200MW)
792
552
659
706
782
866
89%
62%
82%
79%
91%
97%
Butibori (600MW)
99
-
-
17
255
338
44%
0%
0%
8%
59%
76%
Sasan (1,980MW)

394
573
768
1,065
955

44%
65%
52%
75%
65%
Reliance Infra
411
288
380
415
385
427
72%
50%
74%
73%
70%
75%
Dahanu (500MW)
357
224
325
364
373
380
96%
60%
97%
98%
104%
102%
Goa (48MW)
22
22
20
22
13
22
61%
61%
62%
61%
36%
61%
Samalkot (220MW)
33
42
34
30
-
25
20%
26%
23%
18%
0%
15%
Lanco
1,669
1,702
1,644
1,826
1,849
1,904
57%
59%
63%
63%
66%
66%
Aban (120MW)
58
65
65
67
66
74
65%
73%
81%
75%
76%
82%
Kondapalli 1&2 (716MW)
147
110
150
145
159
135
28%
21%
31%
27%
31%
25%
Amarkantak (600MW)
210
181
193
215
191
219
47%
41%
48%
48%
44%
49%
Udupi (1200MW)
675
737
690
717
693
703
76%
83%
86%
80%
80%
79%
Anpara (1200MW)
563
609
542
675
726
741
63%
68%
67%
76%
84%
83%
Budhil (70MW)
17
-
3
7
14
33
32%
0%
7%
14%
28%
63%
JSW Energy
1,973
1,604
1,156
1,164
1,696
1,968
84%
69%
55%
50%
75%
84%
Vijaynagar (860MW)
615
617
602
651
647
654
96%
96%
104%
102%
104%
102%
Ratnagiri (1200MW)
768
592
529
424
430
655
86%
66%
66%
47%
50%
73%
Barmer (1080MW)
590
395
25
89
620
660
73%
49%
3%
11%
80%
82%
Adani Power
2,898
4,735
3,595
4,533
4,491
5,139
66%
80%
68%
75%
73%
81%
Mundra (4,260MW)
2,522
2,803
2,329
2,641
2,827
3,075
73%
82%
75%
77%
85%
89%
Tiroda (1,980MW)
376
1,183
897
1,174
1,149
1,312
38%
80%
67%
72%
60%
67%
Kawai (1,320MW)

749
369
717
516
753

76%
42%
73%
54%
77%
GVK
71
98
87
78
53
74
10%
14%
14%
11%
8%
11%
J1 &2 (455MW)
71
98
87
78
53
74
21%
29%
28%
23%
16%
22%
Gautami (464MW)
-
-
-
-
-

0%
0%
0%
0%
0%
0%
GMR
255
602
570
562
683
688
24%
46%
49%
43%
53%
38%
Vemagiri (370MW)
2
-
-
-
-
-
1%
0%
0%
0%
0%
0%
Mangalore (220MW)
-
-
-
-
-
-
0%
0%
0%
0%
0%
0%
Basin Bridge (200MW)
91
36
71
97
110
90
61%
24%
53%
65%
74%
60%
EMCO (300MW)
19
324
278
249
302
323
9%
73%
69%
56%
68%
72%
Kamalanga (1050MW)
142
242
221
216
270
276
55%
93%
94%
83%
104%
35%
NTPC (37,032MW)
19,938
21,431
19,670
21,519
21,568
21,301
75%
78%
79%
78%
81%
77%
Coal (33,015MW)
18,642
20,422
18,654
20,451
20,326
20,217
79%
83%
84%
83%
85%
82%
Gas (4,017MW)
1,295
1,010
1,016
1,068
1,242
1,084
43%
34%
38%
36%
43%
36%
Tata Power
3,899
3,681
3,495
3,525
3,665
3,746
70%
66%
70%
64%
68%
68%
Mumbai License Area (1,580MW)
822
483
412
449
552
586
70%
41%
39%
38%
49%
50%
Mundra UMPP (4,000MW)
2,152
2,310
2,323
2,167
2,144
2,205
72%
78%
86%
73%
74%
74%
Maithon (1,050MW)
599
584
485
585
607
581
77%
75%
69%
75%
80%
74%
Jojobera (441MW)
200
173
173
213
240
239
61%
53%
58%
65%
76%
73%
Bhira (150MW)
66
73
52
59
71
83
59%
65%
52%
53%
66%
74%
Bhivpuri (75MW)
35
35
29
32
36
36
64%
63%
57%
57%
67%
65%
Khopoli (72MW)
24
24
22
20
15
16
45%
45%
45%
37%
30%
30%
Belgaum (81MW)
-
-
-
-
-
-
0%
0%
0%
0%
0%
0%
JPVL
1,099
408
347
149
358
957
67%
25%
23%
9%
23%
58%
Vishnuprayag (400MW)
204
-
-
-
44
165
69%
0%
0%
0%
15%
56%
Baspa (300MW)
158
33
28
30
39
115
71%
15%
14%
13%
18%
52%
Karcham Wangtoo (1000MW)
597
114
95
119
157
416
80%
15%
14%
16%
22%
56%
Bina (500MW)
139
261
225
-
118
261
37%
70%
67%
0%
33%
70%
Sterlite
1,205
550
582
720
894
704
67%
31%
36%
40%
52%
39%
Jharsuguda (SEL 2400MW)
1,205
550
582
720
894
704
67%
31%
36%
40%
52%
39%
China Light and Power
307
642
408
421
302
351
31%
65%
46%
43%
32%
36%
Jhajjar (1,320MW)
307
642
408
421
302
351
31%
65%
46%
43%
32%
36%
JSPL
759
498
591
737
833
795
102%
67%
88%
99%
53%
99%
Jindal Power (1000MW)
759
498
591
737
714
735
102%
67%
88%
99%
99%
99%
Tamnar (1,200MW)




120
59




14%
7%
KSK Energy
268
150
330
433
274
319
67%
37%
43%
51%
33%
38%
Wardha Warora (540MW)
268
150
89
155
5
93
67%
37%
24%
39%
1%
23%
Akaltara (600MW)


241
278
269
226


60%
62%
62%
51%
ACB
262
270
277
310
288
292
67%
69%
78%
79%
76%
74%
Korba (270MW)
155
158
167
183
188
181
77%
79%
92%
91%
97%
90%
SPGL (208MW)
79
110
108
107
72
84
51%
71%
77%
69%
48%
54%
Ratija (50MW)
27
3
2
20
28
28
74%
7%
5%
55%
79%
75%
Indiabulls Power

116
198
181
109
176

58%
48%
45%
19%
29%
Amravati (540MW)

116
191
181
109
176

58%
91%
90%
28%
44%
Nasik (270MW)


7
-
-
-


4%
0%
0%
0%
Source: CEA, J.P.Morgan. Note: May 2014 numbers are tentative. NTPC’s reported PLF defers from our calculated PLF in the table above.