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India the best performing market
July, 20th 2009

The quarter ended June 2009 saw the BSE Sensex gyrating with elation after the results of the general elections, rising in anticipation of a path-breaking budget, only to sag in disappointment over just another run-of-the-mill budget presentation in July. Even after the negative reaction, however, the sensex quotes 40% higher than the lows of March 2009. I believe the worst is over, and India is emerging as one of the best performing markets.

Indian companies have begun to announce their June quarter results. I expect most sectors to report positive earnings growth; the exceptions would be metals and real estate. Overall sensex earnings for the quarter are likely to be 17% lower year-onyear; excluding metals and real estate. However, sensex earnings would be flat year-on-year and up 2% quarter-on-quarter. Twenty of the 30 sensex stocks would report positive earnings growth, led by Bharti Airtel and State Bank of India.

The last 2-3 quarters saw a stream of downgrades in analysts earnings estimates. The cycle of downgrades in Indian corporate earnings now seems to be behind. I believe the period FY08-10 marks a period of consolidation for Indian corporate earnings, similar to the period of consolidation during FY00-03. Post the consolidation, earnings grew at a CAGR of 25% over FY03-08 . Commissioning of a large number of mega projects coupled with recovery in the global and domestic economies would mark a repetition of the strong earnings growth trend and upgrades starting FY11, in my view.

Going forward, the big drivers for upgrade of aggregate earnings growth for Corporate India would come from cyclicals/high-beta names. We are yet to see major changes in estimates for these stocks, post the major downgrade in 2HFY09. These stocks are highly sensitive to business cycles, with small changes in assumptions resulting in large changes in earnings growth. MOSL estimates sensex EPS for FY10 at Rs 883, flat growth over FY09. Though 1HFY10 would see an 18% drop, sensex EPS would grow 29% in 2HFY10.
For FY11, MOSL estimates sensex EPS at Rs 1,028, implying a growth of 16% over FY10. The key contributors to earnings growth would be Tata Steel, State Bank of India, Reliance Industries, ICICI Bank, HDFC Bank, and Bharti Airtel. Of the 30 sensex stocks, 23 would contribute positively to earnings growth in FY11.

Sensex earnings would grow at a CAGR of 8.6% over FY09-11 v/s a CAGR of 10.1% over FY07-09. Though growth would decelerate, the magnitude of deceleration would be low. Sensex EPS CAGR over FY02-11 would be ~18%.

While I am enthused by the expectations of a bounce-back in corporate earnings growth, upgrades in earnings estimates would depend on a speedy revival in the global economy, buoyancy in domestic businesses, proactive government policy actions and near normal monsoons. The markets had built up high expectations from the Union Budget for FY10, which was presented in the backdrop of a very positive political mandate. However, the lack of bold reform-oriented measures and an inadequate disinvestment target for FY10 was viewed very negatively by the markets.

To be fair, the finance minister was faced with a challenging job. He had to walk the tight rope between stimulating growth and curbing fiscal deficit. The fiscal deficit estimate for FY10 has shot up to 6.8%, largely as a result of the stimulus packages announced earlier. That the FM chose not to roll back any excise duty cuts announced as part of these packages and that he even spared cigarettes from an excise duty hike, shows his leanings towards growth stimulation. Had the fiscal conditions been more benign, he would have had room to take more aggressive steps.

A small target on disinvestment in FY10 is disappointing . However, the positive intent of reducing stake in most state-owned enterprises is heartening and leaves significant scope to raise resources. The rural economy got another boost, with a 144% increase in NREGS allocation. Allocations to infrastructure development schemes for FY10 saw a meaningful increase. Other reforms such as oil price deregulation, and hikes in FDI/FII limits are still on the agenda and would be considered later. In the finance ministers own words, ... a single budget speech cannot solve all our problems, nor is the Union Budget the only instrument to do so.

It is also encouraging to note that the government , in its published medium-term fiscal policy statement, has made its intention clear to roll back fiscal deficit to 5.5% of GDP in FY11 and further down to 4% in FY12. What is not clear, however, is a roadmap for the same. Also, the monsoons continue to pose a worry. IMD has already predicted below normal monsoon season rainfall over the country as a whole. It had also predicted that the monsoons would cover the entire country by the middle of July; a further delay in the progress of the monsoons could have significant implications.

As the dust settles on the budget pronouncements , market attention would once again turn to quarterly earnings, global markets and the progress of the monsoons. Indian equities appear fairly valued at current levels, but I believe that the probability of earnings upgrades is high. I am also optimistic on the economic reforms front. The markets would continue to face turbulence for a while, throwing up good opportunities to invest.

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