India’s benchmark stock exchange index surged 23.3 percent year to date through mid-October — roughly ten times the advance of the S&P 500 over the same period — and analysts and market observers believe the best is yet to come. Hopes are high that the economy of the world’s largest democracy is poised to return to the robust, stable growth it enjoyed before the financial crisis.
Much of the renewed enthusiasm over India’s potential can be attributed to one man: Narendra Modi, the 64-year-old leader of the Bharatiya Janata Party who became prime minister in May. The election marked the first time in 30 years that a single party has dominated India’s parliament.
“The market started anticipating strong election results as early as December 2013, when the BJP had fared quite well in state elections,” explains Ridham Desai, who directs Indian equity research at Morgan Stanley in Mumbai.
As 2014 progressed the chances of a BJP victory became more and more likely, but there were questions as to how decisive it would be. When all the votes were tallied the, National Democratic Alliance, a BJP-led coalition, captured 336 of 543 seats, with the BJP itself winning 282 — ten more than the minimum needed to form a government.
November 11, 2014
November 12, 2014
“The election results turned out to be a surprise even for the most optimistic people,” observes Sanjeev Prasad, co-head of institutional equities at Mumbai’s Kotak Securities. “One single party got a complete majority, and it was also the party that had the most progressive economic policy agenda.”
That itinerary is very much on the minds of institutional investors, who are looking for hearty markets in a world that continues to confound even diminished expectations for growth. Last month the International Monetary Fund lowered its forecast for the global economy, to 3.3 percent, but raised its outlook for India, from 5.4 percent to 5.6 percent in the current fiscal year, which began April 1.
“India has recovered from its relative slump,” the IMF declared in its report. “The postelection recovery of confidence in India also provides an opportunity for that country to embark on its much-needed structural reforms.”
To find out which industries are most likely to benefit from the new government’s liberalization efforts, money managers will look to the sell side for direction. The analysts who provide the most helpful insights, they say, work for Morgan Stanley, which returns to the top of Institutional Investor’s All-India Research Team roster after plummeting to sixth place last year. The firm wins 11 positions, more than double the number it captured in 2013 and one more than last year’s winner, Bank of America Merrill Lynch. Kotak repeats in third place, with nine spots. Down two rungs each, to fourth and fifth place, respectively, are CLSA, with eight positions, and Credit Suisse, with seven.
Runners-up account for more than half the totals at this year’s top two firms. When a rating of 4 is assigned to each first-place position, 3 to each second-place position and so on, Kotak is clearly the favorite, earning a weighted total of 27. Morgan Stanley comes in second, with 20; and Credit Suisse leaps to third, with 18. (See “Weighting the Results.”)
The 2014 All-India Research Team reflects the opinions of more than 250 buy-side analysts and portfolio managers at nearly 170 institutions that collectively manage an estimated $98 billion in Indian equity assets.
While Modi has received the lion’s share of attention — at home and around the world — other factors are helping to spur the current market rally, India’s strongest in years. Efforts by the Indian National Congress–led United Progressive Alliance governments, which had been in power since 2004, to improve the economic environment have led to a cyclical recovery.
“The consolidated national fiscal deficit — central plus states — went from a peak of 9.9 percent of real gross domestic product growth in the year ended March 2009 to 7.6 percent in [the year through March] 2014,” reports Morgan Stanley’s Chetan Ahya, who has been No. 1 in Economics every year since the survey was introduced, in 2011. “We believe the consolidated fiscal deficit will reduce further, to 6.7 percent of GDP in fiscal 2014–’15.”
Consumer prices are also rising less rapidly. “Since January the trend in inflation has moderated, due to the reduction in the fiscal deficit, moderation in rural wage growth, lower global commodities prices and a reduction in property prices,” the Hong Kong–based economist adds. “India’s balance-of-payment situation, which had deteriorated sharply, also started improving.” The nation’s current-account deficit, which stood at 6.5 percent of GDP in fourth-quarter 2012, had plunged to 1.7 percent in the first quarter of this fiscal year, Ahya notes.
When Raghuram Rajan, who had been a chief economist at the IMF and chief economic adviser to the government of India, became governor of the Reserve Bank of India in September 2013, the rupee was trading at roughly 68 to the dollar — down 25 percent for the year and just off its lowest level on record. In the previous month the central bank had come out with measures to stanch foreign exchange outflows, including placing restrictions on gold imports, slashing the level of foreign direct investment by Indians and imposing limits on overseas remittances. Rajan facilitated banks’ raising foreign currency deposits from nonresident Indians and also increased the level that financial institutions could borrow from overseas. These initiatives — aided by the U.S. Federal Reserve’s decision to postpone cutbacks to its bond-buying program, which had been expected to begin that month — helped spark a reversal in the currency’s fortunes; by mid-October 2014 the rupee had strengthened to 61.57 to the dollar.
Also in September 2013 the central bank raised its benchmark short-term lending rate by 25 basis points, to 7.5 percent, with additional hikes in November and January; the repo rate currently stands at 8 percent. Rajan has said further increases are unlikely so long as inflation continues to decelerate.
“The government’s efforts to implement policy actions to improve the growth mix — reviving productive investment and cutting back less effective redistributive policies — have increased our confidence that the economy is on track to transition to higher growth and lower inflation,” Ahya says. He predicts output will expand by 6.5 percent in the fiscal year through March 2016 (the IMF is calling for GDP growth of 6.4 percent) and by 7 percent the year after that. Consumer price index inflation slowed to 6.5 percent in September 2014 — down from an average rate of 10.9 percent last year — and Ahya expects it to moderate to a sustainable 6 percent by next July.
Finally, falling commodities prices have also helped boost India’s economy. The country is heavily reliant on commodities imports, especially oil — India imports about 80 percent of its annual supply. The price of Brent crude has dropped from a 2014 high of just over $115 a barrel in June to approximately $85 in mid-October. Lower costs have allowed Modi to end government subsidies on diesel prices and to raise those on natural gas, two gestures seen as significant in reforming the country’s energy sector.
“The deregulation of diesel can have a material impact on the profitability of the three oil marketing companies” — Bharat Petroleum Corp. and Hindustan Petroleum Corp., both of which are based in Mumbai, and New Delhi’s Indian Oil Corp., explains Sanjay Mookim, who rises from second place to capture top honors in Oil & Gas for the first time since 2011. “These companies should now be able to expand gross margins on the retailing of these fuels.”
In September 2013 the Credit Suisse analyst, who works out of Singapore, upgraded Bharat Petroleum from underperform all the way to outperform, dubbing the shares a bargain at Rs308.19. In May the company reported that net profit had reached a record Rs40.6 billion ($678.2 million) in fiscal 2013–’14, an increase of some 54 percent over the previous year, and earnings per share jumped from Rs36.55 to Rs56.16. By mid-October the stock had skyrocketed more than 116 percent, to Rs666.75, and was ahead of the sector by nearly 102 percentage points, since the upgrade. Mookim remains bullish, with a target price of Rs840.
“The last leg of critical reform in the oil sector is the revamp of the official subsidy policy,” Mookim contends. “Today the oil ministry decides a subsidy number in an ad hoc manner, and Oil and Natural Gas Corp., a state-owned upstream firm, pays it. There has to be transparency in the collection process from ONGC and the distribution process to oil marketing companies. This will help state-owned oil companies plan their cash flows and investments better.”
Free-market diesel pricing is also expected to have a positive impact on India’s automobile industry, which has been emerging from a slump that began in 2011. Auto sales turned positive earlier this year, after the election, and have continued to surge — a development that in some respects was inevitable, according to Jefferies analyst Govindarajan Chellappa, who climbs from second place to lead the Autos & Auto Parts lineup for the first time since 2011.
“After three years of slowdown, demand would have anyway recovered because in a growing economy like India’s, it is hard for the auto industry to not grow for an extended period of time,” the Mumbai-based researcher says. In September, Chellappa upgraded Tata Motors from hold to buy, at Rs516.25, after the vehicle manufacturer posted its largest quarterly profit increase since 2010, in part because of continuing strong demand from China. He also believes that the improving domestic truck market justifies a price objective of Rs627 for the Mumbai-based concern.
“I upgraded Tata Motors and I expect much better upside from it compared to [Maruti Suzuki India] given the current price and the target price,” he explains. Among makers of two-wheeled vehicles, “my preference for Hero MotoCorp over Bajaj Auto continues,” he adds. The former is headquartered in New Delhi; the latter, in Pune.
Just days after the oil and gas reforms, the government announced that over the next three to four months it would auction more than 70 coal-mining licenses to private companies, following the Supreme Court’s September decision to cancel some 200 such permits on the grounds that they had been issued without competitive bidding — a process that had been in place since 1993.
“The government has laid out the road map to restart the process of coal block allocation, and it is broadly as expected and positive for the sector,” affirms Mumbai-based Pinakin Parekh, who celebrates his third consecutive victory in Basic Materials. “The time line is a bit aggressive, but it shows intent on the government’s part.”
The J.P. Morgan analyst alerted clients to a buying opportunity in August 2013 after a sell-off in the metals and mining sector triggered by concerns over declining demand. He advised them to pick up shares of Mumbai-based Hindalco Industries, Goa’s Sesa Sterlite, Steel Authority of India of New Delhi and Tata Steel, which is also headquartered in Mumbai. These particular companies are highly leveraged, he argued, and their capital expenditure cycles were ending just as the economy was showing signs of improving. In the 12 months through mid-October, Hindalco’s shares gained 26.2 percent; Sesa Sterlite’s, 28.1 percent; Steel Authority’s, 37.4 percent; and Tata Steel’s, 47.3 percent. During the same period the sector rose 19.1 percent.
Other industries are facing more formidable challenges — banking, for one. India’s economy expanded by less than 5 percent in each of the past two fiscal years, and “the slowdown has clearly triggered the nonperforming-loan cycle,” attests Aashish Agarwal, who is No. 1 in Financials for a fourth year running. “It is more likely to impact small and medium enterprises. Before it gets extended to larger firms, you will see a pickup in economic growth or deleveraging.”
The CLSA analyst, who is stationed in Mumbai, says corporate lenders are trading at a discount to retail banks because of concerns about their exposure to bad loans. However, he thinks such fears are overblown. Over the past year and a half, many companies saddled with debt have been selling off noncore assets, and that has lessened the likelihood of widespread defaults. “This has led to a relief rally in some of the corporate lenders like ICICI Bank, Axis Bank and even IDFC, to a certain extent,” Agarwal says. Indeed, the Bank Nifty, an index that tracks India’s bank stocks, shot up 40 percent year to date through mid-October.
He maintains valuation-based overweight ratings on Axis and ICICI, both of which are based in Mumbai. The stocks outpaced the sector by a split-adjusted 51.5 and 24 percentage points, respectively, in the year through mid-October.
The nation’s Index of Industrial Production slowed to 0.4 percent year over year in August — a five-month low — as manufacturers scaled back output on falling demand. That has investors wary, according to Venugopal Garre. The Barclays analyst climbs one level to finish on top for the first time in Capital Goods and also earns the No. 2 spot in Power. (Garre is one of only three analysts this year to win highest honors in one sector and also rank in another; matching this feat are Deutsche Bank’s Manoj Menon, who lands on top of both Consumer categories, and Kotak’s Rohit Chordia, deemed the best in Telecommunications and a runner-up in Consumer/Staples.)
“At present, valuations of the capital goods sector are rich — over 24 times forward earnings — and investors are sitting on the sidelines waiting for some policy change,” the Mumbai-based researcher says. In August 2013 he upgraded Larsen & Toubro from equal weight to overweight, at Rs739.21, on rising demand for the Mumbai-based engineering and construction company’s services. Good call. The stock had vaulted to Rs1,452.90 by mid-October 2014, a gain of 96.5 percent that trumped the sector by 16.2 percentage points. At the start of the year, he urged clients to buy L&T’s crosstown rival Voltas, at Rs117 — “a fundamental call based on earnings recovery,” he says. In the nine and a half months since, the share price has nearly doubled, soaring to Rs230.10. He continues to recommend both stocks.
Garre is upbeat over the long term, especially regarding companies with exposure to infrastructure development. “There is overcapacity in power both in terms of existing capacity and capacity under construction,” he advises. “The issue is more to do with coal availability and railway links to transport the coal, which boils down to infrastructure spending — not power spending.”
India was one of the hardest-hit markets last year after officials with the Fed indicated plans to scale back the central bank’s program of quantitative easing. The next big hurdle for many emerging markets is investor reaction to a Fed rate hike, widely expected to happen toward the middle of next year.
“There could be some short-term turmoil until the world adjusts to the new liquidity situation, but as long as things are well flagged, like we saw in the [end of] quantitative easing, it will not be a huge impact,” believes Jyoti Jaipuria, BofA Merrill’s Mumbai-based head of India equity research (and a runner-up in Portfolio Strategy). “Today the differential between U.S. and Indian rates, both inflation and interest, is at an all-time high, so to that extent India is in a position to adapt its monetary policy and bring rates down even as the U.S. raises interest rates.”
Kotak’s Prasad agrees. “We are in a much better position compared to the rest of the world,” he says. “The U.S. will raise interest rates only when the economy is doing well — and a strong U.S. economy is good for the world.”
Prasad, who ranks highest in Portfolio Strategy for a second year running, does admit to turning slightly bearish, however. “In the last three to four months, we have moved money to more defensive plays like consumer staples, information technology and health care and reduced the big weights we had in automobiles and energy. The weightage of banks is more or less the same. We expect consumer staples to benefit from low commodities prices, and they have pricing power.”
Nonetheless, he and others believe that clients are committed to India and will withstand whatever shocks next year might bring. “Foreign investors are overweight on India, and their position is the highest ever,” Prasad reports. “Global emerging-markets funds have an India weightage of 12 to 13 percent, compared to the benchmark India weight of 8 percent.”
Morgan Stanley’s Desai, who ranks third in Portfolio Strategy, concurs. “Except for a couple of occasions when foreign investors wavered — once in December 2011 and then again in May 2013 — there have been continuous inflows,” he says. “We have a net cumulative inflow of $100 billion in the last five and a half years. That’s twice the investment in the previous bull market.”