hsbc india roe0115

Corporate India’s ROE bottoming after

the past few years’ decline

Valuations potentially beginning to reflect ROE revival

Industrials, materials and telecoms set to see largest ROE uptick (we have an overweight stance on these sectors)

Historical valuation premium fuelled by better ROE. The

Indian market has traditionally traded at a PE valuation

premium versus the rest of Asia ex-Japan. Higher economic

growth, coupled with better return on equity (ROE), has

arguably been the driver of the premium.

Corporate India’s ROE has declined since 2008 but is now

poised for a revival. ROE has fallen in most sectors since

2008, particularly among domestic cyclicals, due to:

The rising cost of resources (spectrum in telecoms, land

in infrastructure/real estate etc)

Higher levels of interest rates to temper inflation

Rising component of overseas revenues – reflective of

lower ROE/COE in DMs are a few that top the list.

Although we do not expect ROE to return to the highs of

2005-08 (when India’s ROE averaged 23.5%) anytime soon,

we believe it has bottomed and expect profitability to

improve. We forecast ROE to rise by 150bp (to 16.5%) by

FY16 and 200bp (to 17%) by FY17 from the current level of

15%. Cyclicals could lead the uptick, supporting our

overweight stance on domestic cyclicals (see India Equity

Insights: Tug-of-war between defensives and domestic

cyclicals, 17 October, for more details). We retain our

underweight stance on defensive sectors.

Margin uptick, faster asset turn and fall in borrowing

costs are key catalysts for an expected ROE uptick. Our

five-step DuPont analysis shows that the uptick in ROE will

be driven by a fall in interest rates, increase in operating

margins and uptick in asset turn. Tax burden and equity

multiplier effects remain broadly stable in explicit forecasts.

With valuations already partly reflecting an improvement in

ROE in 2015, earnings will likely take over as the key driver

of returns.

Equity Strategy India

India Equity Insights

The inflection point in Indian ROE

6 January 2015 Jitendra Sriram* Equity Strategist and Head of Research, India HSBC Securities & Capital Markets (India) Private Limited +91 22 2268 1271 [email protected]

View HSBC Global Research at: http://www.research.hsbc.com

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

Issuer of report: HSBC Securities and Capital Markets (India) Private Limited

Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

http://www.research.hsbc.com/

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=3CIeSf2c0G&n=433517.PDF



2

Equity Strategy India 6 January 2015

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ROE analysis in charts

1. ROE gap – Convergence till 2010; slow expansion thereafter (%)

0

5

10

15

20

25

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

MSCI India MSCI EM

Source: Thomson Reuters Datastream, MSCI, HSBC Note: Data on calendar year basis

2. Valuation gap – Convergence a year ahead of ROE convergence in 2010; expansion thereafter (12 months forward PE)

0

5

10

15

20

25

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

MSCI India MSCI EM

Source: Thomson Reuters Datastream, MSCI, HSBC

3. 12 month forward PB vs. ROE/COE – Market potentially factoring COE compression on rate cuts as PB expands (MSCI India)

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1.0

1.3

1.6

1.9

2.2

Jan-

04

Oct

-05

Jul-0

7

Apr-0

9

Jan-

11

Oct

-12

Jul-1

4

ROE/COE (LHS) Fwd PB (x)


3


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ROE breakdown for India using DuPont analysis

4. Five-step DuPont analysis of Nifty index (ex-financials)

Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Tax Burden 0.72 0.74 0.74 0.74 0.73 0.74 0.75 0.73 0.71 0.74 Interest Burden 0.94 0.95 0.94 0.92 0.89 0.91 0.90 0.88 0.86 0.85 Operating Margins 20.6% 19.8% 20.5% 19.2% 14.5% 17.8% 17.6% 15.9% 15.4% 15.9% Asset Turnover 0.80 0.80 0.77 0.81 0.79 0.75 0.74 0.79 0.77 0.71 Equity Multiplier 2.2 2.1 2.1 2.2 2.4 2.3 2.3 2.3 2.3 2.3 ROE 24.1% 23.9% 22.8% 23.4% 17.9% 20.2% 19.8% 18.4% 16.7% 16.4% ROA 11.1% 11.2% 11.0% 10.6% 7.4% 8.9% 8.8% 8.1% 7.2% 7.1% Including financials ROE 22.3% 21.6% 21.3% 21.3% 16.9% 18.4% 18.0% 17.2% 15.7% 15.1% ROA 4.3% 4.1% 4.2% 4.4% 3.3% 3.7% 3.8% 3.6% 3.3% 3.2%

Source: Prowess, Thomson Reuters Datastream, HSBC

5. High interest rates have not helped ROE expansion 6. Operating margins starting to move up

0.75

0.80

0.85

0.90

0.95

1.00

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

Mar

-14

Interest Burden

14%15%16%17%18%19%20%21%

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

Mar

-14

Operating Margins

Source: Prowess, Thomson Reuters Datastream, HSBC Source: Prowess, Thomson Reuters Datastream, HSBC

7. Mixed trends in asset turn 8. ROE close to decade low

0.60

0.70

0.80

0.90

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

Mar

-14

Asset Turnover

15%

17%

19%

21%

23%

25%

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

Mar

-14

ROE


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Indian ROE – a decade of compression

9. Sector ROE analysis for Nifty companies: core sectors drag down ROE

Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Materials 29% 29% 30% 33% 23% 19% 20% 16% 10% 12% Industrials 34% 26% 30% 19% 24% 26% 23% 21% 18% 11% Utilities 15% 15% 15% 15% 15% 16% 16% 13% 15% 13% Financials 16% 14% 16% 16% 14% 13% 13% 14% 13% 12% Health Care 15% 21% 25% 21% 14% 17% 20% 21% 21% 20% Consumer Disc 23% 25% 23% 21% 3% 23% 28% 25% 19% 19% Energy 25% 24% 19% 20% 14% 18% 17% 17% 17% 16% Telecom 27% 27% 35% 31% 28% 26% 18% 12% 9% 10% Consumer Staples 34% 32% 35% 37% 36% 37% 38% 39% 44% 42% IT 34% 36% 36% 33% 32% 30% 29% 27% 33% 37%

Source: Prowess, Thomson Reuters Datastream, HSBC

10. ROE of domestic cyclical sectors 11. Asset turnover of domestic cyclical sectors

0%5%

10%15%20%25%30%35%40%

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

Mar

-14

Materials Industrials

0.600.650.700.750.800.850.900.951.00

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

Mar

-14

Materials Industrials


12. Defensives sector ROE saw uptick… 13. …led by strong operating margins

20%

25%

30%

35%

40%

45%

50%

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

Mar

-14

IT Consumer Staples

15%

18%

21%

24%

27%

30%

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

Mar

-14

IT Consumer Staples


5


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Decade long outperformance but capital efficiency fell…

India has been one of the best performing markets globally over the past 10 years, with the MSCI India

rising by a factor of three times (or at a 14% CAGR) since 2004, driven largely by strong corporate

earnings and the expansion of valuation multiples. During this period, India has boasted a consistently

higher ROE than other emerging markets and we believe this has justified the 20-30% valuation premium

that the Indian market enjoyed over its peers.

However, corporate India’s ROE fell sharply to 15% in 2014 – its lowest level in a decade – from a peak

of 22% in 2005. Although ROE has fallen in all major markets over the past few years on weaker global

growth, India’s ROE contraction has been among the most severe. Table 4 on page 3 shows the steep fall

ROE recovery from FY15e

ROE appears to have bottomed out and we expect it to rise by

1.5ppt by FY16

Improved macro environment and better policies from the new

government should underpin this revival in profitability

We expect cyclical sectors to lead the uptick in ROE, whereas

defensives are already maintaining above-average ROEs

14. India: the best performing major market in the past 10 years (2004-14)

0%

100%

200%

300%

INDIA CHINA KOREA EM BRAZIL USA RUSSIA WORLD UK EUROPE TAIWAN JAPAN

Source: MSCI, Thomson Reuters Datastream, HSBC Note: MSCI countries returns in dollar terms

6


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in ROE has been mainly led by rising interest rates (the interest burden multiplier fell from 0.94 to 0.85

between 2005 and 2014), operating margins down from 20.6% to 15.9% and asset turn deteriorated from

0.80 to 0.71.

ROE compression triggered by multiple factors

In our view, the decline in corporate profitability has been due to three main factors: 1) the rising cost of

resources (spectrum in the telecoms sector, and land in the infrastructure and real estate sectors); 2)

increases in interest rates to temper inflation; and 3) a rising component of overseas revenues.

1. Rising cost of resources: The cost of doing business in India has gone up sharply due to factors such

as an increase in the cost of inputs, difficulty in acquiring land and tougher environmental regulation.

This has been compounded by an increased awareness of the value of resources; the telecoms sector saw a

jump in spectrum charges at auctions; power companies were hurt by Coal India reducing its discount

versus international prices; increases in petroleum prices (prior to the recent fall in crude oil prices) and

subsequently freight rates corrected anomalies in fuel pricing; and ore mining and crude production have

seen an increase in cess and royalty rates.

2. Higher interest rates to temper inflation: RBI hiked rates 13 times between March 2010 and October

2011 as it attempted to curb inflationary pressures. This contributed significantly to the contraction in

ROE, especially among indebted Indian companies. However, lately inflation has fallen sharply, helped

by a decline in the prices of major commodities. Our India economist is expecting RBI to cut its policy

rate by 50bp over the course of 2015, which should help improve corporate profitability (RBI decision:

Promises to cut if inflation stays low, 2 December 2014).

3. An expanding proportion of overseas revenues: Although it is debatable whether overseas

acquisitions reflect poor capital allocation during an era of abundant capital availability (2004-08), the

fact is that returns in developed markets are lower than in India, in line with the lower cost of capital

prevalent in such markets. A number of Indian companies have acquired meaningful overseas assets

(Corus by Tata Steel, Jaguar-Land Rover by Tata Motors, Whyte & Mackay by United Spirits, Taro by

Sun Pharma, Novelis by Hindalco, various African assets by Bharti Airtel, and Repower by Suzlon

Energy to name a few). Most of these overseas investments have struggled to achieve double-digit

returns, whereas domestic Indian operations have generated an average ROE of 15%.

15. Repo rate (%) 16. Overseas exposure of Nifty companies

4.0

5.0

6.0

7.0

8.0

9.0

Feb-

10

Aug-

10

Feb-

11

Aug-

11

Feb-

12

Aug-

12

Feb-

13

Aug-

13

Feb-

14

Aug-

14

0%

10%

20%

30%

40%

2005 2014Foreign Asset as % Total Asset

Foreign Sales as % Total Revenue

Source: RBI, HSBC Source: Thomson Reuters Datastream, HSBC

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Sector drivers

Table 9 shows that the main drag on India’s overall ROE has clearly come from domestic cyclical sectors.

The industrial sector’s ROE plunged from 34% in March 2005 to an all-time low of 11% in the last fiscal

year ending March 2014, the materials sector’s ROE fell from 29% to 12% between FY05 and FY14;

while the telecoms sector saw ROE drop from 27% to 10%. Other sectors which saw a notable decrease

were financials, utilities and energy. Interestingly, Indian defensive sectors, such as consumer staples, IT

and healthcare, saw an increase in ROE mostly driven by INR depreciation (for healthcare and IT) and

improved rural consumption (for staples).

ROE appears to have bottomed: Consensus expects it to rise by 1.5ppt by 2016e

Consensus is forecasting corporate India’s ROE to increase by 1.5ppt from 15.0% currently to 16.5% by

2016. Chart 17 shows most cyclical sectors are expecting a pick-up in profitability. Industrials ROE is

expected to increase the most by 2016 – by 5ppt – followed by consumer staples, financials and materials.

As a result, we expect materials and industrials to contribute significantly to the expected increase in

India’s overall ROE, but ROE to remain below long-term averages of 22% for materials and 23% for

industrials. Meanwhile, we expect telecoms to continue to see single-digit ROE. Interestingly, looking at

the breakdown of corporate India’s forecast ROE (Chart 18), we note that although the IT sector saw the

most ROE deterioration, it should remain one of the highest contributors to overall ROE. Defensive

sectors are expected continue to contribute the most to India’s ROE in the next 12 months. Consensus is

forecasting an ROE of 38% for consumer staples, 24% for IT, and almost 18% for healthcare in 2016.

17. Forecast increases in ROE by FY16e

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

MSCI INDIA Industrials Cons Staples Financials Materials S T/Cm Svs S Utilities S Energy S Health Care Cons Discr IT

Source: MSCI, Thomson Reuters Datastream

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Improved macro and potential lower interest rates remains the key catalysts

With a stable new government in place following the general elections, expectations have increased over

a pick-up in growth. In addition, the recent fall in commodity prices and expectations of lower interest

rates are likely to improve profitability among Indian companies. In table 19, we list companies covered

by HSBC fundamental analysts that are rated Overweight (or OW(V)) that have estimated ROE gains of

more than 1ppt between FY14 and FY17e. Interestingly, 16 of the 24 stocks are from cyclical sectors

such as materials, consumer discretionary, energy, industrials and utilities. The ROE expansion will be

led by a fall in interest rates, margin recovery and improved asset turnover ratio (see next page for details

of the DuPont methodology and table 24 for the breakdown of our DuPont analysis by sector).

18. Sectoral ROE current versus in FY16e

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Cons Staples IT Cons Discr Health Care Financials MSCI INDIA Industrials Energy Materials UtilitieS T/Cm Svs

Current CY2016e

Source: MSCI, Thomson Reuters Datastream, HSBC

19. Stocks rated Overweight by HSBC analysts with estimated ROE gains of more than 1ppt between FY14 and FY17e

Company Ticker Sector Rating Price ROE (% FY14) ROE (% FY17e) Change (ppt)

Asian Paints APNT IN Materials Overweight 760 33.1 35.1 2.0BALLARPUR INDUSTRIES BILT IN Materials Overweight 24 2.0 11.0 9.0Bharat Forge BHFC IN Consumer Discretionary Overweight 970 16.9 29.5 12.6Bharti Airtel BHARTI IN Telecommunication Services Overweight 481 5.0 11.6 6.5Cadila Healthcare Ltd CDH IN Health Care Overweight 1645 25.5 27.3 1.9Cipla CIPLA IN Health Care Overweight 730 13.5 17.3 3.8Coal India Limited COAL IN Energy Overweight 390 33.3 35.7 2.4Colgate-Palmolive CLGT IN Consumer Staples Overweight 2000 90.1 113.2 23.1Fortis Healthcare FORH IN Health Care Overweight 152 3.1 6.7 3.6Godrej Consumer Products GCPL IN Consumer Staples Overweight 1125 22.0 24.3 2.3Hathway Cable & Datacom HATH IN Consumer Discretionary Overweight 432 (12.5) 0.5 13.0Hindalco HNDL IN Materials Overweight (V) 200 6.1 9.8 3.7Hindustan Petroleum HPCL IN Energy Overweight 696 7.8 11.2 3.4ITC ITC IN Consumer Staples Overweight 415 35.3 41.7 6.4Jubilant Foodworks JUBI IN Consumer Discretionary Overweight 1371 24.1 26.9 2.7Just Dial JUST IN Information Technology Overweight (V) 1900 25.1 34.2 9.1Larsen & Toubro LT IN Industrials Overweight 1938 12.8 17.5 4.8Maruti Suzuki India Ltd MSIL IN Consumer Discretionary Overweight 3750 14.1 19.7 5.6Motherson Sumi MSS IN Consumer Discretionary Overweight 425 34.1 39.1 5.1PTC India PTCIN IN Utilities Overweight (V) 120 10.4 10.9 0.6Sesa Sterlite SSLT IN Materials Overweight (V) 354 7.4 9.7 2.2Tata Power TPWR IN Utilities Overweight 125 2.2 9.7 7.4UPL Limited UPLL IN Materials Overweight 352 19.2 20.5 1.3Voltas Ltd VOLT IN Industrials Overweight 307 12.6 18.3 5.7

Source: HSBC estimates. Prices as of 2 January

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Expensive valuations reflects the uptick in ROE

The Indian market is currently trading at 1SD above its long-term average 12-month forward PE and

continues to command a significant premium over its peers in MSCI Asia ex-Japan and MSCI EM. In

2015, we expect the Indian market to move higher, in line with earnings growth albeit with a mild de-

rating in PE. Our end-2015 target for the Sensex is 30,000.

The PE improvement that we saw in 2014, in our view, is partly a reflection of two factors – the acceleration

in growth expectations following the formation of a new government with a stable majority and an

improvement in capital efficiency (softer interest rates, better operating leverage, etc). However, with

growth forecasts buoyant over the next two years on the back of an ongoing economic recovery, we see

share prices likely tracking earnings growth, with a small element of PE de-rating (i.e. mean reversion).

The methodology

ROE drivers: DuPont analysis

We use a five-step DuPont model to break down ROE.

ROE = (Tax Burden) x (Interest burden) x (Operating income margin) x (Asset turnover) x (Equity

multiplier)

Where:

ROE = Net Income / Shareholders’ Equity

Tax Burden = Net Income / EBT

Interest Burden = EBT / EBIT

Operating income margin = EBIT / Sales

Asset turnover = Sales / Total Assets

Equity multiplier = Total Assets / Shareholders’ Equity

In the past decade Indian companies have enjoyed higher ROE than other emerging markets. However,

recently we have seen this ROE edge come down to only 3ppt in 2014 compared to 6ppt in 2002.

Our five-step DuPont analysis shows that the decline in ROE for Indian companies was mainly driven by

a continued increase in interest burden, fall in operating margins and worsening asset turnover; while tax

burden and equity multiplier effect remained stable.

Operating margins followed by interest burden were the main driver for the fall in Indian companies’

ROE. This reflects the macroeconomic backdrop of sticky inflation, high interest rates, buoyant

commodity prices and rupee depreciation.

However, there is renewed hope that reform will be a high priority for the new government. Breaking up

monopolies, opening markets and creating a more investment friendly environment all appear to be high

on the policy agenda. Our DuPont analysis shows that the expected uptick in ROE will be driven by a fall

in interest burden, increase in operating margins and uptick in asset turnover, while the tax burden and

equity multiplier effect remain stable.

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What could upset the forecasts?

1 USD strength: In our view, USD strength which is being witnessed could constrain the degree of

easing the markets expect out of the Indian monetary authority. In case the fall in rates is milder than

expected by consensus, some of the tailwinds arising from the interest burden could be muted.

2 India recovery: Markets are pricing in a recovery in the Indian economy. Any weakness or delay in

the recovery could mean a slower margin recovery than forecast.

3 Global recovery: Weaker crude oil prices represent stresses for oil exporting nations in their ability

to balance their budget. This could mean a slower global recovery than forecast impacting export

growth for Indian companies. India, however, is a large oil importer; thus weakness in crude oil is

usually positive for the Indian economy.

4 Taxation: We believe the market is anticipating stable taxation levels. However, there are two

uncertainties. First is the issue of sops extended to few sectors such as autos where rates have been

tempered temporarily. Reversal to prior higher rates could mean higher doses of indirect taxation.

Second is the migration to a goods and services tax (GST) regime in FY16. If rates on GST are

higher than current levels of state imposed sales tax (post set offs for intermediate taxes), this could

again trigger higher indirect taxes, which could mean a higher pricing level for finished goods. Price

elasticity of demand could then come into play, impacting margins.

20. ROE gap lowest since 1996 (%)

0

5

10

15

20

25

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

MSCI India MSCI EM

Source: MSCI, Thomson Reuters Datastream, HSBC Note: Data on calendar year basis

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The India market significantly outperformed most emerging markets in 2014. MSCI India outperformed

MSCI EM by 30% and MSCI Asia ex-Japan by 22% in 2014. The strong performance was mostly driven

by a PE rerating and strong 2Q14 earnings performance. With PE valuations now 1SD above the long-

term average 12-month forward PE, the India market is now trading at a significant premium to its peers.

An uptick in profitability will lead the market higher from here, in our view.

Relative valuations expensive for financials, industrials and staples

Table 21 shows most India sectors trade at a significant premium to peers. India trades at a 41% premium

to Asia ex-Japan and 52% premium to the global EM index on a 12-month forward PE basis. Comparing

Indian sector valuations with global EM sectors, the financial sector remains the most expensive, trading

at an 87% premium to the global EM financial sector followed by energy, consumer staples and

industrials which are trading at a higher premium to overall country premium. Interestingly, Indian metals

Valuations pricing in ROE inflection

Expectations of an uptick in Indian ROE already visible in the

Indian valuation premia

We expect a mild de-rating in India PE multiples, which are at a

50% premium to MSCI EM index

We are overweight India within Asia, with an end-2015 Sensex

target of 30,000

21. 12-month forward premium

Asia ex-Japan

EM China India Premium to Asia ex-Japan

Premium to EM

Aggregate Index 11.2 10.4 8.9 15.9 41% 52%Consumer Discretionary 10.0 11.4 9.5 13.7 36% 20%Consumer Staples 20.0 19.6 19.8 32.2 61% 64%Energy 9.3 5.7 9.0 9.6 4% 69%Financials 9.5 8.6 6.2 16.2 71% 87%Health Care 22.1 21.2 18.7 23.8 8% 12%Industrials 12.7 13.7 10.8 21.9 72% 59%Information Technology 12.6 12.7 21.5 16.9 33% 33%Materials 11.9 11.2 10.1 11.1 -6% -1%Telecommunication Services 15.1 13.7 12.7 18.0 19% 32%Utilities 10.3 9.3 11.2 10.5 2% 14%


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is the only sector that is trading at a discount to both Asia ex-Japan and global EM, while all other sectors

are trading a premium.

India remains the preferred market for global investors

Global investors continued to raise exposure to the Indian market through 2014, triggering the rerating.

India’s weight in most regional indices such as EM, Asia ex-Japan and global rose consistently in 2014 to

near a record high.

Looking at absolute foreign institutional investors (FII) equity fund flows into Asia ex-Japan countries,

India continues to receive a disproportionately high share for the second consecutive year. Chart 22

shows that of the six major Asia ex-Japan markets for which FII flows data is available, India has

received more than half since January 2013.

22. Absolute net FIIs fund flows

-10

0

10

20

30

40

50

Taiwan Korea Thailand Indonesia Philippines India Asia ex Japan

2013 2014

Source: Bloomberg, HSBC

23. India allocation to regional and global equity funds inching up

0.0%

0.5%

1.0%

1.5%

0%

5%

10%

15%

20%

25%

Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13

GEM Funds BRIC Funds Asia Ex Japan Funds Pacific Funds Global Funds (RHS)

Source: EPFR, HSBC

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DuPont analysis

24. Breakdown by sector

Materials Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Tax Burden 0.75 0.73 0.74 0.79 0.67 0.74 0.70 0.61 0.74

Interest Burden 0.94 0.94 0.85 0.82 0.85 0.85 0.83 0.77 0.76

Operating Margins 25% 27% 19% 12% 16% 18% 16% 14% 17%

Asset Turnover 0.82 0.71 0.91 1.00 0.81 0.76 0.77 0.67 0.57

Equity Multiplier 2.1 2.3 3.1 3.0 2.5 2.3 2.3 2.3 2.3

ROE 29.3% 29.8% 32.7% 23.0% 18.8% 20.3% 16.5% 10.1% 12.2%

Industrials Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-13

Tax Burden 0.75 0.76 0.66 0.68 0.70 0.66 0.66 0.69 0.67

Interest Burden 0.86 0.91 0.86 0.89 0.91 0.90 0.82 0.76 0.64


Asset Turnover 0.98 0.81 0.71 0.62 0.60 0.58 0.56 0.53 0.47


ROE 26.0% 30.2% 19.4% 24.4% 25.8% 22.7% 20.9% 17.8% 11.3%

Utilities Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Tax Burden 0.78 0.79 0.72 0.70 0.74 0.74 0.68 0.70 0.70

Interest Burden 0.88 0.85 0.87 0.84 0.82 0.78 0.72 0.71 0.67


Asset Turnover 0.42 0.44 0.49 0.51 0.49 0.41 0.42 0.40 0.40


ROE 14.5% 15.1% 15.4% 14.6% 16.4% 16.2% 13.4% 15.0% 13.1%

Health Care Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Tax Burden 0.86 0.85 0.88 0.80 0.83 0.88 0.82 0.75 0.77

Interest Burden 0.94 0.95 0.96 0.94 0.98 0.97 0.98 0.98 0.98


Asset Turnover 0.46 0.76 0.67 0.75 0.72 0.69 0.69 0.73 0.71


ROE 20.7% 25.3% 21.1% 13.5% 17.1% 19.5% 21.2% 21.2% 20.2%

Consumer Disc Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Tax Burden 0.73 0.71 0.72 0.36 0.72 0.81 0.90 0.71 0.74

Interest Burden 0.93 0.91 0.85 0.45 0.78 0.85 0.80 0.78 0.79


Asset Turnover 1.11 1.07 0.97 0.97 1.08 1.10 1.07 1.04 1.01


ROE 24.5% 23.5% 21.1% 2.9% 23.1% 27.8% 25.4% 19.4% 19.5%

Energy Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Tax Burden 0.71 0.70 0.71 0.67 0.73 0.72 0.72 0.73 0.73

Interest Burden 0.97 0.96 0.97 0.93 0.95 0.95 0.95 0.95 0.95


Asset Turnover 0.86 0.79 0.82 0.72 0.73 0.81 0.94 0.96 0.90


ROE 24.1% 19.5% 20.4% 14.4% 18.2% 17.2% 17.5% 17.0% 16.4%

Telecom Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Tax Burden 0.88 0.88 0.91 0.95 0.89 0.88 0.82 0.79 0.78

Interest Burden 0.92 0.96 0.97 0.97 0.99 0.93 0.84 0.80 0.88


Asset Turnover 0.56 0.63 0.61 0.64 0.58 0.48 0.46 0.46 0.45

Equity Multiplier 2.7 2.5 2.1 1.9 1.7 1.8 1.8 1.8 1.7ROE 27.4% 35.3% 30.9% 28.0% 25.7% 17.5% 11.6% 9.4% 9.9%

Source: Prowess, HSBC

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24 (Cont’d) Breakdown by sector

Consumer Staples Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Tax Burden 0.73 0.74 0.72 0.73 0.70 0.71 0.71 0.71 0.70

Interest Burden 0.99 1.00 0.99 0.99 0.99 0.99 0.99 0.99 1.00


Asset Turnover 1.07 1.08 1.14 1.25 1.10 1.12 1.17 1.19 1.16


ROE 32.3% 35.2% 36.8% 36.2% 37.1% 38.3% 39.3% 44.2% 42.0%

IT Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Tax Burden 0.86 0.87 0.84 0.85 0.84 0.83 0.77 0.78 0.78

Interest Burden 1.00 1.00 0.98 0.97 0.97 0.98 0.99 0.99 0.99


Asset Turnover 1.24 1.22 1.10 1.02 0.92 0.98 0.99 1.09 1.11


ROE 36.5% 36.4% 32.8% 31.6% 29.5% 28.8% 26.9% 32.6% 36.7%

Source: Prowess, HSBC

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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Jitendra Sriram

Important disclosures

Equities: Stock ratings and basis for financial analysis

HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon; and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below.

This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website.

HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.

Rating definitions for long-term investment opportunities

Stock ratings HSBC assigns ratings to its stocks in this sector on the following basis:

For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, must exceed the required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral.

Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change.

*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However, stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past

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month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.

Rating distribution for long-term investment opportunities

As of 05 January 2015, the distribution of all ratings published is as follows: Overweight (Buy) 46% (29% of these provided with Investment Banking Services)

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Additional disclosures 1 This report is dated as at 06 January 2015. 2 All market data included in this report are dated as at close 02 January 2015, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its

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Global

Daniel Grosvenor +44 20 7991 4246 [email protected]

EU and US

Peter Sullivan Head of Equity Strategy, EU and US +44 20 7991 6702 [email protected]

Europe

Robert Parkes +44 20 7991 6716 [email protected]

CEEMEA

John Lomax Head of Global Emerging Market Equity Strategy +44 20 7992 3712 [email protected]

Wietse Nijenhuis +27 11 676 4218 [email protected]

Kishore Muktinutalapati +91 80 3001 2983 [email protected]

Asia

Herald van der Linde Deputy Head of Research and Head of Equity Strategy, Asia-Pacific +852 2996 6575 [email protected]

Devendra Joshi +852 2996 6592 [email protected]

Steven Sun +852 2822 4298 [email protected]

Roger Xie +852 2822 4297 [email protected]

Taiwan

Jenny Lai Head of Taiwan Research +8862 6631 2860 [email protected]

Bruce Warden +8862 6631 2868 [email protected]

South East Asia

Neel Sinha Head of Equity Research, South East Asia +65 6658 0606 [email protected]

India

Jitendra Sriram Head of Research, India +91 22 2268 1271 [email protected]

Korea

Brian Cho Head of Research, Korea +822 3706 8750 [email protected]

James Jong-pil Lee +822 3706 8776 [email protected]

Latin America

Ben Laidler LatAm Equity Strategist and Head of Research, Americas +1 212 5253460 [email protected]

Francisco Schumacher, CFA Southern Cone & Andean Equity Strategist +1 212 525 4430 [email protected]

Kevin R Gonzalez Associate +1 212 525 4394 [email protected]

Andre C Carvalho Head of Brazil Equity Strategy +55 11 3371 8190 [email protected]

Marina F Valle Equity Strategist +55 11 3371 8191 [email protected]

Gonzalo Fernandez Mexico Equity Strategist and Head of Equity Research, Mexico +52 55 5721 3607 [email protected]

Jaime Aguilera Equity Strategist +52 55 5721 2379 [email protected]

Global Equity Strategy Research Team

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