thematic june 10, 2016 - ambitreports.ambitcapital.com/reports/ambit_strategy_thematic_taking... ·...

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THEMATIC June 10, 2016

Strategy

Substitution plays from our Ten- bagger and G&C portfolios

Company Stance 3m

ADV ($mn)

Mkt Cap ($mn)

ITC BUY 43.5 42,702

HUL BUY 22.3 28,425

Tata Motors BUY 67.4 22,676

Marico BUY 5.5 4,843

Berger Paints BUY 1.5 2,943

Page Industries BUY 2.7 2,338

CIFC BUY 1.7 2,325

TVS Motors BUY 10.3 2,064

City Union Bank BUY 0.9 978

Mahindra CIE BUY 0.9 966

Finolex Cables BUY 0.8 822

DCB NR 1.8 408

Source: Bloomberg, Ambit Capital research.

Research Analyst

Prashant Mittal, CFA

+91 22 3043 3218 [email protected]

Taking the crisis call off the table Although the possibility of Sensex 22K remains real, it is no longer our base case scenario thanks to the firefighting done by the RBI and the Banks Board Bureau. Our new FY17-end target is Sensex 29.5K (implying 10% upside). Given our view that there is no economic recovery underway in India, we reiterate our Tenbagger 5.0 (long term) and G&C 10.0 (medium term) portfolios whilst pointing to 12 stocks that investors can use to profit from Modi and Rajans structural resets.

The global macro picture remains bleak Even as Indian equity markets have rallied by 18% from their Feb16 lows, the risks emanating from a Chinese economy slowdown, the Feds monetary policy tightening and deflationary scenarios in the EU and Japan persist. On the one hand recent data from China and the US has increased the probability of a deflation export from China, on the other hand the BoJ and the ECB have acknowledged the ineffectiveness of continuous monetary easing to resolve the deflationary spiral. Both these scenarios - a sharp Yuan devaluation and the ineffectiveness of the European and Japanese banks in handling deflationary risks - represent a significant risk to the Sensex. Substitution effects are being mistaken as green shoots Our Economics teams 23 May 2016 note highlighted that whilst the Keqiang index points to a mild pick-up in the economy in 4QFY16, it is a result of three substitution effects taking place in the economy rather than a cyclical upturn. Specifically, the three substitution effects are: 1) CV demand substituting for falling railway freight demand; 2) Consumer durables demand substituting for real estate and jewelry demand; and 3) Private banks and NBFC lending substituting for PSBs lack of lending. These effects suggest that the economy is adjusting to the Modi-Rajan-Technology resets (see our 16 December 2015 thematic) but the slow pace of the adjustment also points to protracted economic recovery process that is more likely to fire in FY18 (rather than in FY17). We revise our Sensex target due to reduced domestic risks The Sensex target of 22,000 given in our 22 April 2016 note was calculated by applying a P/E multiple of 14x (the average multiple seen in the six months post the Lehman crisis of 2008) to the Sensex FY17 EPS estimate of `1570 (implying 15% EPS growth YOY). Given the risks around China, the Fed and European and Japanese deflation, we highlight that Sensex 22,000 remains a very real high-risk scenario. Having said that, using the framework that we first outlined in our 15 Feb 2016 note, we take cognizance of the recent efforts of the RBI and the Bank Boards Bureau (to resolve the asset quality and liquidity issues facing the banking sector) by revising our base case scenario Sensex earnings multiple to 19x (which is also the 10-year P/E average). Applying this to our Sensex FY17EPS estimate of `1550 (down from `1570), we arrive at our revised target of 29,500 (implying 10% upside). Investment implications In-line with our sober expectations regarding economic growth (there is no significant economic pick-up underway in India) and interest rates (rate cuts will be limited), we reiterate our investment strategy of focusing on well-managed companies with strong cashflows, credible management teams and believable financial statements. Our Ten-baggers (long term focus) and Good & Clean (medium term focus) portfolios have outperformed the BSE500 index by 2.8 and 3.5 percentage points on an annualized basis respectively since publication on 5th Jan and 5th Feb respectively. Furthermore, we highlight 12 high conviction ideas from these portfolios to play the three big economic substitutions currently underway in India (see table in the right hand margin).

http://reports.ambitcapital.com/reports/Ambit_Economy_Update_KeqiangIndexAGlimmerofHope_23May2016.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_MRT_EarningsrecessioninIndia_16Dec2015.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Good&Cleanroarsagain_22Apr2016.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Noeasyroadtorecovery_15Feb2016.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_TenBaggers5_05Jan2016.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_Good&Clean10_05Feb2016.pdf

Strategy

June 10, 2016 Ambit Capital Pvt. Ltd. Page 2

CONTENTS

Section 1: Global Macro.. 3

Section 2: The Indian economy.. 7

Section 3: The three substitution resets in play. 11

Section 4: Sensex earnings and target 18

Section 5: Investment Implications.. 21

Strategy


Section 1: Global Macro Over the past year, the Chinese and the US economies have been pulling in opposite directions. Whilst the US economy has shown signs of a modest recovery over the past year, the Chinese economy has been slowing down despite the monetary stimulus announced by the PBOC (see chart below). On the back of this recovery, on 16th Dec 2015, the Fed announced plans to begin monetary tightening and laid out plans for as many as four rate hikes in CY2016 (http://goo.gl/pYcnGb)

Exhibit 1: Chinese GDP growth has been slowing down despite monetary stimulus

Source: Bloomberg, Ambit Capital Research.

In the light of these opposing movements, in our note dated 28th August, 2015 we highlighted the risks facing the emerging market currencies, including the India rupee, from a major devaluation of the Chinese Yuan and the export of deflation throughout the world. (China is the biggest source of non-oil imports for India.)

Whilst these fears re-surfaced earlier in the calendar year (http://goo.gl/AQe3o5) and led to a global sell-off in risk assets (see chart below), a supposed economic pick-up in China dampened these fears to an extent and contributed to a major risk-on rally from the Feb16 lows.

Exhibit 2: The Chinese economy seems stuck in a rut with an overvalued currency

Source: Bloomberg, Ambit Capital research.

Exhibit 3: .. even as the US economy shows tangible signs of recovery


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Chinese economy continues to slowdown despite monetary stimulus

while US economy shows tangible signs of recovery

http://reports.ambitcapital.com/reports/Ambit_Economy_EmploymentintensityofGDP_05Nov2015.pdfhttp://reports.ambitcapital.com/reports/Ambit_Economy&Strategy_Thematic_Exitthefantasy_28Aug2015.pdf

Strategy


Exhibit 4: Risk assets corrected significantly in the early part of CY2016 only to bounce back in Feb16

Source: Bloomberg, Ambit Capital Research Note: The values have been computed after rebasing the parameter values to 100 at the start of the period.

However, recent data from the United States (pointing to a pick-up in retail demand and homebuilding) and clear statements from Fed officials are now suggesting that the American economy is recovering and that there is a real possibility of the Fed delivering two more rate hikes this year.

We saw weak growth in the first quarter of the year, and relatively weak growth at the end of last year. The growth looks to be picking up from the various data that we monitor.

- Janet Yellen (WSJ, 27 May 2016, http://goo.gl/JG1xxy)

My sense is that markets are well-prepared for a possible rate increase globally, and that this is not too surprising given our liftoff from December and the policy of the committee which has been to try to normalize rates slowly and gradually over time. - James Bullard - St. Louis Fed President (Reuters, 30 May 2016,

http://goo.gl/fFazfE)

Whilst the market has broadly factored out a June rate hike post the disappointing job market data released on 03rd June, 2016 (as can also be seen in the dip seen in probability of two rate hikes), Janet Yellen in her speech at World Affairs Council of Philadelphia on 6th June, 2016, clearly pointed out that economy can broadly expected to well in the coming months.

Speaking for myself, although the economy recently has been affected by a mix of countervailing forces, I see good reasons to expect that the positive forces supporting employment growth and higher inflation will continue to outweigh the negative ones

- Janet Yellen (WSJ, 07 June 2016, http://goo.gl/mVruxM)

Hence, while the risk of an immediate rate hike has moderated, a continuation of positive data from the U.S. is likely to give the Fed enough reason to go ahead with monetary tightening over the course of this year.

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Fed is likely to deliver two more rate hikes this year

Risk assets sold off globally as concerns around US rate hike and sluggish Chinese economy re-surfaced

Positive data from China and dovish comments from the Fed helped boost the risk assets since Feb16 lows

Strategy


Exhibit 5: While the probability of two hikes has moderated, more positive data from US will increase chances of tightening

Source: Bloomberg, Ambit Capital Research

Secondly, in its 28th April meeting, the BOJ, acknowledging the limits of easy monetary policy and negative interest rates, decided against further easing. It is interesting to note that the CPI data denoting a deflationary scenario and a stagnant the Japanese economy was published before the BOJ announced its policy of not loosening further; and yet the central bank decided not to ease monetary policy. Why? We believe that BOJ realized that negative interest rates are hurting Japanese banks without helping the economy. Hence, loosening monetary policy further and making rates even more negative would simply hasten the demise of the Japanese banking system without conferring any benefit on the economy.

Then, on 2nd June 2016, the ECB also moved along the lines of the BoJ, i.e. it did not loosen monetary policy further in spite of the negative inflation read as of May16. We believe that this too is an acknowledgement by the central bank of the fact that unbounded easy money policy is not helping the economy incrementally. As stockmarkets come to terms with the fact that the central banks are increasingly lost with respect to handling deflation, the downside risk with respect to equities is heightened.

Exhibit 6: ECB decided to stay put despite a negative inflation reading in May


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whilst the BoJ and ECB grapple with deflation risks

Strategy


Exhibit 7: The deflation risk persists in EU and Japan

Source: Bloomberg, Ambit Capital research Note: The Jun16 number is Bloomberg consensus forecast

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Strategy


Section 2: The Indian economy India is undergoing structural resets driven by PM Narendra Modi and RBI Governor Dr. Raghuram Rajan Over the past 15 months, we have repeatedly highlighted that India is undergoing a major structural transformation under the influence of resets driven by PM Narendra Modi and RBI Governor Dr. Raghuram Rajan.

The resets driven by PM Modi were first highlighted in our thematic dated 23rd March 2015, Modi hits the reset button, in which we highlighted that Modi, a man driven by personal goals and searing political ambition, has sensed the need to deliver three structural changes to perpetuate his political success.

Our discussions with the policy ecosystem in Delhi as well as our understanding of the key policy measures announced by the NDA Government suggest that the Prime Minister is seeking to engineer three structural resets: (1) shift Indias savings landscape away from gold and land and towards the formal financial system, (2) disrupt the Indian model of crony capitalism, and (3) redefine Indias subsidy mechanism.

Exhibit 8: Modis motivation to hit the reset button Modis three resets Economic changes underway that necessitated these resets

Reset #1: To increase the ratio of financial savings in India

India has a higher savings rate than any other country at a comparable level of per capita income. Despite this, India is characterised by a high cost of debt capital and poor accessibility to capital, as more than two-thirds of Indias household savings are held in physical form (which includes real estate and gold). If the ratio of financial savings in India could be systematically increased, this could play a pivotal role in lowering the cost of debt capital in India, thereby allowing Modi to push through Make in India and hence create jobs.

Reset #2: To curb black money and crony capitalism

During the ten years of UPA rule, various political-business cliques captured large sectors of the economy and then suppressed competition (in sectors such as real estate and infrastructure) in a bid to maximise their gains. As a result, politically-linked companies were outperforming the market. Modis motivation in crushing this nexus appears to be twofold. Firstly, this is likely to be viewed very positively by the electorate, as several surveys now show that corruption has become a major issue for Indias voter base. Secondly, annihilating the political-business cliques formed under the 10-year UPA rule is likely to decisively cut the flow of funding to the opposition.

Reset #3: To overhaul the subsidy mechanism

Besides the fact that the quantum of subsidies itself grew at a rapid pace during the UPA rule (19% CAGR over FY05-FY14), third-party estimates suggest that ~40% of these subsidies were lost in leakages. Modi in all likelihood will focus on: (1) curtailing the fiscal deficit and (2) improving the targeting of subsidies through the DBT or Direct Benefit Transfer initiative in the initial years of his 5-year rule. The years running up to the CY19 General Elections is then likely to be characterised by a moderate step-up in subsidy spends and by the dramatically better targeting of the same.

Source: Ambit Capital research

We also highlighted that even as these resets are likely to negatively affect GDP growth in the short term, this will benefit the economy in the long run. The impact of three resets can be seen in the exhibits below.

Exhibit 9: The impact of Reset #1 - The crash in demand for physical assets like gold and real estate

Source: CEIC, Ambit Capital research.

Exhibit 10: The impact of Reset #2 The continued underperformance of connected companies

Source: Bloomberg, Ambit Capital research

Exhibit 11: The impact of Reset #3 The acute stress in the rural economy (as seen in rural wage inflation)

Source: RBI, Ambit Capital research

Subsequently, in a thematic note dated 16 December, 2015 we highlighted the resets likely to be driven by RBI governor Raghuram Rajan in order to make the banking landscape in India more competitive. Under his command, the RBI has granted 23 bank licences in the course of last two years as compared to just 12 licenses over 20 years before that. Furthermore, the RBI also plans to give on tap licenses going forward (instead of the current practice of giving bank licenses every few years) and is encouraging foreign banks to set up wholly-owned subsidiaries in India.

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PM modi is driving resets to increase financial savings, to curb crony capitalism and to overhaul subsidy mechanism

http://reports.ambitcapital.com/reports/Ambit_Economy&Strategy_Thematic_Resetbutton_23Mar2015.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_MRT_EarningsrecessioninIndia_16Dec2015.pdf

Strategy


With 23 new banks and with more coming, competitive intensity is set to increase on both sides of the balance sheet in the banking sector. However, we believe that in the near term, competitive intensity would be felt more on the liability side than on the asset side. This is because 11 of these 23 banks - the payments banks - are not allowed to lend and another 10 are specialised microfinance companies that are yet to build lending infrastructure and expertise outside their domain. Therefore, on the asset side, the new banks are somewhat hamstrung in the near term. We also highlighted the increased competition due to development of bond markets. Indian financial markets are mostly bank dominated markets with banks having 61% market share in the lending business. On other hand, the corporate bond market is still minuscule in India with just 21% share of total financial lending compared to far higher market shares in mature markets such as the US, the UK and Japan. Corporate bonds as a percentage of GDP are also the smallest in India at 5% compared with other Emerging Markets such as Korea (93%), Turkey (63%) and Brazil (60%). Historically, a high inflation environment coupled with a weak and volatile rupee and the lack of a bankruptcy regime had kept domestic as well as foreign investors away from Indian debt markets. However, Rajans efforts are leading to a lower inflationary environment coupled with a stable exchange rate. This has resulted in FII/FPI debt inflows into India surging even as FII equity investors are heading for the door. This superior flow of FII funds into the Indian debt market has reduced the cost of borrowing from the bond market compared with borrowing from banks (thus driving Indian corporates to borrow more from the bond market and less from the banks).

Exhibit 12: Growth in corporate bond market higher than growth in bank credit

Source: SEBI, RBI, Ambit Capital research.

Keqiang index showcases the pain delivered by these resets

Our macro teams recent note dated 23 May 2016 highlighted that an analysis of the 16 high frequency indicators used to construct the Keqiang index suggests that even as 8 of 16 indicators registered sequential improvement in 4QFY16 (see the extreme right column in the table on the next page), none of the aggregate measures have shown an improvement. Specifically, it is critical to note that gauges relating to the pricing power in the broader economy, namely core CPI and core WPI, remain weak. This points to an excess supply situation persisting in the broader economy (see rows highlighted in bold font in the table on the next page). Further, our 23rd May note also highlighted that the pick-up in commercial vehicle (CV) sales seems to be a result of a substitution effect (described in detail in the next section). Expensive rail-based freight movement is being replaced by cheaper transportation by road, which in turn was fuelled by low diesel prices. The recent pick-up in passenger vehicle (PVs) sales, two-wheeler (TWs) sales and light electricals sales also seems to be a result of the substitution effect as urban consumers who are not buying residential real estate or jewelry are using spare cash to buy durables such as PVs and 2Ws.

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while Dr.Rajan is increasing competition in banking system by granting 23 banking licenses and developing bond markets

Keqiang index shows core CPI and WPI denoting pricing power in the economy continue to remain weak

http://reports.ambitcapital.com/reports/Ambit_Economy_Update_KeqiangIndexAGlimmerofHope_23May2016.pdf

Strategy


Exhibit 13: Even as several indicators have shown an improvement, core WPI and CPI inflation remains weak

Indicator GDP constituent related to YoY change

in 3QFY16 YoY change

in 4QFY16

Sequential change

(4Qvs 3Q) Commercial vehicle (CV) sales (units) Investment 20% 31% 11%

Two-wheeler sales (units) Consumption 2% 8% 6%

Cement production (Ton) Investment 4% 11% 7%

Retail credit (INR crore) Consumption 16% 20% 4%

Non-oil exports (INR million) Exports -11% -6% 5%

Electricity generation (GWh) Investment 4% 9% 5% Petroleum Products Consumption (000 metric ton)

Consumption/Investment 11% 14% 3%

Core WPI (Index) Investment -2% -2% 1%

Bitumen Production ( ton) Investment 16% 16% 0%

Core CPI (Index) Consumption 5% 5% 0%

Rural wages* (INR per day) Consumption 5% 4% 0%

Bank Deposits (INR) Consumption 10% 9% -1%

Industrial credit (INR) Investment 8% 7% -1%

Coal production (tonnes) Investment 5% -1% -6% Passenger vehicle (PV) sales (units) Consumption 11% 5% -7%

Revex less interest payments**(INR) Consumption -2% -13% -12%

Source: CEIC, RBI, Ambit Capital research. *Data only available until 3QFY16. **Data available only until February. Note Industrial credit is the non-food gross bank credit less retail credit.

We believe such developments are a natural consequence of an economy undergoing a reset as it transforms from a subsidy-driven and crony-capitalism-driven economy to a less corrupt and more efficient economy (less dependent on subsidies for consumption and less dependent on crony capitalists for capex).

Banking system remains under stress; but the issues are now being tackled

We believe that after the RBI Governors intervention last year, the Indian banking systems woes are, finally, well understood. However, nearly 15% of system assets are stressed. Even if we optimistically assume that only a third of these stressed assets are going to be ultimately written off, that still means that nearly ~30% the shareholders equity in the banking system is currently at serious risk.

More specifically, the problem facing public sector banks (PSBs) is altogether more serious. At the end of FY16, ~17% of PSBs assets were stressed. Again, if we optimistically assume that only a third of these assets will be written off, that would imply that nearly ~50% of the shareholders equity of PSBs will be written off by the end of FY18. Based on FY16-end numbers (i.e. without assuming any incremental equity requirement for PSBs to fund future loan book growth), that would imply that the PSBs need $30bn (equivalent to nearly 1.5% of our GDP) equity infusion over FY17 and FY18. Such a figure compares to the $4bn budgeted by the Finance Minister for infusion into PSBs in FY17 and the $7bn promised by the Finance Ministry for PSBs over FY17-19. In short, it is highly unlikely that the Government will be able to find the resources required to recapitalize the ailing PSBs.

So what remedial measures, if any, are being taken?

Firstly, the RBI has moved decisively since 5th April 2016 to inject liquidity into the banking system. In its monetary policy statement on that date, the RBI specifically said that it will continue to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of NDTL to a position closer to neutrality.

The measures taken by the RBI since then have eased liquidity conditions for banks considerably as evident from the marked reduction in 3-month CP and CD rates.

Risks to banking system have moderated given RBI has moved decisively to inject liquidity into the banking system since April 05, 2016

Strategy


Exhibit 14: Liquidity conditions have improved considerably since 1QFY16


In fact, in a recent interview Rajan clearly stated that the chances of a Lehman moment in India are close to none: "There is absolutely no chance we will have a 'Lehman' moment. It is about ensuring that the assets are cleaned up and investors have a good idea of the balance sheets of the bank and that process is under way and some banks have cleaned up much faster than the pace that we had set for them."

- Raghuram Rajan (13 May 2016, CNBC, http://goo.gl/RoOZSU)

Secondly, as highlighted by our banks team in its 13th April 2016 note, the Banks Board Bureau (BBB) under the chairmanship of Vinod Rai, is likely to provide further impetus to the RBI and Governments drive to clean up PSU banks balance sheets through complete bad loan recognition and provisioning by March 2017. It is important to note that whilst the BBB has a clear mandate of appointing board directors and CEOs at PSU banks and helping these banks on strategic matters, it is critical that these banks balance sheets are rid of legacy issues so that new management is better able to raise capital and implement their strategies. We also expect the demand to create a bad-bank to ring-fence banks bad loans to gather force again. The latest to raise this proposal is the new chairman of Bank of Baroda (http://goo.gl/01skby - see excerpt below).

He would also like to see a professional debt management agency. Its (stressed loan resolution) not a core competence of the bank and takes a long time, and then you have joint lending consortia as well, and if you negotiate a settlement then there is the spectre of money having changed hands, he said. Its better for state agency to deal with it. Ravi Venkatesan, Chairman Bank of Baroda

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and is no more likely to face a Lehman moment

http://reports.ambitcapital.com/reports/Ambit_BFSI_BankBoardBureau_13Apr2016.pdf

Strategy


Section 3: Three substitution effects in play The 4QFY16 result season suggests that the core theme that has delivered outperformance is consumption, with companies operating in the two-wheelers and home-improvement materials space (such as light electricals, tiles and plywood) seeing faster topline expansion in 4QFY16 and/or 2HFY16 as a whole (see highlighted numbers in the exhibit below).

Exhibit 15: The 4Q results season suggests the consumption theme has been resilient

FMCG Market cap (USD mn) Revenue growth (YoY)

FY14 FY15 1QFY16 2QFY16 3QFY16 4QFY16 HUL 26,851 9% 10% 5% 4% 3% 4% Dabur 7,597 15% 10% 11% 9% 2% 11% Home building Asian Paints 13,503 16% 12% 8% 4% 14% 12% Havells 3,352 12% 12% -1% -1% 8% 9% Kajaria 1253 15% 20% 9% 13% 8% 13% Century 569 17% 20% -6% 7% -2% 10% V-Guard 538 10% 17% 5% 1% 10% 16% Auto Maruti Suzuki 17,332 4% 14% 18% 13% 20% 12% Hero MotoCorp 8,676 7% 10% -1% -1% 7% 11% TVS Motor 2,099 18% 27% 14% 7% 11% 15% Cement UltraTech 12,903 -1% 10% 2% 2% 4% -10% Ambuja 5,029 0% 13% 7% 4% 5% 5% Industrials BHEL 4.317 -19% -22% -16% -3% -14% -21% Cummins 3,310 -13% 11% 24% 7% 6% -7% L&T 20,342 14% 8% 7% 11% 8% 19% Source: Company, Ambit Capital research

However, as described in the previous section, we believe the pick-up seen in a number of economic indicators in 4QFY16 was the result of three substitution effects taking place in the economy rather than a cyclical upturn. These are:

(1) Pick-up in commercial vehicle demand as rail freight declines: The most significant improvement in 4QFY16 is related to commercial vehicles. As highlighted in our macro teams note dated 23 May 2016 (click here for details), the improvement in commercial vehicle sales is likely to be a result of the substitution effect, whereby expensive rail-based freight movement is being replaced by cheaper transportation by road, which in turn is fuelled by weak diesel prices (see exhibit below for details). This migration from rail to road has been positive for the auto companies and the oil marketing companies (who have seen diesel volumes growing 8% YOY).

Exhibit 16: The pick-up in commercial vehicle sales over the past 18 months has been accompanied by a slowdown in railways freight traffic

Source: CEIC, Ambit Capital research. Note: CV refers to commercial vehicles

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CVs sales (left scale) Railways goods traffic (Right scale)

The 4QFY16 result season suggests that the core theme that has delivered outperformance is consumption

and the economic pickup seen last quarter is a result of three substitution effects CVs substituting for falling railway freight


Strategy


(2) Pick-up in consumer durables as spending on real estate and jewelry declines: As highlighted in the exhibit below, urban consumption appears most resilient as evinced from the buoyancy in PV and consumer durables sales. We believe that as PM Modi has imposed constraints to investment in real estate and gold through his drive against black money, the excess cash in peoples hands (as also seen through a marked spike in currency in circulation) seems to be leading to purchase of autos and home improvement items.

Exhibit 17: Net sales growth for real estate companies in India have been contracting over CY15

Source: CEIC, Ambit Capital research. Note: The top 15 listed real estate companies have been included here namely Anant Ra, Ansal Properties & Infrastructure, BSEL Infrastructure Realty, DB Realty, DLF, Godrej Properties ,Housing Development and Infrastructure, Hubtown, Indiabulls Real Estate, Mahindra Lifespace Developers, Parsvnath Developers, Peninsula Land, Phoenix Mills ,Sobha Developers and Unitech.

Exhibit 18: Indias gold imports declined meaningfully under the current NDA-II government

Source: CEIC, Ambit Capital research

Exhibit 19: Currency in circulation and currency with public rose to a 6-year high growth rate in FY16

Source: RBI, Ambit Capital Research

Exhibit 20: Currency with public increased meaningfully in 2HFY16

Source: RBI, CEIC, Ambit Capital Research

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consumer durables replacing demand for real estate and jewelry

Strategy


Exhibit 21: Consumer durables and PV sales have increased

Source: CEIC, RBI, Ambit Capital Research

The other reason for us to believe that spending on consumer durables and auto will increase is fact that the consumption to GDP ratio is currently at around 65%. At the height of the post-Lehman boom this ratio was running at 71% suggesting that there is some scope for this ratio to move up over the next 2-3 years.

Exhibit 22: Consumption-to-GDP ratio has some scope to increase

Source: CSO, Ambit Capital Research.

3) Pick up in private banks and NBFC lending as PSU banks conk-off: As can be seen in the chart below, the pick-up in loan book growth of private banks and NBFCs has come at the expense of PSU banks. PSU banks and ICICI Bank form 78% of credit outstanding in India and, under pressure due to deteriorating asset quality, have pulled back from corporate lending. As a result, SMEs in need of money are being forced towards other private banks and NBFCs for their credit needs. This has resulted in a spike in credit demand from NBFCs and private sector banks even as overall credit growth continues to languish at 10%.

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and NBFCs and private banks lending substituting for PSBs lack of lending

Strategy


Exhibit 23: NBFCs and private banks have grown their loan books at the expense of PSU banks

Source: Company, Ambit Capital Research Note: The banks and NBFCs under our coverage have been used for the chart above

Exhibit 24: At the system level, credit growth and deposit growth continue to languish near 10%, i.e. at multi-decadal lows


Further, as highlighted in our macro teams note dated 23rd May 2016, there are three reasons why it may be premature to believe that India has entered a phase of a sustained secular recovery: Reason#1: Growth in Government capex is set to slow in FY17 The Central Government has budgeted extremely low capex growth for FY17 as compared to FY16 (see exhibit below).

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Premature to believe India has entered a phase of secular recovery


Strategy


Exhibit 25: Government capex is set to decelerate significantly in FY17 from the highs seen in FY16

Source: Union Budget documents, Ambit Capital research

Exhibit 26: Even the Central Governments adjusted capex* is set to decelerate in FY17

Source: CEIC, RBI, Ambit Capital research. *Note: Adjusted capex adds the revenue grants given by the Centre to states which will be ultimately used for capex back to Central Government capex.

Even after adding back revenue spends by the Government that may ultimately result in capital formation, overall capex growth is not set to accelerate but remain broadly flat (see exhibit above). Even after including the impact of off-balance-sheet capex of the Central Government (in the form of spending undertaken by the National Highways Authority of India, Indian Railways and Other PSUs), the Centres gross capex in FY17 is set to increase by only 0.2% of GDP in FY17 compared to the 0.7% of GDP increase seen in FY16 (see exhibit below).

Exhibit 27: Centres gross capex in FY17 is set to increase only by 0.2% of GDP in FY17 Aggregates as % of GDP FY13 FY14 FY15 FY16 FY17

Adjusted Central Govt. Capex 2.8% 2.8% 2.6% 2.7% 2.7%

Highways and Railways 0.3% 0.3% 0.2% 0.6% 0.8%

Other PSU debt 2.7% 2.9% 2.4% 2.7% 2.7%

Gross central capex 5.8% 6.0% 5.2% 5.9% 6.2%

Change in gross central capex -0.5% +0.2% -0.8% +0.7% +0.2%

Source: Union Budget, Ambit Capital research

Reason#2: PE/VC funding influx looks set to slow down in FY17

Even as the broader economy has been feeling the pressures of a balance sheet recession, about one-third of the economy was thus far protected from these forces. Whilst the balance sheet recession was dragging down the capital intensive sectors of the economy over FY16, the business services segment (which includes sectors such as e-commerce, IT, ITES, telecom and pharmaceuticals) remained buoyant mainly owing to a record influx of private equity/venture capital funds in CY15 (see exhibit below and click here for our January 22 thematic The rise of the three speed economy)

Exhibit 28: India has received record PE/VC flows over the past few years

Source: Bain PE Deals Database, Ambit Capital research

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as growth in government capex is set to decelerate in FY17

PE/VC funding is set to slow down in FY17

http://reports.ambitcapital.com/reports/Ambit_Economy_Thematic_Theriseofthethreespeedeconomy_22Jan2016.pdf

Strategy


A series of signals now suggests that the record influx of private equity/venture capital funds that India received over the last few years (i.e., US$15bn in CY14 and US$22bn in CY15) is likely to abate significantly in CY16 (see exhibit below).

Exhibit 29: Private equity and venture capital influx into India in all likelihood peaked in CY15 Title Description

Private equity exits near 4-year low

(source: Business Standard, April 2, 2016 http://goo.gl/bZ6KDC).

VC funding, which hit a peak during Q1CY15, fell sharply, with only 88 deals in Q1CY16 as against 138 deals during Q1CY15. Deal value shrunk 88% to $334mn in Q1CY16, compared to $1.8bn seen in the same quarter a year ago. The share of VC funding dipped by about half to 14.6% in Q1CY16.

VC circle report, April 2016 (source: http://goo.gl/0HTVNj)

After attracting a record US$20bn in PE/VC funds in 2015 (VCCedge data), up from US$12.5bn in the previous year, Indian companies are already seeing a 50% drop in new funding, if the first quarter of 2016 is any indication. Signs are adding up that the Great Indian Start-up Funding Story is unraveling on the edges. Late-stage funding of at least $20mn has started drying up with many VCs unequivocally saying they would write fewer cheques this year.

As flood of easy money dries up, start-ups put a stop to equity dilution to cash in later (source: The Economic Times, February 2016, http://goo.gl/Uajnwg)

As private equity and venture capital investors are tightening and consolidating their investment portfolios in the start-up space, an increasing number of start-ups are getting sensitised with the new emerging 'funding climate' and are also looking towards debt funding to avoid further equity dilution as valuations are already under pressure and most of them are preferring to dilute equity at a later stage to fetch a better valuation.

Start-ups brace for dry season (source: The Times of India, February 2016, http://goo.gl/2trHqZ

Across the country, warnings are being sounded about the coming summer likely to be the hottest one yet. But the ones already feeling the heat are entrepreneurs looking to raise millions of dollars to fund their big ideas.

Source: Media reports, Ambit Capital research

Reason#3: Willingness to lend amongst PSUs is likely to be low as the RBI, the Banks Board Bureau and the judiciary pursue a clean-up Unlike most emerging markets, banks account for the majority of financial resources used by the corporate sector in India (see exhibit below). Furthermore, public sector banks (PSBs) account for the lions share of credit extended by the banking sector (see exhibit below)

Exhibit 30: Banks accounts for the majority of financial resources used by the Indian corporate sector

Source: RBI, Ambit Capital research. Note: NBFCs refers to non-banking financial companies and CPs refer to commercial papers

Exhibit 31: PSBs account for the lions share of credit extended by the banking sector

Source: RBI, Ambit Capital research. Note: PSBs refers to public sector banks and RRBs refer to regional rural banks.

Even as the RBI has indicated that it will aggressively boost liquidity in the system via its money market operations as well as Open Market Operations (OMO), it is critical to note that the Indian banking sector appears unwilling to lend as banks themselves are suffering from balance sheet problems. The indiscriminate lending over FY04-FY08 to the infrastructure sector and the slowdown that followed have meant that Indian banks have accumulated huge bad debts. The problem is particularly profound for public sector banks (see exhibits below).

Bank Credit, 61%NBFCs,

13%

Corporate Bonds, 18%

CPs, 3% Others, 4%

64%

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PSBs PrivateBanks

ForeignBanks

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Sha

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it

ou

tsta

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ing

and PSBs are likely to remain subdued lenders due to balance sheet stress

Strategy


Exhibit 32: Gross NPAs have increased both in PSBs


Exhibit 33: as well as private sector banks


Given that PSBs account for nearly 60% of the total loans outstanding, their diminished capability to lend to the corporate sector implies capex activity is likely to remain subdued in FY17.

Exhibit 34: MSME growth and corporate lending growth have been slowing since FY15

Source: RBI, Ambit Capital Research.

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Strategy


Section 4: Sensex earnings and target Urban consumption helped offset earnings drag from capex heavy sectors In our macro teams note dated, 22 January 2016, we had highlighted the point that the slowdown in the Indian economy is not uniform - there are three distinct segments of the economy which are growing at different rates. The two segments of the economy which are struggling to grow are linked to the capex cycle and these segments appear to be in the grip of a balance sheet recession. The segment of the economy which is growing at a reasonable pace is not linked to the capex cycle and has in fact received a fillip from the recent influx of private equity and venture capital investments. The earnings growth for the Sensex Index reflects this phenomenon as the sectors which have shown an earnings growth relate to the urban consumption theme. As shown in the table below, sectors like auto, home building, FMCG and private banks (excluding ICICI) have seen earnings growth in FY16. Sensex earnings growth has been dragged down by sectors like Metals & Mining, BFSI (PSU banks and ICICI), Oil & Gas, Pharma and Industrials. Whilst we expect a similar trend to play out over the current financial year (FY17) as well, given the reduced weightage of sectors like PSU banks, Metals & Mining, Oil & Gas and Industrials in the index post the recent correction in stock prices and the fillip to earnings possible on the back of a low base, our bottom-up analysis leads to Sensex FY17E EPS of `1550, implying growth of 14%. (Please note that our Sensex FY17 EPS estimate was `1570 in our 22 April 2016 note i.e. our expectation of FY17 EPS has not changed much after the 4Q earnings season.) Exhibit 35: Sensex earnings growth for FY16 and Ambit vs consensus EPS estimates for FY17

Earnings

growth Ambit

estimate

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(est)

Consensus estimate

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(est) Quarterly earnings

# Name Sector Index

Weight (%) Weighted EPS-FY15

Weighted EPS-FY16

FY16/ FY15

Weighted EPS-FY17 E

FY17/ FY16

Weighted EPS-FY17 E

FY17/ FY16 4QFY15 4QFY16

YoY (growth)

1 Cipla* Pharma 1.0 8.2 10.5 28% 12.6 20% 12.6 20% 1.8 0.6 -69%

2 H D F C* BFSI 8.3 99.5 114.9 15% 114.9 0% 114.9 0% 29.9 39.0 30%

3 Hero Motocorp Auto 1.5 16.6 20.5 23% 22.7 11% 22.5 11% 3.1 5.3 71%

4 Asian Paints Home Building 1.9 7.4 9.3 25% 11.0 19% 10.9 18% 1.8 2.1 20%

5 Hind. Unilever FMCG 2.6 13.6 15.1 10% 18.5 23% 17.2 16% 3.7 4.0 7%

6 ITC FMCG 7.5 71.2 72.8 2% 85.9 18% 78.4 12% 16.8 17.6 5%

7 Larsen & Toubro E&C 5.2 48.1 44.7 -7% 50.4 13% 55.9 17% 21.0 24.9 18%

8 M & M* Auto 2.4 22.2 24.9 12% 33.8 36% 33.8 36% 4.3 4.5 6%

9 Reliance Inds.* Oil & Gas 6.7 150.3 157.6 5% 164.0 4% 164.0 4% 40.7 47.1 16% 10 Lupin* Pharma 1.5 15.1 14.2 -6% 18.6 31% 18.6 31% 3.4 5.1 47%

11 Tata Motors Auto 3.7 107.5 104.0 -3% 111.7 7% 102.1 -2% 11.5 33.4 190%

12 Tata Steel Metals & Mining

0.9 (2.5) (22.2) -780% 3.4 115% 10.4 142% (44.1) (25.1) 43%

13 Wipro IT 1.6 27.2 28.0 3% 29.3 4% 30.0 7% 7.2 7.1 -2%

14 Dr Reddy's Labs* Pharma 1.7 20.8 17.4 -16% 21.0 20% 21.0 20% 4.5 0.6 -86%

15 Adani Ports* Infra 0.7 11.0 13.7 24% 13.4 -2% 13.4 -2% 2.6 2.7 2%

16 SBI BFSI 2.4 74.7 54.6 -27% 60.0 10% 60.3 15% 20.6 5.4 -74%

17 B H E L Capital Goods

0.5 6.3 (3.9) -162% 4.5 215% 2.3 158% 3.8 1.6 -60%

18 Infosys IT 10.6 120.8 132.2 9% 142.4 8% 148.5 12% 30.3 35.2 16%

19 Sun Pharma* Pharma 3.6 35.9 24.4 -32% 38.3 57% 38.3 57% 5.5 9.1 66%

20 HDFC Bank BFSI 9.5 94.8 109.5 16% 131.4 20% 120.3 10% 24.5 28.6 17%

21 TCS IT 5.7 58.4 71.7 23% 77.5 8% 78.4 9% 11.0 18.9 72%

22 ICICI Bank BFSI 6.0 141.1 122.4 -13% 140.9 15% 146.3 25% 33.7 8.1 -76%

23 Maruti Suzuki Auto 2.3 18.7 22.9 23% 28.4 24% 30.3 28% 6.5 5.7 -12%

24 O N G C* Oil & Gas 1.6 44.2 34.0 -23% 39.7 17% 39.7 17% 9.5 10.6 12%

25 NTPC Utilities 1.3 27.7 28.0 1% 25.0 -10% 28.4 -2% 8.4 7.8 -8%

26 Coal India Metals & Mining 1.6 29.8 32.6 9% 32.5 -1% 33.9 9% 9.2 9.2 0%

27 GAIL (India) Oil & Gas 0.7 12.1 8.7 -28% 14.5 67% 13.5 51% 2.0 3.1 51%

28 Bharti Airtel* Telecom 2.1 24.3 22.1 -9% 22.9 4% 22.9 4% 5.1 5.2 3%

29 Axis Bank BFSI 3.4 53.7 59.7 11% 64.4 8% 72.6 21% 15.8 15.5 -2%

30 Bajaj Auto Auto 1.4 14.2 17.8 26% 20.0 12% 20.6 8% 3.1 4.0 29%

100.0 1,373.0 1,362.2 -0.8% 1,553.5 14.0% 1,561.8 14.7% 297.5 337.0 13.3%

Source: Bloomberg, Ambit Capital Research. *Bloomberg consensus earnings estimates have been used for stocks not under our coverage

Whilst sectors like auto, home building and FMCG saw earnings growth, Metals & Mining, PSU banks and Oil and Gas lagged behind

http://reports.ambitcapital.com/reports/Ambit_Economy_Thematic_Theriseofthethreespeedeconomy_22Jan2016.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Good&Cleanroarsagain_22Apr2016.pdf

Strategy


Revisiting our Sensex target of 22,000

In our previous three notes dated, 22 April 2016, 9 March 2016 and 15 Feb 2016, we laid out a framework that used three parameters, based on which we were bearish on the markets:

1. Asset quality stress in the Indian banking system;

2. The liquidity crunch in the Indian banking system; and

3. The risk of deflation in the western world.

Our concerns over these three parameters had led us in our last three strategy notes to re-emphasize the significant risks facing the Indian equity markets and consequently maintain our Sensex target of 22,000 (which was arrived at by applying a P/E multiple of 14x (the average multiple seen in the 6 months after the Lehman crisis of 2008) to the Sensex FY17 EPS estimate of `1570 (implying 15% EPS growth YOY). As highlighted in the opening section of the note, the deflation risk in the West has, if anything, become more real over the past couple of months. To that extent, our Sensex 22,000 target remains a realistic scenario.

However, the steps taken by the RBI and the BBB, as highlighted in Section 2 of this note, have led to a moderation in the risks emanating from parameters 1 and 2 (asset quality stress and liquidity crunch in the banking system). Hence we can longer justify using a post-Lehman P/E multiple of 14x to arrive at our base case Sensex target (especially since Raghuram Rajan said on 13th May that, "There is absolutely no chance we will have a 'Lehman' moment.)

Hence we are revising our base case scenario Sensex earnings multiple to 19x (which is also the 10-year P/E average). Applying this to our Sensex FY17EPS estimate of `1550 (down from `1570 in our 22nd April note), we arrive at our revised target of 29,500 (implying 10% upside).

A significant re-rating of the Sensex P/E multiple seems unlikely

As can be seen in the exhibit below, the Sensex P/E ratio has moved in tandem with the 10-year moving average over the last five years. Also, barring the dotcom boom of 1999-2000, the re-rating of the Sensex Index in past instances was accompanied by an improvement in the earnings growth trajectory. Hence, a material re-rating in the Sensex index trailing P/E multiple from current levels of 19x is unlikely unless the Sensex EPS growth shows a similar trend going forward. As highlighted in the previous sections, given that the uptick seen in earnings in the last quarter is a result of three substitution effects playing out in the economy rather than an overall cyclical upturn, we do not expect a sustained material uptick for the Sensex EPS in the coming quarters. Thus, a major re-rating in Sensex P/E multiple seems unlikely.

Exhibit 36: The Sensex P/E multiple has remained extremely stable over the last five years

Source: Ace Equity. Ambit Capital Research; Note: The Sensex trailing 12m EPS has been back calculated using Sensex P/E ratio and Sensex Index level at each quarter

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In light of the deflation risks in the West, 22,000 on the Sensex remains a realistic scenario

However in light of steps taken by the RBI and BBB to resolve the banking system stress we increase our base case FY17 P/E multiple from 14x to 19x

http://reports.ambitcapital.com/reports/Ambit_Strategy_Good&Cleanroarsagain_22Apr2016.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Afterthestrangestofpostbudgetrallies_09Mar2016.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Noeasyroadtorecovery_15Feb2016.pdf

Strategy


Also, as highlighted in the exhibit below, the S&P 500 index has been consistently re-rating since the lows of the Sep11 quarter and is currently trading at a higher P/E than the 2007-08 boom period (thanks to eight years of extremely accommodative monetary policies from the Fed). Further, over the past 20 years, the correlation between the change in Sensex P/E ratio and change in S&P500 P/E ratio has been 36% with the correlation rising during times of downturn. With the Fed likely to restart its monetary tightening with two more rate hikes expected this year, there is a high risk of the S&P500 P/E multiple de-rating in the coming quarters.

In the light of both subdued earnings growth expectations for the Sensex and potential risks to its P/E multiple from a de-rating of the S&P500 index, we do not see a case for the Sensex P/E multiple to re-rerate from its current level.

Hence, as highlighted in the previous sub-section, we use the current P/E multiple of 19x (which is also the 10-year moving average value) and apply it to our Sensex FY17 EPS estimate of `1550 to arrive at our FY17 Sensex target of 29,500 (implying a return of 10% from current levels).

Exhibit 37: whilst the S&P500 P/E multiple has continuously re-rated over this period


Technical note We have found in the past that a number of clients tend to get confused with our use of a trailing Sensex multiple vs the generally accepted norm of using a forward multiple. We apply a trailing multiple to a particular years EPS estimate to arrive at that years Sensex target. For example, the application of a 19x trailing multiple to our FY17 EPS estimate of 1,550 leads to our 31st March 2017 Sensex target of 29,500. An alternate way to arrive at the March 2016 Sensex target would be to apply a forward multiple but to the FY17 EPS estimate. This, however, would entail forecasting the Sensex EPS two years out, which, given the current uncertainty associated with both a clear direction on domestic reform momentum as well as the ever-changing global climate, will introduce a forecasting error. Hence, we prefer using EPS forecasts one year out (which we believe are more reliable) and applying a trailing multiple.

Exhibit 38: Sensex target old vs new Estimated FY17 EPS=1,570 estimated FY17 EPS=1,550 Trailing target Sensex P/E=14x trailing target Sensex P/E=19x Implied Sensex target=22,000 Implied Sensex target=29,500

Old New

Source: Ambit Capital research

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A re-rating from current P/E multiple (19x) looks unlikely in light of subdued EPS growth expectations and risk of S&P500 de-rating

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Section 5: Investment Implications Whilst we appreciate the fact that consensus estimates of GDP growth in FY17 are materially higher than Ambits (6.8% vs. 7.5%), we believe the consensus is working off the CSOs counter-intuitive advance estimate of GDP growth of 7.6% YoY for FY16, which is likely to be creating an anchoring bias (click here for our macro teams 1st June, 2016 note on the subject). We have also taken a more conservative view of inflation and interest rates than consensus. We expect room for rate cuts to be limited owing to three reasons: (1) a high likelihood that inflation remains sticky at 4.5-5.5% in FY17; (2) it would make a great deal of sense for the RBI to signal to the Central Government that the fiscal maths for FY17 appear overly ambitious and that the Government needs to do more to build credibility by administering limited rate cuts; and (3) though oil prices have a limited impact on CPI inflation, it is worth noting that Brent prices (in INR terms) have rallied by ~34% since January 2016. Hence, after the RBIs 25bps rate cut administered on 5th April, we expect rate cuts to the tune of just 0-25bps to be administered in the rest of FY17 (click here for our macro teams note dated 13th May 2016 for details).

In line with our sober expectations on economic growth (i.e., there is no material economic pickup underway in India) and interest rates (rate cuts will be limited), we reiterate our investment strategy of focusing on well-managed companies with strong cashflows, credible management teams, and believable financial statements. We have for several years articulated this strategy through two model portfolios:

Investment Strategy#1: For investors who are focused on delivering quarterly outperformance, we have for the past five years published a quarterly Good & Clean portfolio. Our Good & Clean 10.0 portfolio published on 5th February is shown below and has generated 350bps outperformance (on an annualized basis) relative to the BSE500 since publication. This medium-term-oriented investment strategy has over the past five years generated 4.5 percentage points of annual outperformance vis-a-vis the BSE500.

Exhibit 39: Over the past five years, our Good & Clean portfolio has generated 4.5 percentage points of annual outperformance vis-a-vis the BSE500


(15.0)

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alpha (vs BSE500) cumulative alpha

We expect room for rate cuts to be limited going forward

Our Good & Clean 10.0 portfolio has generated 350bps of outperformance relative to the BSE500 since publication

http://reports.ambitcapital.com/reports/Ambit_Economy_Update_FY16GDPdataSomemorefiction_01Jun2016.pdfhttp://reports.ambitcapital.com/reports/Ambit_Economy_Foodpricesinflate_13May2016.pdfhttp://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_Good&Clean10_05Feb2016.pdf

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Exhibit 40: Our Good & Clean 10.0 portfolio has generated 120bps of outperformance relative to the BSE500 since publication on 5th Feb

Ticker Company Mcap ($ mn)

Price Performance FY17 P/E FY17 P/B FY17 EV/EBITDA 4-Feb-16 9-June-16

PI IN PI Industries 1,405 662 684 3.3% 26.0 6.4 17.7

TTMT IN Tata Motors 22,673 326 467 43.5% 10.2 1.7 3.7

TVSL IN TVS Motors 2,064 281 290 3.2% 22.3 6.7 13.7

MRF IN MRF Ltd. 2,068 33,725 32,546 -3.5% 8.1 1.7 4.3

MACA IN Mahindra CIE. 966 221 199 -9.9% 23.6 2.9 11.4

ATLP IN Atul Ltd. 841 1,477 1,891 28.0% 18.0 3.6 11.0

TTAN IN Titan 4,851 362 365 0.7% 37.0 7.8 25.8

PAG IN Page Industries 2,337 11,921 13,985 17.3% 53.7 24.1 34.9

ITC IN ITC 42,697 322 354 10.0% 25.7 7.5 16.4

HUVR IN HUL 28,422 835 876 5.0% 40.2 42.8 27.6

MRCO IN Marico 4,843 225 251 11.3% 37.9 12.3 25.6

AIAE IN AIA Engineering 1,455 816 1,030 26.2% 23.5 3.7 14.7

AXSB IN Axis Bank 19,400 383 543 41.8% 12.8 2.1 N/A

IIB IN IndusInd Bank 10,007 913 1,122 22.9% 22.6 3.3 N/A

BOB IN Bank of Baroda 5,146 123 149 21.4% 13.0 0.9 N/A

SCUF IN SCUF 1,682 1,520 1,702 12.0% 14.9 2.1 N/A

CUBK IN City Union Bank 977 81 109 33.9% 12.7 1.9 N/A

DCBB IN DCB Bank 408 77 96 24.0% 14.6 1.4 N/A

HAVL IN Havells. 3,344 298 357 19.9% 34.9 8.0 22.6

BRGR IN Berger Paints 2,943 269 283 5.3% 43.3 11.1 25.4

SI IN Supreme Industries 1,723 719 905 26.0% 28.5 7.3 15.5

GPPV IN Gujarat Pipavav 1,154 147 159 8.1% 25.4 3.6 16.0

TCS IN TCS 76,093 2,420 2,577 6.5% 19.1 6.0 14.0

HCLT IN HCL Tech 15,916 867 753 -13.2% 13.5 3.3 9.6

IGL IN IGL 1,202 550 573 4.1% 15.7 2.9 8.5

LPC IN Lupin 9,639 1,653 1,427 -13.6% 22.0 4.8 14.6

TRP IN Torrent Pharma 3,469 1,351 1,368 1.3% 19.4 5.3 13.2

AJP IN Ajanta Pharma 2,048 1,292 1,553 20.2% 29.6 8.7 19.7

IDEA IN Idea Cellular 5,660 100 105 4.9% 21.5 1.4 5.1

PWGR IN Power Grid 11,978 147 153 4.1% 10.5 1.6 8.2 G&C 10.0 performance 12.2% BSE500 Index 9,771 10,846 11.0% Alpha (G&C 10.0 vs BSE500) 1.2% Source: Bloomberg, Ambit Capital research

Investment strategy#2: For investors who are focused on delivering annual outperformance (alongside low portfolio churn), we have for the past five years published an annual Tenbaggers portfolio. Our Tenbaggers 5.0 portfolio published on 5th January is shown below and has generated 280bps of outperformance relative to the BSE500 since publication. This long-term-oriented investment strategy has over the past five years generated 10.7 percentage points of outperformance vis--vis the BSE500.

Our Tenbaggers portfolio has over the past five years has generated 10.7% points of outperformance vis--vis the BSE500

http://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_TenBaggers5_05Jan2016.pdf

Strategy


Exhibit 41: Over the past five years, our Tenbaggers portfolio has generated 10.7 percentage points of annual outperformance vis-a-vis the BSE500


Exhibit 42: Our Tenbaggers 5.0 portfolio has generated 120bps of outperformance relative to the BSE500 since publication on 5th Jan

Ticker Company Mcap ($ mn) Price

Performance FY17 P/E FY17 P/B FY17 EV/EBITDA 4-Jan-16 9-June-16 ITC IN ITC Ltd. 42,697 325 354 9% 25.7 7.5 16.4 IDEA IN Idea Cellular 5,660 136 105 -23% 21.5 1.4 5.1 HCLT IN HCL Tech. 15,916 846 753 -11% 13.5 3.3 9.6 TCS IN TCS 76,093 2,370 2,577 9% 19.1 6.0 14.0 GPPV IN Gujarat Pipavav 1,154 157 159 1% 25.4 3.6 16.0 MRF IN MRF 2,068 40,506 32,546 -20% 8.1 1.7 4.3 TTMT IN Tata Motors 22,673 377 467 24% 10.2 1.7 3.7 TRP IN Torrent Pharma 3,469 1,448 1,368 -6% 19.4 5.3 13.2 LPC IN Lupin Ltd. 9,639 1,795 1,427 -20% 22.0 4.8 14.6 PSYS IN Persistent Systems 863 647 720 11% 16.9 3.1 10.3 KJC IN Kajaria 1,416 985 1,189 21% 33.2 7.4 17.9 BRIT IN Britannia 4,964 2,973 2,761 -7% 35.0 14.3 23.4 SKB IN GSKConsumer 3,577 6,496 5,676 -13% 31.3 8.4 24.9 PI IN PI Industries Ltd. 1,405 656 684 4% 26.0 6.4 17.7 MTCL IN Mindtree# 1,607 725 639 -12% 16.2 3.7 10.4 PAG IN Page Industries 2,337 13,558 13,985 3% 53.7 24.1 34.9 FNXC IN Finolex Cables 822 251 359 43% 20.8 3.3 12.8 SI IN Supreme Industries 1,723 689 905 31% 28.5 7.3 15.5 BRGR IN Berger Paints 2,943 263 283 7% 43.3 11.1 25.4 EIM IN Eicher Motors 7,563 17,495 18,584 6% 30.7 10.9 17.3 TVSL IN TVS Motor 2,064 287 290 1% 22.3 6.7 13.7 SF IN Sundram Fasteners 528 165 168 2% 15.5 DNA 9.5 AJP IN Ajanta Pharma 2,048 1,328 1,553 17% 29.6 8.7 19.7 HTSMF IN Hatsun Agro Products 767 414 471 14% 34.8 12.7 14.0 LOG IN La Opala 451 618 542 -12% 41.7 10.3 27.7 HUVR IN Hindustan Unilever 28,422 859 876 2% 40.2 42.8 27.6 VO IN Vinati Organics 417 464 539 16% 20.8 4.3 12.3 MRCO IN Marico Ltd. 4,843 225 251 11% 37.9 12.3 25.6 AIAE IN AIA Engineering 1,455 886 1,030 16% 23.5 3.7 14.7 ATLP IN Atul Ltd. 841 1,699 1,891 11% 18.0 3.6 11.0 Ten Bagger 4.6% BSE500 index 10,492 10,843 3.4% Outperformance 1.2% Source: Bloomberg, Ambit Capital research

That said, we recommend the following stocks from sectors like auto, home building and consumer discretionary, which are likely to benefit from the three substitution effects discussed earlier rippling through the Indian economy:

6.7 9.8

43.4 52.6 53.9

(10) - 10 20 30 40 50 60 70 80

2012 2013 2014 2015 2016

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Tenbagger iteration return index return cumulative alpha

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ITC (ITC IN, 6M ADV US$41.7mn, BUY, `415, 17% upside) Investment thesis: Following an increase in cigarette volumes by ~0.5% YoY in 4QFY16, we expect 2-3% YoY volume growth in FY17. After the 10% excise hike in the Union Budget, hawkishness against tobacco by various ministries seems to have softened. We reiterate that the only way to curb tobacco consumption in India is to 'gradually' make it unaffordable over a long period. Our reverse-DCF for the cigarettes business suggests that the current valuation factors in -4%/15% volume/excise-duty CAGR over FY17-FY20. Whilst global cigarette businesses trade at a 10-20% discount to FMCG peers, ITC is currently trading at a ~40% discount to HUL. Over the longer term, we expect excise duty hike of 9-10% with volume growth of ~2% YoY and cigarette EBIT growth of 12-13% YoY. Reiterate BUY on ITC with TP of `415 (implies 25x FY18E P/E). HUL (HUVR IN, 6M ADV US$19mn, BUY, `960, 9% upside) Investment thesis: Governments rollout of subsidies on Direct Benefit Transfer (DBT) platform from FY17 is likely to result in an increase in disposable income for target households. Hindustan Unilever is best positioned to capitalize on these benefits due to: a) its highest proportion of rural sales, b) high exposure to the most-functional staples categories (like soaps, detergents, shampoos, and oral care), and c) increase in the width and depth of its distribution network over the past 3-4 years. Given the benefit that HUL can derive due to the DBT-induced pickup in rural demand from 2HFY17, we expect HUL to deliver sales/EPS CAGR of 15%/22% over FY16-FY20 with >100% RoCE. Our fair value of `960 implies FY18E P/E of 34x. Tata Motors (TTMT IN, 6M ADV US$58.5mn, BUY, `480, 3% upside) Investment thesis: JLR volumes continued to recover in the recent months (January-April 2016 volumes up 24% YoY) on the back of strong response to new launches such as Discovery Sport and volumes stabilising in China. We expect the momentum to continue, helped by (i) continuing strong response to new launches vehicles (viz. Discovery Sport, Jaguar XE amongst others); (ii) incremental volumes coming from new launches such as Jaguar XF, new Jaguar XJ etc; and (iii) favourable base of FY16 in China. We expect JLRs wholesale volumes to witness 11% YoY growth each in FY17/FY18. We expect JLRs margin to stabilise at 14.9% in FY17 as negative impact of Chinese yuan devaluation, lower ASP products (Jaguar XE) and rising incentives in geographies such as the US would be offset by positive impact of operating leverage from higher volumes and lower discounts on newer vehicles. We value JLR at `435/share (implying 4x FY18 EV/EBITDA); standalone business at `25/share and other equity investments at `20/share. Overall, our SOTP-based June 2017 target price is `480/share.

Marico (MRCO IN, 6M ADV US$7.2mn, BUY, `287, 14% upside) Investment thesis: Marico has maintained leadership in its core categories through: (a) a unique work culture which has enabled the firm to attract and retain high quality talent; (b) a high quality Board which is truly independent in helping drive strategic decision-making; and (c) a strong focus on building supportive relationships with its distributors. Over the next five years, we expect the firm to successfully evolve around: (a) product innovation in the non-coconut oil portfolio; (b) nurturing high-quality talent; and (c) better use of IT and data analytics. We expect Marico to deliver FY16-20 sales/EPS CAGR of 16%/25% with RoCE improving from 29% to ~41% over the same period. Our DCF-based TP of `287 implies FY18E P/E of 32x. Berger Paints (BRGR IN, 6M ADV US$1.6mn, BUY, `324, 14% upside) Investment thesis: Promoters have shown staunch focus on (1) the paints industry, (2) controlled capital allocation, and (3) a hands-off approach that gives professionals complete control of ground-level execution. Over the past 3 years, CEO Abhijit Roy has implemented significant changes, including: (a) aggressive marketing campaigns for the Silk and Express Painting service; (b) IT investments in supply chain management; (c) process-oriented approach for hiring, retaining and incentivising the sales team; (d) raw material procurement and manufacturing process efficiencies; and (e) improving the quality of hires at the management trainee level. Through

Strategy


these initiatives, we expect Berger to gain ~500bps market share from Kansai and Akzo Nobel over FY15-FY25 and expand EBITDA margin by 150bps over FY16-FY20. We expect 19%/26% revenue/EPS CAGR over FY16-FY20, with RoCEs rising from 21% in FY16 to 31% in FY20. Our fair value of `324 implies 37x FY18E P/E. Page Industries (PAG IN, 6M ADV US$2.4mn, BUY, `14,787, 6% upside) Investment thesis: Over 10 years, Pages revenue/EPS have grown by 37%/25% CAGR with focus on innerwear and associated categories. The Genomals (founders) have leveraged their experience in the Philippines to fortify Pages moats around: a) product differentiation given in-house manufacturing; b) aspirational brand recall; and c) tight control on the distribution channel. Hence, new entrants offering either international brand recall, or affordable price, struggle to break Jockeys customer loyalty built on a combination of quality, affordability and brand. Weakness in revenue growth momentum in FY16 is temporary and macro-driven. We expect revenue/EPS CAGR of 27%/33% (FY16-18E) with RoCE of ~50% over FY16-18E and a high dividend payout of >55%. We reiterate BUY with a target price of `14,787 (54x implied FY17 P/E). Cholamandalam Finance (CIFC IN, 6M ADV US$1.2mn, BUY, `905)

CIFC enjoys strong mid-term catalysts of declining cost of funds, improving operating leverage and pickup in LCV sales to deliver ~28% EPS growth over FY16-18E. Structurally, it is also well-positioned to sustain earnings growth owing to its competitive strengths in LCV and old CV financing and capabilities in housing finance. Given the multiple structural and medium-term tailwinds, we expect CIFC to deliver 28% EPS growth over FY16-18E, driven by 23% AUM growth and RoAs improving by ~30bps to 2.3%. Our excess-return-based valuation of `905 implies 3.3x FY17E P/B and 20x FY17E P/E.

TVS Motor Company (TVSL IN, 6M ADV US$8.4mn, BUY, TP `340, 17% upside) Investment thesis: TVSM is best placed to ride the increasing shift toward scooters and premium models in 2Ws. We expect launch of Apache 200 and Victor; and the TVS-BMW premium bike in mid-FY17 to drive 135bps market share expansion over FY16-FY18 for TVSM in domestic motorcycles. We expect TVSM to clock 14% volume growth in domestic 2Ws over FY16-18. Increasing capacity utilisation and a healthier product mix (launch of Victor and premium bikes) would increase EBITDA margin (ex-BMW) to 8.2% in FY17E and 9.3% in FY18E vs 6.8% in FY16. We expect exports to BMW (of

Strategy


Mahindra CIE Automotive (MACA IN, 6M ADV US$0.7mn, BUY, TP `240, 21% upside) Investment thesis: CIEs strong track record of profitability (15% margin at its European plants) and turning around flailing businesses through intense cost focus, decentralisation and process improvement make us confident of a turnaround in Mahindra Forgings Europe. MCIE can leverage CIEs relationships, broaden its customer base by establishing a foothold with western OEMs (VW, BMW, etc), and bring in PV products (like common rail forgings, tulip joints, oil plans into India). Furthermore, MCIE could be CIEs gateway to India - CIE has limited presence in Asia (small presence in China and Russia). CIE Automotive, through MCIE, can get a foothold in India and potentially use India as an export hub for Asian car markets. Our May 2017 DCF-based valuation is `240/share implies 10.8x CY17E EBITDA, which is at ~10% discount to Bharat forges 1-year forward (FY17) multiple. Finolex Cables (FNXC IN, 6M ADV US$0.5mn, BUY, TP `400, 11% upside Investment thesis: Finolex Cables is likely to outperform peers in the next five years given strong growth in North India led by brownfield expansion at Roorkee, huge potential to sweat the brand (only 3 SKUs vs ~17 for a diversified player like Havells), rising ad spend (increased 2x over FY14-16), and dealer addition (tripled in the past 6 years). Also, Finolexs entry into switchgears will be margin-accretive. Entry into margin-accretive categories (like switchgears) has the potential to drive 33% EBIT margin in 1HFY17 compared with 14.2% in FY15. Finolex is also well-placed to succeed as its brand is perceived as safe (its wires are known for higher conductivity), and it has a distribution network which can be leveraged for selling switchgears. Finolex also launched fans in 1QFY17. The stock currently trades at an attractive valuation of 12.9x FY18E core EPS [excluding value of Finolex Industries (valued at 25% discount to market price) + cost of other investments from the market cap and excluding investment income from other income] given 21% RoE over FY17-18E and 14% EPS CAGR over FY16-18E. Potential success in switchgears and fans would improve RoIC from 32% in FY16 to 38% in FY18. DCB (DCBB IN, 6M ADV US$1.7mn, Not Rated)

DCB Bank has seen a marked turnaround after the difficult phase of FY09-10. The new management team has de-risked the balance sheet, strengthened its core MSME/retail offering and bolstered its liability franchise. Having followed a consistent strategy until October 2015, the bank then decided to accelerate its branch expansion for a period of two years (opening ~20 branches per quarter that earlier run-rate of 7-10 new branches per quarter) to build muscle before the competition from new banks becomes significant over coming 2-3 years. Beyond the risk taken (that cost ratios would inflate and hurt profitability in the near term), the track record of the bank, after it was allowed by the RBI to open new branches FY13 onwards, has provided some experience in rolling out branches under a proven model. The model that DCB Bank has followed is small-ticket granular lending to the self-employed segment in tier-2 to tier-6 centres with focus on retail liabilities. We believe this business model is the key strength and differentiator of the bank and the track record of last 5-6 years shows that the bank has been able to crack the right model of systems/processes/organization/infrastructure, which is suitable with this business philosophy. During FY11-FY15, the bank has grown its loans at a CAGR of ~24% with stable NIMs in the 3.5-3.6% range and consistently improving asset quality in a difficult environment. DCBB currently trades at a valuation of 1.6x FY16E BV.

Strategy


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research Analysts

Name Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected]

Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected]

Aakash Adukia Oil & Gas / Chemicals / Agri Inputs (022) 30433273 [email protected]

Abhishek Ranganathan, CFA Retail (022) 30433085 [email protected]

Achint Bhagat, CFA Cement / Home Building (022) 30433178 [email protected]

Anuj Bansal Mid-caps (022) 30433122 [email protected] Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected]

Deepesh Agarwal, CFA Power Utilities / Capital Goods (022) 30433275 [email protected] Dhiraj Mistry, CFA Consumer (022) 30433264 [email protected]

Gaurav Khandelwal, CFA Automobile (022) 30433132 [email protected] Girisha Saraf Mid-caps / Small-caps (022) 30433211 [email protected]

Karan Khanna, CFA Strategy (022) 30433251 [email protected]

Kushank Poddar Technology (022) 30433203 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected]

Paresh Dave, CFA Healthcare (022) 30433212 [email protected]

Parita Ashar, CFA Metals & Mining / Aviation (022) 30433223 [email protected]

Prashant Mittal, CFA Strategy / Derivatives (022) 30433218 [email protected]

Rahil Shah Banking / Financial Services (022) 30433217 [email protected]

Rakshit Ranjan, CFA Consumer (022) 30433201 [email protected]

Ravi Singh Banking / Financial Services (022) 30433181 [email protected]

Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 [email protected]

Ritesh Vaidya, CFA Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Sagar Rastogi Technology (022) 30433291 [email protected]

Sumit Shekhar Economy / Strategy (022) 30433229 [email protected]

Utsav Mehta, CFA E&C / Industrials (022) 30433209 [email protected]

Vivekanand Subbaraman, CFA Media (022) 30433261 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Hitakshi Mehra India (022) 30433204 [email protected]

Krishnan V India / Asia (022) 30433295 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Shaleen Silori India (022) 30433256 [email protected]

Singapore

Pramod Gubbi, CFA Director Singapore +65 8606 6476 [email protected]

Shashank Abhisheik Singapore +65 6536 1935 [email protected]

USA / Canada

Ravilochan Pola - CEO Americas +1(646) 361 3107 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Jestin George Editor (022) 30433272 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

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