Investor's Eye: Market Outlook - Resilience amid uncertainty; Update - Cadila Healthcare, Jaiprakash Associates; Switch Ideas - Agri-inputs

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Investor's Eye [March 04, 2014]  Sharekhan www.sharekhan.com

Summary of Contents MARKET OUTLOOK Resilience amid uncertainty Valuations and Modi effect to support equity market despite weak macros Global cues turn unfavourable: Since the release of our 2014 market stratefy report "Hope rises again, this time on wings" on December 30, 2013, the domestic equity market has moved in a fairly narrow range despite some negative cues globally. It began with the unexpected crisis in some of the emerging markets as a fall-out of the tapering of the quantitative easing by the US Federal Reserve. The debt crisis in Argentina and the free-fall in the currencies of Turkey and South Africa raised the risk of the contagion spreading to all the major emerging markets including India. The weak macro data from the largest emerging market, China, is also a reason for risk aversion and uncertainty among global investors. To top it all, the recent political crisis in Ukraine (and the Russian involvement in it) could push up energy prices globally and act as a sore point for investor sentiment in the near future. Domestic macro developments not very supportive either: In addition to the global concerns, the economic data points in India also suggest that the economic recovery could be rather sluggish and delayed. The growth in the manufacturing sector has already moderated significantly. The losing momentum in consumer discretionary spending signals moderation in private consumption as well and will affect the growth of the service sector too (apart from the export-driven businesses that will benefit from a weak rupee). The early predictions of a weak monsoon driven by the El Nino effect could adversely affect the important and resilient leg of rural demand in India. On the positive side, the easing of inflation, curtailment of the current account deficit (CAD) and decent growth in exports are supporting factors. Corporate earnings-a bright spot: Despite the negative global cues and weak domestic macro data, the fairly healthy growth in the corporate earnings (especially the high double-digit growth in the aggregate earnings of the Sensex) in Q3FY2014 is one of the reasons for the resilience in the Indian equity market. The export-driven information technology (IT) service and pharmaceutical companies posted a strong earnings growth during the quarter in addition to the companies with large overseas operations, like Tata Motors. Consequently, the earnings upgrades outpaced the earnings downgrades resulting in a marginal improvement in the consensus earnings estimate for FY2015. On the flip side, the deterioration in the asset quality of the public sector banks and the pronounced impact of a slowing economy on the infrastructure companies (especially construction companies) were the key negative highlights of the Q3FY2014 results. Valuations and Modi effect to support market: The market is entering a phase of seasonal weakness (in the past few years, the equity market tended to grind down and form yearly lows in the May-August period) with the global cues also turning negative; however, we do not expect the benchmark indices to break down from the multi-month base of 5650-5700 on the Nifty. Our prognosis is supported by the valuations (on an absolute basis, the Sensex trades at a 10% discount to the average multiple). Moreover, the gap between the valuations of the emerging markets and that of the developed markets has widened to the levels last seen during the turbulent phase of 2009. The domestic equity market is also supported by the "Modi" effect. The recent opinion polls suggest a growing probability of the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) coming to power after the forthcoming general election. Over the past few months, the estimates of the number of seats the NDA may win in the Lok Sabha election have moved up from 165-175 seats to 220-230 seats. Interestingly, many foreign investors see a change in favour of a stable government with a pro-development and business mindset and the decisive leadership of Narendra Modi as positive triggers for the Indian economy and equity market.  Portfolio strategy-export-led sectors to outperform over next couple of months; add blue chips within cyclical sectors (including private banks) in corrections: In the run-up to the general election, the IT and pharmaceutical stocks, and some of the select bottom-up stocks would continue to outperform, though there is growing interest in the cyclical sectors including the private sector banks (asset quality issues to keep the valuation of the public sector banks under check). The ideal strategy would be to increase one's exposure to quality names in the capital goods and engineering companies (eg Larsen and Toubro, Crompton Greaves, Bajaj Electricals and CESC) and the private sector banks (ICICI Bank, Axis Bank, Yes Bank) during corrections. It could be done by using the cash generated through booking of profits in the defensive sectors like fast moving consumer goods and consumer discretionary spending-driven companies. STOCK UPDATE Cadila Healthcare Recommendation: Buy Price target: Rs1,133 Current market price: Rs1,020 Price target revised up to Rs1,133 Key points  A fresh wave of US approvals and the management's plans to intensify the US filings reaffirms our confidence in the long-term prospects of the company. Currently, the company has nearly 100 ANDA pending approvals including some related to blockbuster products, like Abilify ($4 billion), Niaspan ($1.1 billion) and Lialda ($550 million), which are likely to lose their patent protection in FY2015.  Apart from the US business, the company is also likely to improve its performance in the Indian business in subsequent quarters, as price related issues are getting settled. The focus on niche segments like injectibles, trans-dermal and topical formulations are likely to improve its margin profile as well.  Despite a good quality management and de-risked business model (diversified presence), it has been trading at significant discounts to peers as well as its historical averages, mainly owing to a restructuring-led weaker performance during the past few quarters.  Now, as the US business is coming out of woods, we believe the stock should see a re-rating. We revise our price target to Rs1,133 (17x FY2016E EPS; vs Lupin's 19x) from Rs1,000 (15x FY2016E EPS) and maintain our Buy rating on the stock.   Jaiprakash Associates Recommendation: Hold Price target: Rs42 Current market price: Rs40 Deal valuations disappoint but strategically in the right direction Key points  JPA's divestment of two hydro electric power projects under JPVL (of which 61% is owned by JPA) is in line with JPA's strategy of selling its assets across divisions (ie cement, power and land) to bring down its consolidated debt. Though the valuations of the deal are lower than the market expectations, JPA will benefit from a reduction (11%) in the consolidated debt and interest savings (Rs650 crore per annum). We retain our Hold rating on the stock owing to the inherent value of its assets and the efforts taken to reduce the stress on its balance sheet.     SWITCH IDEAS Agri-inputs Closure of switch call from Tata Chemical to UPL with a net loss of 15%  We close switch call with around -15% negative returns: Our switch idea to shift from Tata Chemicals to UPL released on February 5, 2014, has given a negative return of 15%. The under performance of our switch idea was on the back of two reason: (1) a potential group restructuring of the Tata Group companies, having a positive rub-off effect on the mid-cap Tata Group companies; and (2) an unexpected policy announcement for urea companies (a hike in the fixed cost and urea investment policy) boosted sentiments for Tata Chemicals.  Potential restructuring of the Tata Group companies, having a positive rub-off effect on some of the mid-cap group companies: As per the media and market buzz, Tata Group is planning some major restructuring and brand building exercise under the new leadership of group chairman Cyrus Mistry. The group is finalising a plan for the consolidation of various businesses with the focus on profitability and scalability. The restructuring exercise could be in terms of focusing on fewer companies, the options are either to exit (particularly if they are non-scalable) or merge them into other group companies. Thus, there is a probability of a potential consolidation in the group companies and a stake sell in the non-core companies could happen going forward, which is having positive rub-off effects on some of mid-cap Tata Group companies in the last few months and more in today's trade.  Unexpected policy announcement for urea companies: The government has approved the hike in the fixed cost paid to urea manufacturers by Rs350 per tonne which turns out to be a positive announcement for the urea manufacturer, in addition to the urea investment policy which has boosted the sentiments for urea stocks, including Tata Chemicals. View Though we continue to maintain UPL as our preferred pick for the long-term perspective in the agro-chemicals space driven by: (1) a strong earnings outlook (a 24% earnings per share (EPS) compound annual growth rate FY2013-16); (2) the shift in the focus to value added products augurs well for the margin; and (3) the balance sheet health to improve further (undemanding valuation). At the current market price, the stock is trading at 7.5x and 6.7x its FY2014 and FY2015 estimated earnings respectively. On enterprise value/earnings before interest, tax, depreciation and amortisation, the stock is trading at 4.0x its FY2015. UPL is one of the cheapest stocks available in the agro-chemicals space which is trading at a huge discount of its peers, Rallis India and Excel Crop Care. Click here to read report: Investor's Eye   Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

Regards, The Sharekhan Research Team

 

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