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| Summary of Contents MARKET OUTLOOK Firing on all cylinders
Macro revival, policy push to drive market higher Domestic macros on the mend; no Big-Bang reforms but policy environment improves considerably
Not only has sentiment been upbeat in the first 100 days of the new government, but the macro variables have also started to improve (IIP at a three-year high in Q1FY2015, PMI data, GDP etc) suggesting a recovery in the economy. The rainfall scenario, though sub-optimal, is turning out to be better than expected and therefore should not be a disruptive factor. The domestic currency has largely stabilised at about 60-a-dollar levels, exports are picking up and the external positioning looks much resilient. On the other hand, the government has fast-tracked decision making and announced several smaller measures though the equity market has been expecting some Big-Bang reforms. But the pace of reforms and policy action could pick up after the forthcoming assembly elections in some of the key states like Maharashtra, Haryana, and Jammu and Kashmir in October and November this year. Corporate earnings growth moving to higher trajectory; signs of revival in RoEs
Over the past four quarters corporate earnings have consistently grown in double digits, thereby leading to another quarter of upgrades in the consensus earnings estimates. More importantly, the trends for the domestic demand-based sectors have begun to improve (on the margin and profitability fronts) in the past couple of quarters and may get better with a revival in the economy. Going ahead, the earnings growth is likely to be more broad-based and should be in the range of 17-18% (over FY2014-17) compared with about 8% seen in the past six years (FY2008-14). We believe, the earnings upgrades are a lead indicator of a likely uptick in the RoEs (which have deteriorated by about 300BPS since FY2011) and quite significant from the valuation perspective. Growing faith of foreign investors in India's economic recovery
In addition to strong FII inflows of $30 billion into the Indian equity market since beginning of 2014, the significant foreign fund flow into the Indian debt market is equally encouraging and reflects the growing confidence of foreign investors in the Indian economy and currency. It is believed that a single institution (Franklin Templeton) has pumped in close to Rs16,000 crore into the Indian debt market in the past couple of weeks alone. India has the advantage that it is one of the few large emerging economies where the monetary easing (interest rate cut) cycle has not commenced yet and thus it is better positioned to adjust to the changes in the interest rate regime in the developed economies (especially the likely reversal of the interest rate cycle in the USA from the summer of 2015). Remain bullish on equities--occasional hiccups an opportunity in a multi-year rally
The benchmark indices have made all-time highs in anticipation of a strong economic recovery in India driven by improving both business sentiment and policy environment, and benign global risk aversion. Corporate earnings are already showing signs of a marked improvement in growth rates (in high double digits) and the Indian market is comfortably placed in terms of both absolute valuation and relative valuation compared with the other emerging markets. The recovery in RoEs (which caused the de-rating of the P/E multiples) and the normalisation of the premium vis-a-vis the MSCI World (presently the premium is at a five-year low) will expand the valuations. Moreover, India is one of the few large emerging economies where the interest rate cycle is yet to play out and this is a strong re-rating trigger for the domestic equity market and corporate earnings. From sectoral perspective, we are positive on cyclicals, consumer discretionary segments along with select bottom-up ideas.
VIEWPOINT Salzer Electronics
Current market price: Rs136
View: Positive On the mark, ready to go Key points - Salzer Electronics Ltd (SEL) was established in 1985 as an electrical installation product manufacturer having more than 15 different products with 1,200 employees and five manufacturing plants. The company caters to almost all aspects of indoor and outdoor electrical requirements of the industry, and the building and construction, and automobile component industries. SEL is a market leader in rotary switches, toroidal transformers and wire duct products. It has been consistently spending 2-3% of its total revenues on research and development to develop new products.
- Larsen and Tuobro (L&T) is the single largest shareholder of the company with a 26% stake and two directors on SEL's board. SEL has a marketing tie-up with L&T and derives around 40% of its total revenues through the L&T channel. The other big clients of the company include General Electric and Schneider Electric. In the switchgear segments, exports constitute around 41% of the company's revenues.
- With a gradual revival in the domestic capital expenditure (capex) cycle in the key industries and an improvement in the project spending, the management expects a strong growth in the company's earnings in the next two to three years. The company has bagged a prestigious order worth Rs106 crore from the state government of Tamil Nadu under the Integrated Urban Development Scheme for executing energy efficient projects under the public-private partnership model and expects more deals in the coming year. Overall, the management is quite optimistic of delivering over 20% CAGR in the top line in the next two years.
- After a stagnant net income growth over FY2012-14, SEL is well poised to deliver a CAGR of around 50% in the earnings over FY2014-16. At the current market price of Rs137, the stock trades at 10.6x and 7x FY2015 and FY2016 estimates respectively based on our quick earnings estimates. On a cash earnings basis, the stock trades at 6.6x and 5x FY2015 and FY2016 estimated earnings. SEL is a consistent dividend paying company with a pay-out of around 20% (the company maintained the pay-out ratio even when its earnings growth was muted). Given the significant improvement in the earnings and the fact that L&T is its largest shareholder and marketing partner, we believe SEL deserves a better valuation multiple. We expect a 25-30% potential upside to the stock price in the next six months.
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| Regards,
The Sharekhan Research Team |
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