ambit economy strategy

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THEMATIC August 28, 2015

Exit the fantasy, enter the reality As the fantasy of a ‘secular bull market’ fades, we cut not just our FY16 GDP growth estimate from 7% to 6.8% (driven largely by a drop in industrial growth) but also our end-FY16 Sensex target from 32K to 28K. We further highlight that there is a high risk of the Sensex dropping to as low as 22K, as the odds appear to be in favour of a continued yuan devaluation. The combination of a enfeebled banking system, a sliding real estate sector and a PM determined to reset the way the Indian economy works makes India a risky investment destination. To mitigate this risk, we recommend that investors focus on financially robust, market leading franchises which are trading at sensible valuations.

We cut our FY16 GDP growth estimate

We downgrade our GDP growth estimate for FY16 from 7% YoY to 6.8% YoY (vs 7.3% YoY recorded in FY15). The downward revision in our GDP growth estimate comes on the back of the events unfolding in China. China is the world’s largest exporter, and with the growing likelihood of a significant devaluation in the yuan, Indian promoters are rethinking their modest capex plans. This is likely to result in a further decline in private investment growth, which in turn will bring down the industrial and services sector growth rate. More details are given in Exhibit A.

We cutting our end-FY16 Sensex target to 28K Over the course of the past year, we have cut our Sensex target twice from 36,000 initially (in November 2014) to 32,000 (in May 2015) primarily on the back of a cut in our bottom-up earnings estimates. Through these cuts, we kept the trailing Sensex P/E target unchanged at 20x on the premise that the structural positives emanating from the current dispensation’s three key resets (click here for our March 2015 thematic) will improve India’s long-term growth rate. However, we see risks of a delayed economic recovery emanating from additional headwinds such as: (a) a major real estate price correction; (b) a banking system blowup, and (c) the NDA’s inability to expedite economic reforms. Thus, we are forced to revisit and revise our trailing Sensex P/E multiple from 20x to 18x. This, combined with our bottom-up FY16 EPS estimate of Rs1550 (9% YoY growth on the actual FY15 EPS of Rs1430), leads us to our new end-FY16 Sensex target of 28,000, implying 7% upside.

High risk of the Sensex sliding to 22K

With a high likelihood of the Chinese central bank embarking on a continued devaluation of the yuan, the Indian stockmarket stands exposed to: (a) Indian products losing their competitiveness to their Chinese counterparts; and (b) rising risks to India’s $0.5tn of foreign currency debt. Such a scenario could be a catalyst for more pullbacks in the Sensex with the trailing P/E multiple likely to drop to 14x (as seen in the Lehman crises), implying a Sensex level of 22,000.

Investment implications

Even after the 6% fall over the past nine days, there are no rational grounds for claiming that the Sensex has bottomed out. As Prime Minister Modi’s resets bite deep into the Indian economy, we expect GDP growth to slow down and we expect earnings growth to remain weak. In fact, as retail flows wane, the support system propping up the Sensex is likely to give away. Hence, the only way to invest in such a market is to focus on high-quality franchises which are available at reasonable valuations. Our tenbaggers and coffee can portfolios continue to deliver exemplary results in this regard. More specially, ten high quality BUYS from our sector leads are given in Exhibit B.

Economy & Strategy

Exhibit A: We expect GDP growth of 6.8% YoY in FY16

FY15 FY16 (old)

FY16 (new)

Agriculture 1.5% 3.2% 3.2%

Industries 5.6% 5.4% 5.1%

Services 10.6% 9.1% 9.0% Memo item: Investments 4.3% 3.7% 2.3%

GDP at MP 7.3% 7.0% 6.8%

Source: CEIC, Ambit Capital research; Note: GDP at MP refers to GDP at Market Prices

Exhibit B: Our top high quality BUYs

Company Name Mcap (US$ mn)

Upside (%)

ITC 39,587 21

Coal India 34,623 17

Lupin 12,949 15

Power Grid Corp 10,687 27

IndusInd Bank 7,694 20

Page Inds 2,457 15

PI Inds 1,425 20

Mahindra CIE 1,345 24

Bata India 1,087 21

City Union Bank 879 19

Source: Bloomberg, Ambit Capital research

Analyst Details

Saurabh Mukherjea, CFA Tel: +91 22 3043 3174 [email protected]

Gaurav Mehta, CFA Tel: +91 22 3043 3255 [email protected]

Prashant Mittal, CFA Tel: +91 22 3043 3215 [email protected]

Sumit Shekhar Tel: +91 22 3043 3229 [email protected]

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

Economy & Strategy

August 28, 2015 Ambit Capital Pvt. Ltd.

CONTENTS

Corporate performance is unusually weak…………………………………………………. 3

The disconnect between earnings growth and GDP growth………………………..…….. 5

We downgrade our GDP growth estimates for FY16 to 6.8% YoY…….........................7

We cut our Sensex target from 32K to 28K.................................................................9

Investment implications………………………………………………………………………..14

- ITC (BUY): Solid franchise at inexpensive valuations………………………………..… 17

- Coal India (BUY): Best large-cap reform play…………………………………………. 17

- Lupin (BUY): Earnings momentum unperturbed………………………………………. 18

- Power Grid Corporation (BUY): A clear winner…………………………………...... 18

- IndusInd Bank (BUY): A differentiated assets franchise for uncertain times……...19

- Page Industries (BUY): Revenue growth of >25% YoY likely from 2QFY16…….. 19

- PI Industries (BUY): Speciality chemicals champion…………………………………. 20

- Mahindra CIE (BUY): Fruits of adoption……………………………………………….. 20

- Bata India (BUY): Ongoing strategic initiatives aid growth revival………………… 21

- City Union Bank (BUY): A stable ship for rough waters…………………………….. 21

Appendix………………………………………………………………………………………… 22

Economy & Strategy


Corporate performance is unusually weak Even though the Indian equity market has seen significant inflows (especially from retail investors), this confidence appears to be misplaced in light of the underlying performance exhibited by corporate India. The initial phase of the current market upmove that began in September 2013 was accompanied by an uptick in revenues and earnings growth; however, this trend has reversed for the worse in the last three quarters.

Exhibit 1: Rising retail inflows despite waning corporate performance

Source: Bloomberg, AMFI, Ambit Capital research; Note: Using standalone EPS estimates for HDFC for historical comparison; MF stands for Mutual Funds; *assumes 60% of balanced allocation as equity

The last time corporate India had such a poor performance in terms of revenue and profit growth was during the 2008 financial crisis, the year that had seen the Sensex drop by more than half of its peak. Today, however, in spite of such an abysmal performance, Indian equities have remained afloat, helped by retail investor optimism. In contrast, over the past six months, FII equity flows into India have dried up (average monthly outflows of Rs20bn from FIIs vs average monthly inflows of Rs60bn from MFs over the last six months).

Exhibit 2: BSE Sensex revenue growth*

Source: Ambit Capital research, Bloomberg. Note: GDP growth as per the old series until the Mar’2011 quarter; thereafter, the new series is use.* Sensex revenue numbers are sourced from Bloomberg and include Banking and Financial services’ net revenues (Net interest income, Trading profit, Commissions and fees earned and Other operating income).

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Retail investor optimism looks misplaced in light of weak corporate performance

Economy & Strategy


Exhibit 3: BSE Sensex EPS growth

Source: Ambit Capital research, Bloomberg; Note: GDP growth as per old series until the Mar’2011 quarter; thereafter, the new series is used; these numbers have been sourced from Bloomberg and are NOT adjusted for extraordinary items

As we have repeatedly highlighted since our March 2015 thematic (“Modi hits the ‘reset’ button”), corporate and economic performance in India will remain weak for a longer time than consensus expects as Prime Minister Modi seeks to fundamentally change the way the Indian economy works.

As a quick recap, we believe that the PM is engineering the following three resets: (1) shift India’s savings landscape away from physical assets towards the formal financial system, (2) disrupt the model of crony capitalism, and (3) redefine India’s subsidy mechanism.

Although these resets are structurally positive, they are likely to adversely impact GDP growth in FY16. The short-term pain in GDP growth will be driven by: (1) alterations in the subsidy regime, which will adversely affect rural/semi-urban consumption and construction activity; (2) crony capitalists’ refusal to begin capex activity, as they see reduced scope for supernormal profits under Modi; and (3) Modi’s attack on black money, leading to a crack in land & real estate prices, which will adversely impact lenders’ balance sheets. More details regarding the impact of these resets can be found in the ‘We cut our Sensex target from 32K to 28K’ section of this note.

The three resets have only just started biting, with an unprecedented rural slowdown (explained in detail in our February 2015 rural thematic), a multi-city pullback in real estate prices (explained in detail in our 14th July 2015 thematic) and a near absence of private sector capex. Consequently, the pain in the reported EPS growth numbers is likely to continue over the next few quarters in spite of falling commodity prices. As this happens, the key force that has kept the Indian markets afloat for the last few months, i.e., the Indian retail investors’ optimism, will wane, thereby leaving the Nifty susceptible to more downside pressure.

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

http://reports.ambitcapital.com/reports/Ambit_Economy&Strategy_Thematic_RuralIndia_24Feb2015.pdf

http://reports.ambitcapital.com/reports/Ambit_Economy_Thematic_RealEstate_14Jul2015.pdf

Economy & Strategy


The disconnect between earnings growth and GDP growth The relationship between earnings growth of corporates and GDP growth has broken down over the past three years. Whilst GDP growth was 6.6% YoY in real terms for 3QFY15 and 7.5% YoY in real terms for 4QFY15, the earnings growth of the Sensex companies contracted by 1% YoY in 3QFY15 and 42% YoY in 4QFY15. However, the correlation between corporate earnings and GDP growth broke down in 3QFY13 and beyond (whether we consider the old GDP series or the new one) (see the exhibit below).

The graph in the exhibit below shows the rolling ten-quarter correlation between the earnings growth of Sensex companies and real GDP growth. Similar trends were observed for BSE200 and BSE500.

Exhibit 4: The rolling ten-quarter correlation between corporate earnings and real GDP growth broke down in 3QFY13

Source: Bloomberg, CEIC, Ambit Capital research

Consequently, in the old GDP series (FY05 base), earnings growth and GDP growth shows a strong positive correlation whilst no such correlation exists in the new GDP series (see the exhibits below).

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The relationship between earnings growth of corporates and GDP growth has broken down over the past three years

Exhibit 5: There is a positive correlation between GDP growth and earnings growth in the old GDP series…

Source: Bloomberg, CEIC, Ambit Capital research. Note: Data ranges from 1QFY16 to 2QFY15

Exhibit 6: … which breaks down in the new GDP series


R² = 0.5713

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Economy & Strategy


Similar trends were observed in Gross Fixed Capital Formation (GFCF) as well. However, the positive correlation between real GFCF growth and corporate earnings growth broke down as early as 2QFY12 (as compared to the correlation between GDP growth and corporate earnings which broke down in 3QFY13).

Exhibit 7: The ten-quarter correlation between corporate earnings and real GFCF growth broke down in 2QFY12

Source: Bloomberg, CEIC, Ambit Capital research

Consequently, in the old GDP series (FY05 base), earnings growth and GFCF growth shows a strong positive correlation whilst no such correlation exists in the new GDP series (see the exhibits below).

Exhibit 8: There is a positive correlation between GFCF and earnings growth in the old GDP series…


Exhibit 9: … which breaks down in the new GDP series


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Economy & Strategy


We downgrade our GDP growth estimate for FY16 to 6.8% YoY In our note dated May 19, 2015 (click here for the note), we had cut our GDP growth estimate for FY16 from 7.5% YoY to 7% YoY, as we believe that the three resets that PM Modi has engineered will result in lower investments and hence lower industrial and services sector growth. Secondly, as highlighted in our note dated July 14 (click here for the note), a broad-based real estate pullback has already created a threat to investment growth, as construction activities account for 50% of total GFCF in India.

We now downgrade our GDP growth estimate for FY16 from 7% YoY to 6.8% YoY (vs 7.3% YoY recorded in FY15). The downward revision in our GDP growth estimate comes on the back of the events unfolding in China.

China is the world’s largest exporter, and with the likelihood of a significant devaluation in the yuan growing (see the next section of this note), Indian promoters are rethinking their capex plans (which were pretty modest to begin with). This is likely to result in further decline in private investment growth. Thus, in our GDP model we have assumed that the ‘crisis factor’ (see the exhibit below for details) will be “medium” due to events unfolding in China instead of “low” as assumed earlier. This will have a bearing on investment growth which in turn will bring down the industrial and services sector growth rate. Exhibit 10: Assumptions underlying our FY16 GDP forecast

Explanatory Variable Key assumptions for FY16

Rainfall adjustment factor

The quantum and quality of rainfall in India has a bearing on farm sector growth given that India’s farm sector remains largely rainfall-dependent. Given that the Indian Metrological Department (IMD) expects the south-west monsoon in CY15 to be 93% of the Long Period Average (LPA) i.e. 7% below normal, we have built in a marginally-deficient rainfall in FY16.

Minimum support price (MSP) for paddy

MSPs offered by the Government ahead of the harvesting season affect farmers’ incentive to sow a crop. Typically, higher the MSP, greater is the incentive to produce a crop. The paddy MSP plays a critical role in determining agricultural output in India, as it accounts for 40% of India’s total agricultural produce.

Policy rate This variable has a bearing on investment growth in India albeit to a low extent.

Crisis factor

The extent of equity market returns in India has historically had a bearing on India’s investment growth rate, as India is a capital-scarce economy. In a bid to build this effect into our model (whereby investment growth in India comes under pressure whenever equity market conditions deteriorate), we use an objective rule to determine its value, namely ‘if Sensex returns in a particular financial year are less than 5% then the crisis factor is given a value of 1’. In all other years, the crisis factor is maintained at 0’. We assume the ‘crisis factor’ to be medium in FY16, as we believe the events unfolding in China will drag domestic investments.

Credit offtake As credit offtake and investments are positively correlated, slower credit growth adversely impacts investments in an economy. Our banks team expects credit offtake to be recorded at 12% YoY in FY16.

Advanced economies’ growth rate As 90% of export demand for IT and ITES comes from the EU and the US, the growth rate in the advanced economies affects the Indian services sector. We expect advanced economies to grow at an average of 2.4% YoY in CY16, as projected by the IMF.

Source: Ambit Capital research

We downgrade our GDP growth estimate for FY16 from 7% YoY to 6.8% YoY (v/s 7.3% YoY recorded in FY15)

http://reports.ambitcapital.com/reports/Ambit_Economy_Modisresetsresultinanothercut_19May2015.pdf


Economy & Strategy


Downside risks to GDP The Chinese implosion will drag down domestic investments: We expect

investment growth to be recorded at 2.3% YoY in FY16 (vs our earlier estimate of 3.7% YoY and 4.3% YoY in FY15), as the ‘crisis factor’ explained above weighs down on domestic investments (see the exhibit below). If the situation in China worsens, we will have to increase the “crisis factor” to ‘high’ in our model and thus trigger a further reduction in investment growth.

Lower investment growth adversely affects industrial sector growth, which in turn results in lower Services sector growth: Given that investment growth i.e. the extent of capacity expansion undertaken by an economy affects industrial growth and given that services sector growth itself is a function of industrial sector growth, the cut in investment growth affects both industrial as well as services sector growth (see the exhibit below).

Below-par monsoons could adversely impact agricultural growth in FY16: The Indian Metrological Department (IMD) has predicted that the south-west monsoon is likely to be 7% below the Long Term Average (LTA). Whilst we are not yet factoring in a full-blown drought, we trim our farm sector growth forecast to reflect the high probability of a less-than-ideal monsoon in FY16. It is critical to note that the south-west monsoons account for more than 90% of the total rainfall that India receives and even today 67% of India’s farm sector is largely rainfall-dependent.

Exhibit 11: We expect GDP growth in FY16 to be recorded at 6.8% YoY Growth (YoY change, in %) FY13 FY14 FY15 FY16

(old est.) FY16

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Agriculture 1.7% 3.8% 1.5% 3.2% 3.2% 0bps

Industry 2.3% 4.4% 5.6% 5.4% 5.1% -30bps

Services 8.0% 9.1% 10.6% 9.1% 9.0% -10bps

Memo Item: Investment -0.3% 3% 4.3% 3.7% 2.3% -140bps

GDP at MP 5.1% 6.9% 7.3% 7.0% 6.8% -20bps

Source: CEIC, Ambit Capital research; Note: GDP at MP refers to demand-side GDP i.e. GDP at Market Prices

Economy & Strategy


We cut our Sensex target from 32K to 28K In our 19th May 2014 note, we had moved from using a trailing Sensex P/E of 17x, the ten-year average for the Sensex then, to 20x, on the premise that with a decisive mandate for the BJP in the 2014 General Elections, the Indian economy was entering its fourth wave of economic expansion. The first three years of the previous three cycles have accounted for more than two-thirds of all returns generated by the Sensex in the past 30 years with a return CAGR of ~33%. Further, an analysis of valuations in the first three years of the two most recent waves reveals that whilst in the 1991-1994 recovery period, the trailing Sensex P/E remained north of 20x throughout, the P/E in the 2004-2006 recovery period averaged at about 18.5x. Over the course of the past year, we have cut our Sensex target twice as we have become better aware of the design and implications of the PM’s three resets (discussed earlier in the note). Even as our Sensex target moved from 36,000 initially (in November 2014) to 32,000 (in May 2015), the cuts resulted primarily from a cut in our bottom-up earnings estimates. Through these cuts, we kept the trailing Sensex P/E target unchanged at 20x on the premise that the structural positives emanating from the current dispensation’s three key resets should improve the long-term economy fortunes of India.

However, our base case now also features added headwinds for the economy, forcing us to revisit the trailing FY16 Sensex P/E multiple. These additional factors are:

A major real estate correction: In our note published on 14 July 2015, we highlighted how we are seeing a broad-based real estate pullback, with prices correcting in most tier-1 and tier-2 cities alongside sharp drops in transaction and new launch volumes. The drivers of this slowdown are a mix of supply-side factors (banks have pulled back lending to developers) and demand-side factors (the Black Money Bill has created fear amongst speculators). The result is not just a drop in demand for building materials and challenges for lenders with big mortgage, LAP and housing finance books, but also a generalised slowdown in GDP growth, as the sector which drives 50% of India’s capex and 30% of its jobs conks off.

Exhibit 12: Fall in real estate prices across Indian cities (Apr’14 - Apr’15)

Source: PropTiger, magic bricks, Ambit Capital research

Banking system blowup: The risk of a blowup in the Indian banking system seems to be rising, with the only notable policy response being a feeble recapitalisation plan of US$10.7bn which will be spread over four years (our Banks team says that more than 5x this sum is required to fix the problem). Stressed assets continue to rise in the real estate sector (14% of system assets), the power sector (9% of system assets), the steel sector (5% of system assets) and the infrastructure sector (6% of system assets), implying that over one-third of the banking system’s assets are in stressed sectors.

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The risk of a delayed economic recovery is increasing, as economy faces additional headwinds…

http://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_19May2014.pdf


Economy & Strategy


Exhibit 13: Rising trend of stressed assets in the banking system

Source: RBI, Company filings, Ambit Capital research * estimated numbers

The NDA’s inability to expedite economic reform through the Parliament: Over the past year, the NDA has not been able to expedite meaningful structural reforms. The much-needed amendments to the 2013 Land Acquisition Act have been dropped and the passage of the GST constitutional amendment has been delayed (click here for our detailed 10th August 2015 note on how the NDA dropped the ball on land reforms and click here for our detailed 20th August 2015 note on how the NDA has misunderstood and overhyped GST). Labour reforms do not seem to have been thought through clearly and the situation in the power sector (with respect to the discoms’ receivables) continues to deteriorate.

We believe that these factors are likely to delay the economic revival that formed the basis of our rationale to assign a 20x multiple to our FY16 Sensex estimate. In the light of these risks, we scale down the Sensex P/E multiple to 18x, in line with the historical (last ten-year) average.

This, combined with our bottom-up FY16 EPS estimate of Rs1550 (9% YoY growth on the actual FY15 EPS of Rs1430) leads us to our new end-FY16 Sensex target of 28,000, implying 7% upside from the current level. (Our previous Sensex target of 32K and previous FY16 Sensex EPS estimate of Rs1600 were first published in our 15 May 2015 note.)

According to Bloomberg, the consensus Sensex EPS estimate for FY16 is Rs1650, implying 15% EPS growth (vs the 2% EPS growth seen in FY15).

Note that the FY15 EPS of Rs1430 has been arrived at after removing one-offs from the reported numbers. The actual reported EPS number (before adjustments) is much lower at Rs1350. Whilst we cannot forecast one-offs and extraordinary items, as economic conditions deteriorate further, we believe that these “one-offs” will keep recurring as Indian promoters are likely to be keen to share their personal losses with minority shareholders. For instance, promoters are likely to pass on personal losses on account of FX hedges, speculative trading and real estate investments to their shareholders through the reported corporate numbers and these items in turn are most likely to feature as other income (losses).

The positive catalysts that could lead the Sensex to drift up to 28K by the end of FY16 appear to be: (a) Passage of the GST constitutional amendment through Parliament in September; (b) A potential victory for the NDA in the Bihar elections (results likely to be announced in November); and (c) A rate cut by the RBI in 4QFY16 (which has been factored in our GDP growth model).

2.3 2.3 2.4 2.2 2.8 3.2 4.0 4.6 4.61.12.5

3.9 3.24.2

5.25.8

6.5 6.7

3.34.8

6.35.4

7.08.5

9.811.1 11.3

0

2

4

6

8

10

12

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

1QFY

16*

Gross NPA (%) Standard restructured (%)

…forcing us to revisit and revise our trailing Sensex P/E multiple from 20x to 18x

http://reports.ambitcapital.com/reports/Ambit_Economy_ExpertNote_Failuretoamendlandlaw_10Aug2015.pdf

http://reports.ambitcapital.com/reports/Ambit_Economy_Thematic_GSTOverhyped_20Aug2015.pdf

http://reports.ambitcapital.com/reports/Ambit_Strategy_Modisresetsresultinanothercut_15May2015.pdf

Economy & Strategy


Exhibit 14: Sensex historical trailing Price to Earnings ratio


That said, we believe that there is a high risk that the Sensex will slide further over the next six months based on the situation in China. In our 5th November 2014 note we wrote, “More than any other major economy, China has been, and will continue to be, adversely impacted by the BOJ’s policy of competitively devaluing the yen and these reducing China’s competitiveness. This sort of revaluation of the RMB is the last thing that China needs given its stagnant manufacturing sector and its overburdened banking sector. Given that it has been backed into a corner, it is hard to see what else the Communist Party can do other than to embark upon a program to devalue the RMB. Such a step is likely to send shockwaves around the world because it will be a clear acknowledgement that the Chinese economy is far weaker than the 7% GDP growth headline figure. Indian equities are likely to get dragged down by this shockwave, perhaps by as much as 10%.” Now that the Chinese central bank has begun what would appear to be a programme of devaluing the currency under the garb of letting it float within a wider band, we reiterate the point we made on 5th November 2014, i.e., the Indian stockmarket stands exposed as products (steel, aluminium, chemicals, auto ancillaries, 2Ws, etc) start losing competitiveness to their Chinese counterparts. When the Chinese devalued their currency in the mid-1990s to trigger the South East Asian crisis, India was a reasonably insulated economy, with low levels of foreign currency debt. Now the roles have been reversed – the South East Asian countries have throttled back on foreign currency debt whilst India has loaded up on the same. India’s foreign currency debt now stands at US$0.5bn. In fact, India’s total external debt has grown at an average of 14% YoY during FY05-15 as compared to an average of 3% YoY recorded during FY91-04 (see the exhibit below).

Exhibit 15: India’s total external debt has grown at an average of 14% YoY during FY05-15

Source: RBI, Ambit Capital research.

- 5,000

10,000 15,000

20,000

25,000 30,000

05

1015

20

2530

Mar

-01

Nov

-01

Jul-

02

Mar

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Jul-

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Mar

-05

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-13

Nov

-13

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Mar

-15

P/E ratio (LHS) 10 Yr Average P/E (LHS) Sensex (RHS)

0%

5%

10%

15%

20%

25%

0

100

200

300

400

500

FY04

FY05

FY06

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FY10

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FY15

Total external debt (USD billion, Left scale)

Total external debt (as % of GDP, Right scale)

Continued yuan devaluation poses high risk to Indian stock markets…

Economy & Strategy


Moreover, the share of short-term debt in India’s total external debt has increased from an average of 6% during FY90-04 to an average of 19% during FY05-15 (see the exhibit below).

Exhibit 16: Share of short-term debt in India’s total external debt has increased from an average of 6% during FY90-04 to an average of 19% during FY05-15

Source: RBI, Ambit Capital research

Hence, a further devaluation of the yuan (which to us appears to be a high probability event considering that neither fiscal nor monetary policy has been able to revive the Chinese economy) looks likely to be a catalyst for more pullbacks in the Sensex going forward.

So how far can the Sensex fall when panic sets in? We saw during the Lehman crisis, the Sensex trailing P/E (on an average) can go as low as 14x. Such a multiple implies a lower bound on the Sensex of 22,000. Hence, whilst the fair value for the Sensex as of end-FY16 is 28,000, there is a high risk of the index sliding to 22,000, as the Chinese find themselves left with no other option but to devalue the yuan again.

Exhibit 17: Sensex trailing P/E ratio during the 2008 financial crisis


0%

40%

80%

120%

FY90

FY91

FY92

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

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FY10

FY11

FY12

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FY15Sh

are

in t

ota

l ext

ern

al d

eb

t(i

n %

)

Long term Short term

8

10

12

14

16

18

20

22

Jan-

08

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08

Mar

-08

Mar

-08

Apr

-08

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-08

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-08

Jun-

08

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08

Jul-

08

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-08

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-08

Nov

-08

Dec

-08

Dec

-08

Jan-

09

Feb-

09

Feb-

09

Mar

-09

Sensex trailing PE

…and can lead to Sensex sliding to levels as low as 22,000

Economy & Strategy


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 year’s EPS estimate to arrive at that year’s Sensex target. For example, the application of a 18x trailing multiple to our FY16 EPS estimate of 1,550 leads to our 31 March 2016 Sensex target of 28,000. 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 greater forecasting error. We therefore prefer using EPS forecasts one year out (which we believe is more reliable) and applying a trailing multiple to it.

Exhibit 18: Sensex target – Old vs new

Estimated FY16 EPS=1,600 estimated FY16 EPS=1,550 Trailing target Sensex P/E=20x trailing target Sensex P/E=18x Implied Sensex target=32,000 Implied Sensex target=28,000

Old New Source: Ambit Capital research

Economy & Strategy


Investment implications Even after this week’s fall, there are no rational grounds for claiming that the Indian stockmarket has bottomed out. As Prime Minister Modi’s resets bite deep into the Indian economy, we expect economic growth to slow down and we expect corporate earnings growth to remain weak. In fact, as retail flows wane, the support system propping up the Sensex is likely to give away. Hence, the only way to invest in such a market is to focus on high-quality franchises which are available at reasonable valuations. Our tenbaggers and coffee can portfolios continue to deliver exemplary results in this regard. That quality investing is the most obvious and perhaps the only way to ride out this period of turbulence is a point we have often made in the past. To quote from our 4 March 2015 (click here) note,

“To play out this period of flux, investors are better-off focusing on quality franchises. Investing in well-managed companies with clean corporate governance and an efficient capital allocation track record has historically served investors well to generate healthy return in both upcycles and downcycles. In the current context, this approach should work particularly well. Both our ‘Coffee Can’ portfolio and our ‘Ten baggers’ portfolio have been modelled on this philosophy and we point investors towards these as a lower drawdown way of participating in this Indian resurgence.” The 12 May 2015 (click here) note on our Good & Clean portfolio had echoed the same message, “A weak macro, the Government’s push against crony capitalism and black money, and rich valuations of second-rung names (making drawdown risk more prominent in these pockets) should continue to keep the environment conducive for quality to prosper over the foreseeable future.”

Performance of our Coffee Can portfolio In our 17 November 2014 (click here) note, we had introduced the Coffee Can Portfolio, which is ideal for investors who have the ability to hold stocks for long periods of time (ideally, for ten years). The Coffee Can Portfolio was built using the following two key filters that demonstrate efficient capital allocation: (1) sales growth of at least 10% per annum in each of the last ten years; and (2) RoCE of >15% every year for the past ten years. On a back-tested basis, left untouched for a decade, this portfolio, coupled with the power of compounding, has generated returns that were substantially higher than the benchmark. Even on a live basis, since inception, our Coffee Can portfolio has delivered 13.3% returns on an absolute basis (and 15.5% relative to the BSE500 Index).

Exhibit 19: Performance of our Coffee Can portfolio published on 17 November 2014

Ticker Company Mcap (US$ mn)

ADV - 6m (US$ mn)

Price Performance

14-Nov-14 27-Aug-15 ITC IN Equity ITC 39,624 44.4 369 326 -12% HDFCB IN Equity HDFC Bank 38,960 28.3 930 1,022 10% HCLT IN Equity HCL Tech 19,469 32.6 805 913 13% AXSB IN Equity Axis Bank 18,351 62.4 477 509 7% APNT IN Equity Asian Paints 12,435 17.7 672 855 27% GCPL IN Equity Godrej Consumer 6,450 3.6 979 1,249 28% MRCO IN Equity Marico 4,011 6.4 330 410 24% BRGR IN Equity Berger Paints 2,202 1.3 179 209 17% PAG IN Equity Page Inds. 2,459 3.2 9,663 14,540 50% IPCA IN Equity IPCA Labs 1,483 3.5 684 775 13% GRHF IN Equity Gruh Finance 1,345 1.6 233 244 5% BIL IN Equity Balkrishna Inds. 923 1.3 691 630 -9% CUBK IN Equity City Union Bank 879 1.2 91 97 7% ECLX IN Equity eClerx 794 0.8 1,294 1,720 33% VGRD IN Equity V-Guard Inds 413 0.3 910 909 0% MUNI IN Equity Mayur Uniquoters 296 0.4 423 422 0% Overall average 13.3% BSE500 index 10,752 10,522 -2.1% Outperformance 15.5%


http://reports.ambitcapital.com/reports/Ambit_Strategy_Qualityinvesting_04Mar2015.pdf

http://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_Good&Clean9_12May2015.pdf

http://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_IndianCoffee_17Nov2014.pdf

Economy & Strategy


Performance of our Ten-bagger portfolio

Our ten-bagger portfolio (click here for the latest version) again is premised on the same underlying philosophy of investing in firms with clean managements and efficient capital allocation. The portfolio construction is based on our ‘greatness’ framework that looks for firms with relentless improvement in financial performance over long periods of time (usually six years). This portfolio is ideal for conventional buy-and-hold investors with a 1-3-year horizon.

Since inception on 5 January 2015 click here), the latest iteration of this portfolio, i.e. ten baggers 4.0, has delivered 4.9% returns on an absolute basis (and 8.1% relative to the BSE500 Index).

Exhibit 20: Performance of our Tenbaggers portfolio published on 5 January 2015

Ticker Company Mcap (US$ mn)

ADV - 6m (US$ mn)

Price Performance

2-Jan-15 27-Aug-15

TCS IN Equity TCS 76,468 48.2 2,579 2,575 0%

ITC IN Equity ITC 39,624 44.4 368 326 -12%

TTMT IN Equity Tata Motors 16,480 48.9 506 334 -34%

HCLT IN Equity HCL Tech 19,469 32.6 803 913 14%

IDEA IN Equity Idea Cellular 8,286 17.0 160 152 -5%

IPCA IN Equity Ipca Labs. 1,483 3.5 727 775 7%

ECLX IN Equity eClerx Services 794 0.8 1,324 1,720 30%

COAL IN Equity Coal India 34,656 27.2 382 383 0%

BATA IN Equity Bata Inds 1,088 4.3 1,320 1,116 -15%

LPC IN Equity Lupin 12,961 45.9 1,432 1,900 33%

EIM IN Equity Eicher Motors 7,726 34.4 15,082 18,772 24%

SKB IN Equity GlaxoSmith CHL 3,914 1.4 5,900 6,139 4%

BRIT IN Equity Britannia Inds 5,353 9.4 1,879 2,942 57%

TRP IN Equity Torrent Pharma. 4,118 3.1 1,193 1,605 35%

MRF IN Equity MRF 2,631 8.1 38,192 40,908 7%

BRGR IN Equity Berger Paints 2,202 1.3 226 209 -7%

PAG IN Equity Page Industries 2,459 3.2 12,420 14,540 17%

TVSL IN Equity TVS Motor Co. 1,632 8.4 267 227 -15%

MTCL IN Equity Mindtree# 1,690 4.3 1,299 1,330 2%

WIL IN Equity WABCO India 1,924 1.0 4,661 6,690 44%

SI IN Equity Supreme Inds. 1,139 0.7 597 592 -1%

PI IN Equity P I Inds. 1,426 2.4 550 689 25%

PSYS IN Equity Persistent Sys 829 2.3 937 683 -27%

MCHM IN Equity Monsanto India 697 1.4 2,926 2,664 -9%

KJC IN Equity Kajaria Ceramics 817 1.3 618 678 10%

ASTRA IN Equity Astral Poly 813 0.8 387 453 17%

FNXC IN Equity Finolex Cables 566 0.8 269 244 -9%

SF IN Equity Sundram Fasten. 529 0.3 195 166 -15%

GDPL IN Equity Gateway Distr. 553 1.4 350 336 -4%

VST IN Equity VST Inds. 350 0.2 1,940 1,494 -23%

Overall average 4.9%

BSE500 index 10,866 10,522 -3.2%

Outperformance 8.1%


More specifically, our sector leads have provided more details on ten high-quality stocks on which Ambit has a BUY stance. These stocks are: Mahindra CIE, PI Industries, ITC, Page Industries, Bata India, Lupin, Power Grid Corporation, IndusInd Bank, City Union Bank and Coal India.

http://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_Tenbaggers4_05Jan2015.pdf

http://reports.ambitcapital.com/reports/Ambit_Strategy_Thematic_Tenbaggers4_05Jan2015.pdf

Economy & Strategy


Exhibit 21: : Key metrics for our ten high-quality BUYs

Company Name

Rating Mcap ADV -

3m CMP TP Up RoCE (%) RoE (%) EPS CAGR (%)

P/E (x) P/B (x)

(US$ mn)

(US$ mn)

(Rs) (Rs) (%) FY14 FY15 FY16E FY17E FY16E FY17E FY12-15

FY15- 17E

FY15 FY16E FY17E FY15 FY16E FY17E

ITC BUY 39,587 32.6 326 395 21 36.5 33.6 32.2 33.1 34 34 15 12 26.0 23.8 20.8 8.5 7.6 6.8

Coal India BUY 34,623 31.7 362 425 17 22.5 19.0 19.5 18.5 34 31 (2) 12 16.7 15.1 13.3 5.7 4.6 3.7

Lupin BUY 12,949 46.4 1,900 2,186 15 25.9 28.0 23.3 24.8 28 31 48 31 35.5 30.2 20.8 9.6 7.6 5.8

Power Grid Corporation

BUY 10,687 4.2 135 171 27 5.9 6.0 6.8 7.2 16 17 11 24 13.8 11.1 9.0 1.8 1.6 1.4

IndusInd Bank BUY 7,694 13.9 859 1,030 20 1.8 1.8 1.9 2.0 17 16 25 22 25.3 22.2 17.0 4.4 3.0 2.6

Page Inds BUY 2,457 4.4 14,540 16,650 15 41.9 41.6 46.1 51.3 59 62 30 36 82.7 61.4 44.6 41.9 32.1 24.2

PI Inds BUY 1,425 2.9 689 825 20 23.9 26.3 27.7 31.9 30 33 40 34 38.1 30.3 21.2 10.5 8.1 6.1

Mahindra CIE BUY 1,345 1.3 275 340 24 (12.1) 10.7 12.1 17.5 16 20 N/A 42 36.8 28.0 18.2 5.3 4.6 3.7

Bata India BUY 1,087 4.1 1,116 1,351 21 26.2 18.1 17.5 22.1 17 22 (1) 28 35.9 37.7 25.9 7.0 6.2 5.3

City Union Bank BUY 879 0.9 97 115 19 1.4 1.5 1.5 1.5 15 16 (1) 15 14.6 13.3 11.1 2.1 1.9 1.7

Source: Company, Ambit Capital research

Economy & Strategy


ITC Solid franchise at inexpensive valuations India’s total cigarette volume consumption has remained unchanged in FY12-14; however, a 15% excise hike CAGR over FY13-16 and poor implementation of anti-cigarette regulations have resulted in: (a) increase in the proportion of illegal cigarettes as a percentage of total cigarette sales from 14% in FY10 to 20% in FY15, (b) a 10% YoY decrease in tobacco excise collection for FY14, and (c) increased threat of oral cancer due to shift of consumption from legal cigarettes to chewing tobacco. Over 1993-2000, the UK faced a similar situation of rising proliferation of illegal cigarettes due to high taxation, which eventually led to moderation of excise duty on cigarettes. We expect a similar sequence of events to unfold in the Indian market. ITC’s CMP already factors in the worst-case scenario of -6%/16% volume/excise duty CAGR over FY15-20.

At CMP of Rs321/share, the market ascribes ~Rs220/share to the cigarette business. Our reverse-DCF for the cigarettes business suggests that this valuation factors in -6%/16% volume/excise duty CAGR over FY15-20. Whilst global cigarette businesses trade at a 10-20% discount to their FMCG peers, ITC is currently trading at a ~45% discount to HUL. At our TP of Rs395/share, ITC would trade at an implied FY16/17E P/E of 29.3x/25.7x, a ~17% discount to our implied multiple for HUL. We expect positive catalysts to emerge from 2HFY16, helped by a weak base and higher consumer demand. Given inexpensive valuations coupled with our expectation of a moderation in the Government’s stance on cigarette excise duty going ahead, we reiterate our BUY stance on ITC with a TP of Rs395/share.

Coal India Best large-cap reform play The new Government’s efforts to improve domestic coal availability have led to a sharp uptick in CIL’s production growth (increased to 7% in FY15 and 11% in 4MFY16 from 1.6% over FY10-14). Improved pace of environmental clearances, improving co-ordination with the state governments and partial completion of three critical railway lines by FY17-18 make us believe that CIL is likely to achieve 9-10% offtake growth CAGR over FY15-20E. CIL’s utility characteristics (lack of downside risks to realisations for 90% of volumes and operating leverage as volume growth improves) make it the best large-cap reform play in India (although the proposed 10% government stake sale is likely to remain an overhang in the near term). The stock is currently trading at an FY17E P/E of 12.3x (vs the historical average of 12.7x).

Key catalysts: (a) Offtake volume growth to sustain at 8.8% CAGR over FY15-17E vs 1.6% over FY10-14 on the back of faster grant of clearances and project execution; (b) Auction of linkages to the non-regulated sector in 1QFY17; and (c) Better visibility over the next year on partial completion of the three railway lines by FY17-18E. Key risks to our stance: (a) weaker-than-expected power demand growth if SEB financing issues are not resolved soon; (b) lower-than-expected e-auction realisations; (c) lack of price hikes in the long term; and (d) utilisation of cash for non-core purposes.

BUY Stock Information Bloomberg Code: ITC IN

CMP (Rs): 326

TP (Rs): 395

Mcap (Rs bn/US$ bn): 2,613/39.5

3M ADV (Rs mn/US$ mn): 2,156/32.6

Stock Performance (%)

1M 3M 12M YTD

Absolute 5 3 (8) (12)

Rel. to Sensex 9 7 (6) (7)


Estimates summary

FY15 FY16 FY17

Revenues (Rs bn) 365.1 402.9 460.6

EBITDA Marg (%) 36.9 35.5 35.3

EPS (Rs) 12.0 13.1 15.0


Analysts

Rakshit Ranjan, CFA [email protected] Tel: +91 22 3043 3201

Ritesh Vaidya, CFA [email protected] Tel: +91 22 3043 3246

BUY Stock Information Bloomberg Code: COAL IN

CMP (Rs): 362

TP (Rs): 425

Mcap (Rs bn/US$ bn): 2,286/34.6

3M ADV (Rs mn/US$ mn): 2,092/31.6


1M 3M 12M YTD

Absolute (15) (6) 1 (6)

Rel. to Sensex (10) (1) 2 (1)


Estimates summary (Rs mn)

FY15 FY16E FY17E

Revenues 720,146 768,456 870,683

EBITDA 173,354 183,496 203,401

EPS (Rs) 21.7 24.0 27.3


Analysts

Parita Ashar, CFA [email protected] Tel: +91 22 3043 3223

Economy & Strategy


Lupin Earnings momentum unperturbed As Lupin’s approval rates are starting to improve (monthly product approvals of ~65 as compared to ~40 in March), the company is best positioned among Indian pharma companies to benefit from the GDUFA programme. Lupin has ~160 ANDAs pending approval and is likely to launch 30 products vs its guidance of 15-20 products in FY16 (17 final approvals already YTD). Lupin will evolve into a broad-based complex generics player over the next 2-3 years, as it monetises its complex ANDA pipeline in the US. The next leg of evolution would be into a semi-innovator, with a 70/30 or 80/20 generic/branded revenue mix. Lupin remains the most-competitive firm on our 5’R’ framework and the management’s aspirational target of US$3.75bn-4bn in organic revenues for FY18E, with PAT of US$750mn-800mn, is achievable. Led by 150 product approvals in the US (including limited competition product portfolio of Gavis) through GDUFA will drive 25% revenue and 30% net profit CAGR over FY15-18E.

Lupin is trading at 20x FY17E EPS and we believe valuations will sustain at current levels, given: (a) Earnings growth momentum – we expect 30% net profit CAGR over FY15-18E due to GDUFA timelines resulting in large product approvals in FY17-18E; (b) Investments in longer-term growth drivers – the company is investing in biosimilars and NCEs for India, differentiated products like complex injectables, ophthalmics and dermatology, biosimilars in Japan and respiratory in the US and Japan; and (c) high visibility of earnings through large pipeline in the US and growth acceleration in India. Whilst FY16E could potentially be a lower growth year, higher visibility on the FDA’s actions on the GDUFA front would likely support the stock price. The management has reinforced our view on the GDUFA goals being met and has indicated that it has the capability and bandwidth to launch 100-120 products (ex-Gavis’ 65 ANDAs pending approval) in the US in the next three years.

Power Grid Corporation A clear winner Capitalisation to increase in 2Q/3QFY16: PGCIL’s capitalisation declined 7% YoY in 1QFY16 to Rs45bn, but this is likely to accelerate through FY16 on the back of commissioning of the Rs120bn Bishwanath Chariali–Assam transmission line in 2Q/3QFY16; capitalisation until the middle of August was already at Rs25bn. Strong momentum in the power T&D segment in an otherwise sanguine investment cycle has been highlighted by multiple industry participants during the 1QFY16 earnings season and we expect the momentum to continue. PGCIL’s vendors highlight its increased focus on execution. We build in FY16 capitalisation of Rs293bn (up 35% YoY).

Ample visibility beyond FY16 as well: Increasing spends on additional transmission lines (20% cumulative increase in transmission lines to be added in 13th Five-year Plan vs 12th Five-year Plan) and higher cost per line (higher spend on advanced technology such as smart grids and gas-insulated sub-stations) lead us to believe that the investment plan of Rs1tn in the 13th plan is understated. Its execution capabilities remain unmatched, evidenced by project awards of more than Rs350bn on the behest of SEBs. Even in competitive bidding projects, the company’s superior execution and lower cost of funding will ensure it remains the leader.

Attractive valuations: PGCIL’s current valuation of 1.6x FY16E P/B is at a marginal premium to its five-year 1-year forward average of 1.5x. The valuation is reasonable in the context of PGCIL’s strong competitive advantages derived from execution and access to funding, a regulated RoE model and a 21% earnings CAGR over the next three years. Rising capitalisation rate (closer to capex) will remain the key catalyst.

BUY Stock Information Bloomberg Code: LPC IN

CMP (Rs): 1,900

TP (Rs): 2186

Mcap (Rs bn/US$ bn): 855/12.9

3M ADV (Rs mn/US$ mn): 3,068/46.4


1M 3M 12M YTD

Absolute 17 8 47 33

Rel. to Sensex 22 13 49 38


Estimates summary (Rs mn)

FY15 FY16E FY17E

Revenues 127700 151837 195495

EBITDA 36196 43459 60113

EPS (Rs) 53.4 61.4 86.7


Analysts

Aditya Khemka [email protected] Tel: +91 22 3043 3272

Paresh Dave, CFA [email protected] Tel: +91 22 3043 3212

BUY Stock Information Bloomberg Code: PWGR IN

CMP (Rs): 135

TP (Rs): 171


3M ADV (Rs mn/US$ mn): 279/4.2


1M 3M 12M YTD

Absolute (4) (6) 4 (2)

Rel. to Sensex 1 (1) 5 2


Estimates summary (Rs bn)

FY15 FY16 FY17

Revenues 172 213 253

EBITDA margin 86% 87% 87%

EPS (Rs) 9.8 12.1 15.0


Analysts

Nitin Bhasin [email protected] Tel: +91 22 3043 3241

Economy & Strategy


IndusInd Bank A differentiated assets franchise for uncertain times IndusInd Bank (IIB) is a premium CV lender with unmatched reach and a unique business model. An entrenched relationship-based lending leads to superior yields and asset quality. At a time when competition in banking sector is set to heat-up over medium to long-term horizon, with entry of large number of payment banks, small finance banks and eventual ‘on-tap’ universal bank licensing, we believe, an asset franchise with nonreplicable competitive advantages, such as that IndusInd Bank has in its vehicle financing business, will command significant premium. Vehicle finance is 34% of IndusInd Bank’s loan book, of which core CV/CE is 22% of total loans. In 1QFY16, the CV book saw growth improving to ~18% YoY (7% QoQ) after stagnation in the last two years. Growth in fixed rate vehicle finance book bodes well for the bank’s overall risk adjusted margins, which would further get a boost in an easing rate cycle.

Taking advantage of its strong profitability, IIB has had an accelerated network expansion and the number of branches has more than quadrupled in five years and CASA as a percentage of total borrowed funds has risen from 20% (FY10) to 27%, currently. A comparison with retail liabilities scale-ups by other new generation banks shows that IIB can also build a best-in-class liability franchise, supported by: (1) a stable rate of new branch opening; and (2) its credible branch expansion and sales strategy.

At Rs866, the stock is currently trading at 3.0x FY16E BV and 22.7x FY16E EPS. Post the recent capital raise, tier-1 now stands at >15%. Reflecting this capital raise, we expect an average RoA of 1.8% and RoE of 16% over FY17-18E and an EPS CAGR of 22% (FY15-17E).

Page Industries Revenue growth of >25% YoY likely from 2QFY16 Growth momentum of Page Industries is likely to sustain over the long term, as: (a) long-term competitive advantages around backward-integrated manufacturing (delivering a high-quality product at affordable prices), aggressive approach towards distribution expansion and a highly aspirational brand recall for ‘Jockey’ remain intact , (b) tailwinds from low penetration levels for mid-premium innerwear aid volume growth, and (c) competitive threats to Page’s leadership are low in a large growing opportunity, as peers lack control on distribution and manufacturing with poor aspirational connect.

Key near-term and medium-term triggers include: (1) Revival in growth rates which have improved meaningfully in 2QFY16 vs the growth reported in 1QFY16; (2) Benign input costs and hence the management expects gross margin expansion to continue in the coming quarters; (3) Enhancement of its IT systems (real time in 3-4 months) which will track real-time distributor sales, performance of the sales team, MIS across SKUs, and online stock ordering by distributors/EBOs; and (4) Kidswear re-launch in 3QFY16: Page will launch ~15 SKUs in the Kidswear segment (kidswear accounts for ~20% of the innerwear market) in 3QFY16, with an intention to expand the product range over time.

Valuations and view: Despite an exceptionally weak macro environment, Page has delivered 30%/27% revenue/EPS growth YoY in FY15. We expect 27% revenue growth in FY16 and 30% revenue CAGR, 36% EPS CAGR, 48% RoCEs and a high dividend payout ratio of 55-60% over FY15-21E. Our three-stage DCF gives a fair value of Rs16,650 (~25% upside), implying a multiple of 50x FY17E EPS. The stock is currently trading at 56x/41x FY16/17E EPS.

BUY Stock Information Bloomberg Code: IIB IN

CMP (Rs): 859

TP (Rs): 1,030


3M ADV (Rs mn/US$ mn): 915/13.8


1M 3M 12M YTD

Absolute (9) (0) 49 7

Rel. to Sensex (4) 5 50 12


Estimates summary

FY15 FY16E FY17E

NII 34.2 43.5 55.5

PAT 17.9 22.8 29.8

EPS (Rs) 33.9 38.7 50.6


Analysts

Ravi Singh [email protected] Tel: +91 22 3043 3181

BUY Stock Information Bloomberg Code: PAG IN

CMP (Rs): 14,540

TP (Rs): 16,650

Mcap (Rs bn/US$ bn): Rs162/US$2.5

3M ADV (Rs mn/US$ mn): Rs293/US$4.4


1M 3M 12M YTD

Absolute 2 0 101 24



Ambit Estimates (Rs bn)

FY15 FY16E FY17E

Revenues 15.4 19.6 26.0

EBITDA Marg (%) 3.2 4.2 5.6

EPS 175.7 236.8 325.9


Analysts


Aditya Bagul [email protected] Tel: +91 22 3043 3642

Economy & Strategy


PI Industries Speciality chemicals champion PI has emerged as the best hybrid business model to capitalise on the rising specialty chemicals exports opportunity plus the underpenetrated agri inputs sector. PI has built a strong business model by focusing on in-licensing for unique pesticides and capitalising on the complementary CSM opportunity (60% of revenues). The less-appreciated drivers of PI’s success in CSM are: (a) decade-plus perseverance/investments for building credibility with global innovators; (b) propositions built around capabilities and not cost savings; and (c) agility in long-duration contract pricing.

PI’s domestic business (40% share) has a differentiated approach of in-licensing new molecules from global innovators, thus providing it with superior growth rates, better margins, and increased ‘pull’ effect for its products. In the CSM business (60% of revs), PI has perfected the model by building strong relationships with global innovators through flawless execution of 18 commercialized molecules, clean record on IP protection and establishment of manufacturing facilities of global standards.

We build in 26% FY15-17E CAGR in CSM revenues, due to: (a) healthy order book growth of 38% YoY in 1QFY16 to US$600mn (3.2x last 12-month revenues), (b) on-track commissioning of two plants in Jambusar, for which capacities are tied up, and (c) improvement in farmer sentiments globally post a difficult CY14/CY15. Also, its focus on specialty products and improved farmer/channel connect should keep domestic revenue growth (18% in FY15-17E) ahead of its peers. Our EPS estimates build in 34% EPS CAGR over FY15-17E along with ~30% RoCE. Our 12-month forward TP of Rs825 implies 25x FY17E EPS. The stock is currently trading at 29x/20x FY16/FY17 EPS.

Mahindra CIE Fruits of adoption CIE Automotive, a mid-sized global auto component player has been built around acquiring and turning around sub-scale entities. It is one of the few auto-component companies to have consistently sustained double-digit margin even during the FY09 crisis. These are underpinned by CIE’s intense cost focus through decentralised plant management and best-in-class production processes. Since CIE took over, Mahindra Forgings Europe’s (MFE’s) margin has improved to 8.0% vs 2.8% in FY14. With CIE now focused on optimising product/process/location in the next phase, MFE’s margin (14.0% in FY17) would move closer to that of CIE’s European plants (15.0%).

India business transformation on track: MCIE’s India business revenues are likely to recover from 2HFY16 onwards (up 11% for FY16) underpinned by M&M’s new launches (including three new products). Customer/product diversification remains on track, with new products (fuel tank assembly, cargo body) finding a place in M&M’s recent launch (Jeeto) and with significant progress with few Western OEMs. We continue to expect new customer/new product contribution of 22% to India business revenues by FY20.

Valuation: Our target price of Rs340/share implies 11.5x FY17 EBITDA, 30% discount to Bharat Forge due to lower margin/return ratios. We do not build in potential benefits from: (1) merger of CIE’s global forging business, (2) introduction of aluminium/plastics products in MCIE, and (3) MCIE becoming a hub for CIE’s Asian aspirations. Key risks: Sharp Europe slowdown, weak launches from M&M.

BUY Stock Information Bloomberg Code: PI IN

CMP (Rs): 689

TP (Rs): 825




1M 3M 12M YTD

Absolute 6 1 51 33



Estimates summary

FY15 FY16 FY17

Revenues (Rsmn) 19,403 23,506 29,384

EBITDA Marg (%) 19.2 20.0 21.8

EPS(Rs) 18.1 22.7 32.5


Analysts

Ritesh Gupta, CFA [email protected] Tel: +91 22 3043 3242

BUY Stock Information Bloomberg Code: PI IN

CMP (Rs): 275

TP (Rs): 340




1M 3M 12M YTD

Absolute 4 29 64 29



Estimates summary

FY15 FY16 FY17

Revenues (Rsmn) 55,694 59,41167,306

EBITDA Marg (%) 9.6% 12.4% 14.1%

EPS(Rs) 7.5 9.8 15.1


Analysts

Ashvin Shetty, CFA [email protected] Tel: +91 22 3043 3285

Economy & Strategy


Bata India Ongoing strategic initiatives aid growth revival Bata enjoys long-term competitive advantages around: (a) product quality, (b) superior retail execution with the ability to retain talent at the store level, and (c) a well-entrenched store network. Positive catalysts for the stock over the next 12-24 months include improvement in revenue growth momentum led by implementation of several key initiatives (stated below).

Key catalysts: (1) E-commerce initiative: The creation of a separate team for the online business will help introduce a separate line of ~500 SKUs which would be exclusively sold online and through Bata’s mobile app; (2) Introduction of brand store for ‘Power’: The company intends to launch the first ‘Power’ EBO in Delhi next month with many more stores to follow. The EBO would include footwear, accessories and garments under the Power brand name; (3) Success of the loyalty programme: The company has garnered ~4mn customers in its loyalty programme in 6 months since the loyalty programme went live. The company plans to leverage on the customer data base to implement targeted advertising and promotions in order to drive revenue growth; and (4) Walt Disney characters in the Kids range: The company entered into a 5-year exclusive contract with Walt Disney to use its characters in its kidswear segment. These products will have a distinct identity from the bubble gummers range.

With the challenges around supply chain behind and with the various ground-level initiatives put in place by the management, we expect ~12% revenue growth in 1HFY16 amidst a weak macro environment and 17% CAGR over FY15-18E. With network-size-related expenses of rentals and >50% of employee costs (equivalent to ~25% of revenues) being relatively fixed in nature, we expect Bata’s 17% revenue CAGR to translate into EPS CAGR of ~29% in FY15-18E. We reiterate BUY with a TP of Rs1,351 (33% upside) and an implied P/E multiple of 31x FY17E. The stock is currently trading at 34x/24x FY16/17E EPS.

City Union Bank A stable ship for rough waters City Union Bank has one of the best long-term track records of balancing growth, profitability and asset quality (15 years average loan growth of 25% YoY with average RoA/RoE of 1.5%/22% and credit costs of <50bps). Compared with many of its peers, CUBK has remained focused on a small-ticket, granular franchise on the assets side, geared towards MSME/trade loan. MSME/agro/trade account for ~67% of the bank’s loan book and corporate loans are just 9% of loan book (vs 30-35% average for its peers).

The bank’s assets-side business is based on long-term-relationship-based customised banking to its MSME/trade/self-employed customer base in its home geography. The bank also has benefits from its presence in Tamil Nadu, (the most industrialised state in South India with relatively better credit opportunities). The low cost liabilities have not been a key focus for the banks and the organisational culture is geared towards assets-side relationships to manage superior yields and asset quality. This reflects in the bank’s lower CASA (~19%), and hence higher cost of funds (~7.0%), which is more than offset by high loan yields (~13.0%) and low credit costs. On liabilities, beyond CASA, retail term deposits form the back-bone of deposit base and reliance on wholesale funding is miniscule. Conservative lending (enforcing sole banking relationships and almost fully collateralised lending) has led to superior asset quality.

Further, with a strong tier-1 of 15.3% and investment in its network/systems, the bank is also well placed to accelerate loan growth, if the external environment improves. At Rs91, the stock is trading at 1.8x FY16E BVPS, at a premium to small regional banks, but at a significant discount to new generation private sector banks, despite equally impressive track records in earnings growth.

BUY Stock Information Bloomberg Code: BATA IN

CMP (Rs): 1,116

TP (Rs): 1,351

Mcap (Rs bn/US$ bn): Rs72/US$1.0

3M ADV (Rs mn/US$ mn): Rs269/US$4.1


1M 3M 12M YTD

Absolute (3) 7 (11) (15)

Rel. to Sensex 2 12 (10) (10)


Ambit Estimates (Rs bn)

FY15 FY16E FY17E

Revenues 26.9 25.1 30.1

EBITDA Marg (%) 3.3 3.1 4.3

EPS 31.1 29.6 43.0


Analysts


Aditya Bagul [email protected] Tel: +91 22 3043 3642

BUY Stock Information Bloomberg Code: CUBK IN

CMP (Rs): 97

TP (Rs): 115




1M 3M 12M YTD

Absolute (3) (4) 23 3



Estimates summary

Rs bn FY15 FY16E FY17E

NII 8.1 9.2 10.7

PAT 4.0 4.3 5.2

EPS (Rs) 6.6 7.3 8.7


Analysts

Ravi Singh [email protected] Tel: +91 22 3043 3181

Economy & Strategy


Appendix Exhibit 22: BSE 200 revenue growth

Source: Ambit Capital research, Bloomberg. Note: GDP growth as per the old series until the Mar’2011 quarter; thereafter, the new series is use.* Revenue numbers are sourced from Bloomberg and include Banking and Financial services’ net revenues (Net interest income, Trading profit, Commissions and fees earned and Other operating income).

Exhibit 23: BSE 500 revenue growth

Source: Ambit Capital research, Bloomberg. Note: GDP growth as per the old series until the Mar’2011 quarter; thereafter, the new series is use.* Revenue numbers are sourced from Bloomberg and include Banking and Financial services’ net revenues (Net interest income, Trading profit, Commissions and fees earned and Other operating income).

Exhibit 24: BSE 200 EPS growth


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Economy & Strategy


Exhibit 25: BSE 500 EPS growth


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

Research

Analysts 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]

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

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

Aditya Bagul Consumer (022) 30433264 [email protected]

Aditya Khemka Healthcare (022) 30433272 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

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

Deepesh Agarwal Power Utilities / Capital Goods (022) 30433275 [email protected] Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Karan Khanna Strategy (022) 30433251 [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 / Oil & Gas (022) 30433223 [email protected]

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

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

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

Ritesh Gupta, CFA Midcaps – Chemical / Retail (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 Technology (022) 30433209 [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]

Joel Pereira Editor (022) 30433284 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

E&C = Engineering & Construction

Economy & Strategy


ITC LTD (ITC IN, BUY)


Coal India Ltd (COAL IN, BUY)


Lupin Ltd (LPC IN, BUY)


Power Grid Corp Of India Ltd (PWGR IN, BUY)


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Economy & Strategy


Indusind Bank Ltd (IIB IN, BUY)


Page Industries Ltd (PAG IN, BUY)


PI Industries Ltd (PI IN, BUY)


Mahindra CIE Automotive (MACA IN, BUY)


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Economy & Strategy


Bata India Ltd (BATA IN, BUY)


City Union Bank Ltd (CUBK IN, BUY)


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Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

CITY UNION BANK LTD

Economy & Strategy


Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >10%

SELL <10%

NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events

NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock

Disclaimer This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities is available on request.

Disclaimer 1. AMBIT Capital Private Limited (“AMBIT Capital”) and its affiliates are a full service, integrated investment banking, investment advisory and brokerage group. AMBIT Capital is a Stock Broker, Portfolio

Manager and Depository Participant registered with Securities and Exchange Board of India Limited (SEBI) and is regulated by SEBI 2. AMBIT Capital makes best endeavours to ensure that the research analyst(s) use current, reliable, comprehensive information and obtain such information from sources which the analyst(s) believes

to be reliable. However, such information has not been independently verified by AMBIT Capital and/or the analyst(s) and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties. The information, opinions, views expressed in this Research Report are those of the research analyst as at the date of this Research Report which are subject to change and do not represent to be an authority on the subject. AMBIT Capital may or may not subscribe to any and/ or all the views expressed herein.

3. This Research Report should be read and relied upon at the sole discretion and risk of the recipient. If you are dissatisfied with the contents of this complimentary Research Report or with the terms of this Disclaimer, your sole and exclusive remedy is to stop using this Research Report and AMBIT Capital or its affiliates shall not be responsible and/ or liable for any direct/consequential loss howsoever directly or indirectly, from any use of this Research Report.

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Additional Disclaimer for U.S. Persons 10. The research report is solely a product of AMBIT Capital 11. AMBIT Capital is the employer of the research analyst(s) who has prepared the research report 12. Any subsequent transactions in securities discussed in the research reports should be effected through Enclave Capital LLC. (“Enclave”). 13. Enclave does not accept or receive any compensation of any kind for the dissemination of the AMBIT Capital research reports. 14. The research analyst(s) preparing the email / Research Report/ attachment is resident outside the United States and is/are not associated persons of any U.S. regulated broker-dealer and that

therefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

15. This report is prepared, approved, published and distributed by the Ambit Capital located outside of the United States (a non-US Group Company”). This report is distributed in the U.S.by Enclave Capital LLC, a U.S. registered broker dealer, on behalf of Ambit Capital only to major U.S. institutional investors (as defined in Rule 15a-6 under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”)) pursuant to the exemption in Rule 15a-6 and any transaction effected by a U.S. customer in the securities described in this report must be effected through Enclave Capital LLC (19 West 44th Street, suite 1700, New York, NY 10036).

16. As of the publication of this report Enclave Capital LLC, does not make a market in the subject securities. 17. This document does not constitute an offer of, or an invitation by or on behalf of Ambit Capital or its affiliates or any other company to any person, to buy or sell any security. The information

contained herein has been obtained from published information and other sources, which Ambit Capital or its Affiliates consider to be reliable. None of Ambit Capital accepts any liability or responsibility whatsoever for the accuracy or completeness of any such information. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the date of this document. Emerging securities markets may be subject to risks significantly higher than more established markets. In particular, the political and economic environment, company practices and market prices and volumes may be subject to significant variations. The ability to assess such risks may also be limited due to significantly lower information quantity and quality. By accepting this document, you agree to be bound by all the foregoing provisions.

Additional Disclaimer for Canadian Persons 18. AMBIT Capital is not registered in the Province of Ontario and /or Province of Québec to trade in securities and/or to provide advice with respect to securities. 19. AMBIT Capital's head office or principal place of business is located in India. 20. All or substantially all of AMBIT Capital's assets may be situated outside of Canada. 21. It may be difficult for enforcing legal rights against AMBIT Capital because of the above. 22. Name and address of AMBIT Capital's agent for service of process in the Province of Ontario is: Torys LLP, 79 Wellington St. W., 30th Floor, Box 270, TD South Tower, Toronto, Ontario M5K 1N2

Canada. 23. Name and address of AMBIT Capital's agent for service of process in the Province of Montréal is Torys Law Firm LLP, 1 Place Ville Marie, Suite 1919 Montréal, Québec H3B 2C3 Canada. Disclosure 24. Ambit and/or its associates have financial interest in ITC, Coal India, Power Grid, City Union Bank, Idea, Mindtree, HDFC Bank and Axis Bank. 25. Ambit and/or it associates have received compensation for investment banking/merchant banking/brokering services from City Union Bank, Astral PolyTechnik in the past 12 months. Analyst Certification Each of the analysts identified in this report certifies, with respect to the companies or securities that the individual analyses, that (1) the views expressed in this report reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly dependent on the specific recommendations or views expressed in this report. © Copyright 2015 AMBIT Capital Private Limited. All rights reserved.

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