India Market Strategy "Earnings recovery elusive. For how long?"

UBS Head of India Research Gautam Chhaochharia

UBS cuts Nifty target for Dec-2015 to 9,200, to reflect earnings cuts.

UBS Head of India Research Gautam Chhaochharia

UBS Head of India Research Gautam Chhaochharia

Nifty Dec-2015 target cut to 9,200 from 9,600.

We cut our Nifty target for Dec-2015 to 9,200, to reflect earnings cuts.

We now use a higher multiple of 17x one-year forward PE (vs. 16x earlier) as we expect current multiples to likely sustain. The revised target also reflects our view of the growth recovery being slower than expected, as is playing out in quarterly corporate results. It does reflect possibility of near-term consolidation and even profit-taking, given limited absolute upside from current levels near-term. We remain positive directionally and expect the rates cycle to continue surprising the markets positively. India remains overweight (OW) from Asia and EM perspective.

Portfolio sector positioning – OW Banks, Pharma; UW Auto 2Ws, Staples, IT

Earnings forecasts by street and UBS analysts are building in growth acceleration for Consumers, Autos, Banks, Infra/Cap Goods and building in deceleration in IT Services. We reiterate OW Banks as we believe the rate cycle will be a bigger driver for these stocks (through lower NPLs, and bond book gains) rather than credit growth near-term. We are also OW Coal, Oil & Gas/Petchem, Pharma and Telecom & Media. We reiterate underweight (UW) on Auto 2Ws and Consumer Staples to reflect our concerns on rural growth. We are also UW on IT Services and Real Estate. We are Neutral on Auto 4Ws, Consumer Discretionary, Infra/Cap Goods, Power Utilities and Midcaps.

Earnings recovery key to markets performance, when will they recover?

Positive surprise on rates cycle, lower oil prices and reforms newsflow helped Indian markets over the last 1 year. Hereon, actual earnings and macro data points will matter increasingly. The reality of a slow growth recovery is now being acknowledged and earnings estimates for FY15/16 have been cut 6-7% over last 6 months – recovery is yet elusive. Street forecasts are building in margins recovery, near past peaks, for FY16/17. Topline growth forecasts though appear conservative, at 8%/14% for FY16/17, vs. our forecast nominal GDP growth of 12.8%/13.3%. We continue to expect a mild recovery in FY16 (20bps acceleration in GDP growth) and a sharper recovery only in FY17. Our top-down earnings growth forecast for the Nifty is 10%/18% for FY16/17, post likely 7% growth in FY15. This implies likely further cuts to earnings growth estimates by the street/analysts. 4QFY15 will likely be weak but markets may be arguably already expecting that, based on our discussions with investors.

WPI ignored given focus on CPI – topline surprised negatively

We have been expecting negative GDP growth surprise but positive inflation surprise (ex crude oil) over the last 1 year. Yet earnings disappointed even our top-down expectations for FY15. Earnings cuts and disappointments have been driven more by lower sales growth while margins have broadly gone up, only a bit below earlier expectations. As per our analysis, markets (and us) were focused on CPI as the key inflation metric, given RBI's focus on this as the policy driver. WPI is arguably more relevant for topline growth for companies and the sharper than expected decline in this was ignored. The commodities/oil deflation globally in 2H 2014 has led to WPI printing in negative zone over last 5 months. This also played a role in adversely affecting topline growth for Nifty.