An India Equity Strategy report by Bank of America Merrill Lynch, has narrowed down on 5 evolving themes in India. According to this report, the political landscape over the next 5 years should be dramatically different than the previous five, with the Modi government running the first majority government in 30 years. Along with the changed political landscape, many economic themes in India should be considerably different over the next 5 years. This will likely shape the direction of the markets as well as the components of future growth.
Below is a brief excerpt from the report.
1) Urban income should grow faster than rural income
One of the key drivers of growth for the Indian economy in the last decade had been consumption led by rising rural incomes, which outpaced urban incomes. Rural per capita consumption (ex-food) since FY05 has grown at a 14.3% CAGR, ahead of urban growth at 13.3%.
Acceleration in GDP growth along with lower interest rates should lead to urban income rising faster than over the past 5 years. Rural income will likely continue to grow at a healthy clip but probably slower than the past five as product prices increase at a slower pace and rural wage growth eases off.
While rural income should continue to grow at a healthy clip, we think urban income growth will outpace rural income growth.
Stock implications:
(a) Prefer 4-wheelers like Maruti over Mahindra & Mahindra.
(b) Prefer consumer discretionary stocks like Titan over staples like HUL.
2) Rupee depreciation should give way to stable currency
During 2011-2013, the rupee depreciated 38% vs. the dollar and over the past 5 years it has depreciated 27%. A rising Current Account Deficit (CAD) and falling import reserves have driven the weakness in the currency. The CAD peaked in FY13 at close to 5%.
With a reduction in the CAD, the pressure on the currency has eased, with the rupee appreciating by more than 12% since the August 2013 lows. We see the currency in the near term being flattish in the Rs 58-62/US$ range and over the next 5 years appreciating slightly.
Three factors should drive this:
- A stable current account deficit
- Recouping forex reserves
- Foreign flows should rise
Stock implications:
Stocks that have benefitted from rupee depreciation over the past 3 years would likely lose a driver of EPS growth, e.g., IT (HCL Tech, Tech Mahindra, Wipro, Infosys), pharma (Cadila, Aurobindo, Cipla, Lupin) and commodities (GAIL, Oil India, BPCL, Cairn, ONGC). On the other hand, obvious gainers would be the importers, e.g., Maruti, Hero Motors.
3) From rising interest rates to falling interest rates
Over the past 5 years interest rates have been rising as the RBI undertook a series of rate hikes to counter inflation. The RBI repo rates have risen from 4.75% in Jan ’10 to 8% currently. We expect the RBI to resume cutting rates from early 2015, which would eventually lower lending rates. Two factors should drive this: falling inflation and a lower fiscal deficit.
Stock implications:
Companies gain through an increase in demand. We think gainers include autos (Maruti, Ashok Leyland), real estate (DLF, Oberoi) and industrials. Secondly, high debt companies gain due to lowering of interest costs. These include companies like Industrials (GVK, IRB, etc.) and real estate (DLF, Unitech, HDIL). Finally, as proxy to the rate cycle, banks would also likely do well (SBI, ICICI Bank).
4) From earnings downgrades to earnings upgrades
Since the global financial crisis, earnings downgrades have been a constant theme in India. However, we believe that we are moving toward the end of the downgrade phase. From a sharp spell of earnings downgrades over the past few years, we expect earnings to be upgraded from next year. Over 4 years, we see earnings in India doubling as operating leverage leads to mean reversion in margins and consensus earnings growth could start seeing upgrades from FY16 onwards.
We are probably close to trough levels in terms of both top line as well as operating margins. As the economy improves, higher capacity utilisation and the consequent operational leverage coupled with better pricing power will drive margins and earnings surprises.
Stock implications
Sectors that already have excess capacity and are currently running at low utilisation could easily see upgrades even if there is a marginal recovery in demand. Sectors with low utilisation levels currently are: cement, autos and commodities. Stocks in these sectors include Ashok Leyland, TVS and Maruti.
5) Investment spend to drive GDP
Since the global financial crisis, we have seen weakness in investment spending lead to slowing GDP growth. This trend has been accentuated over the past few years with consumption holding ground relatively well but GDP growth slumping.
This is a late cycle play and will probably be seen over the next 24 months as business confidence improves, government accelerates project clearances, interest rate cuts, and repair of leveraged balance sheets.
Stock implications:
Industrial companies, especially those engaged in EPC and equipment manufacturing would be the early beneficiaries. Utilities will benefit once their projects are commissioned. As a pick-up in investments occurs, loan disbursal will likely pick up, leading to faster growth in financials with exposure to industries.
