Icicidirect Market Strategy Dec08

29 December 2008 | Strategy

Market Strategy 2009 2008: Wealth erosion - Too fast too furious… Pains 2008: Castles built in the air • Lessons to be learnt • Global Rout - The price we paid • Global economies going out of gear • India - No exception • Indian valuation were at astronomically high levels • FII sell-off • Volatility • Fundamentals deteriorating o

IIP data painting a gloomy picture

o

Worsening fundamentals of Indian Corporates

o

Other leading macro indicators

o

Capex plans getting delayed

Silver Lining 2008: After shock events • Economies working in tandem • Falling interest rates • Inflation now moving southwards • Commodity prices – at rock bottom

Speed Breakers • Historical events

Outlook 2009 • Broad theme for 2009

Valuation • Fundamental perspective • Technical perspective • ICICIdirect sectoral outlook • What an investor should do? o

Look for suggested entry levels

1 | Page

2008: Castles built in air… In 2008, the global economy faced its most serious financial crisis and economic slowdown in decades that has brought free-market capitalism under fire. The current crisis dispels the notion that free markets should be self-regulatory as was happening in US. The US philosophy of allowing banks to chase returns in areas beyond their core business is under question. There are a few important lessons to be learnt from the current crisis.

Lessons to be learnt Dispersion of risk should not be construed as reduction of risk

1. Dispersion of risk should not be construed as reduction of risk as indicated by the demise of complex financial products such as credit default swaps 2. Leveraging does not always result in credit creation 3. Self market discipline is no substitute for government regulation. The highly regulated Indian banking sector remained fairly insulated from the financial meltdown worldwide and is one of the best examples of the same.

The price we paid - Global rout Exhibit 1: Global equity melt down Major indices Closing as on 26-Dec,08 US Dow Jones 8468.5 S&P 500 868.2 Nasdaq 1524.9 Europe FTSE 100 4216.6 Euro First 1732.4 CAC 3116.2 DAX 4629.4 Asia Sensex 9328.9 Nifty 2857.3 Hang Seng 14184.1 Shanghai Composite 1851.5 Nikkei 8739.5 Kospi 1117.9 Straight Times 1725.6 Taiwan 4425.1 Others Russia 644.5 Brazil 37061.7

1M

3M

12M

-3% -2% 0%

-39% -28% -30%

-38% -42% -44%

2% -4% -2% 2%

-17% -27% -24% -24%

-35% -45% -44% -42%

3% 4% 6% -2% 6% 9% 1% 4%

-29% -28% -24% -19% -27% -24% -28% -25%

-54% -53% -50% -65% -44% -41% -51% -46%

-2% 2%

-50% -27%

-72% -42%

World indices collapsed with India too losing 54%

Source: Reuters, ICICIdirect.com Research

2 | Page

Global Economies going out of gear Some Evident Reasons for Market Mayhem Exhibit 2: Financial crunch leading to economic slowdown April Projections 2008 2009 3.7 3.8

GDP Growth World Output

November Projections 2008 2009 3.7 2.2

Difference in Projection 2008 2009 0.0 -1.6

United States Euro area Germany Japan United Kingdom

0.5 1.4 1.4 1.4 1.6

0.6 1.2 1.0 1.5 1.6

1.4 1.2 1.7 0.5 0.8

-0.7 -0.5 -0.8 -0.2 -1.3

0.9 -0.2 0.3 -0.9 -0.8

-1.3 -1.7 -1.8 -1.7 -2.9

Emerging and developing economies Russia China India Brazil

6.7 6.8 9.3 7.9 4.8

6.6 6.3 9.5 8.0 3.7

6.6 6.8 9.7 7.8 5.2

5.1 3.5 8.5 6.3 3.0

-0.1 0.0 0.4 -0.1 0.4

-1.5 -2.8 -1.0 -1.7 -0.7

Source: IMF, ICICIdirect.com Research

Most economies have witnessed erosion in growth to the extent of 150 bps.

India - No exception Exhibit 3: India – Not decoupled as yet 160.00 150.00 140.00 130.00 120.00 110.00 100.00 90.00 80.00 70.00 60.00 Jun-07

Sep-07

Dec-07

Mar-08

Jun-08

BSE

NSE

Sep-08

Dec-08

From Jan to Dec ‘08, 54% of the index value was lost leading to erosion of Rs 1449039 cr in market cap

Source: BSE, NSE, ICICIdirect.com Research

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Exhibit 4: Pain felt across the board 18,000.00 16,000.00 14,000.00 12,000.00 10,000.00 8,000.00 6,000.00 4,000.00 2,000.00 0.00 Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

BSE Auto

BSE Bankex

BSE Consumer Durable

BSE Capital Goods

BSE FMCG

BSE Healthcare

BSE IT

BSE Metals

BSE Oil & Gas

BSE Power

BSE PSU

BSE Realty

Source: BSE, ICICIdirect.com Research

Metals, realty, capital goods, auto, midcaps, small cap indices have been worst performers with each of them witnessing more than 56% erosion of their value in 2008

Exhibit 5: Best Performers (BSE Sensex) -34

Exhibit 6: Worst Performers (BSE Sensex) -74

Infosys -31

-77

NTPC -18

-30

-20

0 % YTD

Source: Reuters, ICICIdirect.com Research

10

20

Tata Motors J P Associates

-82

20

-10

Tata Steel

-78

ITC HUL

-40

Sterlite

-75

Bharati Airtel

-29

Hindalco

30

-84

-82

-80

-78

-76

-74

-72

% YTD

Source: Reuters, ICICIdirect.com Research

4 | Page

-70

Global Valuations Exhibit 7: Global PE multiples Nasdaq Dow Jones Malaysia Thailand Nikkie Mexico China Brazil CNX Midcap

After the fall Indian stocks are trading at one of the lowest two year forward PE

BSE Midcap Sensex Nifty 0

2

4

Current P/E

6

8

10

One Year Forward P/E

12

14

16

Two Year Forward P/E

Source: Reuters, ICICIdirect.com Research

Indian valuations were at astronomically high levels Exhibit 8: Trailing PE (BSE Sensex)

Exhibit 9: Market Cap to GDP

32 28 24 20 16 12 8 Jan-08

Mar-08

May-08

Jul-08

Sep-08

Nov-08

P/E Ratio

Source: Bloomberg, ICICIdirect.com Research

Valuations at 8-10x forward PE, which is cheaper than other Asian peers to instigate fund inflow

200% 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% Jan-08

Mar-08

May-08

Jul-08

Sep-08

Nov-08

Market Capitalisation as a % to GDP Ratio Source: Bloomberg, ICICIdirect.com Research

After seeing exuberant market cap greater than 170% of GDP in January, markets have corrected sharply to trade at nearly 67% of GDP

5 | Page

FII Sell off Exhibit 10: FII flow from January 2008 and corresponding Sensex levels 25000 20000 15000

Rs Crore .

10000

Support from MFs not adequate as against FII selling.

5000 0 -5000 -10000 -15000 -20000 Dec-07

Feb-08

Apr-08

Jun-08

FII

Aug-08

Sensex

Oct-08

Dec-08

For CY08 FII net sold Rs. 52,842 crore MF net bought Rs.13,696 crore

MF

Source: SEBI, ICICIdirect.com Research

•

FII: Foreign Institutional Investors

•

MF: Mutual Funds

Exhibit 11: FII shareholding in terms of no of shares in Sensex components 70% 56%

60%

58%

50%

Percentage of FII holding has fallen from 21% to 19% in Sensex components

40% 30%

21%

19%

20%

10%

9%

9%

10%

10%

0% FIIs

DII

Govt.+Promoters

Dec-08

Total Others

Sep-07

Source: BSE, ICICIdirect.com Research

6 | Page

Volatility Exhibit 12: Dow Jones vs. CBOE VIX for CY08 90

Exhibit 13: Nifty vs. India VIX for CY08 15,000

90

80

80

70

70

12,000

60 50

9,000

40

7000 6000 5000

60 50

4000

40

3000

30

30 6,000

20

2000

20

1000

10

10 3,000 0 Jan-08 Feb-08 Mar-08 May-08 Jun-08 Aug-08 Sep-08 Oct-08 Dec-08

Dow Jones (RHS)

0

0 Jan-08 Feb-08

CBOE VIX

Apr-08 May-08 Jul-08

NIFTY

Source: Bloomberg, ICICIdirect.com Research

Aug-08 Sep-08 Nov-08 Dec-08

Volatility Index

Source: NSE, ICICIdirect.com Research

A higher VIX is always negative for the markets. Despite a fall from its Oct 08 peak, VIX is still trading above comfortable levels

Exhibit 14: Reuters/Jefferies CRB Index 500 450 400

Most of the commodities are cooling off in anticipation of recession in major economies

350 300 250 200 150 100 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

CRB Index Source: Bloomberg, ICICIdirect.com Research

•

CBOE: Chicago Board Option Exchange

•

CRB: Commodity Research Bureau

•

VIX: Volatility Index

7 | Page

Fundamentals Deteriorating Exhibit 15: IIP data painting a gloomy picture 350

15%

300

12% 9%

250

6% 200

3%

150

0%

100

-3% Apr-07

Jul-07

Oct-07

Jan-08

IIP %chg (LHS)

Apr-08

Jul-08

For the first time in 15 years, we have seen negative IIP growth resulting from production cuts & demand slowdown

Oct-08

IIP Value

Source: ICICIdirect.com Research, http://mospi.nic.in

Worsening Fundamentals of Indian Corporate BSE 200 financial performance excluding banks and financials Exhibit 16: Strains on topline 15%

16% 14% 12% 10% 8%

Slowdown in sales after peaking in March 2008

9% 7%

7%

6%

6% 4% 2% 0% JAS07

OND07

JFM08

AMJ08

JAS08

Net sales (Q-o-Q growth %)

Source: Capitaline, ICICIdirect.com Research

•

JAS- July, August, September

•

OND- October, November, December

•

JFM- January, February, March

•

AMJ- April, May, June

8 | Page

Exhibit 17: Margins feeling cost pressure 25% 20%

19%

19% 15%

14%

15%

11%

10% 5% 0% JAS07

OND07

JFM08

AMJ08

JAS08

EBIDTA Margin(%)

EBITDA margin has declined by more than 800 bps in the last 5 quarters due to sharp rise in commodity price, with Sept 2008 EBIDTA margins crashing to a low of 11%

Source: Capitaline, ICICIdirect.com Research

Exhibit 18: Depreciation trending down 20%

17%

15% 10%

6%

7%

5%

0%

0% -5%

JAS07

OND07

JFM08

AMJ08

JAS08

-9%

Negative growth in depreciation indicates slowing of expansion plans/ Capex.

-10% -15%

Depreciation (Q-o-Q growth %)

Source: Capitaline, ICICIdirect.com Research

Exhibit 19: Interest outgo on an uptrend 38%

40% 35%

32%

32%

30%

Interest outgo rose significantly amplifying margin pressure

25% 20%

16%

15% 7%

10% 5% 0% JAS07

OND07

JFM08

AMJ08

JAS08

Interest expense (Q-o-Q growth %) Source: Capitaline, ICICIdirect.com Research

9 | Page

Exhibit 20: Declining profitability 20%

13%

10%

4% -2%

0% JAS07

OND07

JFM08

AMJ08

JAS08

-10% -10% -20% -31%

-30% -40%

Corporate profitability moves deeper into the red in Sept 2008 due to combined impact of slowdown in revenues, higher input cost and increased interest outgo.

Net profit (Q-o-Q growth %) Source: Capitaline, ICICIdirect.com Research

Exhibit 21: Other leading macro indicators Units Passenger Car sales (Nov'08) CV Sales (Nov'08) 2W Sales (Nov'08)

Advances (5/12/2008) Deposits (5/12/2008)

Cement Dispatches (Nov08)

Electricity Generation (Nov'08) *Total Capacity (Nov'08)

Wireless Subs (Oct'08) Broadband subs (Oct('08) Wireline (Oct'08) Total subs (Oct'08) Penetration (Oct'08) Production (Nov 08) *YTD growth over 31 Mar'08 base

000 Nos. 000 Nos. 000 Nos.

Rs Bn Rs Bn

Current YoY% Automobile 100.0 -23.7 20.6 -49.5 567.5 -14.7 Banking* 26421.1 35548.9

MoM(%) Cumulative till date

YTD(%)

-20.7 -26.4 -16.3

1,004.9 270.2 5,109.8

1.1 -9.4 3.8

26.3 21.4

0.3 3.0

26421.1 35548.9

12.5 11.4

Mn tonne

Cement 14.4

11.2

0.9

114.7

6.9

Mn MW

Power 58024.3 146902.8

2.7 6.3

-5.9 0.1

474411.3 146902.8

2.7 2.7

50.0 87.7 -3.0 42.3

3.3 3.1 -0.3 2.9

325.7 5.1 38.2 369.0

24.8 29.5 -3.0 21.2

1.2

-5.2

36.22

2.6

Mn Mn Mn Mn % Mn tonne

Telecom* 325.7 5.1 38.2 369.0 31.5 Crude Steel 4.6

Source: CMA, SIAM, CEA, Trai, RBI, JPC, ICICIdirect.com Research

Leading sector sales numbers are depicting diminishing demand and pressure on corporate earnings

10 | Page

Capex plans getting delayed Exhibit 23: Projects shelved

7,500

35000

60

30000

50

25000

40

Nos

6,500 6,000

20000

5,500

R s B illio n

7,000

4,500 4,000 Sep-05

Jun-06

Mar-07

Rs Billion (RHS)

Dec-07

300 250 200 150

30

15000

20

10000

10

5000

0

5,000

450 400 350

N os

8,000

100 50 0 Sep-05

Sep-08

Jun-06

Nos (LHS)

Mar-07

Rs Billion (RHS)

Source: CMIE, ICICIdirect.com Research

R s B illio n

Exhibit 22: Projects under Implementation

Dec-07

Sep-08

Nos (LHS)

Source: CMIE, ICICIdirect.com Research

Liquidity crunch & demand slowdown forcing companies to delay capex plans.

Exhibit 25: Projects completed 350

600

1300

6000

300

500

5000

250

N os

1100

4000

900

3000

700

N os

7000

R s B illio n

1500

100

500

1000

50

300

0 Jun-06

Mar-07

Rs Billion (RHS)

Source: CMIE, ICICIdirect.com Research

Dec-07 Nos (LHS)

Sep-08

300

150

2000

Sep-05

400

200

200 100

0

0 Sep-05

Jun-06

Mar-07

Rs Billion (RHS)

Dec-07

Sep-08

Nos (LHS)

Source: CMIE, ICICIdirect.com Research

Ratio of projects shelved as a percentage of projects announced is increasing

11 | Page

R s B illion

Exhibit 24: New Projects

Silver Lining 2008: After shock events Economies working in tandem The current financial crisis evoked an "unprecedented" global coordination as there was no country which was immune from its effects. The world has not seen such massive coordinated action on a global scale, involving not only the US but also the EU, China, India and other countries. If the Asian financial crisis told us about contagion, this crisis has told us about coordination.

If the Asian financial crisis told us about contagion, this crisis has told us about coordination.

Exhibit 26: Rate cuts by major Economies 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08

US

UK

Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

India

China

Source: Reuters,ICICIdirect.com Research

Key Indian Rates Exhibit 27: Rates trending southwards again 10

25

9

25

8

25

7

25

6

24

%

%

5

24

4

24

3 2

24

1

24

0

Falling inflation & interest rates have led to G-Sec yields falling and bonds rallying

23 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

Repo Rate (LHS)

Reverse Repo Rate (LHS)

CRR (LHS)

SLR (RHS)

Source: RBI, ICICIdirect.com Research

12 | Page

Exhibit 28: Global inter bank lending rates are declining 6 5 4

Narrowing spread indicates easing liquidity situation

3 2 1 0 Mar-06

Jun-06

Sep-06

Dec-06

Mar-07

Jun-07

Sep-07

FDTR Index (Fed rate)

Dec-07

Mar-08

Jun-08

Sep-08

Dec-08

Libor 3 month

Source: Bloomberg, ICICIdirect.com Research

Exhibit 29: Corporate credit spreads in India 5

25

4

20

3

15

2

10

1

5

0 Jan-08

Feb-08

G Sec

Mar-08

May-08

Jun-08

Jul-08

AAA Corporate Yields

Aug-08

Oct-08

Nov-08

AAA Corporate spreads after reaching a high of over 4 % have started moving southwards now.

0 Dec-08

AAA Corporate Spreads -LHS

Source: Bloomberg, ICICIdirect.com Research

Exhibit 30: 10 yr G Sec Yields rallying due to fall in inflation

Exhibit 31: Inflation rate easing after peaking around 13%

10 14

8

12

5.6

%

%

10

6

8

6.6

6 4

4

2 0

2 Dec-07

Feb-08

Apr-08

Jun-08

Aug-08

G Sec Yields

Source: Reuters, ICICIdirect.com Research

Oct-08

Dec-08

Dec-07

Feb-08

Apr-08

Jun-08

Aug-08

Oct-08

Inflation Rate

Source: Reuters, ICICIdirect.com Research

13 | Page

Dec-08

Exhibit 32: Bailout Packages Country US Germany India China

GDP 13808 3320 1101 3280

Bailout Package 1315 677 7 586

(In US$, Bn) % to GDP 9.5% 20.4% 0.6% 17.9%

Source: ICICIdirect.com Research

Exhibit 33: Commodities are at rock bottom Closing price as on Aboslute Change 26-Dec-08 2-Jan-08

Commodity Crude Oil Crude oil WTI (NYMEX active month, USD/ barrel) Crude oil Brent (ICE active month, USD/ barrel) Crude oil WTI (MCX active month, INR/ barrel) Crude oil Brent (NCDEX active month, INR/ barrel) Precious Metals Gold (International spot, USD/ troy ounce) Gold (Indian spot, INR/ 10 gm) Silver (International spot, USD/ troy ounce) Silver (Indian spot, INR/ kg) Base Metals Copper (LME 3-month, USD/ tonne) Copper (MCX active month, INR/ kg) Aluminium (LME 3-month, USD/ tonne) Aluminium (MCX active month, INR/ kg) Zinc (LME 3-month, USD/ tonne) Zinc (MCX active month, INR/ kg) Nickel (LME 3-month, USD/ tonne) Nickel (MCX active month, INR/ kg) Lead (LME 3-month, USD/ tonne) Lead (MCX active month, INR/ kg) Ferrous Metals CRU Global Steel index CRU Flat Steel Index CRU Long Steel Index Indian HRC (Including excise duty, taxes) INR/ USD- Depreciation (Bid)

% Change

37.7 38.4 1823.0 1823.0

99.6 97.8 3898.0 3894.0

-61.9 -59.5 -2075.0 -2071.0

-62% -61% -53% -53%

867.7 13200.0 10.7 17450.0

856.8 10815.0 15.2 19750.0

10.9 2385.0 -4.6 -2300.0

1% 22% -30% -12%

2845.0 146.2 1537.0 73.0 1158.0 55.1 9625.0 468.7 850.0 42.6

6778.0 267.9 2438.0 94.3 2451.0 96.5 27200.0 1067.5 2615.0 103.7

-3933.0 -121.6 -901.0 -21.4 -1293.0 -41.5 -17575.0 -598.8 -1765.0 -61.1

-58% -45% -37% -23% -53% -43% -65% -56% -67% -59%

155.2 145.6 174.5 36200.0

175.9 162.3 203.4 34800.0

-20.7 -16.7 -28.9 1400.0

-12% -10% -14% 4%

48.4

39.4

-9.0

-23%

Source: Reuters, ICICIdirect.com Research

Depreciating INR has reduced the impact of fall in commodity prices to some extent in Indian markets

14 | Page

Speed Breakers Exhibit 34: Major historical events of 2008 Sensex Value Left withdraws support to UPA govt (08.07.08)

Union budget announcement (29.02.08)

22000

Approval of sixth pay commission (14.08.08)

State Assembly elections (08.12.08)

20000 Congress wins trust vote (22.07.08)

18000 16000

Indo-US Nuke deal signed (05.10.08)

14000 12000 10000 8000 1-Dec-08

1-Nov-08

1-Oct-08

1-Sep-08

1-Aug-08

1-Jul-08

1-Jun-08

1-May-08

1-Apr-08

1-Mar-08

1-Feb-08

1-Jan-08

6000

Sensex Value

Source: BSE, ICICIdirect.com Research

In 2008, the market reacted more to international events rather than Indian political events, as shown in Exhibit 36

15 | Page

Outlook 2009 We believe that the following themes such as PSUs, infra, power, pharma, banks, FMCG, auto, and telecom would find favour among investor in 2009. Investors could resort to PSU companies for safety ignoring their weakness on parameters such as capital efficiency and lower return ratios. Also, these companies are light on the balance sheet as there was lower misallocation of capital due to government restriction on investments and procedural hassles. In addition, sectors like infra and associated sectors would be the direct beneficiary of the government’s stimulus package, which benefits banks as they act as canalising agents for investment. We prefer defensive domestic plays like pharma, FMCG and select auto companies as a sharp plunge in commodity prices would cushion them against margin pressures.

Broad Theme For 2009

Safety overrides capital efficiency

Govt. Stimulus

Domestic play

Liquidity improvement lower Commodity prices/ Inflation

PSU

Infrastructure

Auto, FMCG, Pharma, Power, telecom

Banks, Power, Capital Goods

Govt. backing Less leveraged Under owned

Capex push by Govt.

High reliance on domestic market for growth

Lower interest rate to boost MTM/ realised gains on G Sec bonds. Less pressure on margins ahead

Beneficiaries: SBI, Bhel, NTPC, Hero Honda, Maruti, PowerGrid, Bharti, GAIL, HLL, Sun Pharma, Glenmark Pharma, Elder Pharma

16 | Page

Valuations – Fundamental & Technical In all the gloom that engulfs our stock market we now see some positives coming out of the efforts of global governments. In order to bring sanity back to the markets governments and authorities pumped in liquidity into the system. Closer home, the RBI has already lowered rates to ease monetary policy (the repo rate has been cut by 250 bps to 6.5% and CRR by 350 bps to 5.5%). The government has announced a stimulus package worth $7 billion, which has been targeted at the infrastructure space. The government is also planning to give spending a boost by announcing infrastructure projects. These measures are aimed at propelling the growth in infrastructure, cement, and steel consumption back to its previous levels. What comforts us is the fact that the government is proactive in taking actions and doing everything in its capacity to stimulate growth and continue India’s GDP growth story.

Fundamental perspective At the peak, investors across all asset classes were buying for the long term, those assets which were valued for the short-term. After peaking at a P/E of 22x in January, the benchmark indices tumbled 54% (YTD) to trade currently at 10.4x on a trailing earnings basis and 10.5x on one year forward earnings. After touching the historical lows of 8x P/E, the indices saw a sharp bounce back giving over 40% returns over 10-12 days in October 2008. The credit contagion, which had its roots in the subprime mortgage has now spread like an epidemic and affected all economies in one way or the other thereby placing the global economy in the grip of a recession. Leverage has become the villain in the global growth story, with the market mercilessly punishing highly leveraged companies this year. Currently, the Sensex is trading at 2.7x trailing and 1.8x forward P/B, which is quite attractive. Exhibit 35: Sensex multiples 20x 16x 13x

13000

10x

Jul-08

Apr-08

Jan-08

Oct-07

Jul-07

Apr-07

Jan-07

Oct-06

Jul-06

Apr-06

Jan-06

Oct-05

Jul-05

Apr-05

Jan-05

Oct-04

3000

Jul-04

8000

Oct-08

Current Valuation

Apr-04

Sensex Levels

18000

Source: BSE, ICICIdirect.com Research

17 | Page

We believe India and China being key beneficiaries among other Asian economies due to expected high GDP growth of 6%-7% and 8%-9%, respectively, going next year. With US rates sliding to 0%, on a risk- reward basis, Indian equities are offering better returns to overseas investors. With Indian exports at just 16% as a percentage of GDP in FY08, the economy is more resilient to global turmoil. The Indian crude import bill has been falling drastically in the last few months and with internal supplies building faster, our trade deficit should also improve, going ahead, as India is a net importer. We believe these criteria would warrant a re-rating of Indian P/E, going ahead in spite of earnings slowdown due to easing liquidity and lower rates. Also, as the process of deleveraging nears its end we would witness the reversal in fortunes of dollar as a currency, which would again lead to reversal of flows to regions and asset classes, which offer better growth prospects. We expect the Sensex to hover between 12000 and 14000 levels by December 2009 considering a P/E range of 12.6 x to 14.7x, which is still at a discount to the historic average P/E range of 15x-16x at which the index usually trades.

We expect Sensex to trade in the range of 12000 to 14000 by Dec 2009

However, in the near term, the Sensex would trade depending on various factors like intensity of hostility between India and Pakistan, latest quarterly earnings (reaction to over delivery or under delivery in numbers) and outcome of the Lok Sabha elections. Also, the outcome of gas dispute between RIL and RNRL can have meaningful implications for the markets in the near term. Even the trigger of these short-term factors in a positive way would lead to a re-rating of the index multiple in the long run.

18 | Page

Technical Perspective 2008 Flashback The year 2008 has brought the four-year-old secular bull market to an abrupt end, as the Sensex crashed in January 2008 from the highs of 21,207 levels. The Sensex plummeted to the three-year lows of 7697 losing almost 64% from its peak at 21207. As the global financial crisis unfolded first in the US and later engulfed other parts of the world, equity markets across the globe faced the brunt of it. FIIs went on a selling spree and liquidity, which was in abundance during the bull run, became scarce. The biggest investment banks in the US went bankrupt and there are no clear and evident signs that the worst is over. Exhibit 36: Major 2008 events impacting the markets Daily Q.BSESN

01/01/2008 - 26/12/2008 (BOM)

Price INR

21 Jan- Markets Plunge due to growing fears of US recession

21 Aug - WPI at 13 yr high at 12.63 15 Sept- Lehman Bros file for Bankruptcy

19,000

26 June- Crude above $145 per barrel

18,000

17 Sept- Cash Crunch at AIG

17,000 16,000 15,000 14,000

1 July- Denmark becomes the 1st European nation to confirm its recession 13,000 12,000

5 Sept- Failure of Fannie Mae & Freddie Mac 25 Sept- Ireland slides into recession

11,000

10,000 9,887.81

10 Oct- Singapore becomes the 1st Asian economy to side into recession

9,000 .12 01Fri 18/01/2008 16 01

18

03

17

01

16

Q1 2008

02

16

02

Q2 2008

16

01

16

01

18

01

16

Q3 2008

01

16

03

17

01

16

Q4 2008

Source: Reuters, ICICIdirect.com Research

8-year time cycle The Sensex is following a classic eight year cycle ever since its birth. As shown on the chart below, 1984 was the beginning of the eight-year long bullrun till '1992. The next important turning points occurred exactly eight years thereafter, in 1992 and 2000. Both these turning points coincided with the two biggest stock market scams we had and consequently, the leaders of the rally during these turning points had an extremely difficult time later. For example, ACC, the leading stock of the 1992 bull market, remained below its highs till end of 2004. Similarly, the IT stocks, which were leaders of the 2000 rally, lost as much as 90% of their top valuations by 2003, and most are below their top levels even today. In the current year 2008 we were sitting again on this very important cycle, which therefore has thrown up similar possibilities.

Sensex following 8 year cycle

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Exhibit 37: Sell offs as per 8 year cycle

Source: ASA, ICICIdirect.com Research

An important striking fact about this eight year cycle is similarity of both time and price wise correction, which has happened. In the previous eight-year cycle top during 1992-93, Sensex lost 56% from 4546 to 1980. In the next cycle top, the cut was almost 58% from 6150 in 2000 to 2594 in 2001. Timewise, the 1992 cycle completed the bear phase in 12-16 months, while the 2000 cycle took 19 months to hit the low, which was then followed by 19 months of base formation before the bull phase resumed again. Remember, in technical analysis, both time and price forecasts must be achieved. Accordingly, in 2008, we have already achieved price wise correction to the tune of 64%. However, time wise correction should get over by February- March 2009. By then it would have consumed 13-14 months.

Markets likely to form bottom by Feb-Mar 09 as per 8 year cycle

Price & Time Wise correction Exhibit 38: Price-time wise correction Period 1992-93 2000-01 2008-09

Peak levels Bottom levels 4546 6150 21266

1980 2594 7697

Correction Price wise Time wise 56% 12-16 Mth 58% 19 Mth 64% Feb-Mar 09 (13-14 Mth)

Source: ICICIdirect.com Research

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Another peculiar pattern observed in the previous two bear market as per eight-year cycle), was that during 1992-93 and later during 2000-03, four to five sell-offs had been seen. This year we have already seen four sell-offs: (1) January 2008 (2) March 2008 (3) July 2008 (4) October 2008 and so the possibility of one more cannot be ruled out.

Major sell offs in 2008 Exhibit 39: Four major falls for CY08

Source: Reuters, ICICIdirect.com Research

Technical Outlook for 2009 Major Supports

History suggests that major market bottoms are made in panic and followed by a major event like terror attack, war, scam etc. In 1993, there were serial blasts in Mumbai whereas 2001 saw terrorist attack on New York. Technical analysis suggests previous important tops and bottoms act as support or resistance in future. The October 2008 lows of 7697 are near October 2005 lows of 7656. Further, October 2008 lows also rest on the trend line drawn joining February 2000 and March 2005. The confluence of supports at this level suggests 7700 is a good technical support level. However, it remains to be seen if this level holds in the event of another sell-off. If it holds, that is good, else Sensex may break the October 2008 lows and will head southward for another major support area around 6100 – 6500 levels. While February 2000 and January ‘04 highs are at 6100-6250 levels. Also, 80% retracement of the entire bull rally from April ‘03 to Jan ‘08 comes around 6500 levels. Exhibit 40: Sensex support levels

Source: ASA, ICICIdirect.com Research

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Also on the yearly charts the value of 2-4 lines for 2009 is at about 6200-6500 as shown in the graph below Exhibit 41: Long term support for Sensex

Source: ASA, ICICIdirect.com Research

Major resistance On the weekly charts we have drawn the trend line joining the highs of January 2008 and May 2008, which clearly indicates that in the last 12 months the Sensex has been unable to trade above this trend line on the closing basis. If it trades above it, it may fail to sustain beyond one or two weeks, which clearly shows that market has been clearly facing the resistance near this trend line. Currently in the short-term, the value of the trend line is at 10997 levels, so unless the Sensex closes above this trend line and sustains above these levels for some more time, the pain in the market is still not over. However, if it achieves this feat then this will be the first sign of trend reversal. Exhibit 42: Sensex resistance levels

Source: ASA, ICICIdirect.com Research

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On the higher side, 14412-15300 may act as a major resistance for the markets for the coming year. As per change of polarity principle, the lows of January 2008 fall at around 15300, which could act as a stiff resistance for the Sensex because during the current corrective phase beginning with the January top of 21207 to January 22, the low was 15332 (from where it bounced over 3500 points). The March 10 low was 15362 (bounced 1300 points) while the April 1 low was 15297 (bounced 900+ points). All these bounces came from lows around 15300. Further, considering the October 2008 lows of 7697 are held, the 50% retrenchment of the recent fall from 21207 to 7697 will be at 14459 levels. Moving above those levels could further move the Sensex to touch 15300. Considering all the abovementioned technical aspects, we expect the market to remain in a consolidation phase after finding the bottom near the support area. We, therefore, conclude that the Sensex would find strong support in the range of 7600-6500 on the lower side. On the higher side, 14450-15300 could be the maximum upside we see in the year 2009.

We expect Sensex to find strong support in the range of 7600-6500 on the lower side. On the higher side 14450-15300 could be the maximum upside we see in the year 2009.

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ICICIdirect Sectoral Outlook Sector

Comments

Outlook

Automobile

The automobile industry is on a rocky road and no express highway is in sight. Poor sentiments and a severe finance crunch on account of restrictive lending from financial institutions have severely hit auto sales volumes. Seeing the demand setback, almost all companies have announced/initiated a production cut either by shutting the plant temporarily or by reducing shifts. In the aftermath of this, there would be further de-growth in production and sales volumes. We expect, volumes to decline further in December this year making Q3 (otherwise the best quarter) the worst quarter of the year, leading to a bleak outlook for the segment, at least for the few forthcoming quarters.

Banking

Raw material prices have corrected sharply. This can add to EBITDA margins. However, the cut in production and likely reduction in sales price (to push up sales volume) would restrict margin expansion. In spite of the slowing economy, the banking sector would witness stable credit and deposit growth of around 20-22% and 18-20%, respectively, in 2009, despite falling interest rates. Growing risk to non performing assets (NPAs) remains a major concern for banks as asset quality would deteriorate with a lag effect. Falling yields benefit banks in terms of mark to markets gains on G-Sec bonds

Cement

Edible Oil

In view of safety, valuation of PSU banks remains attractive over private sector banks. We expect the demand-supply situation to get worse for the cement industry due to massive capacity additions of 95 MT in the next three years. On the demand side, domestic cement consumption, after reporting growth of 10% in the last three years, has slowed down to 7% in FY09. On the cost front, decline in coal prices and the recent excise duty cut are likely to ease cost pressures. However, worsening of the demand-supply scenario would force cement companies to pass on the saving by reducing prices in the medium-term. The sector is likely to get support after the government imposed custom duty of 20% on import of soy degum (crude soy oil). Rising demand of oil meal by China and South East Asian countries will continue to spur exports, as witnessed in the last two years.

FMCG

Hotels

Higher domestic soybean crop has led to good availability of oilseeds for crushing and to cater the export demand. The FMCG sector faced challenges in 2008 as commodity prices surged to their highest level. However, most of the commodity prices started easing from August onwards, which will result in a drastic improvement in margins from January onwards. We believe some of this cost advantage will be invested into promotions, advertising and offers to consumers, which would accelerate volume growth. Improved margins would also boost the bottomline for major companies. Therefore, we have a positive outlook on the FMCG sector for 2009. Average room rates (ARRs) and occupancy levels of all major hotel players would continue to remain under pressure due to the decline in foreign tourist arrivals (FTAs) led by global slowdown and rising terror activities in India. Operating and net profit margins to continue to remain under pressure on account of sluggish demand outlook despite decline in operating costs. Government measures such as reduction of luxury tax and service tax aimed at reviving hotel room demand would help over a longer term.

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Hospitals

Infrastructure

Demand for hospitals to remain unaffected by global economic slowdown and continue to remain positive on account of shortage of hospital beds. With cheaper medical treatment cost and world class facilities compared to other developed countries, large players to get more benefit on account of growing medical tourism. Elections are approaching due to which there can be slowdown in awarding of projects as election commission code of conduct prohibits government from making new promises. In the current Five Year Plan, around 30% of the financing has to be done from private sector. Due to the adverse conditions in the market, this seems difficult to achieve.

IT

Logistic

A tight credit environment has made it difficult for companies to achieve financial closure of projects and high interest rates also make these projects unviable. However, the government is taking steps to increase funding from public sources. Also, there have been signs of easing in interest rates. Commodity prices are falling. This would prove to be a positive for the sector in the future. The outlook for the sector continues to remain bleak. With the global and, in particular, the US economy going through a phase of slowdown, the next one to two years would remain fairly challenging. With the effects of the slowdown spreading beyond the BFSI space to manufacturing and retail the companies could face pressure both in terms of volume as well as price. In such a situation it is advisable to stick to select larger players in the sector. Logistic players are deferring their expansion plans due to the tightening of volumes in H2FY09E. We believe containerised traffic will get less affected by the global slowdown. So it is positive for the rail logistic players like Concor and Gateway Distriparks Ltd. Increasing rail haulage is a concern as this would reduce the pricing gap that railways enjoy. But entry of private players would increase price competitiveness of this sector. With recent fall in diesel price we expect road transport players like TCI to see improvement in margins in Q4FY09E.

Media

We believe volumes will improve from FY10E. With falling crude prices & reduced demand we expect the newsprint prices to decline further. Newsprint costs form ~40% of the total cost of print media companies and the recent fall will help companies to improve their margins. Multiplex companies began this year in a rather dismal fashion. However, with good content pipeline Q209 was relatively better and we expect these companies to post still better results for the rest of FY09 on the back of higher occupancy.

Pharma

Increasing competition and lower ad revenue has resulted in pressure on earnings and lower visibility. Given the already cluttered national broadcasting space, companies with regional presence are expected to fare better than their national counterparts. The pharma sector has been defensive in nature in a volatile market conditions due to non cyclicality of the business. Selectively the sector would outperform the market.

Retail

We prefer a balanced business model towards domestic and export markets with strong management. High rental prices and interest cost have been affecting the profitability of the retail sector. With economic instability, the footfalls, conversion rate and average transaction price have reduced. Given the economic uncertainty, we have a neutral outlook on the sector despite improving factors like lower rentals, lower interest rate, thrust on cost reduction by retailers and availability of better retail space.

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Steel

Major steel players would face margin compression due to weakening demand, lower realisation, comparatively higher raw material costs and inventory loss in H2FY09E. Steel companies may not see higher realisations but margin pressure is expected to ease after H2FY09E as raw material contract price is set to be negotiated lower in H2FY09E.

Sugar

Announcement of increased spending by China and India towards infrastructure through bailout packages is expected to revive the demand for steel from at least H1FY10E. The fall in cane procurement prices coupled with the noteworthy rise in farm-gate prices has resulted in a shift in acreage from cane to more profitable crops such as wheat, rice and oil seeds. With India witnessing an unprecedented rise in sugar exports from1.5 MT in SY07 to 4.8 MT in SY08, it has resulted in a shrinkage of the sugar surplus to 6.1 MT at the end of SY09.

Shipping

We believe sugar prices will continue to remain firm above Rs 17.5 per kg in SY09 in anticipation of a lower surplus of sugar in the industry, which would drastically boost the earnings for sugar mills and presents a positive outlook for the industry. The shipping sector has been severely impacted by the slowdown in global trade due to fall in commodity demand and lower crude prices. The dry bulk segment has been the worst affected due to virtual drying up of commodity trade because of lack of demand from the Chinese economy with day rates for dry bulk vessels well below their operating cost. Day rates in the dry bulk segment are expected to recover (but remain far below the peak it touched in Q2FY09) in FY10 on account of revival of steel demand on the back of increased spending by China and India on infrastructure through bailout packages. Day rates for crude oil tankers and rigs are likely to remain soft owing to lower crude prices, though winter demand for crude can provide support to the tanker day rates.

Telecom

We maintain a neutral outlook on the sector as Indian shipping companies to an extent are cushioned from the current fall in rates due significantly lower spot exposure compared to global peers The Indian mobile industry continues to grow at an unabated pace. The mobile subscriber base grew at an unprecedented rate, adding ~10 million subscribers each month in the last three months (Sep – Nov’ 2008). We expect the subscriber base to touch 369 million by the end of FY09. As the operators expand into rural parts of the country and increase penetration in the low income group, ARPUs are bound to fall. However, with increasing MOUs and relatively slower decline in ARPM we expect the wireless revenue to maintain its growth trajectory.

Textile

The main concern would be the declining margins in the wireless business, which would be further impacted negatively by 3G rollout and geographical expansion by existing operators. However, this would be compensated by increasing margins in other businesses (Broadband, NLD & ISD, Data) for integrated players like Bharti and Reliance Communications. Volatile rupee, higher raw material prices, higher interest cost and higher fuel cost have impacted the profitability (both operating and net profit margin) of the sector negatively. The government is providing increased thrust on supporting the export-oriented labour intensive sectors like textile wherein one package has already been announced and the second is expected to be announced in the near term. This is expected to provide a cushion to margins. Given the economic uncertainty resulting in weak demand, we have a neutral outlook on the sector despite improving factors like lower raw material cost, lower interest rate and the textile package announced by the government.

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What an investor should do? Exhibit 43: Recommended entry levels Company BHEL Bharti HDFC Bank Ltd. HUL Infosys ITC Ltd. L&T Maruti NTPC ONGC Reliance Industries Reliance Infrastructure SBI TCS Tata Power Glenmark Pharma PNB GAIL Power Grid Bank of Baroda Bank of India SAIL Sun Pharma *CMP as on 26th Dec, 08

CMP* 1,301 686 973 252 1,109 171 745 510 177 643 1,210 543 1,243 472 730 298 499 200 81 263 279 71 1,057

Sector Capital goods Telecom Financials FMCG Technology FMCG Capital goods Auto Power Oil & Gas Oil & Gas Power Financials Technology Power Pharma Financials Oil & Gas Power Financials Financials Metals Pharma

I-direct code BHEL BHATE HDFBAN HINIEV INFTEC ITC LARTOU MARUTI NTPC ONGC RELIND BSES STABAN TCS TATPOW GLEPHA PUNBAN GAIL POWGRI BANBAR BANIND SAIL SUNPHA

Rec. buying range 950-1020 485-560 795-900 218-225 925-1020 145-150 620-660 420-480 140-155 540-630 810-950 360-390 950-1020 445-470 630-650 225-260 420-440 180-200 65-70 215-245 190-220 62-68 890-950

Source: ICICIdirect.com Research

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Pankaj Pandey

Head – Research

[email protected]

ICICIdirect Research Desk, ICICI Securities Limited, Ground Floor, Mafatlal House, 163, HT Parekh Marg, Churchgate, Mumbai – 400 020 [email protected]

Disclaimer The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of ICICI Securities Ltd (I-Sec). The author of the report does not hold any investment in any of the companies mentioned in this report. I-Sec may be holding a small number of shares/position in the above-referred companies as on date of release of this report. This report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This report may not be taken in substitution for the exercise of independent judgment by any recipient. The recipient should independently evaluate the investment risks. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Actual results may differ materially from those set forth in projections. I-Sec may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject I-Sec and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction.

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