20 stocks to play upturn in economy: Morgan Stanley
The macro story is backed by demographics, productivity and globalization implying trend growth of 6.5-7 percent. Profits are likely to gain share in GDP from their historically depressed levels, implying a CAGR of around 19 percent in the next five years.
India is at the crossroads of a cyclical downturn and a structural upturn. The country has the ingredients to deliver growth and stock market returns in the coming three-five years. The macro story is backed by demographics, productivity and globalization implying trend growth of 6.5-7 percent. Profits are likely to gain share in GDP from their historically depressed levels, implying a CAGR of around 19 percent in the next five years.
This comes from a Morgan Stanley report, authored by its managing director Ridham Desai, which identifies themes that will drive both higher growth and stocks and sectors that will likely benefit from it.
The brokerage believes that the persistent slowdown coupled with high inflation over the last few years were led by a sharp acceleration in rural wage growth, rising fiscal deficits, negative real rates and a slowdown in the government’s decision making process.
“[But] we believe the corrective policy actions taken over the last 18 months are helping to gradually reverse all four factors causing distortion in the productivity dynamic,” it said.
“We expect real GDP growth to accelerate on a quarterly basis to 7.2 percent in quarter ending March 2017 from 5.7 percent currently, and CPI inflation to head towards RBI’s comfort zone of 6 percent year-on-year by August 2015, earlier than RBI’s expectation of achieving it by January 2016,” the report added.
According to Morgan Stanley, the three drivers of growth going forward would be demographics, globalization and productivity led by reforms.
Report highlights
Demographics: The ratio of the number of elderly people and children to the working-age (aged 15-64 years) population declined from 68.6 percent in 1995 to 62.8 percent in 2000 and 52.4 percent in 2013, according to United Nations (UN) estimates. In other words, the working-age population has been growing faster than the dependent population. Over the next 10 years alone, India will emerge as one of the largest suppliers of labor, accounting for almost 25 percent of the increase in global working-age population, according to UN estimates.
Globalization: The globalization thrust will continue with the improvement in global growth and India’s reliance on not only goods exports but services exports as well. Indeed, India’s performance in services has been a key differentiating factor, with its share in global services exports rising by 2.5x times to 3.3 percent in 2013 from 1.3 percent in 2003. India now ranks second after China in terms of market share in services exports amongst emerging economies.
Reforms: Six key focus areas where government policy action is likely: (1) managing growth in rural wages in line with productivity; (2) reducing the fiscal deficit by rationalizing expenditure and tax reforms; (3) improving the business environment (ease of doing business); (4) improving the allocation of natural resources through transparent mechanisms; (5) urbanization, and (6) improving infrastructure.
Stocks/sectors to benefit
Capital goods: Bharat Forge is one of world’s largest forging companies; its low-cost India base, consolidation of vendors across global auto OEMs and global capex recovery will likely drive strong earnings momentum for the company over the next three years. Further, we believe the key surprise will come from the non-auto side and by FY17, non-auto will generate 54 percent of earnings (vs. 41 percent in FY14) and be the key earnings driver.
Cement: As EBITDA per ton expands, companies that have a higher share of existing (lower-cost) capacity (as percent of the total) will likely witness larger expansion in ROE as they realize expanded EBITDA/ton on full capacity. Our favorite stock is Shree Cement .
Consumer discretionary: Maruti Suzuki will likely gain share in passenger vehicles (PV) from 42 percent in FY14 to 45 percent in FY17 as it benefits from first-time buyer recovery and launches four new models that expand its addressable target market.
Jubilant Foodworks , with a business model levered to SSG growth, improvement in consumer sentiment and a combination of high-return unit economics and rapid unit expansion offer potential for multi-year stock outperformance.
Improved macroeconomic variables and recent action by the RBI have led to declining gold premium and increased competitiveness for Titan.
Construction: Havells will gain from a pickup in construction, we believe that companies that have established an edge over their peers are likely to perform better. As some of these products have an element of consumption, we focus on a) branding and b) dealer relationship and penetration, since these would lend sustainable competitive advantage.
Financials: HDFC Bank ’s aggressive branch expansion in recent years, strong focus on digitization and robust balance sheet should enable HDFC Bank to sustain and expand its strong retail franchise.
Kotak is a strong play on the financial savings reflation theme, given its exposure to the entire value chain. This is particularly true at the start of the cycle as the hurdle rate for risk-free assets decreases.
Over the years, Shriram City Union Finance has gained expertise in financing micro-enterprises – a large but tough-to-service segment, with the Shriram Chits’ business providing an underwriting advantage.
Healthcare: Solid product portfolio with technical complexity and focus on chronic therapies are the key catalysts for Sun Pharma . Complex generics such as leuprolide, doxil, modafinil, nasal sprays, and auto-injector are already in the pipeline.
Approvals for niche opportunities (12 FTF’s in the pipeline) and new launches such as Loestrin 24 Fe, Renagel and Renvela are the main growth drivers for Lupin .
Infrastructure: With Adani Ports and SEZ already running the largest private sector port in the country and with ports segment returns likely to look up (as TAMP goes away), the company is well placed to use best-in-class cash flows to grow rapidly.
With a dividend payout policy in place, cash flow strong enough to pick up new projects and high earnings visibility, IRB Infra remains one of our top picks.
IT services: Infosys has lagged YTD amid worries over management changes and earnings visibility. With recent leadership transition, renewed focus on winning large deals and potential to improve cost structure, earnings are likely to continue to surprise on the upside.
Metals and mining: Tata Steel should see its regulatory advantage widen from here, given good support from state governments and local communities, long running mining and downstream operations, large land tracts over which it has full control, and clearer (vs. peers) status of mining leases.
Oil & gas: We expect BPCL ’s earnings to double over F2014-18. We cite: a) lower interest expenses with declining petroleum subsidy and lower working capital; b) higher diesel marketing margins, and c) volume and margin expansion projects in refining.
We expect ONGC ’s earnings to nearly double in F14-18. We cite a) higher gas prices; b) higher net oil realisations with falling subsidies, and c) higher production.
Property: Sobha is leveraged to the healthy Bangalore residential market. It is steadily building its base business through new project acquisitions, accelerating pace of new launches and pre-sales lock-ins, geographic diversification into new city markets and better execution.
Telecom: Bharti Airtel , with a strong balance sheet, derives ~20 percent of domestic wireless EBITDA and 11 percent of consolidated EBITDA from domestic data. We see 42 percent p.a. growth in data revenues in F2014-17, resulting in growth of 10.8 percent in overall revenues and 14.7 percent in EBITDA.
Contrarian plays: Despite being negative on PSU banks and FMCG, we are overweight BOI , as it is the cheapest in our coverage on valuation multiples (0.6x F15e BV) and is the weakest in terms of capitalization (7.1 percent CET1 ratio) and hence should benefit most from any ‘proper’ capitalization effort by the government.
ITC has been one of the worst performing consumer stocks over the past 12 months, trailing the Sensex by more than 30 percent. Its multiples have compressed to adjust for rising cigarette volume elasticity. While we do not expect a re-rating from current levels, we see no reason why ITC stock should not track earnings growth from here – we forecast 17 percent for F15.
The macro story is backed by demographics, productivity and globalization implying trend growth of 6.5-7 percent. Profits are likely to gain share in GDP from their historically depressed levels, implying a CAGR of around 19 percent in the next five years.
India is at the crossroads of a cyclical downturn and a structural upturn. The country has the ingredients to deliver growth and stock market returns in the coming three-five years. The macro story is backed by demographics, productivity and globalization implying trend growth of 6.5-7 percent. Profits are likely to gain share in GDP from their historically depressed levels, implying a CAGR of around 19 percent in the next five years.
This comes from a Morgan Stanley report, authored by its managing director Ridham Desai, which identifies themes that will drive both higher growth and stocks and sectors that will likely benefit from it.
The brokerage believes that the persistent slowdown coupled with high inflation over the last few years were led by a sharp acceleration in rural wage growth, rising fiscal deficits, negative real rates and a slowdown in the government’s decision making process.
“[But] we believe the corrective policy actions taken over the last 18 months are helping to gradually reverse all four factors causing distortion in the productivity dynamic,” it said.
“We expect real GDP growth to accelerate on a quarterly basis to 7.2 percent in quarter ending March 2017 from 5.7 percent currently, and CPI inflation to head towards RBI’s comfort zone of 6 percent year-on-year by August 2015, earlier than RBI’s expectation of achieving it by January 2016,” the report added.
According to Morgan Stanley, the three drivers of growth going forward would be demographics, globalization and productivity led by reforms.
Report highlights
Demographics: The ratio of the number of elderly people and children to the working-age (aged 15-64 years) population declined from 68.6 percent in 1995 to 62.8 percent in 2000 and 52.4 percent in 2013, according to United Nations (UN) estimates. In other words, the working-age population has been growing faster than the dependent population. Over the next 10 years alone, India will emerge as one of the largest suppliers of labor, accounting for almost 25 percent of the increase in global working-age population, according to UN estimates.
Globalization: The globalization thrust will continue with the improvement in global growth and India’s reliance on not only goods exports but services exports as well. Indeed, India’s performance in services has been a key differentiating factor, with its share in global services exports rising by 2.5x times to 3.3 percent in 2013 from 1.3 percent in 2003. India now ranks second after China in terms of market share in services exports amongst emerging economies.
Reforms: Six key focus areas where government policy action is likely: (1) managing growth in rural wages in line with productivity; (2) reducing the fiscal deficit by rationalizing expenditure and tax reforms; (3) improving the business environment (ease of doing business); (4) improving the allocation of natural resources through transparent mechanisms; (5) urbanization, and (6) improving infrastructure.
Stocks/sectors to benefit
Capital goods: Bharat Forge is one of world’s largest forging companies; its low-cost India base, consolidation of vendors across global auto OEMs and global capex recovery will likely drive strong earnings momentum for the company over the next three years. Further, we believe the key surprise will come from the non-auto side and by FY17, non-auto will generate 54 percent of earnings (vs. 41 percent in FY14) and be the key earnings driver.
Cement: As EBITDA per ton expands, companies that have a higher share of existing (lower-cost) capacity (as percent of the total) will likely witness larger expansion in ROE as they realize expanded EBITDA/ton on full capacity. Our favorite stock is Shree Cement .
Consumer discretionary: Maruti Suzuki will likely gain share in passenger vehicles (PV) from 42 percent in FY14 to 45 percent in FY17 as it benefits from first-time buyer recovery and launches four new models that expand its addressable target market.
Jubilant Foodworks , with a business model levered to SSG growth, improvement in consumer sentiment and a combination of high-return unit economics and rapid unit expansion offer potential for multi-year stock outperformance.
Improved macroeconomic variables and recent action by the RBI have led to declining gold premium and increased competitiveness for Titan.
Construction: Havells will gain from a pickup in construction, we believe that companies that have established an edge over their peers are likely to perform better. As some of these products have an element of consumption, we focus on a) branding and b) dealer relationship and penetration, since these would lend sustainable competitive advantage.
Financials: HDFC Bank ’s aggressive branch expansion in recent years, strong focus on digitization and robust balance sheet should enable HDFC Bank to sustain and expand its strong retail franchise.
Kotak is a strong play on the financial savings reflation theme, given its exposure to the entire value chain. This is particularly true at the start of the cycle as the hurdle rate for risk-free assets decreases.
Over the years, Shriram City Union Finance has gained expertise in financing micro-enterprises – a large but tough-to-service segment, with the Shriram Chits’ business providing an underwriting advantage.
Healthcare: Solid product portfolio with technical complexity and focus on chronic therapies are the key catalysts for Sun Pharma . Complex generics such as leuprolide, doxil, modafinil, nasal sprays, and auto-injector are already in the pipeline.
Approvals for niche opportunities (12 FTF’s in the pipeline) and new launches such as Loestrin 24 Fe, Renagel and Renvela are the main growth drivers for Lupin .
Infrastructure: With Adani Ports and SEZ already running the largest private sector port in the country and with ports segment returns likely to look up (as TAMP goes away), the company is well placed to use best-in-class cash flows to grow rapidly.
With a dividend payout policy in place, cash flow strong enough to pick up new projects and high earnings visibility, IRB Infra remains one of our top picks.
IT services: Infosys has lagged YTD amid worries over management changes and earnings visibility. With recent leadership transition, renewed focus on winning large deals and potential to improve cost structure, earnings are likely to continue to surprise on the upside.
Metals and mining: Tata Steel should see its regulatory advantage widen from here, given good support from state governments and local communities, long running mining and downstream operations, large land tracts over which it has full control, and clearer (vs. peers) status of mining leases.
Oil & gas: We expect BPCL ’s earnings to double over F2014-18. We cite: a) lower interest expenses with declining petroleum subsidy and lower working capital; b) higher diesel marketing margins, and c) volume and margin expansion projects in refining.
We expect ONGC ’s earnings to nearly double in F14-18. We cite a) higher gas prices; b) higher net oil realisations with falling subsidies, and c) higher production.
Property: Sobha is leveraged to the healthy Bangalore residential market. It is steadily building its base business through new project acquisitions, accelerating pace of new launches and pre-sales lock-ins, geographic diversification into new city markets and better execution.
Telecom: Bharti Airtel , with a strong balance sheet, derives ~20 percent of domestic wireless EBITDA and 11 percent of consolidated EBITDA from domestic data. We see 42 percent p.a. growth in data revenues in F2014-17, resulting in growth of 10.8 percent in overall revenues and 14.7 percent in EBITDA.
Contrarian plays: Despite being negative on PSU banks and FMCG, we are overweight BOI , as it is the cheapest in our coverage on valuation multiples (0.6x F15e BV) and is the weakest in terms of capitalization (7.1 percent CET1 ratio) and hence should benefit most from any ‘proper’ capitalization effort by the government.
ITC has been one of the worst performing consumer stocks over the past 12 months, trailing the Sensex by more than 30 percent. Its multiples have compressed to adjust for rising cigarette volume elasticity. While we do not expect a re-rating from current levels, we see no reason why ITC stock should not track earnings growth from here – we forecast 17 percent for F15.
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