India Strategy

(Thematic)

Nikhil Vora / Nikhil Salvi

IDFC Securities Ltd

(Dir) +91-22-6622 2567 / 2566

(M) +91 –98211 32471

Email: nikhil.vora@idfc.com / nikhil.salvi@idfc.com

SEBI Registration Nos.: INB23 12914 37, INF23 12914 37, INB01 12914 33, INF01 12914 33.

For Private Circulation only. Important

disclosures appear at the back of this report”

Follow the ‘New’ leaders…

‘Follow the leader’….are we playing even today?

Children all over the world have been playing a simple game called ‘Follow the leader’ since many years. This simple game that teaches at an early age to observe, listen and identify who the leader in a group is and follow him/her. The one who does it the best gets rewarded. Everyone likes a leader and the stock market is no exception to this common phenomenon.

From time to time, certain sectors benefit from favourable conditions that propel growth, profitability and emerge as leaders in terms of investor interest. Just as in a rising tide, in which all boats-big and small-rise, similarly in a sector that is benefiting from favourable environment, most stocks rise. Savvy Investors turn risk-adjusted return ratio in their favour by choosing the ‘right’ sector in which to increase exposure, i.e. those sectors which are set to attract increasing investor interest. But how do we identify tomorrow’s leading sectors?

3

Investors seek out sectors that ‘Lead’

3

Savvy Investors turn risk-adjusted return ratio in their favour by choosing the

‘right’ sector in which to increase exposure

Depending on favourable factors different sectors emerge as ‘leaders’ in terms of growth and profitability relative to other sectors

Change

in

Sensex

weight

of

sector

Financials

from 2002-2005

Consumer

goods

from 1997-2001

Oil & Gas

from 2006 - 2009

15

24

32

27 28

10.0

15.0

20.0

25.0

30.0

35.0

1997 1998 1999 2000 2001

(%)

13

17

20

22

10.0

13.5

17.0

20.5

24.0

2006 2007 2008 2009

(%)

6

12

1819

0

5

10

15

20

2002 2003 2004 2005

(%)

4

‘Financials’ sector outpaced others in the past decade

4

Several factors contributed to phenomenal growth of Banking &Finance in past decade

Banking sector

in India has

grown at 25%

CAGR in past

10 years due to

host of factors

High growth in Indian economy during 2000-2010 compared to previous decade (~7% vs ~4%)

High credit demand to finance large scale infrastructure addition programs (share of non-food credit increased from ~3% in 2002 to ~15% in 2012)

Profitability of banks improved (RoA doubled from 0.5% in 2002 to ~1% in 2012)

Bankex increased at 31%

CAGR, as investors chased

banking stocks to capture

growth

‘Technicals’ (Sensex weight) in sync with ‘Fundamentals’ (profitability) for Bankex

Consequently

‘Financials’ weight in Sensex

increased from 6% in 2002 to

26% in 2012

5 5

Sensex weight as barometer of ‘Sector’ leadership

Changes in sector weights act as the ‘Leadership Compass’

6

Sensex weight change driven by index scrip selections

6

Quantitative

criteria for

selection of

constituent

scripts in

Sensex

Index construction methodology based on free float market capitalization

Index constitution mechanism ensures representation to sectors in proportion to investor expectations (reflected in market cap)

Scrip should figure in the Top 100 companies listed by full

market cap

Scrip should have been traded on each and every

trading day for the last one year

Scrip should have been traded on each and every

trading day for the last one year

Scrip should be among Top 150 by average value of shares

traded per day for the last one year

Scrip selected to maintain index sectoral weights that are broadly

in-line with the overall market

Market Capitalisation

Trading Frequency

Average daily trades

Average daily

turnover

Industry

representation

7

Sector weights reflect sector relevance over time

7

Sensex changes reflect changing investor expectations towards sectors

0%

20%

40%

60%

80%

100%

FY93 FY98 FY03 FY07 FY13TD

Metals Construction Oil & Gas Consumer Goods Banking & Finance IT Services

12%

27%

‘New’ economy

sector relevance

increased

42%

21%

‘Old’ economy

sector relevance

declined

32%

40%

8 8

Identifying when a sector leader ‘peaks’

Historical average weight of Consumer goods in Sensex is 16%

Historical peak weight of Consumer goods in Sensex is 28%

28

7

14

0

5

10

15

20

25

30

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13TD

Weight (%)Consumer Goods

Peak

weight in

Sensex

Bottom weight

in Sensex

Current

weight in

Sensex

9 9

Identifying when a sector leader ‘peaks’

Historical average weight of Oil & Gas in Sensex is 15%

Historical peak weight of Oil & Gas in Sensex is 27%

9

27

0

5

10

15

20

25

30

FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06

Weight (%)Oil & Gas

Bottom

weight in

Sensex

Peak weight

in Sensex

10 10

Identifying when a sector leader ‘peaks’

IT Services ‘highest plateau’ at ~18%

Average weight of IT Services in Sensex is 15%

18 18 18

10

0

5

10

15

20

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13TD

Weight (%)IT Services

Peak

weight in

Sensex

Bottom

weight in

Sensex

11

Past leaders in Sensex weights and peak weights

11

1992-1996

Construction

(27%)

1997-2003

Consumer Goods

(25%)

2004

Oil & Gas

(20%)

2005

Financials

(19%)

2006-2007

IT services

(19%)

2008 – 2009

Financials and

Oil & Gas alternately

(20%)

2010 – 2012

Financials

(26%)

Investors need to find the ‘next’ leader and leave the ‘current’ leader

2013-…

???

“What goes UP must come DOWN”

― Isaac Newton

12

13

Has ‘Financials’ reached its peak in Sensex weight?

13

6

26

0

5

10

15

20

25

30

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13TD

Weight (%) Banking & Finance

Bottom

weight in

Sensex

Peak

weight in

Sensex

Overbought signals by

‘Technicals’ 1

Financials currently at 26% of Sensex weight

Historical peak for various sectors is 25-27%

Average weight of financials in Sensex is 16%

‘Fundamentals’

to follow

2

Spectre of looming NPAs unwilling to go away

Competitive pressure may cap gains from lowering of policy rate by RBI

Past driver of growth – Infrastructure lending- unlikely to be revived

quickly

14

Does any other sector hold potential to be leader

14

No clear ‘leader’

among several

sectors

Several sectors are facing their own set of challenges

Construction and Engineering: Infrastructure and capex growth slowed down

IT Services: Weak economic growth in key markets (US, Europe)

Metals: Volatility in global commodity prices and demand

Telecom: Regulatory headwinds and unabated competitive intensity

Power Utilities: Concerns on availability and cost of fuel for existing capacities,

while new capacity additions hampered by delayed clearances for projects

Automobiles: Weak economic growth clouds future prospects

Are Consumer and Pharma next ‘Leaders’?

Consumer goods driven by

strong structural changes

Pharmaceutical sector

driven by favourable global

trend

Strong consumption trend among ‘favourably changing demographics’

Rising income levels

Propensity to consume higher

Premiumisation in established product categories to improve profitability

Steady growth in global spending on medicine expected to continue

The opportunity for Indian companies to increase market share is large

Investors to look favourably at several positive attributes of Indian Pharma

• Low leverage

• Strong FCF

• Proven ability to pursue large ticket acquisitions

• Execution skills demonstrated in acquisition deals that created value

Consumer and Pharma weight in Sensex set to increase

16

Several Consumer Goods and Pharma stocks expected to enter Sensex

Periodic index revisions to take

cognizance of

increased relevance

of Consumer Goods and Pharma stocks

Current

Consumer weight

in Sensex (14%) far

below historical peak

(27%)

Current Pharma

weight in Sensex (5%)

far below historical

peak (10%)

Market cap of non-Sensex consumer stocks

more than bottom Sensex companies

• Market Cap of Nestle (non-Sensex) is higher

than 10 Sensex stocks

• Market Cap of each of United Spirits, United

Breweries and Godrej Consumer is higher

than the bottom-most Sensex stock -

Hindalco

Market cap of non-Sensex Pharma stock

more than bottom Sensex companies

• Market Cap of Lupin Labs is higher than the

last two Sensex stocks by market cap –

Tata Power and Hindalco

‘Caveat Emptor’ to our view on Financials

17

Consumer and Pharma likely to share co-leadership with Financials

If Government allots much awaited banking licenses to new entities….

IDFC, L&T Finance, Bajaj Finserv, M&M Financial Services….

Bank licenses will boost investor sentiment towards banking sector

……will sustain leadership of financials in Sensex weight

1

2

Our view : Follow the ‘New’ leaders

’Consumer Goods and Pharmaceuticals’ weight in

Sensex expected to going forward

18

19

“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in

the next ten”

- Bill Gates

20 November 2012

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21 November 2012

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