INDIA STRATEGY - Edelweiss Mutual Fund

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INDIA STRATEGY: SAILING THROUGH THE GROWTH TIDE

Markets | Beyond Markets | AMC Focus | Expert Talk | Conference | Book Summaries 09th March 2018

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Edelweiss Investment Research

INDIA STRATEGY: SAILING THROUGH THE GROWTH TIDE Sahil Kapoor Chief Market Strategist [email protected]

Shobana Krishnan Economist [email protected]

February 2018

When the Going Gets Tough… ● When interest rates rise they signal exceptional period of growth and inflation. At time when global growth has accelerated to nearly 7.3% in nominal terms, hardening of interest rates is warranted and a healthy sign. ● However, the long end of the yield curve in most markets across the world has failed to replicate the short end’s optimism. Over the last 3 months the acceleration in short term interest rates has been steep. US 2 Yr yield have risen by about 45bps, nearly as much as the US 10 yr yield. We flashed the first warning sign in our Budget Preview and Review notes and subsequent communication. ● Narrowing of gap between short end and long end of the curves has led to flattening of the yield curves. At most instances this would have not made much of a difference to equity markets but at a time when equity valuations are factoring in growth rates which have not been witnessed in a decade the message of the bond markets is a lot less optimistic. ● The failure of long end of the yield curve to move up indicates that other asset class may have rallied ahead of themselves in the short term. This indicates the possibility of a correction which is unfolding across markets. We had highlighted the possibility of such a correction in our Union Budget Review and notes. ● In India there have been a few trigger which are likely to weigh on the markets. Domestic Liquidity which was in surplus post demonetization has been reversing to neutrality. International experience on implementation of Long Term Capital Gains (LTCG) tax suggests that Price to Earnings (P/E) compressions are higher in the first year of implementation and stabilizes thereon. ● However we believe that this short term correction, tough severe will only be a speed bump in the ongoing bull market in India. ● Backed by the revival in global earnings. MSCI World EPS indicates CAGR growth of 19-20% by FY20. This is likely to get replicated in India which is expected to see an earrings revival in FY19 to FY21. 1

…The Tough Gets Going ● India’s gaining share in World GDP (on a Purchasing Price Parity basis) and supposed to be the third largest economy by FY20. ● Fiscal Consolidation in India till FY17 has been better than its EM peers. Government has been performing a fine balancing act by keeping subsidies flat and revenue collections especially direct tax collections have been steadily going. ● Fiscal deficit target for FY19 is 3.2% of GDP and 3.5% of GDP in FY18. Shortfall in revenue collections due to GST and expansion in expenditure led to slippage of fiscal deficit target. DBT Efficiency Gains had reduced leakages and increased impact of fiscal stimulus. Governments thrust on rural and infrastructure is likely to boost consumption and private capex respectively. ● Broad based earnings recovery, revival in growth, higher government expenditure and strong domestic & foreign inflows should keep the bull market intact in India. ● We expect Nifty EPS of FY18/19/20 to be 500/600/700. As highlighted in our union budget review we believe there are short term risks which is likely to lead to correction and consolidation in the short term. ● However the long term bull market is still intact and will exert itself once this short term correction plays out. Eventually the correction will provide an opportunity to enter sustainably profitable business with a lot of margin of safety. ● We are revising our Nifty target price for FY19 to 11,500 (from 12,000 earlier) giving it a PE multiple of ~16.5 1Yr Fwd at an EPS of INR 700 for FY20.~

2

Nifty : What is Wrong ?

3

The Bond Yields in US and India Have Been Inching Up Bonds Yield Rise in Tandem 8

3 2.8

7.8 7.6

2.8 2.6

7.2

2.2

%

2.4

7

2

6.8

1.8

6.6

1.6

6.4

1.4

6.2

1.2

6 Feb-16

Apr-16

Jun-16

Aug-16

Oct-16

Dec-16

Feb-17

US 10 Yr Bond Yields (RHS, %)

Apr-17

Jun-17

Aug-17

Oct-17

Dec-17

%

7.6 7.4

1 Feb-18

India 10 Yr Bond Yields (LHS, %) Source: Bloomberg, Edelweiss Investment Research

• Bond yields had fallen with low inflation expectation and political stability. • With Revenue shortfall the expectation of fiscal slippage in the markets spread. This coupled with higher growth trajectory and inflation risks has hardened the bond yields. Synchronous Rise in Bond Yields in US and India has led to rise in interest costs

4

And Equity Markets React Adversely to Interest Rate Spikes Sharp Rise In Yields Can Lead To Corrections 12000

9.5

Yield 8.90

10000

9 8.5

Yield 7.35

8

6000

7.5

7

Nifty 6100 Nifty 4980 Nifty 4500

4000

%

8000

Index levels

10

Repeat OF 2010-2011 ??

6.5 6

2000

5.5

Nifty Index

Jan-18

Jul-17

Jan-17

Jul-16

Jan-16

Jul-15

Jan-15

Jul-14

Jan-14

Jul-13

Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

Jul-10

Jan-10

Jul-09

Jan-09

Jul-08

5

Jan-08

0

India 10 Year Bond Yield Source: Bloomberg, Edelweiss Investment Research

Although rising interest rates due to credit demand and growth are positive for equity markets spike in Bond Yields have led to corrections historically 5

Spreads In The US Are Narrowing Indicating Flattening Of Yield Curve 2 1.5

30 Year - 10 year

Although the spreads are far from crisis levels recent narrowing of spread may lead to adjustment in equity markets

%

1

With equity markets at all time highs the failure of long end of the yield curve to move higher indicates that bond markets expectation of growth is much more sober than stocks

0.5 0 -0.5

We are here

Hosuing Bubble - Dow Jones Peak, GFC Axis Title

%

Tech Bubble - Nasdaq Peak 3.5 3 2.5 2 1.5 1 0.5 0 -0.5 -1 1994

10 year - 2 year

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

Axis Title Source: Bloomberg, Edelweiss Investment Research

Flattening of curve indicates short term and long term rates being close to each other indicating lower growth and inflation expectations in the long term

6

Easy DeMo Liquidity Is Coming To An End.. Interbank Liquidity Is Back To Neutral After Big DeMo Easing 1000

Deficit

Demonetisation

0

Money Flowing into equity markets

INR Billion

-1000

-2000

-3000

-4000

-5000

Surplus

Jan-18

Jan-18

Jan-18

Dec-17

Dec-17

Nov-17

Nov-17

Oct-17

Oct-17

Sep-17

Sep-17

Aug-17

Aug-17

Jul-17

Jul-17

Jul-17

Jun-17

Jun-17

May-17

May-17

Apr-17

Mar-17

Mar-17

Feb-17

Feb-17

Jan-17

Jan-17

Jan-17

Dec-16

Dec-16

Nov-16

Nov-16

Oct-16

Oct-16

Sep-16

Sep-16

Aug-16

Aug-16

Aug-16

Apr-17

Bloomberg India interbank liquidity Index – 6 month average

-6000

Source: Bloomberg, Edelweiss Investment Research

Excess Liquidity in the banking system has been slowly turning to neutrality, this has lead to inching up even short term rates

7

Very High Issuance Of Paper….Is Sapping More Money … Equity Issuance Increased ~3.5x

INR bn

1565

760 598 443 270

207 125

48 IPOs

QIPs

OFS

Total Equity

IPOs

QIPs

CY16

OFS

Total Equity

CY17 Source: Bloomberg, Edelweiss Investment Research

FY2018 saw a very buoyant primary market. 8

And LTCG Provided The Trigger…… An Analysis On De-Rating Of The Markets 120%

Index Returns after CG implementation 30% 20% 10%

Earnings Growth after CG implementation 98%

100%

24% 25% 16% 9%

9% 10%

80% 60%

0% -1% -1%

-10% -20%

20% -21%

-30% South Africa- 2001 1 year

Hungary - 1997 3 year

Germany -2009

5 year

-18%

Hungary - 1997

Germany -2009

-6%

-9%

32%

14%

6%

-8%

11%

16% 16%

0% South Africa- 2001

Hungary - 1997 1 year

PE De-Rating after CG implementation South Africa- 2001

33% 30%

40%

3 year

Germany -2009

5 year

Cross-country analysis suggests high degree of P/E compression for the first year after LTCG implementation and then stabilizes. First year derating could be as severe as 18%

-25%

LTCG could act as a catalyst for correction in the domestic markets. -82% PE Compression / Expansion - 1 Year

PE Compression / Expansion - 3 Year

Source: Bloomberg, Edelweiss Investment Research

9

But Global Rally Is Still Young

10

Globally There Is Head Room For More…… S&P 500 Returns Are Still Below Average….

Callouts show percentage gains and declines from previous lows and highs based on monthly averages of daily closes

+203%

The Real (inflation-adjusted) monthly averages of daily closes

The latest monthly averages is 203% above the 2009 low

11

Global Earnings Revival After A Decade Global Earnings Set To Rise After Lull of More Than A Decade 160.0 147 140.0

83

85

Dec-16

86

Dec-13

Dec-96

39

44

49

54

45 30

29

Dec-02

35

84

78

57

Dec-01

33

Dec-95

40.0

40

87

66

CY95-00 CAGR 8%

60.0

86

Dec-12

80.0

88

100

96

Dec-11

CY01-07 CAGR 21.5%

CY07-09 CAGR -26%

Dec-10

98

100.0

CY10-16 CAGR -2.5%

Dec-15

MSCI World Index EPS

120.0

130

CY16-19 CAGR 20%

20.0

Dec-19

Dec-18

Dec-17

Dec-14

Dec-09

Dec-08

Dec-07

Dec-06

Dec-05

Dec-04

Dec-03

Dec-00

Dec-99

Dec-98

Dec-97

0.0

Source: Bloomberg, Edelweiss Investment Research

Earnings Revival around the corner globally after a lull. 12

And India Is Just Coming Into Stride…

13

With Rising Share In World GDP (PPP % World GDP) 1950

1980

2000

2017

2022E

US

27.3

21.8

20.6

15.3

14.0

UK

6.5

3.8

3.1

2.3

2.0

5.1

6.6

4.9

3.3

9.1

China

4.6

2.3

7.4

7.5

20.5

India

4.2

7.8

4.2

18.3

2.9

Japan

3.6

2.9

7.0

4.3

3.7

Pakistan

0.3

0.5

0.7

0.8

0.9

Germany

14

And Macro Economic Position Gaining Strength…. India’s Primary Balance Most Improved Among Its Emerging Market Peers 1.0 Brazil

Primary Balance (% GDP)

0.5

Turkey

Mexico

0.0 -6.0

-4.0

-2.0

0.0

2.0

-0.5

4.0 Mexico

-1.0 -1.5

6.0

8.0

Indonesia Turkey

Russia India

-2.5 -3.0

Improvement Deterioration

-3.5

2016

China

Indonesia

-2.0 Brazil

10.0

China Russia

India

Real GDP Growth

Average (2010-2015)

Source: IMF Fiscal Monitor, October 2017

• Country’s vulnerability can be assessed by the difference between receipts and non-interest expenditure. • India’s primary deficit was one of the poorer amongst the emerging market peers from 2010-2015.

• As Government embarked on fiscal consolidation path, primary deficit sharply reduced in 2016 (FY17). India has been spending judiciously since 2014, in contrast to other emerging market peers 15

As Govt. Does A Fine Balancing Act! 260 240

6.00

Large rise in direct taxes has helped government increase its expenditure

5.70

5.50

220

4.80

180

5.00

4.50

4.40

160

4.10 3.90

140

A slowdown in the pace of fiscal consolidation

4.00

3.50

3.50

3.50

120

%

200

Gains from higher compliance reflected in tax gains

3.30

100

3.00 FY12

FY13

FY14 Subsidies

FY15 Direct Tax

FY16 CG Expenditure

FY17

FY18 (RE)

FY19 (BE)

Fiscal Deficit (%of GDP) (RH)

*Nos for subsidies, direct tax and central govt expenditure as normalised as of FY12 Source: Budget Documents, Edelweiss Investment Research

• Subsidies and fiscal deficit has been steadily declining since NDA came to power. • Direct tax collections have been rising at a faster pace on account of widening tax base and higher compliance 16

With Focus On Maximum Governance And Minimum Government 21.0%

High Cost of Nationalization, Slower GDP Growth

19.0%

Higher Capex led

17.0%

Higher Expenditure Esp Farm Loan Waivers

15.0%

13.0%

11.0%

9.0%

7.0%

FY18

FY17

FY16

FY15

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

FY06

FY05

FY04

FY03

FY02

FY01

FY00

FY98

FY99

EX-Capital expenditure as a % of GDP

FY19 BE

Total expenditure as % GDP

FY97

FY96

FY95

FY94

FY93

FY92

FY91

FY90

FY89

FY88

FY87

FY86

FY85

FY84

FY83

FY82

FY81

FY80

5.0%

Source: Budget Documents, Edelweiss Investment Research

The size of the government has been declining gradually. This is visible in government’s commitment to build stronger regulatory institutions rather than do more business 17

As Government Stretches A Bit And Sacrifices Fiscal Discipline For The First Time …. Fiscal Slippage for the first time since NDA-2 7.0%

NDA- 1

NDA-2

UPA 1+2

6.5% 6.0% 5.5%

% GDP

5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

Actual Fiscal Deficit

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

Budget Estimated Fiscal Deficit Source: Budget Documents, Edelweiss Investment Research

Although the timing appears a little challenged the government has bought some headroom for expenditure to revive the growth trajectory.

18

But The Extra Push Is Gainfully Employed As DBT/Aadhaar Take Effect Year Wise DBT Beneficiaries

DBT/Aadhaar Savings Being Used To Finance Fiscal Push 600

60cr

60

31 cr

30

10

36cr

23 cr 11 cr

2

38

400

INR Bn

40

20

87

500

50

82

300

570

200 100

0 2013-14 PAHAL

2014-15 MGNREGS

2015-16 NSAP

2016-17

Scholarship Schemes

0

2017-18

FY16

Others

PAHAL

PDS

MGNREGS

NSAP

Total Savings Upto 2017

Nearly A Third of Amount Equal To Annual Subsidies being Paid Through DBT – Highly Efficient 95000cr 75000cr

100000 60000 cr

80000

410

40000 cr

60000

450 300

75000 cr

40000 20000

600

59

34

28

150

142

0

(No of Schemes)

120000

(Fund Transfer in INR)

No. of beneficiary in Cr)

70

0 2013-14

2014-15

PAHAL

MGNREGS

2015-16

NSAP

Scholarship Schemes

2016-17

Others

2017-18

No of Schemes

Source:www.dbtbharat.gov.in, Edelweiss Investment Research

This extra expenditure can have a larger impact as the end recipient is likely to receive larger share of benefits unlike the past which has dominated by leakages

19

As Tax Collection Increase While No Of Taxes Reduce ……… The government tax revenues are streamlining and in FY19 large tax growth is possible. Lesser number of taxes will lead to more and easy compliance Gross Tax Collection To Hit 12% (as % of GDP)

GST To Replace Taxes, Become one Third of Overall Tax Revenue 12.1

7.9 11.3 7.7 10.1

10.6 10.1

10.5

10

60

9.5 9.5 8.5

6.9

7.5

6.7 7.3

7.2

7.5

7.3

7.3

6.9

7.2

7.6

7.6

7.9

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY18 FY19 BE RE BE Net Tax

23 33

14

13

7 4

Gross Tax

6.5

15

21

5

14

11

50 40

7

13

15

70

7.1

6.5

80

11.5

%

7.3

10.1

90

11.6

%

%

7.5

10.4

11.3

100

12.5

21

23

23

23

28

29

27

FY18 BE

FY18 RE

FY19 BE

30 20

34

10 0 FY15 Corporate

Income

Excise

Services

Customs

GST

Source: Budget Documents, Edelweiss Investment Research

The complexion of the economy is likely to improve as number of taxes reduce and tax revenues increase on back of higher compliance rates. More individuals and businesses likely to participate formally in India growth story 20

And Earnings Landscape Looks Better…

21

Corporate Profits : At The Bottom Of The Cycle Corporate Profit as a % of GDP 8 7.1

6.8

7

Policy Paralysis 6

5.6

5.6

5.2 5

5.2

5

4.2

4.2

4

3.5 2.9

3

2

FY18 profits at 1.5X FY08

4.7

4.5

2.9

3

3.1

FY16

FY17

FY18E

3.3

2 1.7

1

0 FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY19E

Source: CMIE, Edelweiss Investment Research 22

Growth In Profitability Has Been More Broad Based Over The Past One Year PAT growth transition from Dec-15 to Dec-16 for Nifty 100 Index 1,05,000 1,00,000

93% of the PAT growth was driven by Banks, Metals and O&G

(INR cr)

85,000

83,976

(2,167)

3,704

553

O&G

Others

99,277

6,514

95,000 90,000

3,970

1,586

1,140

80,000 75,000 70,000 201512

Automobile

Banks

Finance

IT

Metals

201612

PAT growth transition from Dec-16 to Dec-17 for Nifty 100 Index

1,15,000

PAT growth has been more broad based over the past one year

1,10,000

(INR cr)

1,05,000 1,00,000

99,277

2,595

1,640

1,496

Banks

Finance

1,842

2,694

Metals

O&G

1,120

1,812

1,12,476

Others

201712

95,000 90,000 85,000 80,000 75,000 70,000 201612

Automobile

IT

Source: Capitaline, Edelweiss Investment Research

23

Companies Reporting Profitability In Line With Best Period In Last Decade PAT Growth Estimates for BSE 100 100% 90% 80% 70%

53%

46%

35%

35%

39%

60% 50% 27%

40%

30%

41%

47%

45%

31%

20% 10%

16%

27%

25%

2010

2013

19%

16%

2015

2018

0% 2007

Less than 0%

Between 0-20%

More than 20% Source: Bloomberg, Edelweiss Investment Research

24

Nifty Earnings Growth To Change Gears Nifty Need To Head Back To Higher Earnings Growth 800 720 700

FY17-20 CAGR 19%

600

600

Nifty FY End EPS

INR

495

FY09-17 CAGR 7%

500

424

408 400 323

FY01-08 CAGR 21%

300

275 238

226

200

160

346

356

FY12

FY13

387

384

FY15

FY16

257

179

122 100

74

70

FY01

FY02

92

0 FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY14

FY17

FY18

FY19

FY20

Source: Bloomberg, Edelweiss Investment Research 25

Foreign Investors Are Lining Up For India’s Growth Foreign Investment Flows Nearing Record

FPI Flows Turn To Primary Equity Markets

90 77 68 60

56

60

46

$ Billion

50 37

40 23

30 20

0

10 3 0 3

3 2 0 1

2 1 7

13

14

3 1 9

4 11 -1

14 1 8

16 2

23 33

19

27

21

40

10 32

1 18

24

29

7 25

37

28

27

43

20

16

8 3

30

46

20 10

5 -1

8

0

FDI

Total

CY17

CY16

CY15

CY14

CY13

CY12

CY11

CY10

CY09

CY08

CY07

CY06

CY05

CY04

CY03

CY02

CY01

-20

FII Debt

20

19.8 15

16.2

22.5 17.8

10

15

14.1 1.7

5 0

2.1

2.0

2.1

-10

-20

FII Equity

20

50 40

25

24.6

70 60

50

39

-8

-13

-10

54

23

9 -1

3

34

30

25

USD Billion

70

80

$ Billion

80

10

30

90

3.5 -0.2

3.3

6.4

1.6 1.3

10 8.0 5

2.9

-5

0 2012

2013

FPI Primary Market

2014

2015

2016

FPI Secondary Market

2017

FPI Net

Source: Bloomberg, Edelweiss

Note: For 2017 - FPI is full year; FDI is year to date til Oct

Foreign flows are coming thick and fast in both debt and equity markets. Preference of FDI and Primary market route over the earlier ‘hot’ secondary market route indicates long term commitment of these flows 26

Domestic Money Is Sticky, Expected To Remain So Mutual Funds Have Added 13 Years of AUM in Last 3 Years 12,000

10,000

INR Billion

8,000

6,000

11,307

11,114

262 X more equity purchases

4,000 2,362

2,000 9

CY02-14

MF AUM Added (LHS)

CY15-17

MF Equity Invest (Secondary Market) Source: AMFI, Edelweiss Investment Research

Steady flows into Mutual funds have been serving as an anchor in the markets. Though these flows can’t dictate the direction of the markets they have been able to reduce volatility

27

While Govt Focuses On Rural And Infra

28

Rural Focus Has Been A Blind Spot For NDA Rural spending has gone down in both NDA regimes…

…which has impacted rural wage growth

2.5%

20%

NDA I

2.0%

UPA

NDA II

18% 16% 14%

1.5%

19% 1)MSP increase by 30-40% 2)Farm loan waiver ~INR53K cr

One of the harshest drought ever In 2002 with 79% of LPA

12% 10%

1.0%

7%

8% 6%

Rural spending as % to GDP Note: Rural spending is sum of agriculture, fertilizers and rural development industry

FY17

FY16

FY15

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

FY06

FY05

FY04

FY03

FY02

FY01

FY00

0.5%

5%

4%

4% 2% 0% NDA I (FY99-03)

UPA I (FY04-08)

UPA II (FY09-14)

NDA II (FY15-17)

Nominal Rural Wage Growth Source: Budget Documents, CMIE, Edelweiss Investment Research

Rural economy has been under stress due to lesser government expenditure, bad monsoons and lower commodity prices in India and globally. Since rural economy still accounts for sizeable employment a shift in focus by the government was expected, especially ahead of 2019 general elections 29

Budgetary Allocation, Company Revenues Signal Distress Rural Focus Company Revenues Tell The Story

Agriculture GDP impacted adversely because of poor monsoons and lower government support 18000

15%

16000

30%

NDA II 9%

25%

14000

10% 9%

INR (in bn)

20%

12000 10000

15%

8000

10%

6000

5%

4000 0%

2000

Nominal Agri GDP growth

Rural centric cos revenues (LHS)

FY17

FY16

FY15

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

FY06

FY05

FY04

NDA II (FY15-17)

FY03

UPA II (FY09-14)

FY02

UPA I (FY04-08)

FY01

NDA I (FY99-03)

-5%

FY00

0

FY99

Average growth rates

14%

UPA 17%

NDA I CAGR 11%

Growth

Note: Sample set of more than 1000 companies belonging from two wheeler, agriculture equipments, consumer goods, food & agro products and textiles is included

Source: CMIE, Edelweiss Investment Research

Agricultural GDP has been slowed over the last few years. This is visible in declining revenues of rural centric corporate. 30

Rural Repair – Higher MSPs , Higher Budgetary Allocations Table: Minimum Support Prices (%Y-o-Y) Kharif Crops Paddy Paddy, Grade A Jowar, hybrid Bajra Maize Ragi Arhar(Tur) Moong Urad

FY08 20 19 11 11 15 11 13 14 14

FY09 21 20 40 40 35 53 26 45 45

FY10 11 11 0 0 0 0 15 10 0

FY11 0 0 5 5 5 6 52 33 35

FY12 8 8 11 11 11 9 6 9 12

FY13 16 15 53 20 20 43 4 10 13

FY14 5 5 0 6 11 0 12 2 0

FY15 4 4 2 0 0 3 1 2 1

FY16 4 4 3 2 1 7 6 5 6

FY17 4 4 4 4 3 5 9 8 8

FY18 5 5 5 7 4 10 8 7 8

FY19* 8 5 37 0 10 47 -5 20 -6

2

39

0

0

12

29

3

1

1

2

4

22

Cotton, Medium staple

2,500

Increase in allocation towards rural expenditure 2,027

INR (in bn)

2,000 1,500

1,779

3%

1,321

8% 1,000 500

In the union budget the government has suggested a higher rise in MSP. Minimum support prices (MSP) will be fixed so that they are 50% higher than the unit cost of production. MSP are likely to rise by more than 10% as against this government average rise of nearly 5%

0 FY10

FY14

FY18RE Source: Budget Documents, CMIE, Edelweiss Investment Research 31

MSPs impacting Rural Wages With Lagged Effect As MSPs will rise this year, average rural wages should also rise and boost consumption 25%

30.0%

25.0%

20%

15% 15.0%

y-o-y

y-o-y

20.0%

10% 10.0%

5%

5.0%

0%

0.0% FY10

FY11

FY12

FY13 MSP- RHS

FY14

FY15

FY16

FY17

FY18

Average Rural Wages- LHS Source: CMIE, Edelweiss Investment Research

32

Big Infrastructure Spending, To Become Even Bigger Investments spending (INR Trillion) Power & T&D

Railways

Airports & Ports

Highways

Urban Others

Total

FY08-12 Actual

7.8

2.0

0.8

4.6

0.8

7.4

23.8

FY13-17 RE Niti Aayog

12.7

3.8

0.9

7.6

0.9

10.2

37.2

FY18-22 RE

14.7

8.0

1.0

10.0

5.5

11.0

50.2

Investing spending (Govt +IEBR+Priavte) has been rising. It is expected to see a surge in the next 4 years 33

Removing bottlenecks for faster execution

Increase in land acquisition prices

Single window approval

Fast-tracking arbitration awards

Steps taken to facilitate faster execution

Termination and re-bidding of stalled projects Easy monetization of projects Hire global consultants for better decision making 34

Sector is moving towards financial self-dependence Yearly I.E.B.R to Infrastructure sector doubled under NDA 3000

100% 2500

2x

(INR Bn)

2000

50%

1500

NDA 1000

UPA

500

0 FY10

I.E.B.R Overall Budget

FY14

807

1206

2306

3051

FY19BE

2523

5100 Source: Budget Documents, CMIE, Edelweiss Investment Research

35

Foreign Interest in Indian Infra project is at historic highs Infrastructure FDI in FY18 is highest over last decade INR 3261 bn 3500 3000 2500

(INR BN)

2000

INR 1231 bn

INR 1475 bn 2649

1500 1000

500

1400

1097

611 135

0 FY10

75 FY14 FDI in Infra/Construction

FY18E FDI in others

Overall FDI

Infrastructure has been receiving the largest share of incremental Foreign direct investment flows Source: dipp.nic.in, Edelweiss Investment Research

36

Industry to experience lower stress and higher growth Company’s Balance Sheet stress started reducing 1.5

2500

2408

2166

(INR bn)

2000

1.1

1.0

1500 1000

1.4

9000

1.3

8000

1.2

7000

1.1

6000

1.0 0.9

894

0.8 0.7

500

0.6 0

0.5 FY10

FY14 Total Debt

FY18E Debt/Equity

(INR bn)

1.4

(x)

3000

Execution is expected to pick up pace going forward

5000

21%

8%

4%

FY10

FY14

4000 3000 2000 1000 0 Order Book

Cumulative debt accumulation INR 1273 BN

FY18E

Revenue Growth

Cumulative debt accumulation INR 242 BN

Source: Capitaline, Edelweiss Investment Research

Companies in the infrastructure space witnessing a goldilocks scenario

37

Multi Year Shift From Unorganised To Organised Sector Aided By GST Home Building Materials (excluding cement)

Growth Opportunities Across Various Categories FY17-22E

MDF

FY17

16

100%

100%

Organised Growth 45

2.8x

INR 2.5tn

9.5% CAGR

FY22E INR 4.2tn

Extent of Organised FY17

Faucets

Sanitaryware

Laminates

A number of sectors likely to benefit from formalization of the economy.

47

25

27

Tiles

135

Plywood

39

65%

75%

60%

70%

53%

65%

50%

65%

22%

40%

FY17 INR Organised Share (%) 2017 Bn

95

2.0x

53

2.1x

55

2.0x

289

2.1x

121

3.1x

FY22E Organised Share (%) 2022E

INR Bn

38

Conclusion ● Rising interest rates but only at the short end indicates that its prudent to be cautious. Earnings growth needs to be higher than the short term spike in rates for FY19. ● The failure of long term interest rates, especially in US, to move higher indicates that Bond markets expectation of growth is sober than equity markets. This equity markets could correct to valuations which are more attractive and depict forward growth in a more realistic manner. ● Domestic markets could come under pressure due to confluence of short term negative. These are de-rating of earnings multiples due to application of LTCG, spike in bond yields, slower than expected pick up in earnings and tapering in emerging market inflows. ● We expect Nifty index to see a correction. However the long term bull market remains intact and even this correction will present itself as a buying opportunity later. ● We are revising our Nifty target price for FY19 to 11,500 (from 12,000 earlier) giving it a PE multiple of 16.5 1Yr Fwd at an EPS of Rs. 700 for FY20.

39

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