Robust EPS growth likely over next two years

I expect corporate earnings to be boosted by pick up in consumption,investments and easy availability of funds for the corporate sector. We think an early exit from the stimulus measures looks unlikely and growth will dominate the monetary policy agenda. The Reserve Bank of India RBI will maintain low to neutral interest rates in FY10 although withdrawal of excess liquidity through a hike in the cash reserve ratio CRR looks likely. Interest rate hikes are likely to follow at a later stage when there are more definite signals of a broad-based economic recovery. The topline of Sensex companies is likely to grow by around15 per cent in FY11.

We do not expect the rise in inflationary pressures to derail growth. India faces a supply shock-driven food inflation,mainly due to the drought,rather than systemic high inflation. It is true that inflation may surge to 8 per cent by March 2010. However,average inflation for the year will remain below 5 per cent. We do not foresee significant hardening of commodity prices from here,given the substantial excess capacity in the US. This in turn should ease imported inflation pressures. Further,provided the monsoons are normal next year,the base effect will also lead to lower inflation in FY11.

What is your estimate for FY11 and FY12 Sensex earnings per share EPS?

The domestic environment is conducive for growth in corporate EPS. Availability of capital,low interest rates,improving economic outlook and gradual global recovery all bode well for investment and consumption. Inflation will remain comfortable over the medium term if monsoons are normal next year. The government is not likely to exit from stimulus measures in a hurry. Continued focus on government expenditure and infrastructure growth will also aid growth in the corporate sector. We expect Sensex EPS to be Rs 1,100-1,125 in FY11 and grow further by around 18 per cent in FY12 to over Rs 1,300.

Which sectors do you expect will drive EPS growth?

We will see EPS growth coming from sectors like capital goods,banking,metals and pharma.

This year demand was driven largely by government spending. Do you expect private investment and consumption to pick up next year?

There are visible signs of revival in consumption and private investment. In 2QFY10,non-oil imports grew by 19 per cent quarter-on-quarter,reflecting improvement in demand. IIP growth has recovered from low single digit in May 2009 to average 9 per cent in the next four months. Other lead indicators like auto sales,telecom subscriber additions,railway freight income,consumer durables and capital goods production are showing healthy growth. Although credit growth remains low,the availability of financing from non-banking sources has improved. Corporates have raised 12 billion through initial public offerings and qualified institutional placements to date in calendar year 2009. They raised 2 billion through FCCB foreign currency convertible bonds in October 2009,the highest since February 2007.

The economic growth driver in FY11 will shift from government stimulus to private demand. Having said that,a lot will depend upon the timing and manner of RBIs monetary tightening. However,as I mentioned,we do not expect the RBIs moves to dampen growth.

What impact is the high fiscal deficit expected to have on the markets?

This has been an exceptional year for the world economy. Fiscal deficit has surged across the globe as governments have rolled out massive fiscal stimulus to revive growth. In developed economies like the US and UK,where growth is lagging behind,deficit has reached double digit. By contrast,the Indian economy is back on the growth path. This will further aid the decline in fiscal deficit.

While Indias consolidated fiscal deficit may be nearing double digits in the current fiscal,it will improve going forward. Government revenues will grow led by recovery in economic activities,disinvestment proceeds,revenue from 3G licences,and some roll back of fiscal stimulus. We expect direct tax revenues to surprise on the upside. Further,implementation of GST will be positive for government finances. On the expenditure side,most of the one-time expenditures like farm waiver and arrears of the Pay Commission are behind us.

FIIs have been bullish on Indian markets in 2009. Do you expect this trend to continue in 2010?

We feel India will continue to attract foreign inflows. Global liquidity will continue to chase high-yielding assets in economies with good growth prospects. India is attractively placed as it remains one of the fastest-growing economies. Further,it has the advantage of young demography,high savings rate,low export dependence,low leverage of household and corporate sector,well capitalised financial system and positive corporate earnings growth. A stable government at the helm with willingness to take pro-growth reforms is also a big positive. While India contributes 4.8 per cent of the worlds GDP 2008,its market cap is only 2.6 per cent of world market cap and allocation of global investors to India is less than 1 per cent. We expect global investors to increase their allocation to India.

The emergence of Domestic Institutional Investors DIIs,especially insurance companies,is another positive for the equity markets. FII investments have shown varying trends in the last few years,making our markets vulnerable to their moods. Having a strong DII base provides stability to the markets when FIIs start exiting,as seen in FY09,when against FII outflow of 10.7 billion,DIIs invested 13 billion in the equity markets. In FY10,DIIs are expected to invest 14-15billion in the equity markets and another 18-19 billion in FY11.

Which two sectors are you most bullish about? Why?

In my view,2010 will be a year of stock picking. Markets will be driven by earnings and factors such as valuations,fundamentals and return dispersion. Two key sectors that I am bullish on are banking and capital goods. Banking sector is the pillar of economic growth and is likely to do well in a scenario where interest rates are neutral with a tightening bias. In my view,credit growth is likely to improve sequentially. This will drive earnings growth. Strong pricing power along with re-pricing of high-cost deposits will drive margins. With economic recovery getting broad based,asset quality risk is likely to reduce.

I like capital goods and engineering sector on the back of strong order backlog and revival in economic activity. At present,private sector capex is slow. However,it will be compensated by the uptick in public sector capex. This sector will be driven primarily by the power and the infrastructure sector. We are likely to see healthy earnings growth for many companies in this segment.

Which two sectors are you least bullish about? Why?

We are neutral to negative on telecom and IT sector. There is clear deterioration in the operating matrix of the telecom industry. This is being caused by intensified competition in the sector due to cut in call and SMS rates. The sector is also facing concerns over Mobile Number Portability MNP and delay in 3G auctions. Further,the entry of many new players will keep companies pricing power under check. Margin pressure is clearly visible. And with urban penetration already very high there is little scope for volume expansion.

As far as the IT sector is concerned,it will get impacted by the movement of the Indian rupee. In the medium term,we expect the rupee to appreciate. This will impact the rupee-based realisation of IT companies. Their topline growth remains subdued. Slower than expected recovery in the US remains the key risk to earnings growth. This can impact the sectors valuations to some extent.

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