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Brexit-related reallocation
Essence of the Week
Jun 27, 2016 | Source: AxisDirect
As a result of the expected capital outflow and those companies directly affected by Brexit, we believe that there would be a reallocation of India-portfolio among investors. We provide below, 10 Nifty stocks that could have increased allocation, either due to their stock price having moved below fundamental realities due to Brexit, or a relatively safer haven without being over-expensive. For additional context, we have the following sections: (A) Beneficiaries among Indian Nifty stocks of a potential Reallocation and (B) Macro Impact on India.
A) Beneficiaries among Indian Nifty stocks of a potential Reallocation
Safe havens: ITC, Maruti, HDFC Ltd (& NBFCs/ urban consumption plays), HDFC Bank, IndusInd Bank, HPCL (& OMCs), NTPC, PGCIL, Pharma sector especially Aurobindo (secular, registrations are a long process) safer than IT sector (discretionary spends)
Fallen too much: TAMO, Aurobindo Rationale & key risks for the above Cos (except ITC, which is obvious) provided below are based on Friday intraday prices.
Financials – Domestic retail players to be best placed
Indian Banks/NBFCs which have mainly domestic exposure, a relatively large share of retail book, and adequatelycapitalised such as HDFC Ltd, HDFC Bank and IndusInd Bank. Weak monsoons will remain the key challenge for domestic retail loan book growth and quality
Pharma: A safer haven than IT due to nature of product, tho’ IT has a larger sensitivity to USD/ INR swings
Aurobindo (Buy, TP Rs 1000, 47% upside): Today’s 5-6% decline in stock price to Rs 680 (15x FY17 EPS and 12x FY18 EPS), given concerns of 22% of FY16 revenue in EU, we believe is unwarranted as the EU business is currently EBITDA neutral with most manufacturing and operating costs being Euro based.
Aurobindo is well poised to benefit from increased momentum (growth and margin improvement) in US business – strong approvals momentum and launches picking up (49 approvals – 28 launched in FY16) with improving quality. With 147 ANDAs pending (including 37 injectables), we expect 20% CAGR over FY16-18 in US. Expect EBITDA margin to expand from 23% in FY15 to 25/26% in FY17/18 driven by launch of higher value products (led by injectable) in US coupled with EU business turning EBITDA positive in FY17 (FY15 loss at EUR 10 mn). It also continues to benefit from depreciating INR/ USD.
Oil Marketing Companies (OMCs): Beneficiary of firm domestic demand growth, marketing margins
OMCs sell ~95% of their fuel volumes in the domestic market, where demand to remain firm. Likely weakness in crude prices will (a) give opportunity to OMCs to expand their marketing margins, and (b) allay concerns on excise duty hikes as government will have more leeway on the fiscal front. Key risk: Refining biz (~25% of gross profit in FY16) may be impacted by likely weakness in refining margins (if at all, on weak EU demand). However, we believe it will get more than offset by strong marketing biz profitability. Within OMCs, we prefer HPCL (BUY; TP: Rs 1,080), as it has the highest leverage to marketing margins and lowest export volumes (~2% vs. 5-6% for BPCL/IOC).
Tata Motors (BUY; TP – 545)
Over the last 5/10 years, luxury car sales have grown at CAGR of 11%/6% vs. world growth of 3.7%/3.5% each, indicating relatively less impact of global slowdown
JLR was, until now, present in only 50% of the luxury car market, wherein it enjoys a decent ~15% market share. With successful launch of Jag XE/ F-Pace and small engine variants, it effectively plugs gap in it product portfolio. Post the recent launches, the weighted average age of JLR's product portfolio has fallen from >6 years in FY11/12 to ~3 years currently and should help JLR gain market share
Positive currency impact:
JLR is a net exporter to the tune of ~40% of revenue in USD terms and a net importer to the tune of ~20% of revenue in Euro terms
Sharp depreciation of 10% in GBP/USD and 5% in EUR/USD positively benefits JLR’s realization ~4.4% and EBITDA margin by ~2.2%. Despite factoring the translation loss from INR / GBP movement, our analysis suggests consol earnings can see ~25% upgrades
Key risks: Sharp volume degrowth in UK/Euro zone (40% of revenues)
Maruti Suzuki (BUY; TP – 4,735)
Maruti is the best way to play the impending upcycle in the domestic car industry. It has waded off peak competitive pressure extremely well, filling gaps in its product portfolio (SUVs/sedans/LCVs), reduced its vulnerability to forex fluctuations, and its well-balanced fuel-mix makes it a good hedge against any major volatility in fuel prices
Maruti stock has a high sensitivity to Yen movement, as 14% of sales (incl royalty) are Yen denominated. Every 1% Yen-INR movement impacts MSIL margin/earnings by ~14 bps/~1.5% and 1% INR-USD movement impacts margin/earnings by 10 bps/~0.7%. While Yen movement impacts Maruti, note that the net exposure will gradually reduce as Baleno exports to Japan pick up and MSIL pays royalty on new products in INR terms
Key risks: Unfavorable monsoons impacting discretionary consumption
B) Macro Impact on India
Brexit will weigh on global growth in the near term
This event bodes ill for global GDP growth rate as the EU (which as a block, is a large trading partner for most economies) and UK may plunge into a recession. Trade would also suffer, as multiple agreements would have to be renegotiated. Further, there is risk of contagion of other countries exiting the EU.
But India will eventually stand out in a growth-starved world
However, once the dust settles, India’s lower external orientation with 60%+ of growth being domestic consumption driven will stand out in a growth starved world.
Importantly, India will be a beneficiary of lower commodity prices which will keep its Twin Deficits under control and help rein in inflation. The recent FDI moves, if bolstered with progress on GST, ring-fencing domestic banks, improving the supply side and reviving domestic projects, will add to India’s allure for investors.
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