Strategy

THEMATIC May 19, 2014

The rebooting of India G&C 7.1-Quality at a reasonable

price
With this note we inaugurate a new series, ‘India Rebooted’, which will Company name Sector Weight (%)
focus on the policies of the new Government and their consequent
Bajaj Auto Auto 4.3
impact on the economy and the stockmarket. As highlighted in our 24th
Tata Motors Auto 4.3
December note, a decisive victory for Mr Modi would result in our FY15
GDP estimate going up. We now our raise our FY15 GDP estimate from Exide Inds. Auto Anc 4.3
5.1% to 5.6% (vs 4.7% in FY14) and we raise our end-FY15 Sensex target MRF Auto Anc 4.3
from 24K to 30K. Federal Bank BFSI 4.3
ICICI Bank BFSI 4.3
Raising our FY15 GDP growth estimate to 5.6%
IDFC BFSI 4.3
As highlighted in our 24 December 2013 note, a comparison of the average LIC Housing Fin. BFSI 4.3
GDP growth rate recorded in Gujarat and Maharashtra over two time periods -
Grasim Inds Cement 4.3
namely the pre-Modi period (FY91-01) and the post-Modi period (FY02-12) -
suggests that Gujarat’s lead over Maharashtra in terms of GDP growth Larsen & Toubro E&C 4.3
expanded from 0.4% YoY in the pre-Modi phase to 0.9% YoY in the post-Modi HCL Technologies IT 4.3
phase. Hence, we highlighted that we would add another 50bps to our GDP Coal India Mining 4.3
growth estimate if two conditions are satisfied: (a) Mr Modi emerges as the PM NMDC Mining 4.3
post the General Elections; and (b) the BJP is able to get 210 or more seats on
Oil India Oil & Gas 4.3
its own. Given that both these conditions have now been satisfied, we shift our
base-case GDP growth estimate for FY15 to 5.6% YoY (from 5.1%). ONGC Oil & Gas 4.3
Bharti Airtel Telecom 4.3
Raising the Sensex target to 30,000 Power Grid Corpn Utilities 4.3
Given that the BJP’s majority will almost certainly lead to elevated expectations McLeod Russel Agro 2.1
on economic reform, we raise our trailing P/E target from 17.0x to 20.0x. This TVS Motor Co. Auto 2.1
combined with a FY15 Sensex EPS estimate of Rs1,500 (implying 14% YoY
ING Vysya Bank BFSI 2.1
growth) leads to our new end-FY15 Sensex target of 30,000 (vs the previous
Engineers India E&C 2.1
target of 24,000 and implying 24% upside).
Bharat Electron Industrials 2.1
As highlighted in our 11 March thematic, after three waves of growth in the last
Sadbhav Engg. Infra 2.1
30 years, India is entering its fourth wave. In the previous three waves, more
than two-thirds of all stockmarket returns have come in the first three years MindTree IT 2.1
(with the Sensex CAGR at 33% in this window). D B Corp Media 2.1
Petronet LNG Oil & Gas 2.1
Three sense checks on the ongoing rally
Cadila Health. Pharma 2.1
We believe that the market’s rally over the past nine months has more to it than Oberoi Realty Realty 2.1
just expectations on the political front.
Sobha Developer. Realty 2.1
(1) The RBI governor’s commitment towards positive real interest rates should Torrent Power Utilities 2.1
go a long way towards tackling inflation and preparing the grounds for a shift Source: Bloomberg, Ambit Capital research
from consumption to investment and from real assets to financial assets,
(2) Corporate profitability cycle appears set for the next wave up in sync with Analyst Details
economy and polity, and
Saurabh Mukherjea, CFA
(3) Global data points to a reflating world economy and this should provide saurabhmukherjea@ambitcapital.com
tailwinds to Indian equities. +91 99877 85848
Gaurav Mehta, CFA
Investment implications for the market uptrend!
gauravmehta@ambitcapital.com
The ’quality at a reasonable price’ approach followed in our G&C 7.1 portfolio, +91 22 3043 3255
which results in a portfolio tilted towards ‘cyclical’, ‘value’ and small-cap stocks,
Ritika Mankar Mukherjee, CFA
remains our preferred positioning for the market upmove. Since September ritikamankar@ambitcapital.com
2013, this approach has delivered more than 1,100bps of alpha vis-a-vis the +91 22 3043 3175
BSE500. We also highlight in this note a set of firms with high operating
leverage; the earnings growth of these firms should disproportionately benefit Karan Khanna
from an economic revival. karankhanna@ambitcapital.com
+91 22 3043 3251

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
 Strategy

CONTENTS
Section 1: Raising our GDP growth estimate to 5.6% YoY……………………………….. 3

Section 2: Raising our FY15 Sensex target to 30,000…………………………………….. 7

Section 3: Three sense checks on the ongoing rally………………………………………. 9

Section 4: Investment implications…………………………………………………………. 15

G&C 7.1- Imp lied sector weights…………………………………………………………… 21

May 19, 2014 Ambit Capital Pvt. Ltd. Page 2

 Strategy

Section 1: Raising our GDP growth

estimate to 5.6% YoY
Against the backdrop of India having voted in a single-party majority government
(headed by a pro-development leader) after three decades, we re-visit our growth
estimates for FY15 and raise the same marginally from 5.1% YoY to 5.6% YoY.
Moreover, we expect India’s GDP growth trajectory to head upwards over the next
few years, as CY14 appears likely to mark the beginning of India’s fourth sine wave
of economic growth (click here for our note, ‘Investing into India’s fourth wave’).

India votes out caste-based politics, communism;

demands good governance
Besides electing in a single-party majority Government on 16 May 2014, the Indian
We raise our FY15 GDP growth
electorate systematically delivered four clear messages, namely:
forecast from 5.1% YoY to 5.6%
 India’s readiness to sample market-driven economics or capitalism as is evident YoY
not just from the rise of the BJP but also the voting out of the Left,
 The election results indicate India’s readiness to sample market-driven economics
or capitalism as is evident not just from the rise of the BJP but also the voting out
of the Left
 The declining relevance of caste-based politics as is evident from the decline of
regional parties such as the SP and BSP,
 The rising intolerance towards corruption as was evident from the annihilation of
parties such as the Congress or the DMK, and
 The willingness to give a chance to parties that offer good governance or plain
transparency as evident from not just the rise of the BJP but also smaller parties
such as the AAP or BJD.
Refer to the table below for details.
Exhibit 1: The 2014 election results vs the 2009 election results
2009 2014 Swing
Party
Actuals Actuals (‘09 vs ’14)
NDA 141 338 +197
BJP 116 284 +168
Shiv Sena 11 18 +7
SAD 4 4 0
TDP 6 16 +10
UPA 234 57 -177
Congress 206 44 -162
NCP 9 6 -3
RJD 4 4 0
DMK 18 0 -18
AIADMK 9 37 +28
TMC 19 34 +15
AAP 0 4 +4
BSP 21 0 -21
SP 23 5 -18
BJD 14 19 +5
CPI(M) 16 9 -7
JD(U) 20 2 -18
TRS 2 11 +9
YSRC 2 9 +7
Others 168 148 -20
Total 543 543 0
Source: CSDS, Ambit Capital research

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 Strategy

Looking back at the post-poll surveys

Rajeeva Karandikar, the leading psephologist whose work had projected 276 seats
for the NDA as per his last survey, highlighted that the underestimation of the BJP’s
seat count is attributable to the fact that his vote-to-seat conversion model by design
underestimates the winner’s seat count. Hence, whilst the CSDS projected the broad The post-poll survey conducted by
story accurately (i.e. that the NDA would breach the 272-mark), the survey did end- CSDS, once again shows the
up underestimating the BJP seat count by ~40 seats and the NDA seat count by ~50 power as well as limitation of
seats. He went on to make the point that the entire exercise once again shows the survey-based projections in India
power as well as limitation of survey-based projections in India.

GDP growth normalisation to begin in FY15

In our note dated 24 December 2013 (click here for details) we stated that we expect
GDP growth, in a base case, to rise to 5.1% YoY in FY15 (vs 4.7% YoY in FY14, as per
Ambit estimates), driven by faster industrial sector growth and a minor improvement We add 50bps to our base-case
in services sector growth. Furthermore, we made the point that we would add GDP growth forecast as a Modi-
another 50bps to our GDP growth estimate if two conditions are satisfied, namely led majority Government
that Narendra Modi emerges as the PM post the General Elections and the BJP is able assumes power
to win 210 or more seats on its own. Given that both these conditions have now been
satisfied, we shift our base-case GDP growth estimate for FY15 to 5.6% YoY (see the
exhibit below for details).

Exhibit 2: GDP growth in India is likely to resume the process of ‘normalisation’ in FY15
GDP Growth FY14 FY15 Change 10 year average
FY13
(YoY change, in %) (CSO) (Ambit Est.) (FY15 v/s FY14) (FY03-14)
Agriculture 1.4% 4.6% 2.0% -260bps 3.6%
Industry 1.0% 0.7% 4.2% +350bps 7.2%
Services 7.0% 6.9% 7.1% +20bps 9.0%
GDP 4.5% 4.9% 5.6% +70bps 7.6%
Memo Item: Investment 0.8% 0.2% 5.7% +550bps 10.6%
Source: CEIC, Ambit Capital research

Despite the prospect of the El Nino effect playing out in FY15, we retain our ‘normal’
farm sector growth estimates owing to three sets of mitigating factors namely,
1 Our discussions with food experts suggest that ground water levels in India
currently are above average,
2 We expect a Modi-led Government to focus intensively on boosting farm sector
growth given Narendra Modi’s track record of boosting the same significantly in
his home state, and
3 The Indian Meteorological Department forecasts the Indian south-west monsoon
to be recorded at 95% of the long-term average (LTA) in FY15, which is only
100bps below the ‘normal’ range of 96-104% of LTA.

The rationale for the 50bps ‘Modi premium’

The rationale for the ‘50bps Modi premium’ is based on his track record of
significantly improving Gujarat’s economic performance as its Chief Minister (CM).

Modi has governed Gujarat as its CM since FY02 and a 380bps lift in Gujarat’s trend
GDP growth rate has materialised during this period (see the exhibit below). However
his performance and success at the state level cannot be extrapolated at the national
level for obvious reasons, including the existence and rise of stronger ‘check and
balance institutions’ (eg. CAG, Lokpal, RTI, and AAP), which look likely to remain
activated post-elections as well.

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 Strategy

Exhibit 3: Modi lifted Gujarat’s GDP trend growth rate by Exhibit 4: Gujarat increased its growth differential to
380bps as the state’s CM (refer to the dotted line which Maharashtra by 0.5% YoY after Modi’s entry
jumped by 380bps post Modi’s chief-ministership)

35% 12%
30% 9.7%
10%
Gujarat real GDP growth

8.8%
25%

(YoY change, in %)
State GDP growth
(YoY change, in %)

8%
20%
6.2% 5.8%
15% 6%
10%
4%
5%
0% 2% 0.9%
0.4%
-5% 0%
-10% FY91-01 FY02-12
FY92

FY94

FY96

FY98

FY00

FY02

FY04

FY06

FY08

FY10

FY12
Gujarat Maharshtra Difference

Source: CEIC, Ambit Capital research Source: CEIC, Ambit Capital research

We thus compare Gujarat’s performance with that of its neighbour, Maharashtra, a

state which is comparable to Gujarat in its level of economic development. Given that
Maharashtra has had middle-of-the-road CMs and has not had the benefit of being
managed as effectively as Gujarat, this state makes for an effective benchmark for
delineating the Modi effect on growth.

A comparison of the average GDP growth rate recorded in these two states over two Gujarat’s lead over Maharashtra
time periods namely the pre-Modi period (i.e. FY91-01) and the post-Modi period in terms of GDP growth
(i.e. FY02-12) suggests that Gujarat’s lead over Maharashtra in terms of GDP growth expanded from 0.4% YoY in the
expanded from 0.4% YoY in the pre-Modi phase to 0.9% YoY in the post-Modi phase pre-Modi phase to 0.9% YoY in
(see the exhibit above). the post-Modi phase

What is likely to drive the higher growth in FY15?

Based on the economic philosophies of Modi’s two most favourite economists -
Jagdish Bhagwati and Arvind Panagariya (henceforth referred to as B-P) - as well as
the BJP manifesto, we highlight the five key imperatives that a Modi-led Government
is likely to pursue (click here for details of our 18 February note, ‘Modi’s macro men
and his manifesto’):
(1) Promoting infrastructure growth: Our reading of B-P’s work suggests that
they are keen to ensure that the pace of project clearances is expedited, the
process of land acquisition is simplified with suitable amendments being made to
Land Acquisition Act, the pace of road building is increased and more power is
generated. These views are mirrored in the BJP manifesto as well.

(2) Enhancing agricultural sector productivity: Being a sector that Modi has
successfully reformed in the state of Gujarat, this sector which has hitherto been
ignored is likely to be a key focus area for a Modi-led Government. Besides
undertaking policies aimed at improving the productivity of this sector, both B-P
as well as the BJP manifesto advocates reforming the state-level APMC Acts.

(3) Recapitalising banks: Both Dr. Panagariya and the BJP’s Treasurer, Piyush
Goyal, have spoken publicly about the need to recapitalise India’s ailing banking
system quickly. Whilst it is unclear as to where the funding for this initiative is
likely to be garnered from (the PJ Nayak Committee Report, which was published
last week, states that upwards of US$40bn are required), recapitalising India’s
banking system is likely to feature on the Modi administration’s priority list.

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 Strategy

(4) Power and coal sector reform: With India’s new Government enjoying an
absolute majority in the Lower House of the Parliament, legislative activity is likely
to pick-up in the coming five-year period and amending legislations to allow the
non-captive use of coal is likely to be high on the new Government’s agenda. We
expect this sector to be a core focus area of the new Government especially in
light of B-P as well as Mr. Modi being supporters of reviving the fortunes of this
sector.

(5) Empowerment of States and passing GST: The NDA’s PM candidate, Mr.
Modi, has frequently mooted the idea of engaging Chief Ministers in the national
development process. Given his own experience as a Chief Minister (CM), he is
likely to work towards the creation of a council of CMs, with the goal of furthering
initiatives such as the GST as well as labour reforms.

Thus, the administration of reform aimed at aiding industrial sector growth is likely to The administration of reform
lift India’s GDP growth prospects in FY15. Additionally, given that India is a capital- aimed at aiding industrial sector
starved country and given that our Strategy team expects equity capital availability growth in India is likely to lift
conditions to improve in FY15, we expect investment growth to receive a fillip in India’s GDP growth prospects in
FY15. FY15

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 Strategy

Section 2: Raising our FY15 Sensex target

to 30,000
We raise our FY15 Sensex target to 30,000 from our previous target of 24,000 which
was published on 6 January 2014 (click here for that note). Our new Sensex target We raise our FY15 Sensex target
implies a trailing P/E of 20.0x to our FY15 EPS estimate of Rs1,500. Our previous to 30,000…
target of 24,000 was premised on a 17.0x trailing P/E multiple, which is the last ten-
year average, applied to an estimated FY15 Sensex earnings of Rs1,400 (which in
turn was a 10% growth on our FY14 Sensex EPS estimate of Rs1,270).
Estimated FY15 EPS
As FY14 draws to an end, we are likely to end the year near a Sensex EPS of Rs1,320
(implying 11% YoY growth). Further, our sector leads’ bottom-up number for FY15
stands at around Rs1,530 (implying 15% estimated YoY growth).
In her 24 December 2013 note (click here for that note), our Economist had
estimated another 50bps addition to her base-case FY15 GDP growth forecast of
5.1%, in the event of Mr. Narendra Modi’s ascension as India’s Prime Minister with
210 or more seats for the BJP, taking FY14 growth up to 5.6%.
Given the likely acceleration in the economy (from around 4.7% GDP growth in FY14
… with FY15 EPS estimated at
to 5.6% in FY15), we raise our top-down FY15 EPS to Rs1,500, bringing it closer to
Rs1,500 and applying a 20x
the bottom-up number of Rs1,530. At Rs1,500, the implied YoY EPS growth in FY15
trailing P/E multiple (which
turns out to be 14%.
translates into nearly 17.0x on a
Our new P/E target forward basis)
Our previous P/E target was based on the last ten-year average of 17.0x trailing
earnings. Given the decisive mandate for the BJP in the recently concluded General
Elections, we firmly believe that the conditions outlined by us in our 11 March 2014
thematic have been fulfilled and this is the beginning of the fourth wave in India’s
economy and its markets. Whilst we elaborate on this point a little later in the note,
to recap, India has had three waves over the last 30 years: the first lasted from 1984
to 1991; the second from 1991-2004; and the third and most recent wave lasted
from 2004-2013. For more details please click here for our 11 March thematic, ‘Invest
into India’s fourth wave’. We may be beginning the fourth
wave in India’s polity, economy
Exhibit 5: The remarkable synchrony between political and economic cycles in India
and markets…
Congress forms minority
15% Congress wins government headed by Congress-led coalition
elections with 78% forms Govt. with 62% LS
PV Narasimha Rao
of LS seats Seats
(YoY change, in %)
Real GDP growth

10%

5%

0%
FY85

FY87

FY89

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

Source: CEIC, Ambit Capital research; Note: LS refers to Lok Sabha i.e. the Lower House of India’s Parliament

May 19, 2014 Ambit Capital Pvt. Ltd. Page 7

 Strategy

It is important to note that in each of these three waves, the market returns
were frontloaded, with the first three years accounting for over two-thirds of …and historically over two-thirds
all the returns generated in the three waves. Thus, over the last 30 years, two- of all Sensex returns have been
thirds of all returns have come in the initial three-year period after the General delivered in the initial 30% of the
Elections that have marked the beginning of these waves (i.e. as much as two-thirds time entering into these waves
of all returns have been concentrated in this 30% of time) (see the exhibit below).
Exhibit 6: Sensex returns have been concentrated in the initial phases of the sine
waves

120%

100%

80%

60%

40%

20%

0%

2/3rds of all upsides in In the remainder 70%

the initial 30% of time time, 33% returns

Source: Bloomberg, Ambit Capital research

To put some numbers around this, whilst over the entire 30-year period, the Sensex
has delivered 16% (in CAGR terms), in this initial three-year window following these
three critical elections, it has delivered ~33% (in CAGR terms).
Whilst due to data limitations we do not have Sensex P/E and EPS data for the first
wave (i.e. 1984-1991 period):
 In the second wave, the Sensex returns in the first three-year period, (i.e. the
1991-1994 period) were primarily driven by P/E expansion, as the markets
sought to discount the positive impact of liberalisation on the economy. Hence,
the 47% CAGR in the Sensex over 1991-94 can be broken up into 10% CAGR EPS
growth; 34% CAGR P/E expansion.
 In the third wave, however, the returns in the first three-year period (i.e. in the
2004-2006 period) were driven primarily by EPS growth. Hence, the 35% CAGR
in the Sensex over 2004-06 can be broken up into 31% CAGR EPS growth and a
mere 3% CAGR P/E expansion.
Hence, whilst in the 1991-1994 period the Sensex P/E remained north of 20.0x
throughout, the P/E in the 2004-2006 period averaged at about 18.5x.
(Please note, all of the P/E references here are to trailing P/Es.)
In the current context, whilst we stick to a modest 14% EPS growth for FY15, we
assume a modest P/E expansion to 20.0x trailing (from 18.2x currently and vs the last
ten-year average of 17.0x) given that the BJP’s majority in Parliament will almost
certainly lead to elevated expectations on economic reform. A 20.0x P/E on Rs1,500
leads to our new FY15 Sensex target of 30,000.

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 Strategy

Section 3: Three sense checks on the

ongoing rally
A. Is the current move all about the elections?
The last few years have been characterised by negative real interest rates and Last few years have been
persistently high inflation in India. This has in turn manifested itself in several related characterised by negative real
phenomena like declining savings rate and falling investment growth. rates, high inflation and falling
Eventually, all these put together have resulted in a polarised stockmarket, away from savings and investment…
cyclicals and towards defensives (see Exhibits 7 to 11).

Exhibit 7: The last few years have been characterised by Exhibit 8: …falling savings rates…
negative real rates, high inflation…

20.00 4.0 38.0%

2.0 37.0%
15.00
36.0%
0.0
10.00

Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Mar-13
35.0%
(2.0)
5.00 34.0%
(4.0)
33.0%
-
(6.0)
Mar-03
Jan-04

Mar-08
Jan-09

Mar-13
Jan-14
Nov-04

Nov-09
Sep-05
Jul-06
May-07

Sep-10
Jul-11
May-12

32.0%
(5.00) (8.0) 31.0%
(10.00) (10.0) 30.0%

real rates CPI inflation savings rate (RHS) real rates (LHS)

Source: RBI, Bloomberg, Ambit Capital research Source: RBI, Bloomberg, Ambit Capital research

Exhibit 9: …and falling investments… Exhibit 10: …thus leading to declining share of investments
in India’s GDP vs consumption

6.00 20.0
4.00
15.0
2.00
- 10.0
Mar-03
Feb-04
Jan-05
Dec-05

Oct-07
Sep-08
Aug-09
Jul-10
Jun-11
May-12
Nov-06

Apr-13

(2.00)
(4.00) 5.0

(6.00)
-
(8.00)
(10.00) (5.0)

real rates (LHS) GFCF growth (RHS)

Source: RBI, Bloomberg, Ambit Capital research Source: CEIC, Ambit Capital research. Note: The figures indicate the share of
the said component as a percentage of GDP. The dotted line indicates the
share of that component in the previous phase spanning over FY12-14 whilst
the heavy black line indicates share of that component over FY04-11. This
chart has been reproduced without any changes from our 11th March note.

May 19, 2014 Ambit Capital Pvt. Ltd. Page 9

 Strategy

Exhibit 11: This has polarised the market away from cyclicals and towards defensives

6.00 6.00
4.00
5.00
2.00
4.00
-
Mar-03

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Mar-13

Mar-14
Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Sep-13
(2.00) 3.00
(4.00)
2.00
(6.00)
1.00
(8.00)
(10.00) -

Real rates (LHS) PB ratio (defensives to cylicals, RHS)

Source: Bloomberg, Ambit Capital Research

The real interest rates and persistently high inflation have also resulted in a move
away from financial assets towards physical assets. Whilst savings in the form of
...whilst being negative for
physical assets (such as gold and land) were lower than those in financial investments
cyclical stocks, this has also led to
in 2008, they had increased to account for over two-thirds of all savings by 2013.
a move away from financial
This has resulted in the gap between physical and financial savings widening to
assets into physical assets
multi-year highs (see Exhibits 12 to 14).

Exhibit 12: Whilst physical savings were nearly the Exhibit 13: …they were nearly twice as high in 2013…
same as financial savings in 2008…

32%
48%
52%
68%

Financial Savings Physical Savings Financial Savings Physical Savings

Source: RBI, Bloomberg, Ambit Capital research Source: RBI, Bloomberg, Ambit Capital research

Exhibit 14: Gap between financial savings and physical savings at multi-year highs

80%
70%
60%
50%
40%
30%
20%
2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Financial Savings Physical Savings

Source: RBI, Bloomberg, Ambit Capital research

May 19, 2014 Ambit Capital Pvt. Ltd. Page 10

 Strategy

Thankfully, the current RBI governor, Raghuram Rajan, is committed to arrest the
The current RBI governor’s
persistently high inflation and to keep real interest rates positive, and thus, the
commitment to positive real rates
stockmarket has reversed its multi-year pessimism. This in turn has reflected in the
should support an unwinding of
market’s pricing of defensives relative to cyclicals, with the gap between the two
some of these phenomena…
starting to revert towards the long-term mean (see Exhibits 15 to 17).

Exhibit 15: With Rajan’s commitment towards positive real Exhibit 16: …whilst cyclicals have made a comeback…
rates, defensives have started underperforming…

0.40 1.0 0.7 1.0

0.6
0.35 - -
0.6
(1.0) 0.5 (1.0)
0.30
(2.0) 0.5 (2.0)
0.25 0.4
(3.0) (3.0)
0.4
0.20 (4.0) 0.3 (4.0)
Jun-12
Aug-12

Apr-13
Jun-13
Aug-13

Jun-12
Oct-13
Dec-13
Feb-14
Apr-14

Aug-12
Oct-12
Dec-12

Jun-13
Oct-12
Dec-12
Feb-13

Feb-13
Apr-13

Aug-13
Oct-13
Dec-13
Feb-14
Apr-14
Consumer staples to Sensex (LHS) Capital goods to Sensex (LHS)
Real rates (RHS) Real rates (RHS)

Source: Bloomberg, Ambit Capital research; Note: the above chart plots the Source: Bloomberg, Ambit Capital research; Note: the above chart plots the
price ratio of the BSE FMCG Index to the Sensex. price ratio of the BSE Capital Goods Index to the Sensex.

Exhibit 17: …thereby narrowing the valuation gap between the two

6.0 1.5
5.0 0.5
4.0 (0.5)
3.0 (1.5)
2.0 (2.5)
1.0 (3.5)
Jun-12
Jul-12
Aug-12

Oct-12

Dec-12
Jan-13

Jun-13
Feb-13
Mar-13

May-13

Jul-13
Aug-13

Oct-13

Dec-13
Jan-14
Feb-14
Mar-14
Nov-12
Sep-12

Apr-13

Nov-13
Sep-13

Apr-14

PB ratio (defensives to cyclicals, LHS) Real rates (RHS)

Source: Bloomberg, Ambit Capital research.

B. Will corporate profitability support the rally?

Similar to the three sine waves of economic growth in the last 30 years, there have Like the fourth wave in polity and
been similar waves in corporate profitability of India Inc too. An analysis of the economy, corporate profitability
profitability of the Sensex companies during each of the previous two sine waves has looks ready for the next wave too
been presented in the exhibits below. Whilst the fundamental data for Sensex
companies during the first sine wave is not available in public domain, an analysis of
these companies during the previous two sine waves suggests that the corporate
profitability of India Inc appears to be ready for the next wave too.

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Exhibit 18: Over the past two decades, Sensex companies Exhibit 19: …which can also be seen in the PAT margins
have seen two waves in operating margins…

24% 16%
22% 14%
20% 12%
18% 10%
16% 8%
14% 6%
12% 4%
FY-91

FY-93

FY-95

FY-97

FY-99

FY-01

FY-03

FY-05

FY-07

FY-09

FY-11

FY-13

FY-91

FY-93

FY-95

FY-97

FY-99

FY-01

FY-03

FY-05

FY-07

FY-09

FY-11

FY-13
EBIT margins Adj. PAT margins

Source: Bloomberg, Capitaline, Ambit Capital research Source: Bloomberg, Capitaline, Ambit Capital research

Exhibit 20: Corporates have seen two waves in RoCEs… Exhibit 21: …which was also seen in the RoEs of these
companies

30% 30%
27%
25%
24%
21% 20%

18% 15%
15%
10%
12%
FY-91

FY-93

FY-95

FY-97

FY-99

FY-01

FY-03

FY-05

FY-07

FY-09

FY-11

FY-13
FY-91

FY-93

FY-95

FY-97

FY-99

FY-01

FY-03

FY-05

FY-07

FY-09

FY-11

FY-13

RoE
RoCE

Source: Bloomberg, Capitaline, Ambit Capital research Source: Bloomberg, Capitaline, Ambit Capital research

C. Will global conditions be conducive?

Can the global backdrop be a spoiler in India’s party? Historically, a rise in global
bond yields has been indicative of normalcy returning to global growth. Indeed, Rise in global bond yields have
phases characterised by rising bond yields in developed nations (such as the US) have been positive for Indian equities
historically coincided with strong equity returns in India (see Exhibit 22 below). historically
However, some investors have expressed concerns that the current rise in US yields is
more to do with liquidity withdrawal than any expectation of the economy improving.
At the same time, emerging market equities in general (including India) have lagged
far behind developed market equities so far, raising concerns about the existence and
sustainability of this global reflation.

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Exhibit 22: A gradual rise in US yields has been positive for Indian equities historically…

Source: Bloomberg, Ambit Capital research

Exhibit 23: … and India is currently gently rising after years of underperformance
relative to the developed markets*

4.50 Defty to MSCI World

4.00
3.50
3.00
2.50
2.00
1.50
1.00
Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Jul-13

Jan-14

Source: Bloomberg, Ambit Capital research. Note: * The Defty is the dollar-adjusted Nifty.

There are however plenty of signs that suggest that the move up in US bond yields
since the middle of 2012 has actually been reflective of a recovering global economy Plenty of signs to suggest that the
and that countries like India should participate sooner rather than later. For example, current upmove in US bond yields
the world discretionary consumption (measured by the MSCI Consumer Discretionary is reflective of a reflating global
Index to MSCI Consumer Staples ratio) has been uptrending since mid-2012 whilst economy
safe havens, such as gold and US bond prices, have been declining relative to other
commodities since then (see exhibits 24 and 25 below).
US inflationary expectations, too, are currently stable near 2% whilst the US yield
curve (measured by the yield differential between ten-year bonds and two-year
bonds) remains bullishly steep (see exhibits 26 and 27 below).

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Exhibit 24: World consumer discretionary to staples ratio Exhibit 25: …whilst gold has been declining relative to
is uptrending… other commodities

1.2 7.0
1.1 6.0
1.0 5.0
0.9 4.0
0.8 3.0
0.7 2.0
0.6 1.0
0.5 0.0
Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14
MSCI World CD to CS Gold to CRB, commodity index

Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research

Exhibit 26: US inflationary expectations stable near 2% Exhibit 27: US yield curve stays steep

3.5 3.5
3.0 3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
0.0
0.0
Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14
-0.5
Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

-0.5
-1.0

inflationary expectations US yield diff- 10yr minus 2 yr

Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research

The balance of evidence therefore suggests that global trends are more likely to
provide tailwinds to Indian equities than act as headwinds.

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Section 4: Investment implications

A. What exactly is happening in the markets currently?
Three types of extreme market polarisations are normalising in Indian equities
currently: defensives to cyclicals, large-caps to small-caps, and value to growth
stocks.
Exhibit 28: Valuation premium of defensives to cyclicals is reverting from multi-year highs

18,000 6.0
15,000 5.0
12,000 4.0
9,000 3.0
6,000 2.0
3,000 1.0
- 0.0
Feb-04

Aug-04

Feb-05

Aug-05

Feb-06

Aug-06

Feb-07

Aug-07

Feb-08

Aug-08

Feb-09

Aug-09

Feb-10

Aug-10

Feb-11

Aug-11

Feb-12

Aug-12

Feb-13

Aug-13

Feb-14
Sensex (inflation adjusted, LHS) PB ratio (defensives to cyclicals, RHS)

Source: Bloomberg, Ambit Capital research

Exhibit 29: Small-caps are reverting from excessive Exhibit 30: …as are mid-caps
valuation discounts to large-caps…

0.70 BSE Small Cap Index P/B to BSE Sensex P/B 0.90 BSE Mid Cap Index P/B to BSE Sensex P/B

0.60 0.80
0.70
0.50
0.60
0.40
0.50
0.30
0.40
0.20 0.30
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14

Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Source: Bloomberg, Ambit Capital research Jan-14
Source: Bloomberg, Ambit Capital research

Exhibit 31: Value now appears to be staging a comeback

Source: Bloomberg, Ambit Capital research

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B. What works and doesn’t work in a market uptrend

 Low RoCE stocks do not deliver irrespective of the market
phase!
Exhibit 32: Performance of RoCE quintiles in the bear phase of 2008-13

200 Performance of RoCE quintiles

Growth of INR 100 invested in

CAGR
160
12% High RoCE stocks did well in the
Q1 bear phase of 2008-13…
120 6%
Q2
'08

Q4 -8%
80
Q3 -10%
40 Q5 -15%

-
2008

2009

2010

2011

2012

2013
Source: Bloomberg, Capitaline, Ambit Capital research

Exhibit 33: Performance of RoCE quintiles in the bear phase of 1992-2000

250
Growth of INR 100 invested in

Performance of RoCE quintiles

CAGR
200
Q1 6% … similar to the bear phase of
150 -4%
Q2 the 90s
'92

Q3 -10%
100
Q4 -17%
50 Q5 -22%

-
1992

1993

1994

1995

1996

1997

1998

1999

2000

Source: Bloomberg, Capitaline, Ambit Capital research

Exhibit 34: Performance of RoCE quintiles in the ‘normal’ phase of 2000-08

400
Growth of INR 100 invested in

Performance of RoCE quintiles

CAGR
300
16% However, medium RoCE stocks
Q4
performed the best in the more
200 Q3 15%
optimistic setting of 2000-08
'00

Q2 9%
100 Q5 8%
Q1 3%
-
2000

2001

2002

2003

2004

2005

2006

2007

2008

Source: Bloomberg, Capitaline, Ambit Capital research

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 High beta does not deliver irrespective of the market phase!

Exhibit 35: Performance of beta quintiles in the bear phase of 2008-13

250
Growth of INR 100 invested in

Performance of beta quintiles

200
CAGR
150 Low beta stocks did well in the
Q5 15%
'08

bear phase of 2008-13…

100 Q4 5%
Q2 2%
Q3 1%
50
Q1 -13%
-
2008

2009

2010

2011

2012

2013
Source: Bloomberg, Capitaline, Ambit Capital research

Exhibit 36: Performance of beta quintiles in the bear phase of 1992-2000

140 Performance of beta quintiles

Growth of INR 100 invested in

120

100
CAGR … similar to the bear phase of
80 Q5 the 90s
3%
'92

60 Q2 2%
Q3 -2%
40
Q4 -4%
20 Q1 -5%

-
1992

1993

1994

1995

1996

1997

1998

1999

2000

Source: Bloomberg, Capitaline, Ambit Capital research

Exhibit 37: Performance of beta quintiles in the ‘normal’ phase of 2000-2008

800 Performance of beta quintiles

Growth of INR 100 invested in

700
600
CAGR
500 However, medium beta stocks
400 Q3 27% performed the best in the more
'00

Q4 24% optimistic setting of 2000-08

300 22%
Q2
200 Q5 17%
12%
100 Q1
-
2000

2001

2002

2003

2004

2005

2006

2007

2008

Source: Bloomberg, Capitaline, Ambit Capital research

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 Strategy

 ‘Value’ delivers, except in bear markets!

Exhibit 38: Performance of P/B quintiles in the bear phase of 2008-13

200 Performance of P/B quintiles

Growth of INR 100 invested in

CAGR
160
Q1 14%
120 Expensive stocks did well in the
Q2 2%
bear phase of 2008-13…
'08

80 Q5 -2%

Q3 -2%
40
-3%
Q4
-
2008

2009

2010

2011

2012

Source: Bloomberg, Capitaline, Ambit Capital research 2013

Exhibit 39: Performance of P/B quintiles in the bear phase of 1992-2000

140 Performance of P/B quintiles

Growth of INR 100 invested in

120 CAGR
100 Q2 -1% … similar to the bear phase of
80 Q1 -7% the 90s
60
'92

Q3 -10%
40 -20%
Q4
20 -22%
Q5
-
1992

1993

1994

1995

1996

1997

1998

1999

2000

Source: Bloomberg, Capitaline, Ambit Capital research

Exhibit 40: Performance of P/B quintiles in the ‘normal’ phase of 2000-2008

800
Growth of INR 100 invested in

CAGR
600
Q5 21% However, in the more optimistic
Q3 14% market setting of 2000-08,
400 cheaper stocks delivered the best
'00

Q4 14%
200 Q2 5%
1%
Q1
-
2000

2001

2002

2003

2004

2005

2006

2007

2008

Source: Bloomberg, Capitaline, Ambit Capital research

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C. What works best in the current context?

 The QARP approach of G&C 7.1
Summarising the current context
As described in the opening section of this note, the Indian economy looks likely to
recover mildly in FY15. At the same time, the Indian stockmarket’s three big
In an uptrending market, ‘value’
polarisations are reverting to the mean.
works best but ‘quality’ cannot be
Neither the market’s obsession with quality nor its blind eye to valuations (as seen completely ignored …
over the last few years) continues in a bull phase. More importantly, low quality never
delivers, irrespective of the market phase!
In a normal market scenario, cyclicals and small/mid-caps outperform defensives
and large-caps, with this inflection preceding the inflection in Sensex returns (see our
29 January note).

Implications for portfolio strategy

As we move toward a ‘normal’ market scenario, combining valuations with quality
should work best.
Our version of ‘QARP’ involves identifying stocks that fulfil the following criteria:
…a ‘quality at a reasonable
 Do well on our ‘greatness’ and ‘accounting’ frameworks (click here for our price’ (QARP) approach should
26 November 2013 note explaining our ‘greatness’ framework and click here for work best
our 22 November 2013 note explaining our ‘accounting’ framework); and
 Are cheap on at least one of P/E, P/E and EV/EBITDA vs their own five-
year history.
This ‘quality at a reasonable price’ (QARP) approach to portfolio construction in
today’s environment results essentially in a play on ‘cyclicality’, ‘value’ and
‘small/midcaps’ without losing sight of ‘quality’.
We first incorporated the QARP approach into our G&C portfolio construction with the
23 September 2013 iteration of the portfolio. Since then, between the three G&C
iterations (including the current one) that have used the QARP framework, cumulative
alpha of over 1,100bps has been generated over the BSE500 Index (in a little less
than 8 months).

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Exhibit 41: G&C 7.1 - The composition

6M ADV Earnings Average Average
Mcap FY13 Net FY15 FY15
Company Ticker Sector (US$ CAGR RoE PBITM
(US$ mn) D/E P/E P/B
mn) (FY10-13) (FY11-13) (FY11-13)
Bajaj Auto BJAUT IN Auto 9,522 10.1 (0.7) 23% 58% 18% 14.6 4.7
Tata Motors TTMT IN Auto 22,728 40.4 0.6 89% 50% 10% 8.4 2.1
TVS Motor Co. TVSL IN Auto 942 3.5 0.8 53% 18% 4% 18.6 3.8
Exide Inds. EXID IN Auto Anc 1,780 4.3 (2.3) 4% 21% 14% 18.1 2.7
MRF MRF IN Auto Anc 1,606 5.3 0.4 33% 21% 7% 10.3 1.6
Federal Bank FB IN BFSI 1,564 4.3 N/A 25% 13% N/A 9.6 1.2
ICICI Bank ICICIBC IN BFSI 28,838 70.0 N/A 28% 13% N/A 15.2 2.1
IDFC IDFC IN BFSI 3,205 18.9 N/A 20% 14% N/A 9.5 1.1
ING Vysya Bank VYSB IN BFSI 2,007 1.2 N/A 40% 14% N/A 13.9 1.5
LIC Housing Fin. LICHF IN BFSI 2,677 13.0 N/A 15% 20% N/A 10.1 1.8
Larsen & Toubro LT IN E&C 22,564 46.7 1.6 6% 16% 14% 23.1 3.1
Engineers India ENGR IN E&C 1,496 2.2 (1.1) 12% 35% 22% 15.9 3.1
Coal India COAL IN Mining 37,164 17.6 (1.3) 22% 38% 19% 13.1 4.5
NMDC NMDC IN Mining 10,939 6.6 (0.8) 23% 32% 74% 9.6 2.0
Oil India OINL IN Oil & Gas 5,809 3.2 (0.6) 11% 20% 35% 8.3 1.5
Petronet LNG PLNG IN Oil & Gas 1,796 2.5 0.4 42% 29% 7% 13.6 1.9
ONGC ONGC IN Oil & Gas 55,986 20.2 (0.0) 8% 19% 17% 10.2 1.7
Power Grid Corpn PWGR IN Utilities 10,654 18.8 2.5 27% 15% 70% 11.8 1.6
Torrent Power TPW IN Utilities 1,036 2.8 1.1 -24% 18% 20% 10.8 0.9
Grasim Inds GRASIM IN Cement 4,800 3.3 0.1 -6% 15% 17% 12.1 1.2
HCL Technologies HCLT IN IT 16,271 30.2 (0.0) 25% 25% 13% 13.7 3.9
MindTree MTCL IN IT 986 2.7 (0.4) 15% 23% 12% 12.3 2.9
Cadila Health. CDH IN Pharma 3,178 2.3 0.8 8% 30% 17% 19.3 4.4
Bharti Airtel BHARTI IN Telecom 22,522 27.2 1.3 -38% 9% 14% 24.7 2.0
Oberoi Realty OBER IN Realty 1,260 0.8 (0.3) 3% 15% 55% 13.3 1.5
Sobha Developer. SOBHA IN Realty 711 1.1 0.6 18% 10% 27% 12.7 1.7
McLeod Russel MCLR IN Agro 507 1.9 0.1 6% 17% 23% 8.0 1.2
Bharat Electron BHE IN Industrials 1,930 0.9 (0.8) 5% 16% 10% 12.4 1.4
Sadbhav Engg. SADE IN Infra 415 0.3 3.7 -45% 9% 11% 20.7 2.0
D B Corp DBCL IN Media 863 0.6 (0.0) 6% 27% 23% 14.6 3.8
Source: Bloomberg, Ambit Capital research

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G&C 7.1- Implied sector weights

Exhibit 42: G&C 7.1- Implied sector weights
G&C 7.1 weight (%) Delta between G&C 7.1 and Nifty

Agro 2.1 2.1

Auto 10.6 1.6

Auto Anc 8.5 8.5

BFSI 19.1 (8.0)

Capital Goods - (0.6)

Cement 4.3 1.2

E&C 6.4 1.7

FMCG - (12.5)

Industrials 2.1 2.1

Infra 2.1 2.1

IT 6.4 (9.7)

Media 2.1 2.1

Metals & Mining 8.5 3.6

Oil & Gas 10.6 (1.0)

Pharma 2.1 (3.2)

Realty 4.3 3.9

Telecom 4.3 2.6

Utilities 6.4 3.6

nd
Source: Ambit Capital research; Note: This chart has been reproduced without any changes from our 22 April
note.

 As highlighted earlier, for the construction of G&C 7.1, we look for stocks that do
well on the ‘greatness’ framework, pass our accounting tests, are cheap versus
their own five year average multiples and are relatively liquid.
 Even within this set of stocks, we assign 2x weightage to more liquid names
(above US$2.5mn ADV) and 1x to illiquid names.
 The sector weights, as displayed in the exhibit above, are ‘implied’ weights and
an outcome of the above process. We do not start with the Nifty as a reference
point for portfolio construction.
 As can be seen from this exhibit, there are four key sectors we are underweight
on- Consumer Staples, Pharma, Technology and BFSI (banks and financial
services). While underweights on the former three are by design, given your view
of a recovery and consequently the G&C 7.1 portfolio being cyclically geared,
clients will be surprised by our underweight in BFSI. This cautiousness on BFSI
stems from our discomfort on asset quality issues facing large banks in India,
private and public. While from a macro perspective we have written, over the last
few months, on PSU banks’ rerating (eg .in the recent Inflation, corruption,
thematic), from a bottom up perspective based on the historic and likely future
trajectories on reported financials, it is very difficult to put buys on these names or
include them in the G&C portfolio.

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 Strategy

 High operating leverage

With the economy poised for a recovery, firms with a high degree of operating Firms with high operating
leverage are bound to benefit disproportionately from such a recovery. leverage should
To identify stocks that would do well in such a scenario, we screen the BSE500 disproportionately benefit in an
universe (after excluding BFSI firms and firms belonging to defensive sectors such as economic recovery
FMCG, Pharma, etc) for firms that fulfil the following criteria:
 Have increased capacity by at least 40% (over FY10-FY13), i.e. firms with at
least 40% growth in fixed assets (gross block + CWIP)
 Have seen a decline in their asset turnover (FY13 vs FY11), and
 Have fixed cost, representing at least 25% of the total cost (FY13). (This
metric allows us to capture another dimension of operating leverage.)
The resultant list of firms that have seen a decline in their asset turnover yet
increased capacity and with substantial fixed costs has been shown below.
(Note: This list has been filtered for accounting quality using our accounting
framework)
Exhibit 43: List of firms with high operating leverage
Growth in CWIP + F/A FY15 FY15
Mcap 6M ADV FC as a %
Company Ticker Sector Gross Block Turnover
(US$ mn) (US$ mn) of TC-FY13 P/E P/B
(FY13 over FY10) (FY13)
BHE L BHEL IN Capital Goods 9,660 18.3 60% 35% 4.8 17.7 2.4

Bharti Infra. BHIN IN Infrastructure 7,507 3.0 50% 100% 0.4 24.8 2.4
Carborundum Uni. CU IN Industrials 457 0.1 54% 55% 1.7 18.8 2.1
Elgi Equipment ELEQ IN Capital Goods 282 0.1 193% 31% 3.4 19.7 3.1
Engineers India ENGR IN E&C 1,496 2.2 68% 68% 12.7 15.9 3.1
Grindwell Norton GWN IN Industrials 303 0.1 62% 44% 2.3 15.6 2.9

Hind.Zinc HZ IN Metals 9,782 2.8 43% 87% 1.1 8 1.3

IL&FS Transport ILFT IN Infrastructure 659 0.3 391% 97% 1.7 7.6 0.7
Ingersoll-Rand INGR IN Capital Goods 248 0.2 144% 26% 6.7 19.7 1.1
Kalpataru Power KPP IN E&C 332 0.5 156% 53% 3.7 9.5 0.8
Larsen & Toubro LT IN E&C 22,564 46.7 54% 57% 5.1 23.1 3.1

NMDC NMDC IN Mining 10,939 6.6 149% 78% 4.3 9.6 2

NTPC NTPC IN Utilities 18,492 15.5 47% 99% 0.7 10.4 1.2
Oberoi Realty* OBER IN Realty 1,260 0.8 71% 111% 1 13.3 1.5
Phoenix Mills PHNX IN Realty 617 0.4 85% 93% 0.2 14.3 1.7
Power Grid Corpn PWGR IN Utilities 10,654 18.8 85% 98% 0.2 11.8 1.6

Prestige Estates* PEPL IN Realty 1,097 0.6 133% 125% 0.9 13.7 1.9
Sadbhav Engg. SADE IN Infrastructure 415 0.3 55% 84% 3.8 20.7 2
Shree Cement SRCM IN Cement 3,663 1.7 55% 61% 1.1 26.2 4.3
Sobha Developer. SOBHA IN Realty 711 1.1 53% 51% 3.6 12.7 1.7
SRF SRF IN Chemicals 411 1.7 46% 35% 0.9 8.6 1.1

S AI L SAIL IN Metals 5,500 5.3 54% 47% 1.1 11.9 0.7

Tata Power Co. TPWR IN Utilities 4,190 6.7 71% 77% 0.7 14.6 1.6
Thermax TMX IN Capital Goods 1,655 0.9 141% 30% 4.5 26.8 4.2
UltraTech Cem. UTCEM IN Cement 10,909 6.0 226% 51% 1.1 23.3 3.3
WABCO India WIL IN Auto Anc 696 0.2 56% 35% 2.9 26.8 4.6
Source: Bloomberg, Ace Equity, Ambit Capital research; Note; For the purpose of calculating Fixed costs as a % of Total costs, we have treated Power & Fuel cost,
Employee cost, Other Manufacturing expenses, General & Administration expenses and Depreciation expense as fixed costs. Raw Material consumed and S&D
expenses have been treated as variable costs, while Miscellaneous expenses have been ignored altogether; *FC as a percentage of TC is greater than 100% due to
stock adjustments.

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 Strategy

 Integration of QARP and operating leverage

Combining the two themes to portfolio construction highlighted here, i.e. the ‘quality
at a reasonable price’ (QARP) approach and high operating leverage firms should
work even better for investors.
The list of firms that meet that meet our ‘QARP’ and ‘operating leverage’ criteria is
displayed in the exhibit below.
Exhibit 44: Integrating ‘QARP’ with ‘operating leverage’
Growth in
FC as a FY15
Mcap 6M ADV CWIP + Gross F/A Turnover FY15
Company Ticker Sector % of P/B
(US$ mn) (US$ mn) Block (FY13 (FY13) P/E
TC-FY13
over FY10)
Engineers India ENGR IN E&C 1,496 2.2 68% 68% 12.7 15.9 3.1
Larsen & Toubro LT IN E&C 22,564 46.7 54% 57% 5.1 23.1 3.1
NMDC NMDC IN Mining 10,939 6.6 149% 78% 4.3 9.6 2.0
Oberoi Realty* OBER IN Realty 1,260 0.8 71% 111% 1.0 13.3 1.5
Power Grid Corpn PWGR IN Utilities 10,654 18.8 85% 98% 0.2 11.8 1.6
Sadbhav Engg. SADE IN Infrastructure 415 0.3 55% 84% 3.8 20.7 2.0
Sobha Developer. SOBHA IN Realty 711 1.1 53% 51% 3.6 12.7 1.7
Source: Bloomberg, Ace Equity, Ambit Capital research; Note; For the purpose of calculating Fixed costs as a % of Total costs, we have treated Power & Fuel cost,
Employee cost, Other Manufacturing expenses, General & Administration expenses and Depreciation expense as fixed costs. Raw Material consumed and S&D
expenses have been treated as variable costs, while Miscellaneous expenses have been ignored altogether; *FC as a percentage of TC is greater than 100% due to
stock adjustments.

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 Strategy

Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 saurabhmukherjea@ambitcapital.com

Research
Analysts Industry Sectors Desk-Phone E-mail
Nitin Bhasin - Head of Research E&C / Infrastructure / Cement (022) 30433241 nitinbhasin@ambitcapital.com
Aadesh Mehta Banking / Financial Services (022) 30433239 aadeshmehta@ambitcapital.com
Achint Bhagat Cement / Infrastructure (022) 30433178 achintbhagat@ambitcapital.com
Aditya Khemka Healthcare (022) 30433272 adityakhemka@ambitcapital.com
Akshay Wadhwa Banking & Financial Services (022) 30433005 akshaywadhwa@ambitcapital.com
Ashvin Shetty, CFA Automobile (022) 30433285 ashvinshetty@ambitcapital.com
Bhargav Buddhadev Power / Capital Goods (022) 30433252 bhargavbuddhadev@ambitcapital.com
Dayanand Mittal, CFA Oil & Gas / Metals & Mining (022) 30433202 dayanandmittal@ambitcapital.com
Deepesh Agarwal Power / Capital Goods (022) 30433275 deepeshagarwal@ambitcapital.com
Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 gauravmehta@ambitcapital.com
Karan Khanna Strategy (022) 30433251 karankhanna@ambitcapital.com
Krishnan ASV Real Estate (022) 30433205 vkrishnan@ambitcapital.com
Nitin Jain Technology (022) 30433291 nitinjain@ambitcapital.com
Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 pankajagarwal@ambitcapital.com
Pratik Singhania Retail (022) 30433264 pratiksinghania@ambitcapital.com
Parita Ashar Metals & Mining / Oil & Gas (022) 30433223 paritaashar@ambitcapital.com
Rakshit Ranjan, CFA Consumer / Retail (022) 30433201 rakshitranjan@ambitcapital.com
Ravi Singh Banking / Financial Services (022) 30433181 ravisingh@ambitcapital.com
Ritesh Vaidya Consumer (022) 30433246 riteshvaidya@ambitcapital.com
Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 ritikamankar@ambitcapital.com
Ritu Modi Automobile (022) 30433292 ritumodi@ambitcapital.com
Tanuj Mukhija, CFA E&C / Infrastructure (022) 30433203 tanujmukhija@ambitcapital.com
Sales
Name Regions Desk-Phone E-mail
Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 sarojini@panmure.com
Deepak Sawhney India / Asia (022) 30433295 deepaksawhney@ambitcapital.com
Dharmen Shah India / Asia (022) 30433289 dharmenshah@ambitcapital.com
Dipti Mehta India / USA (022) 30433053 diptimehta@ambitcapital.com
Nityam Shah, CFA USA / Europe (022) 30433259 nityamshah@ambitcapital.com
Parees Purohit, CFA UK / USA (022) 30433169 pareespurohit@ambitcapital.com
Praveena Pattabiraman India / Asia (022) 30433268 praveenapattabiraman@ambitcapital.com

Production
Sajid Merchant Production (022) 30433247 sajidmerchant@ambitcapital.com
Sharoz G Hussain Production (022) 30433183 sharozghussain@ambitcapital.com
Joel Pereira Editor (022) 30433284 joelpereira@ambitcapital.com
Nikhil Pillai Database (022) 30433265 nikhilpillai@ambitcapital.com
E&C = Engineering & Construction

May 19, 2014 Ambit Capital Pvt. Ltd. Page 24

 Strategy

Explanation of Investment Rating

Investment Rating Expected return

(over 12-month period from date of initial rating)
Buy >5%

Sell <5%

Disclaimer
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Additional information on recommended securities is available on request.

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