INDIA India Strategyonline.wsj.com/Public/Resources/Documents/MacquarieReport.pdfAppendix 2 Consumption: Playing catch up 50 Appendix 3: Performance, Valuation and Earnings Estimates

Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/research/disclosures.

INDIA

Inside

Summary 2

Further upsides but play the second derivative 5

Factors to Watch Out For 11

Themes to Play 18

Introducing Our Model Portfolio 26

Sector Summary 30

Risks and Concerns 41

Appendix 1 Investment Cycle Gradually

Turning Up 46

Appendix 2 Consumption: Playing catch up 50

Appendix 3: Performance, Valuation and

Earnings Estimates 56

Rakesh Arora, CFA +91 22 6653 3054 [email protected] Arjun Bhattacharya +91 22 6653 3064 [email protected]

24 August 2010

India Strategy Play the Second Derivative It’s about picking the right stocks

The recovery story has played out: Post global crisis, India has re-

established confidence in the structural growth story driven by – a) strong

rural consumption growth, b) rebound in industrial activity and c) a relatively

stable government with a reform focus. Our Sensex target stands at 19500, a

6% upside which reflects that majority of this story is factored in.

Time to focus on execution and earnings growth: The next trigger in

performance would revolve around sectors/stocks that are geared to the

structural domestic story, are able to execute and maintain their earnings

growth momentum. We introduce our model portfolio and 10 focus stocks.

Themes to play remain the same but stock selection critical

Investment - on the rise: India remains constrained on both industrial

capacity and infrastructure. We see capex cycle picking up and also notice

increased focus on infrastructure development by the government. Execution

remains the key differentiator. We prefer L&T and JSPL on this play.

Consumption – evergreen theme but largely priced: It has held up well

owing to strong rural demand, despite a drought year, while urban demand is

on a rebound on an improving job market, higher incomes and softening food

inflation. We prefer ITC and M&M to play rising rural consumption.

Reforms – some progress: Many reforms that were left in limbo due to

political hurdles in the previous government have seen significant progress –

such as Direct Tax Code, GST and Fuel Price Deregulation. GAIL and BPCL

are our top picks on this theme.

Model portfolio – skewed towards late cycle sectors

Global environment still remains uncertain and we believe that funds flow into

India will remain strong. Since we are well advanced into the recovery, we

expect higher upside from late cycle sectors. Our model portfolio is

benchmarked against the MSCI India Index and is overweight on Industrials,

Materials and Healthcare; underweight on Telecom and Consumer Staples and

Neutral on Consumer Discretionary, IT, Energy, Financials and Utilities.

Risks and Concerns

While the overall picture looks promising we are mindful of certain issues that

could possibly create a roadblock for India moving towards a 10% growth level:

Slowdown in the pace of reforms

Government’s inability to curtail an already high fiscal deficit

Persistent high inflation due to the recent pick up in non-food WPI

A tightening rate cycle slowing down consumption and investment

A double dip recession in the developed markets, especially the US

Macquarie Research India Strategy

24 August 2010 2

Summary Poised for Superior Growth

In the aftermath of the global crisis India undertook measures to counter the headwinds

emanating from a bruised global financial system as well as the worst drought since 1972.

These measures, while timely and necessary, took India a bit off-track from the policy

objectives it had set out to achieve. However, it is important to appreciate that the majority of

the economic outcomes for India following the crisis were less negative than expected. And

we are now moving into a trajectory where the positive outcomes, especially on investment

and domestic consumption, will likely surprise on the upside.

Sensex Target

Our one year forward Sensex target is 19500, reflecting a mid-cycle PE estimate of 18X,

which we believe is fair given India’s current growth potential. Our FY11 EPS forecast for the

Sensex is Rs.1090, reflecting a 12% growth over FY10 EPS while consensus is currently 4%

below our estimate.

Themes to Play

Investment: The growth trajectory has shifted up towards 8% and industrial activity has

gained more traction, both in capital goods and consumer goods. We see capex cycle

picking up and also notice increased focus on infrastructure development by the government.

Execution remains the key differentiator. We prefer L&T and JSPL on this play.

Domestic Consumption: Rural demand helped sustain consumption despite a drought

year and is expected to contribute strongly to consumption in the next few years. We

prefer ITC and M&M to play rising rural consumption. Urban demand also looks set to

rebound on an improving job market, higher incomes and softening food inflation. Some of

the important consumption indicators like auto sales have already shown good momentum.

Reforms - Necessary to sustain the pace of growth: Many reforms have seen

significant progress – such as Direct Tax Code, GST and Fuel Price Deregulation -- GAIL

and BPCL are our top picks on fuel subsidies reform. In addition, certain measures

that have been part of the Government’s plan for a while now, need to be fast-tracked and

implemented. These are:

a) A fiscal policy that is focused on creating productive assets and bringing down the

ballooning fiscal deficit

b) Better supply-side management of essential items such as food-grains to avoid wastage

c) An effective approach to managing movements in the rupee due to volatile capital inflows

while at the same time making the export sector more competitive

Concerns around Valuation but Markets still have upside potential

Valuation premium needs to be looked at in the right context: In the last ten years

India has traded at an average 25% premium to emerging markets, and this premium has

increased further in the post-Lehman crisis period. From late 2007 to mid-2008, the

market was at a similar premium and many were concerned about valuations. But a lot has

changed since then and risks have lessened to a great degree.

Equities look attractive relative to bonds: We estimate the risk premium of equities over

bonds (real yield) at around 5% which makes equities look attractive, especially since

inflation is high and real yields are close to zero or even negative.

Valuations could move higher: PE ratios move closely with GDP growth and given the

current strong growth projections for India (including the IMF at 9.4% for FY11), we remain

comfortable with the current valuation at which India is trading (Sensex is trading at 17X

FY11 EPS while MSCI India is trading at 16X FY11 EPS).

Investment and

domestic

consumption will

likely surprise on

the upside

Our 1-year forward

Sensex target is

19500, reflecting a

mid-cycle PE

estimate of 18X

India’s structural growth story is

driven by strong rural consumption growth, rebound in

industrial activity and a relatively

stable government with a reform focus

In the last ten years

India has traded at

an average 25%

premium to

emerging markets


24 August 2010 3

However…

Funds flow into India has been very high of late due to the relative attractiveness of the

economy. However, it is important for such flows to sustain since there is always a risk of

short term money flowing out in the event of risk aversion coming back into the system. In the

past very high flows have indicated modest returns for the market over the next 12 months.

Earnings upgrades have become modest now given how quickly they have risen over

the past one year. There may be some downgrades in the near term as input cost

pressures eat into margins but the underlying demand remains strong and bodes well for

corporate earnings.

Focus on Execution of Reforms and Structural Gearing of Sectors

We believe the next trigger in performance would revolve around those sectors and stocks

that are geared to the structural domestic story and maintain their earnings growth

momentum. It is time to start focusing on implementation of reforms at the macro level and

consistency and quality of earnings at the sector/stock level.

Our Model Portfolio

The market bounce-back last year was a more or less broad-based recovery across most

sectors. However, in terms of sector leadership, it has been a somewhat predictable

outcome with the early-cycle consumer discretionary and financials outperforming relative

to the market while the late cycle industrial underperforming.

Since we are well advanced into the recovery we expect higher upside from late cycle

sectors such as industrials and materials.

In terms of valuation, most sectors are now trading near or above their long term range.

However, given the growth potential in certain sectors (such as infrastructure), there may

be a case for them to re-rate in the future though execution would remain the key

differentiator.

Our model portfolio is benchmarked against the MSCI India Index and is overweight on

Industrials, Materials and Healthcare; underweight on Telecom and Consumer Staples and

Neutral on Consumer Discretionary, IT, Energy, Financials and Utilities.

Fig 1 Sector Recommendations

Benchmark Weight in MSCI India

Weight in Macquarie Portfolio

Relative to Benchmark

Consumer Staples 6.0 5.6 Underweight Consumer Discretionary 4.9 4.7 Neutral Energy 14.2 14.3 Neutral Finance 27.5 27.2 Neutral Healthcare 3.7 3.9 Overweight Industrials 10.1 10.8 Overweight Information Technology 16.8 16.2 Neutral Materials 10.6 11.3 Overweight Telecom 0.7 0.5 Underweight Utilities 5.6 5.5 Neutral Total 100.0 100.0

Source: Bloomberg, MSCI, Macquarie Research, August 2010

Earnings upgrades have become

modest now given how quickly they

have risen over the past one year

Since we are well

advanced into the

recovery we expect

higher upside from

late cycle sectors

such as industrials

and materials


24 August 2010 4

Macquarie Top 10 Recommended Stocks

We recommend a concentrated list of stocks for those looking for high absolute returns from

good quality stocks. The recommended list consists of stocks that we believe are ahead of

their peers in terms of earnings visibility and growth potential.

Fig 2 Macquarie Top 10 Stocks

Company Name Recommend. FY11 PE

FY11 Price/Book

FY11 Est. ROE

Potential Upside

Rationale

Dr. Reddy's Outperform 22.0 4.5 23.2 13% Among the best proxies to play growth opportunities in the

global generics space

GAIL India Outperform 14.6 2.9 21.4 17% An oligopolistic player, poised to double its transmission

volumes over the next few years,

Stands to benefit from the exemption from subsidy burden

ICICI Bank Outperform 21.8 2.0 9.5 11% Improving asset quality and steadily rising ROE driven by

improvements in NIMs and margin ratios

ITC Outperform 25.5 7.8 32.1 15% Virtual monopoly in cigarettes

Non-cigarette businesses to report strong cyclical growth

Direct play on strong domestic consumption growth

Jindal Stl and Power Outperform 12.6 4.2 39.2 41% Largest private sector resource owner (2.5bn tonnes of coal

and 1bn tonne of iron ore) with lowest cost of steel production

Larsen & Toubro Outperform 24.8 4.5 19.9 7% Top pick in large cap, revival in execution to aid revenue

growth of 28% and earnings growth of 30% in FY11

Mahindra & Mahindra Outperform 14.7 3.7 27.4 20% Strong brands, new products to drive growth in auto space

Tractor segment to benefit from rising rural wealth

New business initiatives to add value in medium term

Tata Power Outperform 16.3 2.4 15.9 26% Organic, low-risk growth driving EPS growth of 22% over next

two years (PER from 16x to 11x). Maithon added in FY11 and

higher coal pricing flowing through

Tata Steel Outperform 6.5 1.7 28.7 49% Tata Steel is trading at a discount of 32% to its Indian peers. It

is the cheapest steel stock regionally at these levels

Consensus underestimating the profitability of European arm

Major milestones in FY12 have the potential to re-rate

operating margins by 400–500bp

TCS Outperform 23.1 6.4 31.0 10% Has done a commendable job of expanding operating margins

by 310 bp in FY10

Greatest geographic dispersion including a focus on India

Source: Macquarie Research, August 2010, Prices as of August 20, 2010


24 August 2010 5

Further upsides but play the second derivative The Indian equity market recently touched levels last seen around the beginning of 2008.

While the developed world continues to crawl back to recovery, the Indian economy has

emerged a winner over the past 18 months and appears in a much better shape compared to

its emerging peers. The vote of confidence that India received last summer after the election

results led to a re-rating of Indian equities – the market went up 17% in a single day post the

results. Since then, the Sensex has gained a further 27% and has been a clear outperformer

relative to the rest of the world. Although there may be some correction in the near term, we

believe there is further upside to the market provided the triggers play out the way we expect

them to. Our 12 month forward target on the Sensex is 19500, around 6% higher from current

levels, reflecting that majority of this story is factored in. We believe focussing on stocks with

quality and visibility of earnings would be the recipe to outperform the market.

Broad Macro Story Seems Priced-In

We believe what has unfolded over the past 18 months is a result of certain incremental

factors that have helped re-establish confidence in the structural growth story of India:

Gradual global recovery has helped inflow of capital: Although the pace of recovery in

developed economies continues to be sluggish, the fiscal and monetary measures along

with the restructuring of the banking system have helped reinstate market confidence. This

has primarily benefitted emerging markets as it has restored the flow of capital back into

growth economies, especially India.

Indian Election results allayed fears of a stable government: Concerns around stability

of the federal government were allayed when the UPA regained power at the centre, but

more importantly without a nagging Left wing ally that had left many important

policies/reforms in limbo.

Strong rebound in consumption and economic activity in a drought year: The

strength of India’s structural growth factors has been underscored by the strong show in

consumption and industrial activity last year. While rural consumption held up well in a

drought year, industrial activity made a strong comeback on the back of rising demand.

Fig 3 GDP Growth – by Industry Fig 4 GDP Growth – by Expenditure

Source: CMIE, Macquarie Research, August 2010 Source: CMIE, Macquarie Research, August 2010

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

FY91 FY94 FY97 FY00 FY03 FY06 FY09

% yoy

1.0

3.0

5.0

7.0

9.0

11.0

% yoy

Agriculture Industry Services GDP Growth (rhs)

0

2

4

6

8

10

12

14

16

18

20

FY00 FY02 FY04 FY06 FY08 FY10

% yoy

GDP Private Consumption Investment

Our 12 month

forward target on

the Sensex is 19500,

around 6% higher

from current levels,

reflecting that

majority of this

story is factored in


24 August 2010 6

Time to Play the Second Derivative

With the recovery story playing out, the next trigger in stocks would revolve around

those that are geared to the structural domestic story, are able to execute and maintain

their earnings growth momentum.

At the macro level

Execution of reforms and infrastructure projects is the key: Having established the

strength of its structural pillars that helped India withstand the worst global recession ever,

the time is right for India to leverage on these pillars and start implementing reforms. And

we are already seeing signs of that happening -- projects are taking-off, reforms are being

fast-tracked, consumption is increasing on rising incomes and corporate capex seems

poised for the next round of investment.

At the stock level

Geared to the structural domestic growth dynamics: Amongst sectors and stocks, it is

time to look at factors that would help companies sustain their growth in earnings. We

believe companies that have a greater exposure to the domestic growth dynamics would

benefit more than the ones that don’t.

Quality earnings growth and margins: After the recent quarterly results it is clear that

most sectors are facing margin pressures. And it seems likely that the headwinds

emanating from rising raw material costs and a rising interest rate environment would

continue. Therefore, we believe companies that are able to show visibility in earnings and

maintain their margins would be the ones to focus on. In Fig 41, we present our top 10 list

of stocks that match our desired characteristics.

Why focus on the second derivative?

Many are questioning the pace at which industrial recovery has occurred and

whether it is sustainable. The simple answer to that is no. Put simply – the recovery

process started from a very favourable base and it is only time before the base effect

catches up, much the same way WPI inflation has. Yes, the recovery has been very strong

but ‘growth rates’ will have to cool-off to more sustainable levels. That would be a healthy

sign, in our view, and allow other variables in the economy to adjust accordingly.

Another area of concern is valuation. The Sensex is currently trading at 17X 12-month

forward EPS (based on consensus estimates) and at a significant premium to most other

markets. If one looks at the last ten years data – which we think is a more appropriate time

frame to look at India – India has traded at an average 25% premium to emerging markets,

and this premium has only increased in the post-Lehman crisis period. From late 2007 to

mid-2008, the market was at a similar premium and many were concerned about

valuations even back then, and for legitimate reasons. But we believe a lot has changed

since then and many of the concerns that were prevailing then have either changed or

lessened to a great degree.

Execution of

reforms and

infrastructure

projects is the key

Companies that are

able to show

visibility in earnings

and maintain their

margins would be

the ones to focus on

A lot has changed

since 2008 and

many of the

concerns that were

prevailing then have

either changed or

lessened to a great

degree


24 August 2010 7

Valuations need to be viewed in the Right Context

We think India is in an excellent position to leverage its economic fundamentals to embark

on a multi-year high growth trajectory.

There may be headwinds ahead primarily due to reasons emanating from the developed

world, but the recent recovery has given us enough comfort to fall back on the cushion

provided by the domestic economy.

Even China has shifted gears now and is concentrating on its internal drivers of growth, i.e.

domestic consumption, rather than relying solely on external demand. However, it would

take a while before the Chinese economy adjusts to this change. Till then India’s

favourable consumption demographics would likely continue to command a premium over

China and other economies.

Figures 5 and 6 below outline our reasons around why we think a valuation premium is justified.

Fig 5 Comparison of recent instances when India was at a high premium to its peers

THEN NOW

Late 2007- Mid 2008 2010

GDP Growth

The US mortgage market contagion had started spreading and was dragging the global economy to the brink of a recession. Although emerging markets weren’t directly in the path of the financial turbulence, many worried about the magnitude of impact on these economies from a global slowdown.

The global economy is gradually recovering. Although concerns about a double-dip recession continue to send jitters, the markets have adjusted now to the well-established fact that India is much better shielded from external factors compared to others such as China.

Progress on Reforms

Reforms were in a limbo due to constant roadblocks created by the Left allies and the government's shift in focus towards the upcoming general elections.

The left is not a hindrance now and we have already seen proactive steps from the government towards fast-tracking some of the long pending reforms such as GST, direct tax code and fuel price deregulation.

Commodity Prices and High Inflation

Crude and other commodity prices were nearing their all time highs and inflation was progressively inching higher, which threatened to impact demand.

Commodity prices are low and demand continues to be strong. Although inflation is at elevated levels and is a cause for concern, food prices have started to ease and monsoon has turned out quite well so far. The main concern now is on how non-food inflation pans out.

Monetary Tightening

Monetary tightening was on the cards due to high inflation which added to the likelihood of a slowdown in demand. Added to this were the concerns around high commodity prices, a fragile financial system and a possible global slowdown.

Monetary tightening is already underway which has somewhat allayed fears about persistent high inflation and over-heating of the economy. Although it does put a question mark on the impact on demand and the pace of economic activity, current signals from banks suggest they may not raise lending rates anytime soon.

Source: Macquarie Research, August 2010

India is in an

excellent position to

leverage its

economic

fundamentals to

embark on a multi-

year high growth

trajectory

Ma

cq

ua

rie R

esea

rch

In

dia

Stra

teg

y

24 A

ug

ust 2

01

0

8

Fig 6 MSCI India 12 Month Forward Price-to-Earnings Ratio Relative to MSCI Emerging Markets

Events Around the Changing Premium of India Relative to Emerging Markets (MSCI)

Source: Bloomberg, Macquarie Research, August 2010

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Ratio

Long Term Average +1 Std. Dev. -1 Std. Dev.

- High commodity prices

- High inflation

- The US mortgage market contagion starting to spread

- Global economy at the brink of a recession

- Worries around the magnitude of impact on emerging

economies

Monetary

tightening

Concerns around

slowing demand

Lehman bankruptcy

Reforms in limbo:

- Hurdle from Left allies

- Shifting focus on general elections

- Gradual global recovery

- India's sound structural factors

- Better shielded from external factors

- More flexibility around reforms: efforts stepped up around

GST, direct tax code and fuel price deregulation

Election results

- Consumption held up despite

worst drought since 1972

- Investment and industrial

activity picked up

- Inflation continues to be a worry

- However food prices easing

- Monsoon has turned out much better

- RBI on track with tightening; should

allay fears around inflation and

overheating of economy

THEN NOW


24 August 2010 9

Is there Potential for India to Re-rate Further?

Re-rating of Indian equities may not happen in a hurry since there are plenty of uncertainties

around various external and internal factors. However, in the next 12–18 months, as triggers

begin to play out, the potential for higher growth will likely begin to look more reasonable. This

would involve the following:

1. Timely implementation of reforms by the government – such as direct and indirect

taxes, subsidies, financial sector reforms etc.

2. Investor friendly policies in order to attract more foreign capital since India continues

to be internally capital deficient

3. Making growth more broad-based by involving various sections of the population in

the growth process – just as the government has done with successful rural schemes

such as NREGA

While many of these issues have been addressed over time, the inability to crack down on

widespread corruption has always discounted India’s potential to grow and its ability to attract

foreign capital. However, the important point to note is that the economy has grown in spite of

these plaguing issues.

The MSCI India 12 Month forward PE ratio is trading near its 10-year average but far from the

valuations seen back in late 2007 and its upper trading band (+1 standard deviation). The

multi-year growth potential that India currently presents does create a large opportunity for

the market to re-rate from here.

Fig 7 MSCI India 12 Month Forward PE and Trading Bands


In addition, Sensex valuations (12-month forward PE ratio) and growth in its market

capitalization have closely tracked GDP growth over the past 15 years (see Fig. 8 and 9

below). Given current growth expectations we don’t think valuations look stretched. Recently

there have been large scale upgrades in the annual GDP forecast for FY11 with the IMF

plugging it at 9.4%. If events play out the way we expect them to, we would likely see further

upgrades to growth forecasts for subsequent years.

5

7

9

11

13

15

17

19

21

23

25

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Ratio

10-year Average

+1 Std. Dev.

-1 Std. Dev.

In the next 12–18

months, as triggers

begin to play out,

the potential for

higher growth will

likely begin to look

more reasonable

The MSCI India 12

Month forward PE

ratio is trading

above its 10-year

average; but far

from the levels seen

back in late 2007

Sensex valuations (12-month forward

PE ratio) have closely tracked GDP growth over the past

15 years


24 August 2010 10

Fig 8 GDP Growth and Sensex 12-Month Forward PE Ratio

Source: Bloomberg, CMIE, Macquarie Research, August 2010

Fig 9 Growth in GDP and Sensex Market Capitalisation

Source: Bloomberg, , CMIE, Macquarie Research, August 2010

3

4

5

6

7

8

9

10

11

12

FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14

6

8

10

12

14

16

18

20

22

24

26

28

30

Current 12M

Fwd PE

9%

8.5%

7.5%

GDP Forecast Under 3

Avg. Growth Scenarios

% yoy Ratio

GDP Growth (LHS)

12M Fwd PE (RHS)

3

4

5

6

7

8

9

10

11

12

FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14

-60

-20

20

60

100

140

180

220

9%

% yoy % yoy

8.5%

7.5%

GDP Forecast Under 3

Avg. Growth Scenarios

GDP Growth (LHS)

Growth in Mkt Cap

(RHS)


24 August 2010 11

Factors to Watch Out For Are Equities Attractive or is it Just an Illusion?

Traditionally, the spread between earnings yield and government bond yield (or the equity risk

premium) indicates the attractiveness of equities relative to risk-free bonds. We use the

earnings yield based on 12-month forward EPS estimates, ie inverse of the 12-month forward

PE ratio. We compare this to the real bond yield which is the difference between nominal

yield and core inflation (ex-food and energy, estimated using the non-food and -energy

components of WPI). Currently the spread is at 5% which we believe makes equities look

attractive relative to bonds, especially since high inflation has rendered real yields near zero

or even negative.

Fig 10 Earnings Yield minus Real Bond Yield (risk premium)


10-year bond yields moved up considerably since last year due to high government debt and

recently due to high inflation and in anticipation of monetary tightening, while short term rates

were low due to high liquidity leading to a steep yield curve. But recent tightening in liquidity

and increase in short term rates has flattened the curve somewhat. We believe long term

yields would remain elevated till the time concerns ease on inflation and fiscal deficit is

brought down to more manageable levels.

Fig 11 Slope of the Yield Curve (10Y – 2Y)


-10-8-6-4-202468

101214161820

Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

% spread

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0


% points

Slope of the Yield Curve (10y - 2y)

Equity risk premium

is at 5% which we

believe makes

equities look

attractive relative to

bonds

Long term yields

would remain

elevated till the time

concerns ease on

inflation and fiscal

deficit is brought

down to more

manageable levels


24 August 2010 12

Earnings Estimates

Growth in 12-month forward EPS estimates has come off its peak. This is of course largely

being driven by the wearing off of last year’s favourable base effect. More importantly,

however, growth in forward estimates continues to be in high double digits. We don’t expect

any large-scale upgrades from here on however, since competitive and input cost pressures

are on the rise for many sectors and analysts would likely wait for another quarter to assess

how these may impact operating margins and bottom-line. The main trigger for upward

revisions would likely be positive earnings surprise, much the same way it has happened for

many stocks such as Tata Motors and SBI post the 1Q11 results.

Fig 12 MSCI India 12M Forward EPS Estimate (% YoY)


Earnings upgrades have slowed down over the past 4 weeks

The MSCI India index has seen a marginal decline in 1 year forward EPS estimates over the

past 4 weeks, driven by Telecom (-17.8%) and Materials (-6.6%) while Industrials (16.6%)

and Healthcare (1.5%) saw upgrades. This compares with an improving outlook for other

markets; 0.8% for China, 2.6% for emerging markets, 4.1% for Asia ex-Japan and 0.9% for

the S&P 500.

Fig 13 Earnings Revision Balance* by Sector (4-week change in estimates)

* (No. of upgrades - No. of Downgrades)/Total no. of Estimates


-40

-30

-20

-10

0

10

20

30

40

50

60


% yoy

9.55.1 3.5 1.3

-3.2 -3.6 -3.7

-10.7-13.8 -14.5

-19.2

-44.0-50

-40

-30

-20

-10

0

10

20

Indu

stria

ls

Hea

lth

Mat

erials IT

MSCI I

ndia

Finan

ce

Sense

x

Energ

y

Con

s. D

isc.

Con

s. S

tap.

Utilities

Telec

om

% Net Balance

Growth in 12-month

forward EPS

estimates has come

off its peak

Earnings upgrades

have slowed down

over the past 4

weeks driven by

Telecom and

Materials


24 August 2010 13

Fig 14 MSCI India Sectors EPS Estimates

12M Trailing EPS

FY11 EPS Est

4-Wk % Chg in Est

FY12 EPS Est

4-Wk % Chg in Est

Long Term Fwd EPS

Growth Rate (%)

Consumer Discretionary 24.2 29.2 0.7 33.2 0.8 13.8 Consumer Staples 7.9 9.9 -1.5 11.5 -1.5 19.5 Energy 59.6 92.7 0.7 113.9 2.1 19.5 Financials 170.3 217.3 0.8 275.1 0.1 24.2 Healthcare 29.4 34.2 1.7 39.6 -0.6 20.0 Industrials 41.6 69.0 15.8 94.1 14.7 25.2 IT 29.0 30.9 -0.1 36.0 -0.1 16.2 Materials 52.4 82.4 -6.8 100.5 -4.8 14.9 Telecom 7.1 3.5 -17.8 3.8 -18.7 1.3 Utilities 34.8 42.2 -1.6 48.7 -1.7 16.3


Sensex Earnings Estimate

Our FY11 EPS forecast for the Sensex is Rs1090, reflecting a 12% growth over FY10 EPS

while consensus is currently 4% below our estimate. But we believe there are certain

upgrades yet to be reflected in consensus estimates (such as SBI and Tata Motors) and there

may be an upside to their numbers. Our one year forward Sensex target is 19500, reflecting a

mid-cycle PE estimate of 18X, which we believe is fair given India’s current growth potential.

Fig 15 Sensex Estimates – Macquarie vs Consensus

Company Bloomberg Code FY11 EPS Est

4-Wk % Chg in

Est

Macquarie Est

Macquarie vs Consensus

Est.

Macquarie Rating

ACC Ltd ACC IN Equity 70.1 1.2 75.5 7.7 Underperform BHEL BHEL IN Equity 113.1 0.0 111.9 -1.1 Neutral Bharti Airtel Ltd BHARTI IN Equity 20.3 -2.5 20.9 3.1 Underperform Cipla Ltd/India CIPLA IN Equity 14.5 -0.8 14.1 -2.7 Underperform DLF Ltd DLFU IN Equity 13.9 -6.3 13.6 -2.2 Outperform HDFC Bank Ltd HDFCB IN Equity 89.0 0.0 85.1 -4.4 Outperform Hero Honda Motors Ltd HH IN Equity 117.9 -3.8 113.6 -3.7 Underperform Hindalco Industries Ltd HNDL IN Equity 15.6 7.8 17.5 11.9 Outperform Hindustan Unilever Ltd HUVR IN Equity 10.1 -4.1 10.2 0.2 Underperform HDFC HDFC IN Equity 23.2 0.1 21.6 -6.9 Outperform ICICI Bank Ltd ICICIBC IN Equity 45.9 0.6 45.7 -0.4 Outperform Infosys Technologies Ltd INFO IN Equity 122.0 0.1 117.8 -3.4 Outperform ITC Ltd ITC IN Equity 6.2 0.0 6.4 2.6 Outperform Jaiprakash Associates JPA IN Equity 5.1 -5.1 6.8 32.1 Outperform Jindal Steel & Power Ltd JSP IN Equity 48.8 0.2 54.6 11.8 Outperform Larsen & Toubro Ltd LT IN Equity 71.4 2.7 75.5 5.7 Outperform Mahindra & Mahindra Ltd MM IN Equity 44.1 5.8 41.9 -4.9 Outperform Maruti Suzuki India Ltd MSIL IN Equity 86.5 -3.6 82.4 -4.7 Underperform NTPC Ltd NATP IN Equity 12.0 -2.2 11.7 -1.9 Outperform Oil & Natural Gas Corp ONGC IN Equity 114.4 -0.7 119.0 4.0 Neutral Reliance Communications Ltd

RCOM IN Equity 10.3 -17.8 10.2 -1.1 Outperform

Reliance Industries Ltd RIL IN Equity 68.4 -2.2 73.4 7.3 Outperform Reliance Infrastructure RELI IN Equity 62.4 -0.4 NA NA Not Rated State Bank of India SBIN IN Equity 186.7 2.9 217.7 16.6 Underperform Sterlite Industries India STLT IN Equity 16.1 -28.3 14.7 -8.6 Outperform TCS TCS IN Equity 40.6 0.4 37.6 -7.3 Outperform Tata Motors Ltd TTMT IN Equity 90.4 61.9 104.0 15.1 Outperform Tata Power Co Ltd TPWR IN Equity 76.2 -0.3 79.3 4.0 Outperform Tata Steel Ltd TATA IN Equity 62.6 1.0 80.3 28.3 Outperform Wipro Ltd WPRO IN Equity 21.9 0.7 20.8 -5.0 Outperform SENSEX Sensex Index 1046.4 0.2 1090.0 4.2


Our FY11 EPS

forecast for the

Sensex is Rs1090,

reflecting a 12% yoy

growth over FY10

EPS


24 August 2010 14

Fund Flows

Foreign Institutional Investor (FII) Flows have been Strong Lately

In June and July, valuation concerns amongst investors saw funds flowing to other Asian and

emerging market economies that are currently at cheaper valuations relative to India.

However, recently flows to India have picked up again. Year-to-date, India has seen the

highest amount of net inflows amongst peers at nearly US$12bn. On the other hand domestic

mutual funds have been net sellers in excess of US$300m, year-to-date. In the last 7 days

domestic mutual funds have redeemed US$12m while FIIs have pumped in around US$1bn.

Fig 16 Foreign and Domestic Institutional Fund Flows

Source: Bloomberg, BSE, Macquarie Research, August 2010

And Excessive Inflows in the Past Have Indicated Future Modest Returns

High liquidity has resulted in excessive fund inflows making the market more volatile. In many

cases the market has moved up too quickly, making valuations look unattractive as too much

money ended up chasing stocks. In the past, excessive flows have signalled modest returns in

the following 12 months. We do see support, however, from domestic investors who have been

net sellers lately and would likely be waiting on the sidelines to enter at more attractive levels.

Fig 17 FII Inflows and Forward Returns Fig 18 12M Forward PE and Forward Returns

Source: Bloomberg, BSE, Macquarie Research, August 2010 Source: Bloomberg, BSE, Macquarie Research, August 2010

-10

-5

0

5

10

15

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Rs bn

-4

-3

-2

-1

0

1

2

3

4

5

FII Net Inflows (12 week rolling sum, LHS)

Domestic MFs, net equity purchases (12 week rolling sum, RHS)

Rs bn

-90

-40

10

60

110

160

Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10

% yoy, 1Y Fwd

-15

-10

-5

0

5

10

15

20

US$ bn,

inverted

Sensex 1Y Fwd Returns (lhs) 120 Day Rolling Net FII Inflows (rhs)

-80

-60

-40

-20

0

20

40

60

80

100

120


% yoy, 12M Fwd

7

9

11

13

15

17

19

21

23

25

PE Ratio ,

Inverted

Sensex 12M Fwd Returns (lhs) 12M Fwd PE Ratio (rhs)

Year-to-date, India

has seen the

highest amount of

net inflows amongst

peers at nearly

USD12bn

Excessive Inflows in

the Past Have

Indicated Future

Underperformance


24 August 2010 15

However FDI Flows have been Encouraging

FDI flows were resilient throughout the slowdown period and seem poised to increase in line

with our expectation of a pick up in the investment cycle. India is better off now compared to

late 2008 when it had to deal with high global risk aversion at a time when the domestic

investment cycle was at its peak. Further, the shock in 2008 came after multi-year increasing

capital inflows that hit investment hard when they reversed suddenly. The ongoing focus on

infrastructure development and faster progress on the reforms front would likely continue to

attract FDI through the course of the year.

Fig 19 FDI Inflows

Source: CMIE, Macquarie Research, August 2010

External Shocks Seem More Manageable Now

India is less dependent on exports than most other Asian economies. That low

dependence is the reason why the export-driven hit to the Indian economy was relatively

modest during the post-Lehman global downturn. Admittedly, that low dependence was

also the reason why the sequential export-driven rebound was not as significant as it was

for India’s export-driven neighbours.

Fig 20 Asia Exports as a % of GDP*

*As of end 2008

Source: ADB, Macquarie Research, August 2010

0

1

2

3

4

5

6

Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10

US$ bn

25 50 75 100 125 150 175 200

India

Indonesia

Philippines

China

Korea

Taiwan

Thailand

Malaysia

Singapore

% of GDP

FDI flows were

resilient throughout

the slowdown

period

India is less

dependent on

exports than most

other Asian

economies


24 August 2010 16

However exports to Europe are high: While India is less dependent on exports, the

reported proportion of its exports bound for Europe is higher than that of other Asian

economies; India exports around 22% of its total goods to Europe. While this share

appears high relative to the rest of Asia, the difference is mainly because other countries

are more intricately tied in with each other’s export cycles and with China’s, so that

bilateral trade data do not give an accurate picture of dependence on Europe. For example

electronics, where India is not an important part of the supply chain for electronics, so its

export trends are less correlated with those of other Asian economies that are major

exporters of these products.

Fig 21 Exports by Destination

Asia Europe North and Central

America

Middle East

South America

Africa Oceania Rest of the world

China 40.3 23.7 22 4.4 2.9 2.9 1.8 1.9 Hong Kong 66.8 13.6 12.8 1.7 0.9 0.6 1.6 2.1 India 35.4 22.7 15.2 15.8 2.4 5.7 1 1.8 Indonesia 63.5 12.7 10.9 3.7 1.2 1.6 3.4 3 Korea 51 15.6 16.2 5.3 2.7 2.7 2.2 4.2 Malaysia 60.9 11.7 15 3.5 0.6 1.3 4.3 2.7 Philippines 67.9 11.4 14.4 1 0.3 0.3 1.5 3.1 Singapore 66.1 10.1 10 2.5 0.5 1.7 5.7 3.3 Taiwan 66.3 11.7 13.9 2.2 1.7 1.1 1.7 1.3 Thailand 54.7 14.9 13.2 5.4 1.7 3.3 4.9 2 *As of end 2008

Source: ADB, Macquarie Research, August 2010

Volatile Capital Flows Increase Vulnerability: While India is less dependent on external

trade flows, the economy is more dependent on capital flows. In addition, while the

economic cycle of India is not highly correlated (although the correlation has increased as

the economy has enhanced its export orientation in recent years) with that of the rest of the

world, the equity market is more highly correlated than the real economy with external

drivers, especially shifting global risk appetite. That in turn causes shifting capital inflows to

have real economy-wide effects, depending on the magnitude of the reversal in flows.

Fig 22 Sensex and INR Movements

Source: CMIE, Bloomberg, Macquarie Research, August 2010

And make exchange rate management an arduous task: Risk aversion in global

markets, more recently due to the European debt problems, has tended to make capital

flows to India fairly volatile. This has posed a problem as the equity market and the Rupee

are more highly correlated with such flows than the real economy. Managing such

movements in the Rupee becomes a challenging balancing act between managing liquidity

in the market and the impact it has on the export sector.

8000

10000

12000

14000

16000

18000

20000

22000

2006 2007 2008 2009 2010

Index

38

40

42

44

46

48

50

52

54

USD/INR, inverted

Sensex Index (LHS) USD-INR (RHS, inverted)

India exports

around 22% of its

total goods to

Europe

While India is less

dependent on

external trade flows,

the economy is

more dependent on

capital flows

Risk aversion in

global markets,

more recently due to

the European debt

problems, has

tended to make

capital flows to India

fairly volatile


24 August 2010 17

Risk Aversion has also impacted inflow of long term capital (FDI) but it has held up

much better annually: Annual FDI flows have been resilient and seem poised to increase

in line with our expectation of a pick up in the investment cycle. India is better off now

compared to late 2008 when it had to deal with the heightened global risk aversion at a

time when the domestic investment cycle was at its peak. Further, the shock in 2008 came

after multi-year increasing capital inflows that hit investment hard when they reversed

suddenly.


24 August 2010 18

Themes to Play

Investment, Consumption, Reforms

In the aftermath of the global crisis India undertook measures to counter the headwinds

emanating from a bruised global financial system as well as the worst drought since 1972.

These measures, while timely and necessary, took India a bit off-track from the policy

objectives it had set out to achieve. However, it is important to appreciate that the majority of

the economic outcomes for India following the crisis were less negative than expected. And

we are now moving into a trajectory where the positive outcomes, especially on investment

and domestic consumption, will likely surprise on the upside.

Investment: The growth trajectory has shifted up towards 8% and industrial activity has

gained more traction, both in capital goods and consumer goods. We see capex cycle

picking up and also notice increased focus on infrastructure development by the government.

Execution remains the key differentiator. We prefer L&T and JSPL on this play.

Domestic Consumption: Rural demand helped sustain consumption despite a drought

year and is expected to contribute strongly to consumption in the next few years. We

prefer ITC and M&M to play rising rural consumption. Urban demand also looks set to

rebound on an improving job market, higher incomes and softening food inflation. Some of

the important consumption indicators like auto sales have already shown good momentum.

Reforms - Necessary to sustain the pace of growth: Many reforms have seen

significant progress – such as Direct Tax Code, GST and Fuel Price Deregulation -- GAIL

and BPCL are our top picks on fuel subsidies reform. In addition, certain measures

that have been part of the Government’s plan for a while now, need to be fast-tracked and

implemented. These are:

a) A fiscal policy that is focused on creating productive assets and bringing down the

ballooning fiscal deficit

b) Better supply-side management of essential items such as food-grains to avoid

wastage

c) An effective approach to managing movements in the rupee due to volatile capital

inflows while at the same time making the export sector more competitive

Fig 23 Domestic Fixed Capital Formation Fig 24 Private Consumption

Source: CMIE, Macquarie Research, August 2010 Source: CMIE, Macquarie Research, August 2010

0.0

2.0

4.0

6.0

8.0

10.0

12.0

00 01 02 03 04 05 06 07 08 09 10 11E 12E

% yoy

-5.0

0.0

5.0

10.0

15.0

20.0

% yoy

GDP Growth (lhs) Gross Fixed Capital Formation (rhs)

0

2

4

6

8

10

12

01 02 03 04 05 06 07 08 09 10 11E 12E

% yoy

Real GDP Growth Private Consumption

India’s structural growth story is

driven by strong rural consumption growth, rebound in

industrial activity and a relatively

stable government with a reform focus


24 August 2010 19

Theme 1: Investment Corporate capex poised to grow: Past few quarters have signalled corporate intent to

invest in capex owing to strong domestic demand growth seen since last year. As demand

picks up, firms will have little choice but to go ahead with higher levels of investment, which in

any case will continue to get the boost from the ongoing higher spending on infrastructure.

Fig 25 Corporate Capex* Trend Appears Positive

*Non-financial companies under Macquarie coverage


Thrust on infrastructure: The focus on infrastructure development continues with the

government’s allocation around Rs. 1.7 trillion towards development of roads, ports,

airports and railways in both rural and urban areas, which accounts for 46 per cent of the

total plan allocations for FY11. The 11th 5-year Plan (ending FY12) targets infrastructure

investment at 9% of GDP -- from 5% in the previous Plan – which implies an investment of

Rs20tr (or US$430bn), which is unlikely to be achieved, but spending will still jump

significantly over the prior Plan.

Fig 26 Capital Raised by Various Sectors from Primary Capital Markets


0

400

800

1200

1600

2000

2400

2800

2007 2008 2009 2010 2011E 2012E

Rs bn

3-year Average

0

10

20

30

40

50

60

70

80

Manufacturing Mining Electricity Construction

Rs bn

FY08

FY09

FY10

As demand picks

up, firms will have

little choice but to

go ahead with

higher levels of

investment

The 11th 5-year Plan

targets

infrastructure

investment at 9% of

GDP from 5% in the

previous Plan


24 August 2010 20

Buyers of late-cycle sectors

Given the way demand has shaped up since last year and the expected pick-up in capex we

would prefer to buy into the long-term opportunity that capital goods and infrastructure sectors

currently offer. Order inflows spanning a variety of projects have picked up. At the same time

project execution has improved, particularly for some of the bigger companies.

Fig 27 Order Inflow and Execution have picked up


Sector and Stock Preferences on the Infrastructure Theme

Fig 28

Company Ticker Recommendation Target Price

Upside Rationale

Crompton Greaves

CRG IN Outperform 327 15% Top pick in T&D space, several levers to deliver margin surprise

GAIL India GAIL IN Outperform 548 17%

- An oligopolistic player, poised to double its transmission volumes over the next few years - Stands to benefit from the proposed exemption from subsidy burden

GVK Power and Infra

GVKP IN Outperform 53 16% Top pick in developer space - several triggers in the next 9-12months

Jindal Steel and Power

JSP IN Outperform 968 41%

- Largest private sector resource owner with lowest cost of steel production - Power capacity set to increase five-fold over the next four years

L&T LT IN Outperform 2006 7% Top pick in large cap, revival in execution to aid revenue growth of 28% and earnings growth of 30% in FY11


For a detailed discussion on the Investment cycle see Appendix 1.

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10

Rs. bn

15

25

35

45

55

65

75

% yoy

Projects added during the qtr (lhs)

Projects implemented during the qtr (% yoy, rhs)

We would prefer to

buy into the long-

term opportunity

that capital goods

and infrastructure

sectors currently

offer


24 August 2010 21

Theme 2: Consumption

Favourable demographics: India currently enjoys favourable dynamics in terms of its

population demographics. While the majority of the population, which is in the high

consumption bracket, will continue to drive consumption growth, the evolving trend on

working-age population will continue to support higher economic growth.

Fig 29 Favourable demographics of India

Source: CEIC, UN, Macquarie Research, August 2010

Rural rules! Despite bad monsoons last year, consumption in rural India grew at a healthy

pace. Some of the dynamics that have favourably impacted rural consumption:

Rural employment guarantees (NREGA): played a crucial role in a drought year by

supplementing rural household incomes. Since women form a significant portion of the

NREGA workforce, whatever they earn works out as additional income for the household.

Income from previous season’s production was boosted by rising prices of foodgrains.

Farm loan waiver: The Government’s approximately Rs650bn farm loan waiver,

announced in 2008, which was in effect an income transfer scheme

Higher Minimum Support Prices (MSP): Higher support prices for crops, which act as a

benchmark for market prices, have been increasing since the past few years. Recently the

Government raised the support prices of rice and pulses ahead of the Kharif crop season.

Fig 30 NREGA Scheme helped supplement rural household income

Source: NREGA website, Macquarie Research, August 2010

0

50

100

150

200

250

300

350

400

2006-07 2007-08 2008-09 2009-10

10

15

20

25

30

35

40

45

50

55Expentiture (in Rs bn, LHS)

No. of man-days of work (in mn, LHS)

No.of households provided employment (in mn, RHS)

The evolving trend

on working-age

population will

continue to support

higher economic

growth

Despite bad

monsoon last year,

consumption in

rural India grew at a

healthy pace


24 August 2010 22

Urban Consumers to Bounce Back: We expect urban consumption to stage a comeback

on an improving job market, higher incomes and softening food inflation over the course of

the year. Most consumption indicators, such as auto sales, have been very robust over the

past few quarters. In addition the AC Nielsen consumer confidence survey for Q2 CY2010

showed that Indian consumers were the most optimistic lot in terms of economic growth, job

prospects and their intention to spend on discretionary items over the next 12 months.

Fig 31 AC Nielsen Consumer Confidence Survey

Source: The Nielsen Company, Macquarie Research, August 2010

Good monsoon season should ease food inflation: Last year’s drought was tough for the

urban consumer as food inflation remain stubbornly high. However, we expect food inflation

to ease during the course of the year which would have a favourable impact on private

consumption. After getting off to a slow start, monsoon picked up significantly in the month of

July, which is an important crop sowing period. Currently monsoon is just 5% below its long

term average and the prospects look good for a good harvest this year.

Fig 32 Rainfall Distribution has been favourable this Monsoon

Source: IMD, Macquarie Research, August 2010

80

85

90

95

100

105

110

115

120

125

130

India

Indonesia

Norw

ay

Philippin

es

Austr

alia

Saudi

Ara

bia

Bra

zil

Chin

a

Sin

gapore

UA

E

Glo

bal

Avera

ge

Index

Improving job

market, higher

incomes and

softening food

inflation should help

urban consumption

Monsoon picked up

significantly in the

month of July,

which is an

important crop

sowing period


24 August 2010 23

Both Consumer Staples and Discretionary Should Benefit; however we are cautious given their extended run

The structural underpinnings of the consumption theme should ensure both consumer

staples and discretionary would benefit. These sectors have had a great run and have

significantly outperformed the market over the past few months.

Consumer staples, due to their inherent defensive nature, have been doing well for some

time now while the outperformance in the early cycle consumer discretionary has come

about since the recovery process gained momentum.

However, competitive pressures and high input costs in these sectors are forcing margins

down. In addition, there’s the risk of rising interest rates slowing down discretionary

spending.

Therefore, we doubt whether these sectors would be able to lead the market up further.

Nevertheless, we do find compelling stories within these sectors and recommend stocks

that are closely geared to the structural drivers of consumption growth, primarily rural.

Fig 33 Stocks With Significant Exposure to the Rural Consumption Theme

Company Ticker Recomm. Target Price Upside Rationale

Dabur DABUR IN Outperform 235 14% - Skincare, oral care and health supplements product penetration still low in rural India.

- Any meaningful rise in penetration of these products in rural India would benefit Dabur as its consumer care segment contributes 71% of total sales

Emami HMN IN Outperform 550 19% - Key new distribution initiatives to facilitate quick marketing response,

better inventory management and increased rural contribution

- Planning to boost sales force by 500 to expand rural reach and semi-urban hubs with 5,000 populations

ITC ITC IN Outperform 187 15% - Virtual monopoly in cigarettes

- Non-cigarette businesses to report strong cyclical growth

- Direct play on strong domestic consumption growth

Mahindra & Mahindra

MM IN Outperform 740 20% - Strong brands, new products to drive growth in auto space

- Tractor segment to benefit from rising rural wealth and PTL merger

Marico MRCO IN Outperform 145 13% - Dominates Coconut oil market and strong brand equity for its flagship brand, Parachute

- Has built multiple growth drivers like international business, Kaya, value added hair oil

Maruti Suzuki India

MSIL IN Underperform 1170 -6% - Product portfolio is dominated by entry-level compact cars

- Low overall cost of ownership and hence, have been the preferred products for first-time car buyers in rural areas

- However, high input costs, increased competition and royalty issues makes the stock look expensive

Hero Honda HH IN Underperform 1630 -15% - Largest number of products in the economy and executive motorcycle

categories

- Derives around 40% of sales from rural areas, expected to increase this to 50% in the next three to five years

Hindustan Unilever

HUVR IN Underperform 210 -22% - Long-term strategy of a product portfolio straddling consumer pyramid should help tap rural consumption boom

- Medium-term outlook will remain sluggish due to heightened competition


For a detailed discussion on Consumption see Appendix 2.

The structural

underpinnings of

the consumption

theme should

ensure both

consumer staples

and discretionary

would benefit


24 August 2010 24

Theme 3: Key Reforms

GST: Overall, a unified tax system for goods and services would definitely be beneficial in the

long run as it would plug the current deficiencies in the system and make it more efficient. More

specifically, it would facilitate better administration of indirect taxes, improve compliance and

diminish the cascading effect of multiple taxes, as is the case presently. The modalities of the

GST rates and administration have not been finalised yet and are subject to agreement

between both the centre and the states. However, the government’s proposal of an initial 20%

rate and eventually converging to 16% in 3 years has broadly found acceptance amongst tax

experts. Although the exact impact will be known once it is finalised, an initial look into the

current tax system indicates that consumer sectors such as FMCG and automobiles might

benefit more than other sectors. A single GST rate here would be less than the current effective

rate due to the current multiplicity of taxes. Services would become more expensive as the GST

rate is sure to be greater than the current service tax of 10%, and hence would be negative.

Direct Tax Code: The draft of the new tax code has undergone changes since it was first

introduced last year. That is because some contentious issues were either withdrawn or

modified in accordance with suggestions from experts and members of the public. Any

significant modifications from its original form would mean adding exceptions and provisions,

which would be a complete departure from the whole idea of a simple tax structure, in our

view. At the same time it could impact market sentiment due to a) higher tax burden on FIIs,

b) the intended benefit of the DTC not being met and c) potential impact on the fiscal deficit. A

simple and efficient tax structure would put more money into the hands of people and also

increase government revenues due to a widening tax base and greater compliance. This

would positively impact private consumption and bring down the overall fiscal deficit.

Fuel subsidies: The government has already taken the first step towards deregulating prices

of petrol (gasoline), diesel and kerosene, although not to the full extent of the amount

suggested by the Kirit Parekh committee report. There have been wide-scale protests from

the opposition but the government has taken a hard stand on this one for now. This is positive

for all oil companies but would benefit the downstream companies more than the upstream

players. It would also allow private players to re-enter the fuel retail business as they would

now be able to sell them at market driven prices. However, most PSU oil companies have not

seen the benefit since the remaining subsidy has not been paid by the government yet.

Disinvestment: The Government has set itself a disinvestment target of Rs400bn in FY11

compared to Rs250bn it earned in FY10. So far the Government has raised Rs10.8bn

through divestment of its stake in Satluj Jal Vidyut Nigam and closed the IPO for Engineers

India, while the others in the pipeline are Coal India, Hindustan Copper, SAIL, Power Grid,

IOC, Manganese Ore India Ltd, RINL, MMTC and SCI. While it was earlier expected that a lot

of PSU paper would hit the market post the announcement of new public holding norms,

recently the government has agreed to relax the norms for PSUs to a public holding limit of at

least 10%, to be met over 3 years. For others, it continues to remain at 25%, to be achieved

over 3 years; however norms have been relaxed to the extent that the compulsory annual

offer of at least 5% per annum is no longer applicable. This is positive, in our view, since it

would prevent a surge of equity issuance from hitting the market all at once.

Overall, we believe the impact of the reforms currently being pursued would be most beneficial for consumption and oil stocks.

GST would facilitate

better

administration of

indirect taxes,

improve compliance

and diminish the

cascading effect of

multiple taxes

A simple tax

structure would

increase

government

revenues by

widening the tax

base and ensuring

greater compliance

Oil marketing

companies would

benefit the most

from fuel price

deregulation

The Government

has set itself a

disinvestment target

of Rs400bn in FY11

compared to

Rs250bn it earned in

FY10


24 August 2010 25

Fig 34 Stocks that may benefit from tax reform and fuel deregulation

Company Name Bloomberg Code Recommendation - Name Price Target Price* Potential Upside

BJAUT Bajaj Auto BJAUT IN Underperform 2120 2795 -24% BPCL Bharat Petroleum BPCL IN Outperform 742 698 6% DABUR Dabur DABUR IN Outperform 235 206 14% GAIL GAIL India GAIL IN Outperform 548 468 17% HDFCB HDFC Bank HDFCB IN Outperform 2570 2231 15% HH Hero Honda HH IN Underperform 1630 1916 -15% HMN Emami HMN IN Outperform 550 463 19% HPCL Hindustan

Petroleum HPCL IN Outperform 491 509 -4%

HUVR Hindustan Unilever

HUVR IN Underperform 210 269 -22%

ICICIBC ICICI Bank ICICIBC IN Outperform 1100 995 11% IOCL Indian Oil IOCL IN Outperform 430 392 10% ITC ITC ITC IN Outperform 187 163 15% MM Mahindra &

Mahindra MM IN Outperform 740 618 20%

MRCO Marico MRCO IN Outperform 145 128 13% MSIL Maruti Suzuki

India MSIL IN Underperform 1170 1239 -6%

OINL Oil India OINL IN Outperform 1567 1437 9% ONGC Oil and Natural

Gas Corporation ONGC IN Neutral 1127 1258 -10%



24 August 2010 26

Introducing Our Model Portfolio We believe the market has limited upside in the medium term as most positive momentum

factors are priced in. At the same time we would view any near term correction as healthy and

an opportunity to enter the market. In the longer term we remain positive on India’s prospects

as there are a number of triggers that have the potential to play out.

At the macro level, the liquidity driven surge in the market has played out, in our view, and

we think it is time now to start focusing on structural factors that would drive certain sectors

and stocks.

We have included stocks in our portfolio that fit our themes the best and are positioned to

show superior growth over the long term.

In addition, given the current uncertain global environment, we strongly believe that

focusing on the domestic structural growth drivers makes utmost sense. Hence it is

advisable to take shelter under safe domestic plays, and our portfolio is strongly biased

towards this theme.

Sector Recommendation

Our sector preference accounts for the following factors:

1. Gearing to domestic growth

2. Relative growth potential

3. Profitability

4. Valuation

Fig 35 Sector Recommendations

Benchmark Weight in MSCI India

Weight in Macquarie Portfolio

Relative to Benchmark

Consumer Staples 6.0 5.6 Underweight Consumer Discretionary 4.9 4.7 Neutral Energy 14.2 14.3 Neutral Finance 27.5 27.2 Neutral Healthcare 3.7 3.9 Overweight Industrials 10.1 10.8 Overweight Information Technology 16.8 16.2 Neutral Materials 10.6 11.3 Overweight Telecom 0.7 0.5 Underweight Utilities 5.6 5.5 Neutral Total 100.0 100.0


Sector Performance, Valuation and Growth

Broad based: As is the case in most market bounce-backs, the recovery has been more

or less broad-based and across all sectors, except telecom.

Somewhat Predictable: However, in terms of sector leadership, it has been a somewhat

predictable outcome with the early-cycle consumer discretionary and financials

outperforming relative to the market while the late cycle industrial underperforming the

market.

Valuations are high in certain sectors but growth potential remains: In terms of

valuation, most sectors are now trading near or above their long term range. Market

participants appear cautious at current levels as they look for new triggers for the market to

move up further.

We would view any

near term correction

as healthy and an

opportunity to enter

the market

We believe gearing

to domestic growth

is an important

criterion for relative

outperformance


24 August 2010 27

Fig 36 MSCI Sector Performance (% return)

India 1M 3M 6M 1Y YTD

Consumer Discretionary 0.2 11.1 20.9 42.7 13.0 Consumer Staples 5.5 19.3 19.1 27.4 16.0 Energy -4.5 3.5 5.1 5.3 -5.1 Financials 6.6 19.6 23.7 29.2 16.6 Healthcare -0.2 4.5 8.3 42.3 5.2 Industrials 1.6 14.0 13.1 20.9 5.0 IT 0.4 9.8 7.5 39.2 7.2 Materials 0.3 5.3 -0.7 25.3 -8.5 Telecom -13.6 20.9 3.0 -32.4 -2.8 Utilities -2.5 2.3 2.8 0.1 -8.0 Market 1.3 11.2 11.6 22.8 4.9


Fig 37 12 month Forward PE Ratio (MSCI India)

Fwd PE Avg +1stdev Spread Against Avg Spread against +1stdev

Consumer Staples 23.9 24.5 31.5 -0.7 -7.6 Consumer Discretionary 15.0 16.6 22.2 -1.7 -7.2 Energy 12.4 10.4 14.1 2.0 -1.7 Finance 18.8 11.5 17.4 7.3 1.4 Healthcare 20.1 22.4 30.2 -2.3 -10.1 Industrials 19.3 15.1 20.5 4.2 -1.2 Information Technology 20.0 20.9 26.2 -0.9 -6.2 Materials 9.6 10.3 12.3 -0.7 -2.7 Telecom 13.1 12.6 21.2 0.5 -8.1 Utilities 16.7 11.0 16.0 5.7 0.7 Market 16 14.7 17.6 1.3 -1.6


Fig 38 Price to Book Ratio (MSCI India)

PBK Avg +1stdev Spread Against Avg Spread against +1stdev

Consumer Staples 7.6 10.6 14.1 -3.0 -6.5 Consumer Discretionary 5.1 3.1 4.6 2.0 0.5 Energy 2.4 2.5 3.5 -0.1 -1.1 Finance 2.7 2.2 3.4 0.5 -0.7 Healthcare 5.1 6.1 7.8 -1.0 -2.7 Industrials 4.3 3.4 5.9 0.9 -1.6 Information Technology 6.0 7.0 9.5 -1.0 -3.5 Materials 2.4 2.2 3.2 0.2 -0.7 Telecom 0.9 2.4 4.1 -1.5 -3.2 Utilities 2.5 1.8 2.6 0.7 -0.1 Market 3.2 3.1 4.12 0.1 -0.9


Fig 39 Growth and Profitability (MSCI India)

Consensus Avg Expected Long-Term Growth

ROE PEG

Consumer Staples 19.5 25.8 1.2 Consumer Discretionary 13.8 28.9 1.1 Energy 19.5 12.2 0.6 Finance 24.2 11.2 0.8 Healthcare 20.0 22.3 1.0 Industrials 25.2 14.3 0.8 Information Technology 16.2 29.0 1.2 Materials 14.9 16.0 0.6 Telecom 1.3 11.3 10.4 Utilities 16.3 12.8 1.0 Market 20.0 15.0 0.8


In terms of sector leadership, it has been a somewhat

predictable outcome with the

early-cycle consumer

discretionary and financials

outperforming the market

Valuations are high in certain sectors but

growth potential remains


24 August 2010 28

Fig 40 Model Portfolio

Sector / Stock Ticker % Weight in the MSCI Index

% Weight in Macquarie Portfolio

Deviation from Benchmark

Macquarie Recommendation

Consumer Staples MXIN0CS Index 6.0 5.6 -7% Hindustan Unilever Ltd HUVR IN Equity 2.0 1.0 -50% Underperform ITC Ltd ITC IN Equity 3.0 3.6 19% Outperform United Spirits Ltd UNSP IN Equity 1.0 0.5 -49% NR Marico MRCO IN Equity 0.0 0.5 - Outperform

Consumer Discretionary MXIN0CD Index 4.9 4.7 -3% Bajaj Auto Ltd BJAUT IN Equity 1.0 0.8 -19% Underperform Hero Honda Motors Ltd HH IN Equity 1.3 0.9 -29% Underperform Mahindra & Mahindra Ltd MM IN Equity 1.3 1.8 35% Outperform Maruti Suzuki India Ltd MSIL IN Equity 0.7 0.6 -17% Underperform Zee Entertainment Enterprises Ltd Z IN Equity 0.6 0.6 9% Underperform

Energy MXIN0EN Index 14.2 14.3 1% Bharat Petroleum Corp Ltd BPCL IN Equity 0.5 0.7 43% Outperform Cairn India Ltd CAIR IN Equity 1.1 1.0 -8% Underperform Oil & Natural Gas Corp Ltd ONGC IN Equity 2.0 2.0 -1% Neutral Reliance Industries Ltd RIL IN Equity 10.6 10.6 0% Outperform

Financials MXIN0FN Index 27.5 27.2 -1% Axis Bank Ltd AXSB IN Equity 2.3 2.1 -8% Neutral DLF Ltd DLFU IN Equity 1.1 0.9 -17% Outperform HDFC Bank Ltd HDFCB IN Equity 5.1 5.1 1% Outperform Housing Development & Infrastructure Ltd

HDIL IN Equity 0.3 0.1 -66% Outperform

Housing Development Finance Corp HDFC IN Equity 5.7 5.7 0% Outperform ICICI Bank Ltd ICICIBC IN Equity 6.6 7.2 10% Outperform IDFC Ltd IDFC IN Equity 1.5 1.4 -4% Neutral Indiabulls Real Estate Ltd IBREL IN Equity 0.5 0.3 -42% Outperform Kotak Mahindra Bank Ltd KMB IN Equity 0.9 1.1 20% Outperform Reliance Capital Ltd RCAPT IN Equity 0.6 0.5 -21% Underperform Rural Electrification Corp Ltd RECL IN Equity 0.6 0.8 25% NR State Bank of India SBIN IN Equity 1.5 1.5 0% Underperform Unitech Ltd UT IN Equity 0.8 0.5 -40% Outperform Bank of Baroda BOB IN Equity 0.0 0.2 - Outperform

Healthcare MXIN0HC Index 3.7 3.9 6% Cipla Ltd/India CIPLA IN Equity 0.8 0.3 -64% Underperform Dr Reddy's Laboratories Ltd DRRD IN Equity 1.1 1.6 42% Outperform Piramal Healthcare Ltd PIHC IN Equity 0.4 0.0 -100% Outperform Ranbaxy Laboratories Ltd RBXY IN Equity 0.4 0.6 44% Neutral Sun Pharmaceutical Industries Ltd SUNP IN Equity 0.9 0.9 -2% Neutral Glenmark GNP IN Equity 0.0 0.5 - Outperform

Industrials MXIN0IN Index 10.1 10.8 6% Adani Enterprises Ltd ADE IN Equity 0.8 0.3 -62% NR Aditya Birla Nuvo Ltd ABNL IN Equity 0.3 0.3 19% NR Bharat Heavy Electricals Ltd BHEL IN Equity 2.4 1.8 -26% Neutral Jaiprakash Associates Ltd JPA IN Equity 1.0 0.7 -28% Outperform Larsen & Toubro Ltd LT IN Equity 3.1 4.0 29% Outperform Siemens India Ltd SIEM IN Equity 0.5 0.1 -79% Underperform Suzlon Energy Ltd SUEL IN Equity 0.3 0.0 -100% Underperform Tata Motors TTMT IN Equity 1.9 2.3 23% Outperform GVK Power and Infra GVKP IN Equity 0.0 1.3 - Outperform

Information Technology MXIN0IT Index 16.8 16.2 -3% HCL Technologies Ltd HCLT IN Equity 0.5 0.2 -63% Outperform Infosys Technologies Ltd INFO IN Equity 10.7 10.5 -2% Outperform Satyam Computer Services Ltd SCS IN Equity 0.4 0.2 -52% NR Tata Consultancy Services Ltd TCS IN Equity 3.4 3.6 6% Outperform Wipro Ltd WPRO IN Equity 1.7 1.7 0% Outperform

Materials MXIN0MT Index 10.6 11.3 7% ACC Ltd ACC IN Equity 0.4 0.2 -48% Underperform Ambuja Cements Ltd ACEM IN Equity 0.6 0.6 -5% Neutral Hindalco Industries Ltd HNDL IN Equity 1.7 1.8 9% Outperform Jindal Steel & Power Ltd JSP IN Equity 2.1 2.8 32% Outperform JSW Steel Ltd JSTL IN Equity 0.8 0.8 1% Outperform Sesa Goa Ltd SESA IN Equity 0.9 0.5 -44% NR Steel Authority of India Ltd SAIL IN Equity 0.7 0.3 -59% Neutral Sterlite Industries India Ltd STLT IN Equity 1.8 2.0 11% Outperform Tata Steel Ltd TATA IN Equity 1.2 2.0 62% Outperform United Phosphorus Ltd UNTP IN Equity 0.4 0.3 -16% NR Telecom Services MXIN0TC Index 0.7 0.5 -29% Reliance Communications Ltd RCOM IN Equity 0.7 0.5 -29% Outperform

Utilities MXIN0UT Index 5.6 5.5 -1% GAIL India Ltd GAIL IN Equity 1.5 2.0 37% Outperform GMR Infrastructure Ltd GMRI IN Equity 0.5 0.5 1% Neutral NTPC Ltd NATP IN Equity 1.5 1.2 -18% Outperform Reliance Infrastructure Ltd RELI IN Equity 0.9 0.2 -78% NR Reliance Natural Resources Ltd RNR IN Equity 0.2 0.0 -100% NR Tata Power Co Ltd TPWR IN Equity 1.1 1.3 24% Outperform Adani Power ADANI IN Equity 0.0 0.3 - Outperform

MSCI India MXIN Index 100.0 100.0



24 August 2010 29

Macquarie Top 10 Recommended Stocks

We recommend a concentrated list of stocks for those looking for absolute returns from good

quality stocks. The recommended list consists of stocks that we believe are ahead of their

peers in terms of earnings visibility and growth potential.

Fig 41 Macquarie Top 10 Stocks

Company Name Recommend. FY11 PE

FY11 Price/Book

FY11 Est. ROE

Potential Upside

Rationale

Dr. Reddy's Outperform 22.0 4.5 23.2 13% - Among the best proxies to play growth opportunities in the global generics space

GAIL India Outperform 14.6 2.9 21.4 17% - An oligopolistic player, poised to double its transmission volumes over the next few years,

- Stands to benefit from the exemption from subsidy burden

ICICI Bank Outperform 21.8 2.0 9.5 11% - Improving asset quality and steadily rising ROE driven by improvements in NIMs and margin ratios

ITC Outperform 25.5 7.8 32.1 15% - Virtual monopoly in cigarettes - Non-cigarette businesses to report strong cyclical growth - Direct play on strong domestic consumption growth

Jindal Stl and Power Outperform 12.6 4.2 39.2 41% - Largest private sector resource owner (2.5bn tonnes of coal and 1bn tonne of iron ore) with lowest cost of steel production

Larsen & Toubro Outperform 24.8 4.5 19.9 7% - Top pick in large cap, revival in execution to aid revenue growth of 28% and earnings growth of 30% in FY11

Mahindra & Mahindra Outperform 14.7 3.7 27.4 20% - Strong brands, new products to drive growth in auto space - Tractor segment to benefit from rising rural wealth - New business initiatives to add value in medium term

Tata Power Outperform 16.3 2.4 15.9 26% - Organic, low-risk growth driving EPS growth of 22% over next two years (PER from 16x to 11x). Maithon added in FY11 and higher coal pricing flowing through

Tata Steel Outperform 6.5 1.7 28.7 49% - Tata Steel is trading at a discount of 32% to its Indian peers. It is the cheapest steel stock regionally at these levels

- Consensus underestimating the profitability of European arm - Major milestones in FY12 have the potential to re-rate

operating margins by 400–500bp

TCS Outperform 23.1 6.4 31.0 10% - Has done a commendable job of expanding operating margins by 310 bp in FY10

- Greatest geographic dispersion including a focus on India



24 August 2010 30

Sector Summary

Autos

Analyst: Sanjay Doshi

[email protected]

Sector View

Remain cautious: Expect earnings growth to moderate from FY10 levels.

Recommend investors look at stocks that have a clear visibility on earnings growth

Volumes growth to slow down: Volume growth to slow down in FY11 as the pent-up

demand effect wears off and fiscal and monetary stimuli are gradually withdrawn

Negative impact on margins due to rising raw material prices and increasing

competition: Rising prices of steel, aluminium and tyres along with increasing

competition will be negative, particularly for the two wheeler players

Top Picks:

Mahindra & Mahindra (MM IN)

Target Price: INR740; Potential Upside: 20%

Strong brands, new products to drive growth in auto space

Tractor segment to benefit from rising rural wealth and PTL merger

New business initiatives to add value in medium term

Tata Motors (TTMT IN)


Significant benefit from the revival in sales in the domestic and developed markets on

the back of a macroeconomic recovery.

Aggressive cost-cutting measures being undertaken at Jaguar Land Rover should

further aid earnings growth over the next couple of years

Fig 42 Auto Stocks Under Coverage

Company Name Bloomberg Code

Recommend. FY11 PE FY11 Price/Book

FY11 Est. ROE

Price Target

Price Potential Upside

Ashok Leyland AL IN Neutral 15.6 2.3 15.3 69.5 70 0% Bajaj Auto BJAUT IN Underperform 18.4 9.2 60.1 2120 2795 -24% Hero Honda HH IN Underperform 16.9 7.8 54.2 1630 1916 -15% Mahindra & Mahindra MM IN Outperform 14.7 3.7 27.4 740 618 20% Maruti Suzuki India MSIL IN Underperform 15.0 2.6 18.7 1170 1239 -6% Tata Motors TTMT IN Outperform 9.8 4.3 55.0 1210 1015 19%


Autos have had a

great run since last

year and certain

headwinds are now

evident

Our top picks are

M&M, which is a

play on the rural

story, and Tata

Motors which has

been able to turn

around the JLR

business

successfully

Amongst other

stocks, royalty

issues aside, Maruti

should also benefit

from rising rural

demand

mailto:[email protected]


24 August 2010 31

Capital Goods / Infrastructure

Analyst: Inderjeet Singh Bhatia

[email protected]

Sector View

Execution bottomed out in 4QFY10: Domestic construction sector revenue growth at

22% in 4QFY10 against 10% in 9MFY10. Base effect to further accelerate growth in

FY11

Margins to remain stable: Margins are expected to remain stable across the E&C

space. Price variation clauses to absorb input price hikes. Operating leverage and soft

commodity prices to provide cushion to margins

Order books continue to remain healthy: Strong order inflow would aid revenue

growth in FY11. Speedy award of road contracts would add to order backlog in FY11

Top Picks:

Larsen & Toubro (LT IN)


Top pick in large cap, revival in execution to aid revenue growth of 28% and

earnings growth of 30% in FY11

Crompton Greaves India (CRG IN)


Top pick in T&D space, several levers to deliver margin surprise

GVK Power and Infrastructure (GVKP IN)


Top pick in developer space - several triggers in the next 9–12months

Fig 43 Capital Goods/Infra Stocks Under Coverage



FY11 Est. ROE

Price Target


ABB India ABB IN Underperform 31.0 5.7 19.8 499 773 -35% ICSA AURFI IN Outperform 4.1 0.8 20.3 197 128 54% BHEL BHEL IN Neutral 22.1 6.0 30.4 2297 2469 -7% Crompton Greaves CRG IN Outperform 19.2 5.6 33.1 327 285 15% GMR Infrastructure GMRI IN Neutral 82.4 3.2 4.0 57 63 -10% GVK Pwr and Infra GVKP IN Outperform 27.8 2.0 7.5 53 46 16% IVRCL IVRC IN Outperform 14.3 1.5 10.8 220 164 34% JP Associates JPA IN Outperform 18.2 3.0 17.5 152 123 23% Larsen & Toubro LT IN Outperform 24.8 4.5 19.9 2006 1869 7% Mundra Port & SEZ MSEZ IN Outperform 39.1 7.7 21.5 781 802 -3% Nagarjuna Const. NJCC IN Outperform 13.5 1.7 13.1 219 165 33% Patel Engineering PEC IN Outperform 13.2 1.8 14.5 483 402 20% Punj Lloyd PUNJ IN Underperform 24.0 1.2 5.2 80 116 -31% Siemens India SIEM IN Underperform 30.8 7.0 25.0 542 707 -23% Suzlon Energy SUEL IN Underperform nmf 1.0 -2.8 42 49 -15%


Execution is on

track while order

books remain

healthy and margins

remain stable

We see great upside

in L&T, CRG and

GVK

L&T vs BHEL – we

believe consensus

is overlooking lack

of growth in BHEL’s

order book



24 August 2010 32

Consumer

Analyst: Amit Mishra

[email protected]

Sector View

Remain positive: We believe this year’s bumper winter crop and normal monsoon

combined with an 8% increase in procurement prices will directly add US$6bn to rural

income in FY11.

Volumes growth to remain high: We expect FMCG growth to be driven by strong

volumes. Under-penetrated categories like skin care & packaged food - would drive

the sector growth.

Stock selection is key: We prefer companies that have greater exposure to India’s

rural markets with strong competitive positioning; it is critical in an environment where

input costs are likely to rise.

Top Picks

ITC Limited (ITC IN)


Virtual monopoly in cigarettes

Non-cigarette businesses to report strong cyclical growth

Direct play on strong domestic consumption growth

Marico (MRCO IN)


Robust pricing power in large brands: Dominates Coconut oil market (55% share)

and strong brand equity for its flagship brand, Parachute.

Diversification benefits of new ventures: Marico has built multiple growth drivers

like international business, Kaya, value added hair oil.

Fig 44 Consumer Stocks Under Coverage



FY11 Est. ROE

Price Target


Dabur DABUR IN Outperform 29.1 12.6 48.9 235 206 14% Emami HMN IN Outperform 29.0 10.3 36.9 550 463 19% Hindustan Unilever HUVR IN Underperform 26.4 19.0 77.0 210 269 -22% ITC ITC IN Outperform 25.5 7.8 32.1 187 163 15% Marico MRCO IN Outperform 25.8 9.3 40.7 145 128 13%


Growth in consumer

staples to remain

high due to higher

rural demand

ITC and Marico have

strong brands to

help them grow

We also like Dabur

and Emami while

HUL continues to

face headwinds

from greater

competition



24 August 2010 33

Financials

Analyst: Suresh Ganapathy / Mudit Painuly [email protected] [email protected] Sector View

Cautious on the sector: Several headwinds likely in the form of weaker than

expected loan growth, subdued NIMs and NPL increases from restructured assets

portfolio

Several negatives for state-owned banks: 1. Inability to raise lending rates

immediately in a rising interest rate environment 2. Unaccounted pension obligation

which could impact earnings by 10% for PSU banks 3. Much larger restructured asset

portfolios 4. Top management changes in few smaller banks

Prefer private banks over PSU banks: Private banks currently trading at historic low

premiums to PSU banks and the premium is expected to increase further

Top Picks

ICICI Bank (ICICIBC IN) Target Price: INR1100; Potential Upside: 11%

Improving asset quality and steadily rising ROE driven by improvements in NIMs and

margin ratios

HDFC Bank (HDFCB IN) Target Price: INR2570; Potential Upside: 15%

Stronger-than-peers deposit franchise; sharp improvement in productivity and

efficiency

Housing Development Finance Corp (HDFC IN) Target Price: INR710; Potential Upside: 11%

Could see mortgage disbursements above 20%. Other catalysts are disclosure of

embedded value and NBAP margin by its insurance subsidiary and its listing

Fig 45 Financial Stocks Under Coverage


Recommend. FY11 PE

FY11 Price/Book

FY11 Est. ROE

Price Target


Bank of India BOI IN Neutral 8.6 1.5 18.3 400 460 -13% Canara Bank CBK IN Underperform 7.5 1.3 18.3 405 527 -23% IDBI IDBI IN Underperform 11.2 1.1 11.3 105 132 -20% Power Finance POWF IN Outperform 14.0 2.4 18.7 380 333 14% Union Bank of India UNBK IN Underperform 8.8 1.5 18.4 271 363 -25% Axis Bank AXSB IN Neutral 18.1 3.0 17.8 1300 1366 -5% Bank of Baroda BOB IN Outperform 10.1 1.8 18.6 850 831 2% HDFC HDFC IN Outperform 16.0 5.4 19.2 710 640 11% HDFC Bank HDFCB IN Outperform 26.2 4.1 16.8 2570 2231 15% ICICI Bank ICICIBC IN Outperform 21.8 2.0 9.5 1100 995 11% IDFC IDFC IN Neutral 22.5 2.6 13.8 180 188 -4% Kotak Mahindra Bank KMB IN Outperform 21.2 2.9 15.9 930 862 8% Punjab National Bank PNB IN Outperform 9.5 1.8 20.5 1300 1193 9% Reliance Capital RCAPT IN Underperform 34.2 2.4 7.1 660 783 -16% State Bank of India SBIN IN Underperform 12.8 1.9 15.6 2300 2784 -17%


Cautious on the

sector owing to

weaker loan growth,

subdued NIMs and

NPL increases

Prefer private banks

over PSU banks

Amongst other

stocks we like Kotak

Mahindra Bank and

Punjab National

Bank




24 August 2010 34

IT Services

Analyst: Nitin Mohta

[email protected]

Sector View

Best play on global recovery: Expect global economic recovery to drive solid top-line

growth of 25% for sector leaders in FY3/11E

Euro concerns overplayed: Indian IT vendors have less than 5% revenue exposure

to PIIGS country and less than 10% revenue is billed in Euro.

Minimal risks to FY11E EPS: Prolonged European crisis could dent our above

consensus revenue growth forecasts. Even so, uncertain economic environment

implies depreciating USD-INR rate. As a result, we see minimal risks to our FY11 EPS

forecast.

Top Picks

TCS (TCS IN)


Sustained margin strength would drive re-rating: TCS has done a commendable

job of expanding operating margins by 310 bp in FY10. Preserving margins coupled

with solid revenue growth should drive outperformance

Greatest geographic dispersion including a focus on India.

HCL Technologies (HCLT IN)


Infrastructure management and EAS service offering differentiate vs. other Tier 2

players

Preferred pick to play rise in discretionary spend

Fig 46 IT Stocks Under Coverage



FY11 Est. ROE

Price Target


HCL Technologies HCLT IN Outperform 16.9 3.4 21.9 435 408 7% Infosys Technologies INFO IN Outperform 23.5 5.7 26.5 3120 2769 13% Mphasis MPHL IN Underperform 12.2 3.7 36.1 500 594 -16% Tata Consultancy Services

TCS IN Outperform 23.1 6.4 31.0 950 867 10%

Wipro WPRO IN Outperform 19.8 4.2 23.2 485 412 18%


Global trend in IT

spend seems to be

reviving

TCS on margins and

HCL on

discretionary spend

are our preferred

plays



24 August 2010 35

Metals and Mining Analyst: Rakesh Arora

[email protected]

Sector View

Positive supply demand fundamentals: Supply should remain constrained. On the

other hand, demand has remained strong, with GDP forecast of 8% and low per capita

consumption of all metals at a very low level

Low cost integrated producers: Indian base metal companies are at the low end of

the cost curve and are highly profitable

Prefer exposure in integrated companies: Getting access to resources is

increasingly getting difficult and integrated companies already have resources locked

in

Top Picks

Jindal Steel and Power (JSP IN)


Largest private sector resource owner (2.5bn tonnes of coal and 1bn tonne of iron ore)

with the lowest cost of steel production

Hindalco (HNDL IN)


Cheap valuations, and with a strong recovery at subsidiary Novelis, should see

continuing earnings upgrades

Gujarat NRE Coke (GNC IN)


Growing coking coal production from 1.2mtpa to 6mtpa in four years; developing about

550mt of coking coal reserves in Australia

Fig 47 Metals and Mining Stocks Under Coverage


Recommend. FY11 PE

FY11 Price/Book

FY11 Est. ROE

Price Target


Associated Cements ACC IN Underperform 11.4 2.3 22.2 771 869 -11% Ambuja Cements ACEM IN Neutral 14.5 2.5 18.5 118 121 -3% Gujarat NRE Coke GNC IN Outperform 9.6 2.3 26.3 101 60 69% Grasim Industries GRASIM IN Outperform 8.4 1.2 15.6 2400 2091 15% Hindalco Industries HNDL IN Outperform 9.2 1.4 16.2 205 178 15% Hindustan Zinc HZ IN Neutral 11.8 2.2 20.1 948 1122 -15% India Cements ICEM IN Underperform 17.6 0.8 4.6 94 111 -15% Jindal Steel and Power JSP IN Outperform 12.6 4.2 39.2 968 689 41% JSW Steel JSTL IN Outperform 10.7 1.5 17.4 1244 1138 9% National Aluminium Company

NACL IN Underperform 23.0 2.4 10.7 254 401 -37%

NMDC NMDC IN Underperform 13.3 5.1 44.6 237 258 -8% Steel Authority of India SAIL IN Neutral 9.1 2.0 23.5 208 192 9% Sterlite Industries STLT IN Outperform 10.8 1.5 13.4 213 160 33% Tata Steel TATA IN Outperform 6.5 1.7 28.7 776 520 49% Ultratech Cements UTCEM IN Underperform 14.3 2.3 22.6 831 948 -12%


We prefer exposure

in integrated

companies that

have resources

already locked in

Our top pick is JSP

which has large

resources and

lowest cost of steel

production



24 August 2010 36

Oil and Gas Analyst: Jal Irani

[email protected]

Sector View

Upstream: Bullish in the long run: Ramp-ups of hydrocarbon production by private

players (RIL, Cairn) hold centrestage, while the recent hike in APM gas prices have

lifted the gas subsidy burden off the PSU (ONGC, OIL) bottomlines

Downstream: Refining margins have resurrected providing relief to low-complexity

refineries (typically PSUs), while high complexity refineries look forward to a jump in

profits.

Midstream: Gas production ramp-up from KG D6 and incremental LNG

capacities to fulfil India's burgeoning gas demand is driving creation of

infrastructure as well as evolution of regulations regarding tariffs, etc.

Top Picks

GAIL India (GAIL IN)


An oligopolistic player, poised to double its transmission volumes over the next few

years,

Stands to benefit from the proposed exemption from subsidy burden (as per the Kirit

Parikh committee)

Reliance Industries (RIL IN)


Ramping up of KG D6 volumes, sharp resurrection of GRMs

Strong growth potential from upstream upsides

Removal of overhang regarding the RNRL dispute augurs well for RIL

Fig 48 Oil & Gas Stocks Under Coverage


Recommend. FY11 PE

FY11 Price/Book

FY11 Est. ROE

Price Target


Aban Offshore ABAN IN Neutral 7.6 1.3 17.5 914 832 10% Bharat Petroleum BPCL IN Outperform 11.5 1.6 14.7 742 698 6% Cairn India CAIR IN Underperform 18.4 1.8 10.1 251 344 -27% GAIL India GAIL IN Outperform 14.6 2.9 21.4 548 468 17% Hindustan Petroleum HPCL IN Outperform 9.2 1.3 14.7 491 509 -4% Indian Oil IOCL IN Outperform 10.9 1.7 16.0 430 392 10% Oil India OINL IN Outperform 11.3 2.2 20.4 1567 1437 9% Oil and Natural Gas Corporation

ONGC IN Neutral 10.6 2.7 26.9 1127 1258 -10%

Petronet LNG PLNG IN Underperform 16.0 3.1 20.9 70 110 -36% Reliance Industries RIL IN Outperform 13.5 1.9 14.9 1290 988 31%


Bullish in the long

run on upstream

while oil marketing

companies to

benefit from

deregulation of fuel

prices

GAIL, our top pick,

stands to benefit

from the proposed

exemption from

subsidy burden



24 August 2010 37

Pharma and Healthcare

Analyst: Abhishek Singhal

[email protected]

Sector View Positive outlook on Global generic pharmaceutical market, CRAMS and domestic

pharma consumption.

Sustained growth – for generics: Patent expiries, rapid expansion of the elderly

segment and increased prevalence of chronic diseases bode well for generics

Focus on profitable growth adopted by leaders in the sector has started to pay

dividends

Top Picks

Dr. Reddy's Laboratories (DRRD IN)

Target Price: INR1,500; Potential Upside: 13%

Among the best proxies to play growth opportunities in the global generics space

Glenmark (GNP IN)


We like GNP due to its credible innovation infrastructure (available as a free option),

emerging visibility of niche opportunities in the US, a receding debt overhang, and a

25% valuation discount to its peers

Jubilant (JOL IN)


Largest CRAMS player in India, low-cost manufacturing advantage (~1/7th the cost of

US); Visibility of financial discipline and receding debt overhang

Fig 49 Pharma and Healthcare Stocks Under Coverage


Recommend. FY11 PE

FY11 Price/Book

FY11 Est. ROE

Price Target


Cipla CIPLA IN Underperform 22.0 3.6 17.6 275 310 -11% Dr. Reddy's Laboratories

DRRD IN Outperform 22.0 4.5 23.2 1500 1326 13%

Glaxosmithkline Pharmaceuticals

GLXO IN Neutral 29.2 8.3 30.5 1900 2016 -6%

Glenmark Pharmaceuticals

GNP IN Outperform 20.2 2.6 14.5 380 282 35%

Jubilant Organosys JOL IN Outperform 11.4 2.2 21.8 430 332 30% Piramal Healthcare PIHC IN Outperform 17.8 4.9 30.4 600 494 21% Ranbaxy Laboratories

RBXY IN Neutral 36.3 3.5 11.1 450 493 -9%

Sun Pharmaceuticals SUNP IN Neutral 26.0 3.8 16.0 1700 1785 -5%


Sustained growth

for generics on

patent expiries,

rapid expansion of

the elderly segment

and increased

prevalence of

chronic diseases

Top picks are

DRRD, Glenmark

and Jubilant while

Piramal has fallen

out of favour due to

recent sell off of its

business



24 August 2010 38

Power

Analyst: Jeff Evans

[email protected]

Sector View

Ongoing merchant price strength: We are confident in buoyant merchant prices

driven by demand-supply deficit and ongoing supply constraints (fuel, funding, water,

approvals). Supports strong pricing.

Fuel Supply/Security: Lack of domestic coal supply vs. demand will boost thermal

imports and threaten new addition based on coal linkages. Preferred exposure to

plants with operating captive coal supply or competitive (lower-cost) imported fuel

source. Supports strong pricing and strategic stock selection.

Distribution reform: The elephant in the room. Longer-term, distribution reform is

needed to ensure pass-through of power costs to end-consumers.

Top Picks

Tata Power (TPWR IN)


Organic, low-risk growth driving EPS growth of 22% over next two years (PER from

16x to 11x). Maithon added in FY11 and higher coal pricing flowing through

Adani Power (ADANI IN)


Strong capacity growth in next 18 months, merchant exposure and imported fuel

source lowers risk. PER of 12x FY12

Fig 50 Power Stocks Under Coverage



FY11 Est. ROE

Price Target


NTPC NATP IN Outperform 16.4 2.3 14.9 258 193 34% Tata Power TPWR IN Outperform 16.3 2.4 15.9 1627 1289 26% Adani Power ADANI IN Outperform 38.0 4.6 12.9 141 140 1% Lanco Infratech LANCI IN Outperform 23.0 4.1 19.6 83 70 19% Power Grid Corporation of India

PWGR IN Underperform 19.1 2.2 12.7 83 103 -20%

Reliance Power RPWR IN Underperform 59.5 2.5 4.2 111 154 -28%


Longer-term,

distribution reform

is needed to ensure

pass-through of

power costs to end-

consumers

Tata Power offers

organic, low-risk

growth drivers over

next two years while

Adani is building

capacity in the next

18 months



24 August 2010 39

Real Estate

Analyst: Jal Irani

[email protected]

Sector View

Strong demand momentum continues in residential; signs of recovery visible in

commercial.

Home loan rate hikes likely to be gradual rather than sudden

Healthy balance sheet position will likely mitigate the risk of real estate lending

rates

Attractive valuations: Indian property companies trading at discount to NAV of ~35%

compared to Hong Kong and Singapore market which is trading at 10-25% discount

and US market which is trading at a significant 10–20% premium to NAV

Top Picks

DLF (DLFU IN)


Largest real estate developer, DLF remains the best play on Indian real estate

recovery

Successful residential launches combined with strong project pipeline provides

enhanced visibility of cash inflows

Comfortable balance sheet position. DLF’s current net debt/equity stands at 0.68x

Unitech (UT IN)


Highest ever sales achieved in FY10

Net debt/equity improved to ~0.5x from 1.5x in FY09 end

Fig 51 Real Estate Stocks Under Coverage


Recommend FY11 PE FY11 Price/Book

FY11 Est. ROE

Price Target


Anant Raj Industries ARCP IN Outperform 12.2 1.1 9.5 157 141 12% DLF DLFU IN Outperform 16.3 1.9 12.5 387 333 16% Housing Development and Infrastructure

HDIL IN Outperform 11.9 1.3 11.1 325 293 11%

Indiabulls Real Estate IBREL IN Outperform 25.7 0.9 3.4 226 192 18% Unitech Limited UT IN Outperform 19.1 1.6 8.9 101 85 19%


Real Estate has

bounced back on

strong demand and

valuations look

attractive

We view DLF and

Unitech as biggest

gainers due to their

improved balance

sheet position

strong sales



24 August 2010 40

Telecom

Analyst: Nitin Mohta

[email protected]

Sector View

Domestic story still bleak since pricing still has some downside led by postpaid price

correction when MNP gets implemented; new capacities still coming up from Tata

DoCoMo, Telenor, Videocon

In-market consolidation between any of the top seven wireless telcos is not

possible in the current regulatory framework, smaller players still adding capacity.

Balance sheets very stretched across the sector; post BWA auctions, Net

Debt/EBITDA may range between 2.5x (Bharti) to 5x (IDEA)

Equity dilution inevitable for RCOM and IDEA

Valuations highest in the region: EV/EBITDA at 7x, PER at 18-20x FY3/11E, zero

dividend yields

Top Pick:

Reliance Communications (RCOM IN)

Target Price: INR250; Potential Upside 54%

Second largest wireless telecom operator in India

TowerCo demerger in US$11bn deal with GTL Infra (GTLI IN, Not rated) with

indicative cash infusion of ~US$4bn to clear balance sheet overhang

Post GTLI deal, RCOM's leverage falling to 0.35x Net debt/Equity and 1.4x Net

debt/EBITDA FY3/11E

Fig 52 Telecom Stocks Under Coverage



FY11 Est. ROE

Price Target


Bharti Airtel BHARTI IN Underperform 14.8 2.7 19.4 280 310 -10% Idea Cellular IDEA IN Underperform 121.9 1.8 1.5 35 70 -50% Reliance Communications

RCOM IN Outperform 7.2 1.0 12.4 250 163 54%


Domestic story still

bleaksince pricing

still has some

downside led by

post-paid price

correction when

MNP gets

implemented

We see some

upside in RCOM

following the big

sell-off after the 3G

and BWA auctions



24 August 2010 41

Risks and Concerns Pace of Reforms

We believe that the single biggest factor that would enable growth to continue to scale the

upward trajectory would be an unfailing commitment towards reforms by the UPA

government. Governments in India, over time, have not managed to hold a great track record

of implementing reforms on time. However, details in the FY11 budget hold a lot of promise -

infrastructure is a key focus area, with planned expenditure for the sector up 17% YoY, it

accounts for 46% of total planned expenditure. The government has also stepped up its effort

to implement key reforms such as the goods and services tax (GST), the direct tax code, and

scaling back of oil and fertilizer subsidies. There is also hope that companies that are in the

disinvestment pipeline would go through as planned.

Fiscal Deficit

Fiscal deficit has ballooned over the past couple of years; however for good reasons.

Expansionary fiscal policy, along with the aggressive monetary easing, was critical in

cushioning the hit to the Indian economy from the global credit crisis. The consolidated

(federal plus states) fiscal deficit (including off-budget subsidy bonds) turned out to be around

9.6% of GDP in 2009–10 of which the federal government deficit was 6.5% of GDP. Fiscal

consolidation has to be a key focus now with a renewed focus on reforms particularly on

taxation, subsidies and disinvestment.

Fig 53 Fiscal Deficits


The federal fiscal deficit targets for FY11, FY12 and FY13 are 5.5%, 4.8% and 4.1% of GDP,

respectively. The Government has already raised more than Rs1tr from its 3G and BWA

auctions (against and estimate of Rs350bn), which should provide some cushion to its

spending over the course of the year. A number of disinvestment plans are also in the

pipeline that should augment government finances.

0

2

4

6

8

10

12

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

Federal Govt Consolidated

% of GDP, FY Mar end

India, over time, has

not managed to hold

a great track record

of implementing

reforms on time

The federal fiscal

deficit targets for

FY11, FY12 and

FY13 are 5.5%, 4.8%

and 4.1% of GDP,

respectively

Federal government

deficit was 6.5% of

GDP in FY10


24 August 2010 42

Fig 54 India Budget 2010–11

Source: CEIC, Ministry of Finance, Macquarie Research, August 2010

Inflation Worries

Inflation is a big worry on several counts – it may derail growth rising rates may cut into

investment and consumer spending. As we have noted recently, inflation drivers are now

shifting – food inflation has eased while, more importantly, non-food inflation has started to

pick up. The big swing in headline WPI inflation was initially driven by food prices that were

affected by last year’s drought and the fiscal boost that strengthened purchasing power.

Looking ahead, we believe a normal monsoon and better food stock management by the

government should ease food inflation.

Fig 55 Inflation remains a worry


-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

% yoy

CPI-Industrial Workers WPI

Inflation drivers are

now shifting from

food to non-food


24 August 2010 43

Fig 56 WPI Inflation - Key Contributors


Increase in Minimum Support Prices (MSPs) could be inflationary: Although food

inflation has been easing, the recent increase in MSPs for rice and pulses for the current

Kharif season could potentially be inflationary. One could argue that market prices of these

essential crops are way higher than the support prices offered. However, support prices

set the benchmarks for market prices and tend to drive them up whenever MSPs are

increased. In addition, the government’s management of food stocks needs a complete

overhaul. Large stocks of food grains lay rotting in godowns last year while food inflation

was on the rise. A better management of these stocks may have checked at least a part of

the price rise.

Fig 57 Minimum Support Prices of Kharif Crops

Kharif Crops Old MSP New MSP Increase

(Rs./Quintal) (Rs./Quintal) (%) Paddy 950* 1000 5.3 Arhar 2300 3000 30.4 Moong 2760 3170 14.9 Urad 2520 2900 15.1 Groundnuts 2100 2300 9.5 Sunflower Seeds 2215 2350 6.1 Soya beans 1390 1440 3.6 Sesamum 2850 2900 1.8 Niger Seeds 2405 2450 1.9

* Bonus of Rs. 50 payable in addition to MSP

Source: Department of Agriculture, India, Macquarie Research, August 2010

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10

pp contribution

Primary Articles Fuel-related Manufactured goods

Increase in MSPs

for rice and pulses

could potentially be

inflationary


24 August 2010 44

Fig 58 WPI Pulses and MSP


Monsoon has held up well this year: There were worries around monsoon season in

June as it got off to a slow start. However, over the past two months it has picked up

significantly and more importantly, the month of July, which is an important sowing period,

saw well distributed rainfall. So far, with the exception of Bihar, which has declared this

year as a drought year for the state, rainfall has been much better distributed compared to

last year. As per the latest data, rainfall since the beginning of June has been 5% below

normal with the eastern part of India showing deficiency.

Fig 59 Rainfall Deviation and Kharif Crop Production


-40

-20

0

20

40

60

80

100

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

% yoy

-10

0

10

20

30

40

% yoy

WPI (Pulses - Arhar) Increase in MSP (Pulses-Arhar)

90

95

100

105

110

115

120

125

FY04 FY05 FY06 FY07 FY08 FY09 FY10

Mill Tonnes

-25

-20

-15

-10

-5

0

5

10% Deviation

Kharif Foodgrains Production (lhs) % Deviation in Jun-Sep Rainfall (rhs)

The month of July,

which is an

important sowing

period, saw well

distributed rainfall


24 August 2010 45

Fig 60 Rainfall Deviation and WPI Mfg - Food


Monetary Policy – Striking a balance between inflation and growth

RBI has been on track: Interest rates have increased by 100–125 bps since March (repo

by 100 bps and reverse repo by 125bp) and RBI appears on track to tackle inflation that

has been stubbornly high for the past few months.

And faster tightening was never under question: While there was no doubting RBI’s

intention to raise interest rates, it is the pace of tightening that has been under debate.

Inflation has been sticky and its drivers are slowly shifting from food to non-food, indicating

price increases are slowly becoming more broad-based.

A slow down in growth is the biggest concern: While the RBI’s stance of moving on

rates has been credible in the face of persistent high inflation, it has raised concerns about

its impact on investment and consumption and on growth in general.

Fig 61 Key Interest Rates

Source: CMIE, Bloomberg, Macquarie Research, August 2010

-10

-5

0

5

10

15

20

25

30

1997 1999 2001 2003 2005 2007 2009

% YoY

-30

-25

-20

-15

-10

-5

0

5

10

% Deviation

WPI Mfg - Food (lhs) % Deviation from Normal Rainfall (rhs, inverted)

3

4

5

6

7

8

9

10

11

Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

%

Reverse repo rate Repo rate CRR

RBI appears on

track to tackle

inflation that has

been stubbornly

high for the past few

months


24 August 2010 46

Appendix 1 Investment Cycle Gradually Turning Up Domestic spending on private capex has been the main casualty of the global credit crisis.

Capex was affected by slowing demand (domestic and external), higher borrowing costs and

inadequate financing (domestic and external). This cycle seems to be turning now as

reflected in the FY10 GDP data -- the 7.4% growth was achieved on the back of a significant

pick up in investment and industrial activity. However, the strength of the upturn in the

investment cycle will be vital to sustain the higher economic growth trajectory. It is important

to bear in mind that it is still relatively early for the investment upturn to be in the strong

phase, as the turning point for the economy was not that long ago. There are compelling

reasons why we think that the turn in the investment cycle is sustainable. Our key assumption

is a scenario where gradual global recovery continues and risk aversion in capital markets,

due to worries around Eurozone debt problems, abates.

Economic growth trajectory shifting up towards 8% and beyond: Our GDP forecast

currently signals a shift towards realisable trend growth of 8% annually. At the same time

industrial production (IP) recovery is gaining more traction because of improving domestic

demand. In terms of external demand, even if global GDP growth remains subpar, it will

still be positive for industrial activity.

Fig 62 GDP and Gross Fixed Capital Formation


Fig 63 Investment cycle turning up


0.0

2.0

4.0

6.0

8.0

10.0

12.0

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E

% yoy

-5.0

0.0

5.0

10.0

15.0

20.0

% yoy

GDP Grow th (lhs) Gross Fixed Capital Formation (rhs)

Forecast

-5

0

5

10

15

20

25

Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10

% yoy

-5

0

5

10

15

20

% yoy

Gross Fixed Capital Formation 4-Qtr Moving Avg.

Remember to use

side comment.

The strength of the

upturn in the

investment cycle

will be vital to

sustain the higher

economic growth

trajectory


24 August 2010 47

Strong industrial activity and pick up in exports: Growth in industrial production has

shown good traction since 3QFY10 (latest reading for May shows 17.6% yoy growth),

driven primarily by manufacturing. The important trend here is the contribution from capital

goods and consumer goods which have featured prominently in sustaining this turnaround.

At the same time, exports have also shown a rebound, reflecting revival in external

demand.

Fig 64 Industrial Production and Exports


Corporate profit cycle improving: Recent corporate results have shown that order

inflows are increasing in the capital goods sector. At the same time project execution

improved, particularly for some of the the bigger companies, which bodes well for a pick up

in the capex cycle. As demand picks up, firms will have little choice but to go ahead with

higher levels of investment, which in any case will continue to get the boost from the

ongoing higher spending on infrastructure.

Fig 65 Improving profit cycle in the corporate sector*

* Macquarie coverage universe

Source: Company Data, Macquarie Research, August 2010

0

2

4

6

8

10

12

14

16

18


% yoy

-30

-20

-10

0

10

20

30

40

50

60

70

% yoy

Growth in Industrial Production, 3mma (lhs) Exports, 3mma (rhs)

0

2

4

6

8

10

12

14

2004 2005 2006 2007 2008 2009 2010 2011 2012

% yoy

-50

-30

-10

10

30

50

70

% yoy

GDP Grow th (lhs) PAT Grow th (rhs)

Forecast

Growth in industrial

production has

shown good traction

since 3QFY10

Recent corporate

results have shown

that order inflows

are increasing in the

capital goods sector


24 August 2010 48

Fig 66 Trends in Corporate Capex*

* Macquarie coverage universe

Source: Company Data, Macquarie Research, August 2010

Infrastructure spending to remain elevated: which would provide a cushion (but it may

not fully offset the initial hit to non-infrastructure capex). In the FY11 budget, the

Government has allocated around Rs1.7tr towards the developemnt of roads, ports,

airports and railways in both rural and urban areas, which accounts for 46% of the total

plan allocations. The 11th 5-year plan (ending FY12) targets infrastructure investment of

9% of GDP – from 5% in the previous plan – which implies an investment of Rs20tr (or

US$430bn), which is unlikely to be achieved, but spending will still jump significantly over

the prior plan.

Fig 67 Investment in new projects (Public and Private)


0

500

1000

1500

2000

2500

3000

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11E

Rs. bn

Corporate Capex

3 Year Avg.

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10

Rs. bn

15

25

35

45

55

65

75

% yoy

Projects added during the qtr (lhs)

Projects implemented during the qtr (% yoy, rhs)

The 11th 5-year plan

targets

infrastructure

investment of 9% of

GDP – from 5% in

the previous plan


24 August 2010 49

Fig 68 Government Expenditure in Key Infrastructure Areas (Rs bn)

Sector 2007-2008 2008-09 2009-10 2010-11 % Chg (FY10/FY09)

% Chg (FY11/FY10)

Railway 733 817 907 977 11.1 7.7 Roads and Bridges 167 186 220 250 18.6 13.3 Water Supply and Sanitation

32 36 69 95 92.5 39.0

Power 50 69 73 80 5.5 10.8 Civil Aviation 12 7 10 15 50.4 39.9 Irrigation 4 6 7 7 9.9 4.5 Ports & Light Houses 6 5 5 7 -14.2 47.7

Source: Government Budget Documents, Macquarie Research, August 2010

Risks of crowding out won’t materialise immdediately: High government borrowing

increases the risk of crowding out private investment; however it won’t be until next year

that we might see this impact materialising in our view. At the same time a pickup in

foreign capital inflows and revival of equity markets is likely to be positive for investment

spending. Aggressive monetary easing and sizeable fiscal stimulus have been the right

mix of policy response in the wake of the global crisis. However, the risk from current

elevated inflation levels has prompted the central bank to speed up the rate normalisation

process. Nevertheless, we believe the investment upturn is likely to strengthen despite the

gradual withdrawal of monetary and fiscal stimulus.

Fig 69 Government Borrowing from the Market and 10-Year Yield


0

200

400

600

800

1000

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Rs. bn

3

4

5

6

7

8

9

10

%

Government Market Borrowing (LHS) 10 Year Govt Bond Yield (RHS)

We believe the

investment upturn is

likely to strengthen

despite the gradual

withdrawal of

monetary and fiscal

stimulus


24 August 2010 50

Appendix 2 Consumption: Playing catch up The emerging India economy story is largely owing to the initiatives and drive of the private

businesses, with the households contributing to consumer spending as incomes rise, interest

rates decline structurally on a sustained basis, and access to credit increases. The slowdown

following the global credit crisis had a significant impact on urban spending which we think is

already on a road to speedy recovery owing to an improving job market, even as the evolving

rural consumption remains compelling. Also, the favourable dynamics for the evolving trend

on working-age population will continue to support higher economic growth.

Fig 70 Favourable demographics of India

Source: CEIC, UN, Macquarie Research, August 2010

Consumption growth indicators showing momentum

Private consumption is yet to catch up with the recent growth drivers of GDP growth -

manufacturing and private investment. However, this may change soon as a wider

improvement in economic activity coupled with a likely good monsoon season and softening

inflation should have a positive impact on private consumption. Most bellwether indicators of

consumption growth have turned and are now pointing in a positive direction. Growth in

automobile sales has shown great momentum in the past 6–8 months while cement

despatches have also started to move up. In addition, the volume of goods traffic on railways

is at a higher level than it was at the peak of the demand cycle in late 2007/early 2008.

Fig 71 Automobile sales growth


-100

-50

0

50

100

150

200

250


% yoy

-20

-10

0

10

20

30

40

50

60

70

% yoy

Passenger Vehicles

Commercial Vehicles

Total (rhs)

The slowdown

following the global

credit crisis had a

significant impact

on urban spending

Most bellwether

indicators of

consumption

growth have turned

and are now

pointing in a

positive direction


24 August 2010 51

Fig 72 Railways goods traffic and revenues


Rural all the way; urban catching up

The slowdown in growth last year hit the urban consumer the most, particularly the urban

poor. High food inflation persisted for most of the year partly due to the worst drought since

1972 – with rainfall around 23% below average – and partly due to the Government’s

inefficiency in the management of the food shortfall. In addition, there was a large number of

job losses reported as companies downsized their workforce to lower their operating costs.

Consumption, however, turned out better than expected due to demand growing higher in

rural India. Despite bad monsoons last year, consumption in rural India grew at a healthy

pace due to the following reasons:

Support from prior season’s harvest: Income from the previous season’s normal

production was boosted by rising prices of foodgrains

Farm loan waiver: The Government’s approximately Rs650bn farm loan waiver,

announced in 2008, which was in effect an income transfer scheme

Higher Minimum Support Prices (MSP): Higher support prices for crops, which act as a

benchmark for market prices, have been increasing since the past few years and are

unlikely to ever head south in the future. In a recent move the Government raised the

support prices of paddy to Rs1000 per quintal (Rs10/kg) , up from Rs950 per quintal

(Rs9.50/kg), while prices of pulses were increased in the range of Rs50–Rs700

(Rs0.50–Rs7/kg)

4000

4300

4600

4900

5200

5500


Rs. Cr

60000

65000

70000

75000

80000

'000 Tonnes

Railways' Earnings from Goods Traffic (3mma, lhs)

Goods Traffic on Railways (3mma, rhs)

Consumption turned

out better than

expected due to

demand growing

higher in rural India


24 August 2010 52

Fig 73 MSP for Rice and Wheat

Source: CMIE, CACP, Macquarie Research, August 2010

Rural employment guarantees (NREGA): played a crucial role in a drought year by

supplementing rural household incomes. The scheme provides 100 days of employment in

a year and upto Rs100 per day. Since women form a significant portion – and in many

states, the majority – of the NREGA workforce, whatever they earn works out as additional

income for the household.

Fig 74 NREGA helped cushion demand in a drought year


The focus on India’s rural market is not without reason. The rural market size in India is

estimated at Rs14tr compared to Rs16tr for urban India1. While rural India accounts for more

than two-thirds of India’s population it is only one-third of its national income. At the same

time, according to NCAER estimates, the bottom 80% of India’s population constitutes 65% of

the total consumption, and a significant portion of this group resides in rural India2.

1 Market Skyline of India, 2008-09, Indicus Analytics; Source: Financial Express article, dated Thursday, 31

December 2009 2 According to NCAER estimates; Source: Financial Express article, dated Thursday, 31 December 2009

4

5

6

7

8

9

10

11

12

2004 2005 2006 2007 2008 2009 2010 2011

Rs./Kg

Rice (Paddy) Wheat

NREGA played a

crucial role in a

drought year by

supplementing rural

household incomes

While rural India

accounts for more

than two-thirds of

India’s population it

is only one-third of

its national income

http://www.financialexpress.com/news/the-rural-consumer/561671/




24 August 2010 53

Urban consumer will find a way back We expect urban consumption to stage a comeback on an improving job market, higher

incomes and softening food inflation over the course of the year.

Higher expected growth to drive consumption: GDP growth is poised to accelerate to

8–9% over the next couple of years, led by domestic demand, especially the anticipated

upturn in private investment spending. Government consumption will gradually ease, but

private consumption, especially in urban areas, is likely to recover as the labour market

improves.

Fig 75 Private consumption


Food inflation expected to ease: Last year was tough for the urban consumer as inflation

remained stubbornly high, owing mostly to high food prices. There was a kind of income

redistribution in terms of the pass-through of higher prices to the farm sector that helped

sustain rural consumption while impacting urban consumption. However, food inflation has

started to ease which would have a favourable impact on private consumption.

Fig 76 Food Products Inflation Easing


-5

0

5

10

15

20

25

30


% YoY

WPI Mfg - Food

WPI Mfg - Non-Food

Private

consumption in

urban areas is likely

to recover as the

labour market

improves

Food inflation has

started to ease

which would have a

favourable impact

on private

consumption


24 August 2010 54

Consumer Confidence back to pre-recession levels: The AC Nielsen consumer

confidence survey, conducted in 1Q10 amongst internet consumers from 55 countries,

showed that Indian consumers turned out to be the most upbeat lot in terms of the state of

domestic economic growth, job prospects and their intention to spend on discretionary

items over the next six months. Moreover, global confidence also improved dramatically

compared to 3Q09, although it was largely skewed towards the east as western countries

reel under sluggish growth post the financial crisis.

Fig 77 Top 10 Countries in AC Nielsen Consumer Confidence Survey, April 2010

Source: The Nielsen Company, Macquarie Research, August 2010

Urban Consumption Prospects are better over the Longer Term

With growing industrialisation, there will be increasing urbanisation over time. And with

growing incomes of the maturing middle class segment, the importance of the urban

consumer will continue to gain prominence. Recent research has shown that of the total

urban income, 61% comes from households that can be classified as middle class3.

Fig 78 Shifting demographics

Source: Business Monitor International, Macquarie Research, August 2010

3 Market Skyline of India, 2008-09, Indicus Analytics

80

85

90

95

100

105

110

115

120

125

130In

dia

Indonesia

Norw

ay

Philippin

es

Austr

alia

Saudi

Ara

bia

Bra

zil

Chin

a

Sin

gapore

UA

E

Glo

bal

Avera

ge

Index

0

10

20

30

40

50

60

70

80

2005 2010f 2020f 2030f

% of Total

% Urban Population % Rural Population

Rural % estimated to decline

from 70% to 60% in 20 years

Indian consumers

turned out to be the

most upbeat lot in

the AC Nielsen

consumer

confidence survey

With growing

industrialisation,

there will be

increasing

urbanisation over

time


24 August 2010 55

Over the longer term, strong underlying economic growth, increasing wealth of expanding

middle and upper middle class segments, and the greater availability of personal credit will

provide the required impetus for sales of consumer goods and services to grow. According

to estimates from Business Monitor International, retail sales are estimated to grow from

Rs16.26tr (US$353.01bn) in 2010 to Rs25.02tr (US$543.15bn) by 2014.

Fig 79 Per Capita GDP and Retail Sales

Source: Business Monitor International, Macquarie Research, August 2010

0

500

1000

1500

2000

2500

2007 2008 2009 2010f 2011f 2012f 2013f 2014f

US$

0

100

200

300

400

500

600

US$

GDP per Capita (lhs) Retail Sales per Capita (rhs)

Over the longer term

increasing wealth of

expanding middle

class segments will

provide the required

impetus for

consumption to grow


24 August 2010 56

Appendix 3: Performance, Valuation and Earnings Estimates Market Performance

Fig 80 MSCI India Fig 81 MSCI India Relative to China

Source: Bloomberg, MSCI, Macquarie Research, August 2010 Source: Bloomberg, MSCI, Macquarie Research, August 2010

Fig 82 MSCI India Relative to Emerging Markets Fig 83 MSCI India Relative to Asia ex-Japan


Fig 84 Performance of Global Equity Indices (% return)

Index 1M 3M 6M 1Y YTD MSCI India 2.8 10.8 12.3 25.2 5.1 MSCI China 3.3 9.1 6.4 6.6 -3.5 MSCI EM 4.3 12.7 6.5 18.8 0.5 MSCI Asia EM 4.2 10.4 9.3 18.2 1.4 MSCI Asia ex-Japan 4.2 10.6 9.4 17.2 1.6 MSCI World 1.2 4.1 -2.4 4.1 -5.3 S&P 500 -0.7 0.4 -3.0 6.8 -3.5 FTSE 100 1.4 2.7 -2.7 9.6 -3.7 Nikkei 225 -1.3 -8.5 -9.3 -11.6 -13.0


85

89

93

97

101

105

Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10

Index

90

95

100

105

110


Index

90

95

100

105

110


Index

90

95

100

105


Index


24 August 2010 57

Market Valuation

Fig 85 MSCI India 12 Month Forward PE Fig 86 Sensex 12 Month Forward PE


Fig 87 MSCI India Relative to Emerging Markets: 12 Month Forward PE

Fig 88 MSCI India Relative to Asia ex-Japan: 12 Month Forward PE


Fig 89 Global Index Valuations

12M Fwd PE Price-to-Book EV/EBITDA Div Yield ROE

MSCI India 16.0 3.2 13.5 1.0 15.2 MSCI China 12.3 2.4 8.0 2.3 14.2 MSCI EM 10.6 2.0 11.6 2.2 13.2 MSCI Asia EM 11.7 2.1 8.1 2.1 12.8 MSCI Asia ex-Japan 12.2 2.0 8.6 2.2 11.9 MSCI World 12.0 1.7 11.3 2.6 10.3 S&P 500 12.9 2.0 9.7 2.1 NA FTSE 100 10.6 1.8 9.5 3.6 NA Nikkei 225 16.3 1.2 8.3 1.9 NA


5

10

15

20

25

1996 1998 2000 2002 2004 2006 2008 2010

Ratio

Average +1 Stdev -1 Stdev

5

10

15

20

25


Ratio

Average + 1 Std Dev -1 Std Dev

0.2

0.6

1.0

1.4

1.8

1996 1998 2000 2002 2004 2006 2008 2010

Ratio


0.2

0.6

1.0

1.4

1.8

1996 1998 2000 2002 2004 2006 2008 2010

Ratio



24 August 2010 58

Sector Performance Relative to Market

Fig 90 MSCI Cons. Discretionary Relative to Market Fig 91 MSCI Consumer Staples Relative to Market


Fig 92 MSCI Energy Relative to Market

Fig 93 MSCI Financials Relative to Market


Fig 94 MSCI Healthcare Relative to Market

Fig 95 MSCI Industrials Relative to Market


95

100

105

110

115

120

125


Index

95

100

105

110

115

120


Index

95

98

101

104

107

110


Index

95

99

103

107

111

115


Index

95

100

105

110

115

120


Index

100

105

110

115

120


Index


24 August 2010 59

Fig 96 MSCI IT Relative to Market Fig 97 MSCI Materials Relative to Market


Fig 98 MSCI Telecom Relative to Market Fig 99 MSCI Utilities Relative to Market


Fig 100 India Sector Performance (% return)

1M 3M 6M 1Y YTD

Consumer Discretionary 0.2 11.1 20.9 42.7 13.0 Consumer Staples 5.5 19.3 19.1 27.4 16.0 Energy -4.5 3.5 5.1 5.3 -5.1 Financials 6.6 19.6 23.7 29.2 16.6 Healthcare -0.2 4.5 8.3 42.3 5.2 Industrials 1.6 14.0 13.1 20.9 5.0 Information Technology 0.4 9.8 7.5 39.2 7.2 Materials 0.3 5.3 -0.7 25.3 -8.5 Telecom -13.6 20.9 3.0 -32.4 -2.8 Utilities -2.5 2.3 2.8 0.1 -8.0 Market 1.3 11.2 11.6 22.8 4.9


95

98

101

104

107

110


Index

90

95

100

105

110

115

120


Index

85

90

95

100

105

110

115


Index

85

95

105

115

125


Index


24 August 2010 60

Fig 101 India Sector Performance Relative to Emerging Markets (%)

1M 3M 6M 1Y YTD

Consumer Discretionary -3.3 -4.6 7.1 13.3 6.0 Consumer Staples 3.3 2.5 6.2 -9.1 6.0 Energy -3.4 -4.5 8.2 1.6 4.7 Financials 7.1 7.3 15.3 10.7 15.5 Healthcare -2.2 -1.6 6.9 23.0 0.6 Industrials -2.0 -4.9 4.7 3.1 -1.6 IT 0.1 4.9 7.2 21.1 12.8 Materials -0.9 -7.9 -4.7 2.7 -7.9 Telecom -15.3 9.5 -3.1 -38.2 -6.6 Utilities -2.8 -6.4 -0.1 -9.8 -7.1 Market 0.6 -0.2 6.5 6.0 5.0


Fig 102 India Sector Performance Relative to Asia ex-Japan (%)

1M 3M 6M 1Y YTD

Consumer Discretionary -5.0 -4.8 5.0 9.3 1.4 Consumer Staples 2.5 1.5 6.8 -7.9 6.4 Energy -4.6 -3.0 1.8 -7.2 -2.3 Financials 6.2 8.7 16.6 16.8 17.3 Healthcare -3.1 -0.8 3.8 7.1 0.7 Industrials -2.4 -4.0 4.5 4.1 -2.8 IT 0.0 4.8 7.6 20.0 12.9 Materials -3.7 -10.9 -5.7 2.3 -8.0 Telecom -16.1 10.2 -3.4 -37.7 -10.7 Utilities -2.6 -2.9 -2.1 -8.7 -10.6 Market -0.3 0.3 5.4 6.2 3.8



24 August 2010 61

Sector 12 Month Forward PE Ratio Relative to Market

Fig 103 MSCI Cons. Discretionary Relative to Market

Fig 104 MSCI Consumer Staples Relative to Market


Fig 105 MSCI Energy Relative to Market

Fig 106 MSCI Financials Relative to Market


Fig 107 MSCI Healthcare Relative to Market

Fig 108 MSCI Industrials Relative to Market


0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

2000 2002 2004 2006 2008 2010

Ratio


0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

2000 2002 2004 2006 2008 2010

Ratio


0.0

0.2

0.4

0.6

0.8

1.0

1.2

2000 2002 2004 2006 2008 2010

Ratio


0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2000 2002 2004 2006 2008 2010

Ratio


0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

2.5

2000 2002 2004 2006 2008 2010

Ratio


0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2000 2002 2004 2006 2008 2010

Ratio



24 August 2010 62

Fig 109 MSCI IT Relative to Market Fig 110 MSCI Materials Relative to Market


Fig 111 MSCI Telecom Relative to Market Fig 112 MSCI Utilities Relative to Market


Fig 113 MSCI India Sector Valuations


Consumer Discretionary 15.0 5.1 10.8 1.1 28.9 Consumer Staples 23.9 7.6 21.7 1.6 25.8 Energy 12.4 2.4 11.0 0.9 12.2 Financials 18.8 2.7 NA 1.0 11.2 Healthcare 20.1 5.1 17.6 0.7 22.3 Industrials 19.3 4.3 17.5 0.7 14.3 Information Technology 20.0 6.0 17.6 1.0 29.0 Materials 9.6 2.4 8.1 0.9 16.0 Telecom 13.1 0.9 10.0 0.4 11.3 Utilities 16.7 2.5 14.4 1.1 12.8 Market 16.0 3.2 13.5 1.0 15.2


0.4

0.9

1.4

1.9

2.4

2.9

2001 2003 2005 2007 2009

Ratio


0.4

0.5

0.5

0.6

0.6

0.7

0.7

0.8

0.8

0.9

0.9

2000 2002 2004 2006 2008 2010

Ratio


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2000 2002 2004 2006 2008 2010

Ratio


0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2000 2002 2004 2006 2008 2010

Ratio



24 August 2010 63

Fig 114 MSCI India Sector Valuations Relative to Emerging Markets


Consumer Discretionary 1.3 2.1 1.2 -0.3 12.5 Consumer Staples 1.4 2.3 1.7 -0.2 9.5 Energy 1.8 1.7 1.7 -1.3 -2.5 Financials 1.6 1.4 NA -1.2 -1.5 Healthcare 1.1 1.3 1.2 0.1 5.2 Industrials 1.5 2.3 1.9 -0.9 3.6 Information Technology 1.8 2.6 2.5 -1.2 15.9 Materials 1.0 1.2 0.7 -1.1 5.0 Telecom 1.2 0.4 1.8 -3.4 -6.3 Utilities 1.4 2.0 1.7 -2.0 4.6 Market 1.5 1.6 1.2 -1.2 2.1


Fig 115 MSCI India Sector Valuations Relative to Asia ex-Japan


Consumer Discretionary 1.2 2.1 1.2 -0.4 12.3 Consumer Staples 1.5 2.3 1.5 -0.1 8.6 Energy 1.2 1.2 1.3 -1.4 -1.8 Financials 1.5 1.6 NA -1.3 1.0 Healthcare 1.0 1.1 0.9 0.1 4.0 Industrials 1.5 2.6 1.9 -1.0 5.6 Information Technology 1.8 2.6 2.5 -1.2 16.4 Materials 0.9 1.3 0.8 -1.2 2.7 Telecom 1.1 0.4 1.8 -3.5 -4.5 Utilities 1.1 1.5 1.3 -1.4 3.1 Market 1.3 1.6 1.6 -1.3 3.3



24 August 2010 64

12 Month Forward EPS Estimates (% YoY growth)

Fig 116 MSCI India Consumer Staples Fig 117 MSCI India Consumer Discretionary


Fig 118 MSCI India Energy Fig 119 MSCI India Financials


Fig 120 MSCI India IT Fig 121 MSCI India Materials


-30

-20

-10

0

10

20

30

40


% yoy

-40

-20

0

20

40

60

80

100


% yoy

-30

-10

10

30

50

70

90

110


% yoy

-50

-30

-10

10

30

50

70


% yoy

-40

-20

0

20

40

60

80


% yoy

-80

-60

-40

-20

0

20

40

60

80

100

120


% yoy


24 August 2010 65

Fig 122 MSCI India Telecom Fig 123 MSCI India Utilities


Fig 124 MSCI India 12 Month Forward EPS Estimates (% yoy)


Fig 125 Sector Earnings Revision Balance* (4 week change in estimates)

* (Total no. of upgrades – Total no. of downgrades)/Total no. of estimates


-100

-50

0

50

100

150

200

250

300

350


% yoy

-30

-20

-10

0

10

20

30

40


% yoy

-40

-30

-20

-10

0

10

20

30

40

50

60

2005 2006 2007 2008 2009 2010

% yoy

9.55.1 3.5 1.3

-3.2 -3.6 -3.7

-10.7-13.8 -14.5

-19.2

-44.0-50

-40

-30

-20

-10

0

10

20

Indu

stria

ls

Hea

lth

Mat

erials IT

MSCI I

ndia

Finan

ce

Sense

x

Energ

y

Con

s. D

isc.

Con

s. S

tap.

Utilities

Telec

om

% Net Balance


24 August 2010 66

Fig 126 Sector 12 Month Forward EPS Estimates

12M Trailing EPS

1Y Fwd EPS Est

4-Wk % Chg in Est

2Y Fwd EPS Est

4-Wk % Chg in Est

Long Term Fwd EPS

Growth Rate (%)

Consumer Discretionary 24.2 29.2 0.7 33.2 0.8 13.8 Consumer Staples 7.9 9.9 -1.5 11.5 -1.5 19.5 Energy 59.6 92.7 0.7 113.9 2.1 19.5 Financials 170.3 217.3 0.8 275.1 0.1 24.2 Healthcare 29.4 34.2 1.7 39.6 -0.6 20.0 Industrials 41.6 69.0 15.8 94.1 14.7 25.2 IT 29.0 30.9 -0.1 36.0 -0.1 16.2 Materials 52.4 82.4 -6.8 100.5 -4.8 14.9 Telecom 7.1 3.5 -17.8 3.8 -18.7 1.3 Utilities 34.8 42.2 -1.6 48.7 -1.7 16.3


Fig 127 Index 12 Month Forward EPS Estimates

12M Trailing Index EPS

1Y Fwd Index EPS

Est

4-Wk % Chg in Est

2Y Fwd Index EPS

Est

4-Wk % Chg in Est

Long Term EPS Growth

Est.

MSCI India 38.2 41.5 -0.6 50.9 -0.1 22.5 MSCI China 4.1 4.6 1.0 5.4 0.6 19.8 MSCI EM 67.9 82.7 1.9 96.1 0.9 21.6 MSCI Asia EM 25.7 32.2 3.2 36.2 2.0 18.6 MSCI Asia exJap 32.4 37.7 3.1 42.2 2.0 17.8 MSCI World 73.5 86.5 1.2 99.8 0.2 13.8 S&P 500 75.3 83.3 0.7 96.0 0.1 11.3 FTSE 100 299.4 494.5 2.3 571.2 0.6 16.6 Nikkei 225 407.0 563.5 4.5 628.0 3.5 18.7



24 August 2010 67

Commodities and Currency Rates

Fig 128 Crude Oil WTI (US$/bbl) Fig 129 Gold (US$/Ounce)

Source: Bloomberg, Macquarie Research, August 2010 Source: Bloomberg, Macquarie Research, August 2010

Fig 130 LME Index Fig 131 CRB Index


Fig 132 Commodity Prices

Last Price Week-to-date %

change

1M % Change

3M % Change

6M % Change

1Y % Change

YTD % Change

Crude Oil 74 0.2 -6.8 0.6 -8.8 -7.3 -11.2 Gold 1227 -0.1 3.2 4.2 11.2 28.6 11.8 LME Index 3312 0.0 3.4 5.1 0.8 13.7 -2.7 CRB Index 453 1.2 7.5 5.7 7.1 19.5 7.5


70

75

80

85

90

95


US$/bbl

1060

1110

1160

1210

1260


US$/oz

2800

2900

3000

3100

3200

3300

3400

3500

3600

3700

3800


Index

400

410

420

430

440

450

460


Index


24 August 2010 68

Fig 133 USD-INR Fig 134 EUR-INR


Fig 135 GBP-INR Fig 136 JPY-INR


Fig 137 Currency Rates

Last Price Week-to-date %

change

1M % Change

3M % Change

6M % Change

1Y % Change

YTD % Change

USD-INR 46.6 0.1 0.6 0.7 -0.9 4.2 -0.3 EUR-INR 59.3 0.0 2.2 -2.0 5.5 17.3 12.4 GBP-INR 72.5 0.0 -0.3 -6.7 -1.6 10.0 3.7 JPY-INR 0.5 -0.5 -2.1 -5.2 -6.4 -6.2 -8.7 CAD-INR 44.6 -0.1 1.8 -0.9 -1.8 1.3 -1.0 AUD-INR 41.8 -0.2 0.8 -7.1 -1.3 -2.4 -0.2


44

45

45

46

46

47

47

48

48


USD/INR

55

57

59

61

63

65

67


EUR/INR

65

66

67

68

69

70

71

72

73

74

75


GBP/INR

0.47

0.48

0.49

0.50

0.51

0.52

0.53

0.54

0.55


JPY/INR


24 August 2010 69

Important disclosures:

Recommendation definitions

Macquarie - Australia/New Zealand Outperform – return >3% in excess of benchmark return Neutral – return within 3% of benchmark return Underperform – return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield

Macquarie – Asia/Europe Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie First South - South Africa Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie - Canada Outperform – return >5% in excess of benchmark return Neutral – return within 5% of benchmark return Underperform – return >5% below benchmark return

Macquarie - USA Outperform (Buy) – return >5% in excess of Russell 3000 index return Neutral (Hold) – return within 5% of Russell 3000 index return Underperform (Sell)– return >5% below Russell 3000 index return

Volatility index definition*

This is calculated from the volatility of historical price movements. Very high–highest risk – Stock should be expected to move up or down 60–100% in a year – investors should be aware this stock is highly speculative. High – stock should be expected to move up or down at least 40–60% in a year – investors should be aware this stock could be speculative. Medium – stock should be expected to move up or down at least 30–40% in a year. Low–medium – stock should be expected to move up or down at least 25–30% in a year. Low – stock should be expected to move up or down at least 15–25% in a year. * Applicable to Australian/NZ/Canada stocks only

Recommendations – 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations

Financial definitions

All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).

Recommendation proportions – For quarter ending 30 June 2010

AU/NZ Asia RSA USA CA EUR Outperform 50.55% 64.29% 54.41% 45.63% 65.08% 50.26% (for US coverage by MCUSA, 4.58% of stocks covered are investment banking clients)

Neutral 35.16% 17.15% 38.24% 47.91% 30.69% 35.16% (for US coverage by MCUSA, 5.56% of stocks covered are investment banking clients)

Underperform 14.29% 18.56% 7.35% 6.46% 4.23% 14.58% (for US coverage by MCUSA, 0.00% of stocks covered are investment banking clients)

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24 August 2010 70

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Conglomerates

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Leah Jiang (China) (8621) 2412 9020

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Jessie Qian (China, Hong Kong) (852) 3922 3568

Toby Williams (Japan) (813) 3512 7392

Lyall Taylor (Indonesia) (6221) 2598 8489

HongSuk Na (Korea) (822) 3705 8678

Edward Ong (Malaysia) (603) 2059 8982



Amit Mishra (India) (91) 22 6653 3051

Emerging Leaders

Jake Lynch (Asia) (8621) 2412 9007

Jonathan Hsu (China, Hong Kong) (852) 3922 4625

Minoru Tayama (Japan) (813) 3512 6058

Robert Burghart (Japan) (813) 3512 7853

Industrials

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Janet Lewis (Japan) (813) 3512 7475 Chang Han Joo (Korea) (822) 3705 8511


David Gambrill (Thailand) (662) 694 7753

Insurance

Makarim Salman (Japan) (813) 3512 7421

Media

Jessie Qian (China, Hong Kong) (852) 3922 3568

George Hogan (Japan) (813) 3512 7851 Prem Jearajasingam (Malaysia) (603) 2059 8989


Oil and Gas

Laban Yu (Asia) (852) 3922 4691

Christina Lee (Hong Kong) (852) 3922 3571 Jal Irani (India) (9122) 6653 3040 Polina Diyachkina (Japan) (813) 3512 7886

Shawn Park (Korea) (822) 3705 8669

Edward Ong (Malaysia) (603) 2059 8982 Sunaina Dhanuka (Malaysia) (603) 2059 8993


Trevor Buchinski (Thailand) (662) 694 7829

Pharmaceuticals

Christina Lee (Hong Kong) (852) 3922 3571 Abhishek Singhal (India) (9122) 6653 3052 Naomi Kumagai (Japan) (813) 3512 7474

Property

Callum Bramah (Asia) (852) 3922 4731

Eva Lee (China, Hong Kong) (852) 3922 3573

Hiroshi Okubo (Japan) (813) 3512 7433 Chang Han Joo (Korea) (822) 3705 8511

Alex Pomento (Philippines) (632) 857 0899 Tuck Yin Soong (Singapore) (65) 6231 2838

Elaine Cheong (Singapore) (65) 6231 2839 Corinne Jian (Taiwan) (8862) 2734 7522

Patti Tomaitrichitr (Thailand) (662) 694 7727

Resources / Metals and Mining

Andrew Dale (Asia) (852) 3922 3587

Graeme Train (China) (8621) 2412 9035

Christina Lee (Hong Kong) (852) 3922 3571 Rakesh Arora (India) (9122) 6653 3054

Adam Worthington (Indonesia) (852) 3922 4626

Riaz Hyder (Indonesia) (6221) 2598 8486 Polina Diyachkina (Japan) (813) 3512 7886

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Zona Chen (Hong Kong) (852) 3922 3578

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David Gibson (Japan) (813) 3512 7880

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Yukihiro Goto (Japan) (813) 3512 5984

Daniel Kim (Korea) (822) 3705 8641 Abraham Leu (Taiwan) (8862) 2734 7511

Chia-Lin Lu (Taiwan) (8862) 2734 7526

Daniel Chang (Taiwan) (8862) 2734 7516 James Chiu (Taiwan) (8862) 2734 7517

Jeffrey Su (Taiwan) (8862) 2734 7512

Samson Yu (Taiwan) (8862) 2734 7532 Jimmy Hsu (Taiwan) (8862) 2734 7533

Telecoms

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Riaz Hyder (Indonesia) (6221) 2598 8486

Nathan Ramler (Japan) (813) 3512 7875 Prem Jearajasingam (Malaysia) (603) 2059 8989

Haj Narvaez (Philippines) (632) 857 0891 Best Waiyanont (Thailand) (662) 694 7993

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Anderson Chow (Asia) (852) 3922 4773

Janet Lewis (Asia, Japan) (813) 3512 7475

Wei Sim (China, Hong Kong) (852) 3922 3598 Chang Han Joo (Korea) (822) 3705 8511


Utilities

Adam Worthington (Asia) (852) 3922 4626

Zhi Aik Yeo (Asia) (852) 3922 1402 Carol Cao (China, Hong Kong) (852) 3922 4075

Jeff Evans (India) (9122) 3356 3053

Ayako Mitsui Boston (Japan) (813) 3512 7885 Prem Jearajasingam (Malaysia) (603) 2059 8989


Haj Narvaez (Philippines) (632) 857 0891

Commodities

Jim Lennon (4420) 3037 4271 Max Layton (4420) 3037 4273

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Data Services

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Richard Gibbs (Australia) (612) 8232 3935

Paul Cavey (China) (852) 3922 3570 Renee Chen (Hong Kong, Taiwan) (852) 3922 3597

Quantitative

Martin Emery (Asia) (852) 3922 3582

Viking Kwok (Asia) (852) 3922 4735

George Platt (Australia) (612) 8232 6539 Patrick Hansen (Japan) (813) 3512 7876

Burke Lau (852) 3922 5494

Strategy/Country

Michael Kurtz (Asia) (852) 3922 1403

John Woods (Asia) (852) 3922 4636 Mark Matthews (Asia) (852) 3922 3585

Jiong Shao (China, Hong Kong) (852) 3922 3566

Rakesh Arora (India) (9122) 6653 3054 Ferry Wong (Indonesia) (6221) 515 7335

David Gibson (Japan) (813) 3512 7880

Peter Eadon-Clarke (Japan) (813) 3512 7850 Chan Hwang (Korea) (822) 3705 8643

Kieran Calder (Malaysia) (603) 2059 8992

Prem Jearajasingam (Malaysia) (603) 2059 8989 Edward Ong (Malaysia) (603) 2059 8982


Patrick Yau (Singapore) (65) 6231 2835 Daniel Chang (Taiwan) (8862) 2734 7516

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Chris Gray (ASEAN) (65) 6231 2888

Justin Crawford (Asia) (852) 3922 2065

Peter Slater (Boston) (1 617) 598 2502

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Kenneth Yap (Indonesia) (6221) 515 1555

JJ Kim (Korea) (822) 3705 8799

Jason Lee (Malaysia) (603) 2059 8888

Gino C Rojas (Philippines) (632) 857 0761

Greg Norton-Kidd (New York) (1 212) 231 2527

Luke Sullivan (New York) (1 212) 231 2507

Scot Mackie (New York) (1 212) 231 2848

Regional Heads of Sales cont’d

Sheila Schroeder (San Francisco) (1 415) 762 5001

Angus Kent (Thailand) (662) 694 7601

Michael Newman (Tokyo) (813) 3512 7920

Charles Nelson (UK/Europe) (44) 20 3037 4832

Rob Fabbro (UK/Europe) (44) 20 3037 4865

Sean Alexander (Generalist) (852) 3922 2101

Sales Trading

Adam Zaki (Asia) (852) 3922 2002

Yat Quan Tan (Hong Kong) (852) 3922 2028

Phil Sellaroli (Japan) (813) 3512 7837

Matthew Ryan (Singapore) (65) 6231 2888

Mike Keen (Europe) (44) 20 3037 4905

Chris Reale (New York) (1 212) 231 2616

Sales Trading cont’d

Stanley Dunda (Indonesia) (6221) 515 1555

Mario Argyrides (Korea) (822) 3705 8610

Edward Robinson (London) (44) 20 3037 4902

Michael Santos (Philippines) (632) 857 0813

Isaac Huang (Taiwan) (8862) 2734 7582

Dominic Shore (Thailand) (662) 694 7707 Alternative Strategies

Convertibles - Roland Sharman (852) 3922 2095

Depository Receipts - Robert Ansell (852)3922 2094

Derivatives - Wayne Edelist (852) 3922 2134

Futures - Tim Smith (852) 3922 2113

Structured Products - Andrew Terlich (852) 3922 2013