CLSA Forecast - Sensex @9500

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CLSA: Forecast End FY10 Sensex At 9500

With turbulence in global financial markets and potential knock-on impact on economic growth, we estimated bedrock value for top stocks in our universe to determine relative risk-reward for stocks at current share prices.

These estimates build in scenarios of extreme ‘stress’ for key earnings drivers and stock valuations, using historical benchmarks where appropriate.

With RCom, Cairn, ICICI, Bharti, Idea, DLF already near bedrock value, we see favourable risk-reward.

For M&M, ACC, SAIL, Unitech, Tata Motors, however, bedrock value is >35% away.

Global turbulence hurts India as well

q Although the Indian economy is less geared to slowing global growth, we still see a slowdown in GDP growth to 7.3% in FY09 and 6.5% in FY10.

q Given the global credit crunch, selling by FIIs and monetary tightening by the RBI, stocks geared to capital raising for growth are at greater risk.

q With FII holding >40% of market free-float, rising risk aversion will hurt multiples.

Translating the macro to the bedrock case

q Over past quarter, we have cut FY09 Sensex EPS by 10%, FY10 Sensex EPS by 15% to reflect slowdown in consumption, investment and pressures on margins.

q However, the bedrock FY10 Sensex EPS, which assumes a scenario of extreme stress for individual constituents, could still be 36% lower (26% ex-Tata Steel).

q Taking into account bedrock multiples as well (for many cyclicals, trough multiples will, however, be higher), bedrock value for the Sensex works out to 9,500.

q Biggest cuts in EPS could be for Tata Steel, Hindalco and Cairn, while ITC, HUL and NTPC have relative resilience in earnings.

q Note that continued weakness in the rupee will have some offsetting impact, however; a weak rupee boosts EPS for 53% of the earnings basket.

q Likewise, the implied FY09 Sensex P/E of 11.3x at the bedrock value (versus 8.6x in 2003) should be seen in the context of the big rise in ‘embedded value’.

Stocks closest to bedrock value

q Since the bedrock value reflects the worst case - and thus a low probability event – any stock close to bedrock value offers favourable risk-reward.

q Telcos RCom, Idea and Bharti are all within 20% of bedrock value.

q Other stocks close to bedrock values are ICICI (13%), Cairn (14%), DLF (14%), RCom (15%), Reliance Infra. (16%), Tata Power (16%) and Reliance Ind. (20%).

Stocks with some downside to bedrock value

q Commodity stocks, with earnings highly leveraged to prices, are most vulnerable. For ACC, SAIL and Tata Steel, bedrock value is over 35% lower.

q Other large caps where bedrock value is over 35% away are M&M, HDFC Bank, Unitech, Tata Motors and Ranbaxy. Axis, Pantaloon, Dr Reddy are ~35% away.