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Global Research
Elections a watershed, but expect a slow recovery afterwards Earnings expectations remain lofty, while mutual funds already have high exposure to India We stay underweight India for now. Prefer sectors such as energy, power, non-ferrous metals and telecoms
India revisited. HSBCs Annual India Conference in February provided us with an opportunity to revisit our India equity views. We stay underweight for now. Earnings expectations, mutual fund holdings both high. Indias economy is still stuck in a rut. A fiscal drag in the first half of the year (most of the budget was spent last year), weaker consumption and stalled investment prevent the economy from building any sort of momentum. Added to this, interest rates could move higher and consensus appears overoptimistic on earnings growth (forecasting 18.2% for 2014). We believe upside in Indian equities is also capped by mutual funds already-high exposure to them. Indias (elusive) long-term growth. Indias long-term growth prospects have always been a source of optimism. But in several presentations at the conference, it became clear to us that the development of rural consumption a hoped-for source of long-term growth will happen very slowly. Conversely, we were excited by a presentation on the prospects for Indias defence industry. Elections a watershed. Pent-up demand should be released after the elections are over. But given that passions are running high, the outcome could bring considerable volatility to Indian equities. Nearer to the time, we will look more closely at how investors can better position themselves for a recovery in the aftermath. For now, we stay underweight. Preferred sectors: Energy (on subsidy changes), Power (stands to benefit from distribution reform), Non-ferrous metals (corporate restructuring) and Telecoms (more clarity post the auctions). Stocks we like: ONGC, NTPC, Sesa Sterlite, Hindalco, Bharti, L&T, and Kotak Mahindra (an HSBC Super 10 portfolio stock).

The Flying Dutchman

India still stuck in a rut. UW for now

India underweight Market indicators Index target 21750, (+6.3%) EPS growth 14 (5yr avg) 18.1% (11.1%) 12mo fwd PE (5yr avg) 13.6.x (14.5x) 12mo fwd PB (5yr avg) 2.2x (2.3x) Earnings revision ratio (chg) 62.1% (pos)

Index

HSBC forecasts

2014 year-end

GDP growth 5.3% FX forecast 62 Headline CPI 7.2% 10yr yield, 12mo 8.2% (steepening) Policy rate (change) 8.25%(+25 bp)

target based on Sensex Note: Arrow represents change from previous year: up () / down () Source: HSBC estimates

21 February 2014
Herald van der Linde* Head of Equity Strategy, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited +852 2996 6575 heraldvanderlinde@hsbc.com.hk Jitendra Sriram* Equity Strategist and Head of Research, India HSBC Securities and Capital Markets India Private Limited +91 22 22681271 jitendrasriram@hsbc.co.in Devendra Joshi* Equity Strategist, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited +852 2996 6592 devendrajoshi@hsbc.com.hk

View HSBC Global Research at: http://www.research.hsbc.com *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations Issuer of report: The Hongkong and Shanghai Banking Corporation Limited

Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

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Sector views Sector Consumer Discretionary Sub-sector Autos Media Consumer Staples Energy Financials PSU banks Private sector banks Real estate Healthcare Industrials Information Technology Materials Telecoms Utilities Weight Weighting 6.3% neutral 0.4% overweight Forward PE (x) HSBC comment 11.1 Rising fuel prices and slower growth in auto sales make us neutral on the sector 26.2 Subscription revenues to multiply for TV broadcasters after digitisation 29.5 Expensive valuation, with growth slowing down. 8.7 Recent move to revenue sharing on new exploration contracts, and review of natural gas pricing make us positive on the sector 6.5 Valuations remain attractive, but asset quality issues continue 13.1 Loan growth is more balanced, reflects better asset quality prospects, but high ownership of foreign institutional investors, coupled with firm interest rates makes us negative on the sector 20.4 Higher interest rates and slower economy continue to impact buyer sentiment 20.7 Weakness of currency and US growth makes us positive on the sector 13.1 Slowing order inflow is negative, but valuations remain attractive 16.4 Positive on the sector on account of improved demand environment 9.7 Slow global growth negative for commodities 20.4 We are neutral on the sector on account of regulatory uncertainty and increasing cost; valuations look attractive 9.7 Debt restructuring and the CERC judgment are likely to be incrementally positive for sector sentiment

11.0% neutral 11.8% overweight 2.4% underweight 18.6% underweight

0.4% underweight 7.2% overweight 4.3% neutral 25.2% overweight 6.3% neutral 2.3% neutral 3.7% overweight

Source: MSCI, Thomson Reuters Datastream, I/B/E/S, HSBC estimates

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Stuck in a rut
Post elections, growth could start a slow recovery In the meantime, rates could rise further, and earnings

expectations and mutual funds India exposure are both high

Stay underweight for now. Prefer stocks such as L&T, ONGC,

NTPC, Sesa Sterlite, Hindalco, and Bharti

In with the old, out with the new

The Flying Dutchman felt the march of time during his latest trip to Mumbai where he attended HSBCs Annual India Conference in February. As Mumbai airport opened its new international terminal the day after the conference ended, we arrived in India through a tired-looking terminal and left through a futuristic new one. In truth, we dreaded the prospect of visiting Mumbai airports new facility. While we have no love for the long immigration lines and mystifyingly slow baggage checks of the old terminal, it seemed preferable to the chaos that generally greets a traveller at a newly opened international terminal (think the opening day of the Hong Kong International Airport some years ago). Such was the Flying Dutchmans desperation to avoid such pandemonium, he even tried to arrange a flight through neighbouring Chennai (but was ultimately foiled by his secretary). In the event, he need not have worried. Passing through the new terminal proved painless, with his only complaint being that the airports Wi-Fi network didnt work (nobody knew why). Being too bearish on India, it appears, has its risks.

A tale of two halves

The opening of Mumbai airports new international terminal was not the only thing in India we have had downbeat expectations about; we have been underweight on Indian equities since late last year. Arriving in Mumbai, we wanted to take advantage of the HSBC Annual India Conference to re-visit our stance. With some 60 companies presenting and an interesting macro track (featuring industry speakers, political analysts, key policymakers and even a senior intelligence officer), the conference was an opportune occasion for us to update our views. In Mumbai, we quickly realised the topic on everybodys lips was the general elections, scheduled to take place in April and May. From companies speaking at the conference itself to taxi drivers, it was impossible to get away from election talk and discussion of the myriad potential outcomes. From the company presentations we attended, it was clear that most companies have put major investment decisions on pause ahead of the elections. Bureaucrats too appear to have stopped signing off on new infrastructure contracts, as they wait to find out who their new leaders will be. It is as if all of Indias decision makers are collectively holding their breath.

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While recent opinion polls1 suggest the Bhartiya Janata Party (BJP) led by Narendra Modi is pulling ahead in popularity, an enthusiastic political analyst explaining the intricacies of the elections to conference attendees took a measured view of the possible outcomes. He suggested that coalition forming will be needed, whoever wins the race. Moreover, the usual trading of allegiances, personality clashes and intricacies of a five-phased election process means that everyone will likely keep everyone guessing right to the end. When asked what he thought the most probable outcome would be, he suggested it might make more sense to flip a coin than to seek an answer. Irrespective of who wins, pent-up demand is set to be released after the elections are over. Companies that have shelved expansion plans will at some point start investing and hiring, while the bureaucrats will resume the approval of new infrastructure projects. The year 2014 could thus prove to be a tale of two halves: with some, albeit modest, economic recovery and return to normal business conditions emerging in the latter half of the year.

Manufacturing activities expanded in the Jan

65 60 55 50 45 40 35 30

India PMI

Source: Markit, HSBC

Corporates are similarly reticent about their outlook. Hero Motors, for example, talked about sluggish demand and indicated its inventories had risen to six weeks of sales. Infrastructure player L&T indicated that domestic order flow was weak as well, but their Middle East business remains buoyant for now. Meanwhile, they have kept a close eye on working capital and cash flow. Some domestic banks, such as ICICI though, believe that the economy has reached its lowest level of growth, but were quick to note that they did not expect a significant uptick in activity anytime soon. Still, some resumption in activity after the elections should be positive for selected banks and infrastructure players such as L&T.

Stuck in the mud

For now, the underlying economy appears stuck in mud. A fiscal drag in the first half of the year (most of the budget was spent last year), weaker consumption and stalled investment suggest that economic momentum will remain weak in the very near term. This view is supported by recent soft PMI numbers.

______________________________________ 1 CVoter and Times Now in July 2013 and October 2013, respectively, and CVoter and India Today Group in January 2014

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13

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Inflation is expected to decline from here 14.0 %

Inflation (avg)

Policy rate

12.0 10.0 8.0 6.0 4.0 2.0 0.0 2000 2002 2004 2006 2008 2010 2012 2014f
Source: CEIC, HSBC estimates

Leverage for companies (excluding financials) is even higher outside the top 50 140% Broader BSE Index BSE Index (ex top 50)
120% 100%
HSBC forecast

80% 60% Gross debt to equity 40% 2008 2009 2010 2011 2012 2013
Source: Thomson Reuters Datastream, HSBC

Meanwhile, inflation remains an issue. Some make a political argument for peaking interest rates. Inflation, they say, is driven by high cash levels in the economy prior to the election (a common occurrence in elections across the region). But our India economist Leif Eskesen begs to differ. While he sees inflation coming down from the near 10% levels witnessed in 2013, he believes that demand pressure prevents inflation from falling to levels seen some years ago. We would add that Indias central bank seems to have shifted its bias from growth to inflation fighting and, thus, remain of the view that Indian interest rates might remain elevated. Indias economy is thus not yet ready for a sustained recovery. Most banks presenting at our conference were eyeing lower loan growth in 2014. They expected system loan growth of approximately a slowdown from the 20% levels seen in previous years.

But going forward there should be some support on the currency front as our FX team doesnt expect much volatility in INR movement. Indeed, the INR has held up comparatively well in recent weeks, despite the weakness seen by other EM currencies with current account deficit. It is an encouraging sign that the INRs vulnerability to contagion has fallen from last year and the HSBC FX team maintains the year-end USD-INR forecast of 62. The reasons for this optimism are: (1) Indias improving current account position, (2) tighter monetary policy, and (3) proactive measures to increase FX cover (for further details, see Asian FX Focus, INR: A vote of confidence, 14 February 2014, by Paul Mackel). Still, leverage remains high. A local infrastructure fund presenting at the conference showed data that net-debt-to-EBITDA of 150 listed infrastructure companies had risen to 5.6x at March 2013 (from 2.7x in March 2009). Thus, a large part of the stress in banks portfolios relates to infrastructure assets gone bad. But there has been no strategic institutional response to the problem. In the view of this infrastructure fund, the response so far has been one of denial (2011), followed by anger (2012-13), with the potential for slow acceptance beginning this year.

FX and bad assets

The real issue for banks is asset quality which again is related to the trajectory of corporate leverage in India. The accompanying chart shows that leverage for small- and mid-cap companies has risen sharply in recent years, partially driven by USD debt exposure.

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Gross NPLs of PSU banks have deteriorated

5% 4% 3% 2% 1%

Gross NPL

Little room for fiscal manoeuvre

Neither can the government go on a spending binge to support growth in the near term. The Union Budget 2014-15 was predictably tabled as an interim budget and was devoid of any significant policy measures. Planned expenditure has been kept flat for the interim period 1QFY15 until the new government presents the budget around June 2014. Overall there is no major change in direct and indirect taxes, as has been the established convention. Tax reforms, such as the goods and services tax (GST) and direct tax code (DTC) have been left to the new government to deal with. This means the earliest that tax reforms could be implemented is in FY16; by that time all, objections should be addressed. Although Indias success in containing the FY2014 deficit at less than 4.8% of GDP is positive, our India economist points out that this has largely been achieved by pushing back expenditures and moving forward tax and dividend collections. This will make targeted fiscal consolidation difficult to achieve in the next fiscal year. It was clearly an election budget, with the excise duty cuts having the most obvious appeal. However, it may prove difficult to achieve the targeted reductions in the fiscal deficit in FY2015. In addition to the cost of the tax cuts, the budgeted 18% increase in tax revenues implies very optimistic assumptions for tax buoyancy given the less than 14% growth rate assumed for nominal GDP. Moreover, our economists forecast for nominal GDP growth is lower at around 11%, suggesting that it could be even more difficult to achieve than assumed in the budget (for further details, see India: FY2015 interim budget: Hello elections, 17 February 2014, by Leif Eskesen).

Source: RBIl, HSBC

Corporate debt restructurings have risen, but slowly so. And with a lack of asset restructuring companies, this process might take some time.
Corporate Debt Restructuring (CDR) have increased

2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000

Feb-12

Feb-13

Jun-11

Jun-12

Aggregate Debt Restructured (lhs) No. of cases

Source: CDR cell, HSBC

This is not just an infrastructure issue. Reform in other sectors is slow too. Take the power sector for example. Power availability in parts of the country has improved, but there are still issues that keep the sector back, such as delays in power tariffs and inefficient use of power (tariffs are skewed to very cheap rates for agriculture which creates wasteful usage). Thus, the economy is weak. Although some cyclical recovery is expected after the elections, momentum is unlikely to recover fast and asset restructuring remains a slow, tedious process.

Jun-13

Oct-11

Oct-12

Q1 FY07 Q3 FY07 Q1 FY08 Q3 FY08 Q1 FY09 Q3 FY09 Q1 FY10 Q3 FY10 Q1 FY11 Q3 FY11 Q1 FY12 Q3 FY12 Q1 FY13 Q3 FY13 Q1 FY14 Q3 FY14

Pvt Banks

PSU Banks

INR bn

450 400 350 300 250 200

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Indias (elusive) long-term growth

Internet and military defence
Some argue that near-term growth wobbles can be ignored. There is plenty of room for long-term growth is the argument in view of Indias young population, low per capita income, and determination to catch up with other parts of the world. The process of drawing rural labour with low productivity to cities where they can be more productive suggests some interesting longterm dynamics. At the conference we realized that long-term growth can be elusive at times. We found a presentation by Matrix Partners, an unlisted internet investment company, of particular interest. Matrix stated that Indias internet penetration is low, at only 12% in 2013 vs 50% in Brazil and 43% in China and 81% in the US. This suggests that there are plenty of growth opportunities. More importantly, with 33m users a day, an advertising model based on the Internet starts to make sense. One would expect India to be on the cusp of an explosion in Internet spending. The speaker told us that in five years time, Indian Internet would be a massive market. But he was honest in admitting that he had forecast the sector would take off in five years in 1999, 2004, and 2009. The odds, it seems, are not in his favour. There are good Internet-specific reasons for this. The Indian Internet model differs from other markets. In China, in-app purchases work. In India, this model does not. Indian consumers are still very price-sensitive. This means that free content is key, which again suggests that a solid advertising model is more important. A second difference is that the mobile operator landscape is more fragmented in India compared

to other emerging markets such as China. This makes market penetration more difficult, as apps need to be sold through different mobile operators and mobile networks. Thirdly, local language content is an interesting growth area, but the keyboards dont work yet. There are 100m people confident in English which implies that there are over 1bn that prefers communicating in their local language. But it shows that while there are 100m Indians that are well-off and speak fluent English, there are a billion people who are not and have not been well-off for some time, and have limited access to English media. Another long-term structural theme that interested us was the development of Indias defence industry. Instead of buying 70% of military equipment abroad, the country aims to source 70% of its military equipment needs domestically buy 2025. Even if this does not fully materialize, this will still be an interesting growth sector. Already some Indian companies are involved in making the components used in fighter planes and frigates. A recent McKinsey & Company study2 shows that industries and companies such as L&T, Mahindra, Tata as well as OEMs such as BAE Systems, Boeing and Israel Aerospace Industries are likely to benefit from this transformation.

India ROEs in medium term

What does this all mean for Indian equities? For this, some understanding of the trajectory of Indian ROEs is required. Weaker growth in 2014 is likely to pressure ROEs in the near term. But when it comes to assessing
______________________________________ 2 B Chhibber and R Dhawan, A bright future for Indias defense industry? in McKinsey on Government, Spring 2013, available on the McKinsey website

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Indias long-term ROEs, India does have some advantages over other Asian markets. Across the region, Asia faces rising cost, mostly because of wages. Asia is becoming less competitive. This is why Asian ROEs are weak. One key issue the region needs to tackle is how to move away from the low-cost export model which has been so successful in the previous decade. Asian corporates need to step up and export better products. Our analysis (see Asia exporters roll up their sleeves, 28 January 2014) is that this is happening across Asia. That is good news. But India is one of the most consistent performers in this regard. Take for example the domestic car industry. With weak domestic sales, exports are a new consideration. The Financial Times wrote that global car companies including Volkswagen, Ford and Renault-Nissan are redoubling plans to transform India into an auto export hub and targeting vehicle shipments to Europe and the US. At the conference, Tata Motors aired a similar view. Indeed, these auto makers now view exports as their only solution to chronic oversupply in a country where vehicle capacity will more than double to 9.5m by 2018, up from 4.5m last year, according to LMC Automotive (source: Global car groups to rev up India exports, The Financial Times, 9 February 2014).

And for domestic industries, consolidation and high entry barriers (it took some companies decades to establish an effective distribution network in India), margins should remain intact.
MSCI India ROE under pressure (excluding financials) 30 Margin (%) IN ROE (%)

25 20 15 10 5 0 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Source: MSCI, Bloomberg, Thomson Reuters Datastream, HSBC

Thus, while in the near term, weaker demand might add to the pressure on margins, we do not expect erosion to be as high as in China or Thailand where market entry is significantly easier. See the accompanying chart on India ROEs and margins. Margins hold up, a reflection of better export product and less competition in the domestic market (versus, for example, Thailand or China). But ROEs are under pressure.

A larger percentage of Indian exports are products produced in higher-income countries 45 % share 2002 2007 2012 40 35 30 25 20 15 10 5 0 <5K 5k - 10k- 15k- 20k- 25k- 30k- 35k- >40k 10k 15k 20k 25k 30k 35k 40k

As for increasing exports value-added, India is in the middle

2012 % change 2007-12

80% 70% 60% 50% 40% 30% 20% 10% 0% SG HK KR IN TW MY TH PH CH ID

Source: US Census Bureau, World Bank, HSBC

35000 30000 25000 20000 15000 10000 5000 0

Product Sophistication Index

Source: US Census Bureau, World Bank, HSBC

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Earnings and valuations

Consensus is expecting earnings to grow by 18.2% in 2014, backed by 10.7% sales growth and margin expansion (17.1% EBITDA growth). As the table below shows, a lot of this is driven by telecoms (Bharti in particular). We view this as a tad high. A weaker economy and dealing with high leverage should imply some weakness in earnings growth as well.
Consensus earnings growth for MSCI India and sector 2014 EPSg (%) Energy Materials Industrials Consumer disc Consumer staples Health care Financials Technology Telecoms Utilities MSCI INDIA
Source: MSCI, Thomson Reuters Datastream, HSBC

The Indian equity market is now trading near its historical average, at a forward PE of 13.9x, and forward PB of 2.2x. This is a significant premium (30% and 42%, respectively) to the broader Asia ex Japan index, although part of this can be explained by the higher ROEs generated in India.
PE valuation band chart
Price lev el 1350 1200 1050 900 750 600 450 300 150 0

25x 20x 15x

2015 EPSg (%) 7.5 13.7 23.0 15.3 18.2 13.6 18.2 14.8 33.8 11.7 14.8

13.0 21.3 19.4 16.9 19.4 22.3 18.7 20.3 47.5 9.9 18.1

10x

Dec-02

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Source: MSCI, I/B/E/S, Thomson Reuters Datastream, HSBC

MSCI India fwd PB vs RoE

22

ROE% (LHS)

Fwd PB (x)

Indias earnings revision ratio (which measures the percentage of upgrades in all earnings revisions strengthened in January. Indeed, it has strengthened throughout 2H 2013, as shown in the accompanying chart. Some optimism is being built into earnings forecasts, in our view.
Earnings revisions ratio has risen sharply
90 80 70 60 50 40 30 20 10 0
2004 2005 2006
IN

20 18 16 14 12 Jan-04 Nov-05 Sep-07 Jul-09 May-11 Mar-13

Source: MSCI, I/B/E/S, Thomson Reuters Datastream, HSBC

Meanwhile, India remains the most over-loved market in the region by mutual fund investors.

2007

2008

2009

2010

2011

2012

2013

Note: Earnings revision ratio is calculated as number of earnings upgrade as a percentage of total earnings change in a month Source: MSCI, I/B/E/S, Thomson Reuters Datastream, HSBC

2014

Dec-13
4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0

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Funds are overweight India (Dec 2013)

India Singapore Philippines China Korea Hongkong Thailand Malaysia Indonesia Taiwan -3 -2 -1 0 1 2 3 4 5

If we look at ownership levels across sectors, we sense a large degree of polarisation towards the traditional safe haven sectors of IT, pharmaceuticals and consumer staples. Ownership levels across core sectors of energy, metals, industrials and utilities have come off sharply in the past five years. In our view, the completion of the elections could spur rotation into under-owned investmentoriented sectors even as overall flows remain subdued against the backdrop of a Fed taper. As of now we stay underweight India in the regional context.
FII ownership in defensive sectors

Note: Red dot shows z-score of current fund weight with respect to the neutral benchmark, black dot shows the same three month ago and grey bar represents the five-year range Source: MSCI, I/B/E/S, Thomson Reuters Datastream, HSBC

Optimistic earnings assumptions and already high mutual fund exposure to India equities were the reason for our cautious stance on India. However, with the elections nearing, we also feel that there could be considerable volatility in Indian equities, with the upside and downside determined partly by the outcome of the elections. In addition, a cyclical recovery suggests that earnings could recover in the second half of the year.

26% 22% 18% 14% 10%

24%

23% 18% 20% 16%

16%

Health Care

IT
Mar-09 Dec-13

Consumer Staples

Source: Prowess, HSBC

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Sector and stock views

Over past two years, defensives and exporters outperformed

while domestically oriented sectors underperformed

Our focus sectors are energy, power, non-ferrous metals, and

telecoms and selected infra plays

Stocks we like include L&T, ONGC, NTPC, Sesa Sterlite,

Hindalco, Kotak Mahindra, and Bharti

Sector views
In the past two years, defensives (staples), exporters (IT and pharma) and consumer discretionary (such as autos) have outperformed on the back of the governments 2009 stimulus package and various subsidies, which have helped support rural income (higher support prices on crops, farm loan waivers, rural employment guarantee scheme (MNREGA) and direct subsidy transfer to reduce leakages). A weak INR has helped boost margins for exporters in conjunction with the DM recovery. Domestic sectors such as energy, industrials, materials and telecom have underperformed due

to a severe slowdown in investment activity and the sluggish economy. And as we mentioned elsewhere, inflation has resulted in rate increases and lower asset quality. While the economic outlook remains uncertain, businesses give us the impression they want to get back to spending and investing after the elections, irrespective of who is in charge of the country. We therefore like exposure to some high-quality cyclical names such as ONCG, L&T, Sesa Sterlite, Bharti, and Maruti.

Sectors which outperformed MSCI India over last two years

180
Return rel. to MSCI India

130

80 Feb-12

Jul-12

Dec-12

May -13

Oct-13

Return rel. to MSCI India

Consumer Discretionary Consumer Staples Health Care Information Technology

Sectors which underperformed MSCI India over last two years 160 Financials Energy Industrials Materials Telecommunication Services Utilities

60 Feb-12

Jul-12

Dec-12

May-13

Oct-13

Source: MSCI, Thomson Reuters Datastream, HSBC

Source: MSCI, Thomson Reuters Datastream, HSBC

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The following is a summary of our sector views.

Energy
The recent move to revenue sharing on new exploration contracts and review of natural gas pricing make us positive on the sector.

Consumer
Rising fuel prices and slower growth in auto sales make us neutral on the sector. We remain positive on the outlook for two-wheelers and motorcycles, as rural demand supports industry growth. As for the passenger vehicle segment, near-term demand and pricing continues to remain sluggish. The commercial vehicle market also faces a prolonged slowdown in economic activity, driven by subdued infrastructure activity, a tight financing environment and weak operating economics for transporters due to lower fleet utilization. As for consumer staples, overall industry growth has slowed down over the past few quarters. This is resulting in consumer preferences moving away from premium products, which again impact profit margins. Valuations are expensive compared to history. Foreign ownership remains at record high levels.

Information Technology
The IT services sector significantly outperformed the broader market in 2013, as consensus became increasingly positive on its prospects. Despite this, we are overweight the sector on account of improved demand and rupee depreciation.

Healthcare
Currency weakness and US growth make us positive on the sector. India healthcare players are able to gain market share in global pharma on the back of their low-cost production and access to faster growing markets, such as India itself.

Industrials
The sector is hurt by delayed policy measures, a slower industrial production growth and high interest rates. But valuations remain attractive. We are therefore neutral on the sector.

Financials
Continuing stickiness in inflation results in firm policy rates set by the central bank. This is impacting the sector in two ways. First of all, it slows credit growth which again will likely impact valuation multiples for the private sector. Secondly, deterioration in asset quality is a drag, especially for the state-owned enterprise (SOE) banks. In general, private sector banks loan growth is more balanced and reflects better asset quality prospects than public sector banks. But high foreign institutional investor ownership, coupled with firm interest rates, leave us cautious on the sector. While PSU banks continue to trade at attractive valuations, their asset quality issues remain a concern.

Utilities
Debt restructuring and the CERC judgment are likely to be positive to sentiment on the sector.

Telecoms
While valuations look attractive, we are neutral on the sector on account of regulatory uncertainty and increasing cost.

Metals
Although commodity prices appear to be bottoming, anaemic demand and supply outlook remains a drag on earnings. We are neutral on the sector. Within metals our analysts are constructive on the non-ferrous space (aluminium, zinc) and are negative on the ferrous space.

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Stocks we like
Oil & Natural Gas Corp
ONGC IN INR277; OW, TP INR400 covered by Kumar Manish

improvement in operating leverage and a falling working capital cycle as an execution pick-up follows a macro recovery. We expect the company to post a 14% EPS CAGR during FY13-16, which should act as a valuation catalyst. Our target price implies a 16.1x FY16e PE while the shares are now trading at 16.6x FY15e. Valuation methodology: Our target price of INR1,210 factors in 14.5x L&Ts standalone E&C business one year forward earnings. We argue our target PE for the E&C business reflects its early cycle performance relative to the market. L&Ts subsidiaries are valued at INR307 per share (incorporates 20% holding company discount). Our valuation base for both E&C business and subsidiaries is March 2016. Key downside risks to our view include sustained slow government decision-making and higherthan-expected EBITDA margin erosion

Kumar Manish* Analyst HSBC Securities & Capital Markets (India) Private Limited +91 22 2268 1238 kmanish@hsbc.co.in Ashutosh Narkar* Analyst HSBC Securities & Capital Markets (India) Private Limited +91 22 2268 1474 ashutoshnarkar@hsbc.co.in Arun Kumar Singh* Analyst HSBC Securities & Capital Markets (India) Private Limited +9122 2268 1778 arun4kumar@hsbc.co.in *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

ONGC is the dominant oil and gas producer in India, contributing 71% of the countrys oil and 54% of gas production. However, domestic production meets only 25% of Indias oil needs. India remains the worlds fourth-largest oil importer behind the US, China, and Japan. We believe the current price level offers an attractive entry opportunity, as some of the key concerns, related to either ONGCs profitability or its capex outlay, are overblown, in our view. Also, the domestic gas price hike could be a material trigger for the stock. Valuation methodology: We value ONGC on a 9.3x PE-based valuation FY15e EPS, which represents a 15% discount to pure E&P players. Historically, ONGCs one-year forward PE multiple has ranged between 8.0x and 10.0x. This valuation is also consistent with a Gordon growthbased multiple, for which we assume a 13% cost of capital, a 19% ROE and a 2.5% long-term growth rate. This valuation methodology yields a target price of INR400 per share. Key downside risks to our investment case are higher subsidies, a sharper production decline, and higher royalty or cess burden than we estimate.

NTPC
NTPC IN INR134; OW, TP INR176 covered by Arun Kumar Singh

Larsen & Toubro

LT IN INR1,017; OW, TP INR1,210 covered by Ashutosh Narkar

NTPC is the largest power generation company in India, with an installed capacity of c42GW (c18% of Indias capacity); it generated c240bn units in FY13 (c26% of Indias generation). In terms of operations, NTPC has consistently been above the national average, with availability factor (PAF) for coal-based power stations at c90% and plant load factor (PLF) of 79% compared with a national average of 65% in 9MFY14. NTPC operates on a cost-plus regulated return (after-tax ROE of 15.5%) as well as incentives on efficient operations (additional c4-5% ROE); hence, cash flows are stable. Operational performance is improving, with availability factor (PAF) improving significantly, in line with our view. PAF for 9MFY14 improved (by 320bp to 89.7%) after a continued decline over the past

L&Ts diversified business presence should enable the company to target early growth segments of railways, road and power equipment orders, where it is already one of the top five players. Its strategy to expand in the Middle East is paying off, as competition there is slowly receding while the company is moving up the value chain of orders. L&T is well placed to benefit from an

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three years; this is a key driver for fixed cost recovery, ROE and incentives. We expect this to drive earnings in future but we do not factor it into our estimates pending clarity on regulations. We expect the company to report a steady earnings CAGR of 6.5% over FY15-16 due to capacity additions. Given the overhang of new regulations and availability falling in the past few years, the stock is trading close to its historical lows (FY15e 1.1x PB and 9.1x PE). We think this is not justified, as regulations could be less negative and availability is structurally improving. Valuation methodology: We use DCF to value NTPC and apply a WACC of 10.3% to derive our target price of INR176 per share. This target price implies a FY16e PB of 1.4x and PE of 11.5x. Downside risks to our rating and estimates include finalisation of the proposed draft tariff regulations (FY15-19) in their current form.

this would make cash fungible among entities. We believe that SSLT will be a natural contender for that stake and assume HZ will eventually be merged with SSLT as our base-case scenario. Valuation methodology: We value SSLT (exinvestment in Cairn India) at an FY16e EV/EBITDA of 5.5x, in line with the historical trading average of diversified metals and mining companies. We believe that, with fungibility of cash improving within the group, the sharp discount of SSLTs valuations to its global peers is likely to narrow. Key downside risks to our view are lower-thanexpected volumes and commodity prices and an unfavourable regulatory environment. The Cairn investment forms a significant portion of SSLTs valuations, and downside there could impact the valuation of SSLT. Fungibility of cash within the group is critical given the quantum of debt-servicing obligations and, in this context, any unfavourable outcomes in the sale of governments residual stake in HZ would be negative.

Jigar Mistry* Analyst HSBC Securities & Capital Markets (India) Private Limited +91 22 2268 1079 jigarmistry@hsbc.co.in *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

Sesa Sterlite
SSLT IN INR189; OW(V), TP INR240 covered by Jigar Mistry

Hindalco
HNDL IN INR99; OW, TP INR123 covered by Jigar Mistry

SSLT is a subsidiary of the London-listed Vedanta Group and was recently formed as a merger between Sesa Goa and Sterlite Industries. The company has a diversified asset portfolio, spanning zinc, lead, silver, aluminium, copper, iron ore, oil and merchant power, with operations mainly located in India and spread across Africa, Australia and Sri Lanka. We expect SSLTs EBITDA to grow 20%, to USD5.2bn, by FY16, on the back of growth in earnings from its iron ore business and its subsidiary Hindustan Zinc, the commissioning of its Talwandi Sabo power project, and increasing PLF from the Jharsuguda 2400MW IPP. We are OW(V) on SSLT as we believe the shares will start trading closer to our assessed fair value once the Government of India disposes of its holdings in HZ (source: Bloomberg, 17 February 2014), as

We are Overweight on HNDL shares as we believe the market will be forced to assign a higher value to the investments made by the company in its expansion projects (Utkal Alumina and Mahan Aluminium) once the projects become fully commissioned in FY2014/15. We also believe the worst is over for Novelis (HNDLs subsidiary) and that its exposure to high-margin business and sourcing programmes will increase earnings over next few years. Valuation methodology: We value HNDL using a sum-of-the-parts approach based on FY2016e EV/EBITDA, with multiples of 5.5x for the standalone company and 6.5x for Novelis. We derive a TP of INR123 and rate HNDL Overweight.

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Risks to our view: Lower-than-expected aluminium prices and copper TC/RCs, coupled with delays in project execution at Mahan Aluminium and Utkal Alumina, are the key risks. While we expect Noveliss performance to improve, the overhang from its exposure to developed markets remains, and prolonged macro weakness in these markets could hurt shipments and earnings. Also, NVLs auto sheets segment is leveraged to the focus on tightening fuel efficiency and emission norms, so policy backtracking could hurt volume growth. NVLs beverage can business growth hinges mainly on its Brazil expansions and a sustained slowdown there could hurt demand.

DCF methodology, assuming a WACC of 12 % (cost of equity of 14%, cost of debt of 11%). We arrive at a 12-month TP of INR362. Downside risks to our thesis include a lowerthan-estimated rise in revenue per minute; disruptions in operations caused by any loss of spectrum in the 900 MHz spectrum band.

Rajiv Sharma* Analyst HSBC Securities & Capital Markets (India) Private Limited +91 22 2268 1239 rajivsharma@hsbc.co.in Tejas Mehta* Analyst HSBC Securities & Capital Markets (India) Private Limited +91 22 2268 1243 tejasmehta@hsbc.co.in *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

Kotak Mahindra Bank

KMB IN INR680; OW, TP INR842, covered by Tejas Mehta an HSBC Super 10 portfolio stock

Bharti Airtel
BHARTI IN INR302; OW, TP INR362, covered by Rajiv Sharma

We see a case for margin expansion, as we expect Bharti to benefit not only from an improvement in the rate per minute but also from improved cost rationalisations, for which the first item to focus on will be IT costs (per an Economic Times report of 4 January 2014, Bharti plans to have multiple vendors for its IT solutions/services, and this should drive margin expansion, in our view). Added savings could come from cutting employee costs (we see this as a possibility as the outsourcing nature of business model prevents Bharti from doing much with network costs) and efficiencies that have already been incorporated into the other cost items, such as selling and distribution. All these factors combined could drive 100-150bp margin expansion for the India wireless business. Valuation methodology: For our DCF valuation, we assume a cost of equity is 13.5%, a cost of debt of 11% and a WACC of 12.1%, deriving a fair value of INR446 per share for the India operations. We have a negative adjustment of INR55 per share for regulatory levies. We value the international operations at negative INR29 per share using a

Following the FY09 global financial crisis, Kotak Mahindra Banks (KMB) management sensibly shifted from the volatile capital market business to the structurally promising lending business, significantly reducing earnings volatility over the past three years. We believe management has permanently shifted to a lending-dominated model while the incremental profit contribution of a volatile businesses has fallen substantially, which we believe augurs well for the future. While peers were always lending focused, KMBs management has not only moved in line with peers, but also delivered higher profitability (1.8% ROA in FY13), despite remaining sufficiently conservative. Management has called macro trends early and been quick to learn from past lending mistakes. Accordingly, KMB has reduced its unsecured loan book and avoided project and infrastructure lending over FY09-13. We believe the current profitability level is sustainable over the long term as the liability structure improves further. Valuation methodology: KMB is trading at a 4.2x 12- month forward P/AB. Excluding subsidiary value, the standalone parent is trading at a 2.9x P/AB, which is also its five-year average multiple and at a premium to most other private banks. We believe its focus on ROA, its strong positioning to capitalise on the next credit cycle, and its high-quality management team have enabled KMB to trade consistently at a premium

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valuation. Accordingly, based on our Gordon growth model, we arrive at a target P/AB of 3.4x for the parent. Adding the subsidiary value to this, we derive a total fair value and target price of INR842 per share. Key downside risks to our call include a prolonged weak macro environment, asset quality risks, and continuing low leverage.

Rating rationale
Under HSBCs Equity Research model, the 12month potential return band for stocks meriting a Neutral rating (the Neutral band) equals the local hurdle rate (average cost of equity) set by our Global Equity Strategy Team (11% for India,), plus or minus 10ppt for volatile stocks or 5ppt for non-volatile stocks. At the time we set our target prices, they implied potential returns above the respective Neutral bands; accordingly, we rate the stocks Overweight, with a (V) if the stock is volatile (see Disclosure appendix for HSBCs definition of volatility). Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

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Notes

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Notes

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Notes

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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Herald van der Linde, Devendra Joshi, Jitendra Sriram, Kumar Manish, Ashutosh Narkar, Arun Singh, Jigar Mistry, Rajiv Sharma and Tejas Mehta

Important disclosures
Equities: Stock ratings and basis for financial analysis

HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investors existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: (1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12-month horizon; and (2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0- to 3-month horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below. This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website. HSBC believes an investors decision to buy or sell a stock should depend on individual circumstances such as the investors existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.

Rating definitions for long-term investment opportunities

Stock ratings

HSBC assigns ratings to its stocks in this sector on the following basis: For each stock we set a required rate of return calculated from the cost of equity for that stocks domestic or, as appropriate, regional market established by our strategy team. The target price for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, must exceed the required return by at least 5ppt over the next 12 months (or 10ppt for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5ppt over the next 12 months (or 10ppt for a stock classified as Volatile*). Stocks between these bands are classified as Neutral. Our ratings are re-calibrated against these bands at the time of any material change (initiation of coverage, change of volatility status or change in target price). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change. *A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However, stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past months average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5ppt past the 40% benchmark in either direction for a stocks status to change.

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Rating distribution for long-term investment opportunities

As of 20 February 2014, the distribution of all ratings published is as follows: Overweight (Buy) 45% (33% of these provided with Investment Banking Services) Neutral (Hold) Underweight (Sell) 37% 18% (32% of these provided with Investment Banking Services) (30% of these provided with Investment Banking Services)

Information regarding company share price performance and history of HSBC ratings and target prices in respect of its longterm investment opportunities for the companies the subject of this report,is available from www.hsbcnet.com/research.

HSBC & Analyst disclosures

Disclosure checklist Company BHARTI AIRTEL HINDALCO KOTAK MAHINDRA BANK LARSEN & TOUBRO NTPC OIL & NATURAL GAS CORP SESA STERLITE
Source: HSBC

Ticker BRTI.NS HALC.BO KTKM.NS LART.BO NTPC.NS ONGC.BO SESA.BO

Recent price 302.55 98.85 685.90 1031.30 132.35 279.40 186.15

Price date 19-Feb-2014 19-Feb-2014 19-Feb-2014 19-Feb-2014 19-Feb-2014 19-Feb-2014 19-Feb-2014

Disclosure 1, 2, 5, 6, 7 2, 6, 7 6, 7 1, 2, 5, 6, 7 5, 6, 11 7 4

1 2 3 4 5 6 7 8 9 10 11

HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. As of 31 January 2014 HSBC beneficially owned 1% or more of a class of common equity securities of this company. As of 31 December 2013, this company was a client of HSBC or had during the preceding 12-month period been a client of and/or paid compensation to HSBC in respect of investment banking services. As of 31 December 2013, this company was a client of HSBC or had during the preceding 12-month period been a client of and/or paid compensation to HSBC in respect of non-investment banking securities-related services. As of 31 December 2013, this company was a client of HSBC or had during the preceding 12-month period been a client of and/or paid compensation to HSBC in respect of non-securities services. A covering analyst/s has received compensation from this company in the past 12 months. A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in securities in respect of this company

HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments (including derivatives) of companies covered in HSBC Research on a principal or agency basis. Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenue. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research.

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Additional disclosures
1 2 3 This report is dated as at 21 February 2014. All market data included in this report are dated as at close 18 February 2014, unless otherwise indicated in the report. HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBCs analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBCs Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.

MSCI Disclaimer
The MSCI sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, redisseminated or used to create any financial products, including any indices. This information is provided on an as is basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to, computing or compiling the information hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are services marks of MSCI and its affiliates.

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Disclaimer
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Global Equity Strategy Research Team

Global
Garry Evans Global Head of Equity Strategy +852 2996 6916 garryevans@hsbc.com.hk Daniel Grosvenor +44 20 7991 4246 daniel.grosvenor@hsbcib.com

South East Asia

Neel Sinha Head of Equity Research, South East Asia +65 6658 0606 neelsinha@hsbc.com.sg

India
Jitendra Sriram Head of Research, India +91 22 2268 1271 jitendrasriram@hsbc.co.in

EU and US
Peter Sullivan Head of Equity Strategy, EU and US +44 20 7991 6702 peter.sullivan@hsbcib.com

Korea
Brian Cho Head of Research, Korea +822 3706 8750 briancho@kr.hsbc.com James Jong-pil Lee +822 3706 8776 jplee@kr.hsbc.com

Europe
Robert Parkes +44 20 7991 6716 robert.parkes@hsbcib.com

CEEMEA
John Lomax Head of Global Emerging Market Equity Strategy +44 20 7992 3712 john.lomax@hsbcib.com Wietse Nijenhuis +27 11 676 4218 wietse.nijenhuis@za.hsbc.com

Latin America
Ben Laidler LatAm Equity Strategist and Head of Research, Americas +1 212 5253460 ben.m.laidler@us.hsbc.com Francisco Schumacher, CFA Southern Cone & Andean Equity Strategist +1 212 525 4430 francisco.j.schumacher@us.hsbc.com Andre C Carvalho Head of Brazil Equity Strategy +55 11 3371 8190 andre.c.carvalho@hsbc.com.br Juan Carlos Mateos, CFA Mexico Equity Strategist and Head of Equity Research, Mexico +52 55 5721 3607 juan.mateos@hsbc.com.mx Jaime Aguilera Equity Strategist +52 55 5721 2379

Asia
Herald van der Linde Deputy Head of Research and Head of Equity Strategy, Asia-Pacific +852 2996 6575 heraldvanderlinde@hsbc.com.hk Devendra Joshi +852 2996 6592 Steven Sun +852 2822 4298 Roger Xie +852 2822 4297 devendrajoshi@hsbc.com.hk stevensun@hsbc.com.hk rogerpxie@hsbc.com.hk

jaime.aguilera@hsbc.com.mx

Taiwan
Jenny Lai Head of Taiwan Research +8862 6631 2860 jennylai@hsbc.com.tw Bruce Warden +8862 6631 2868 brucebwarden@hsbc.com.tw