Time for a brief pause

With Corporate India currently overleveraged, investing for tomorrow's growth has taken a backseat

"Caesura: In musical notation, a caesura (||) denotes a break in the music, which can be a good time for musicians, like trumpeters, to catch their breath. Usually, a caesura means total silence, but not for long".

Indian stock markets were on a song in 2012, rising 25 per cent on the back of $25 billion of foreign institutional investor net inflows. The strong performance surprised many, especially in the backdrop of several negatives. In our previous strategy reports, we had taken the risk to be optimistic, even when environment and consensus outlook was negative and were proved right subsequently. But, now, we trade our optimism for caution. Suggest CAESURA:

Cautious private sector: India's top 10 corporate groups have witnessed increase in debt by 35 per cent compounded annual growth rate (CAGR) over FY07-12, but witnessed revenue growth of only 28 per cent CAGR. With Corporate India currently overleveraged, investing for tomorrow's growth (incremental capex) has taken a backseat. Survival for today is on top of the agenda.

Announcement of new orders declining: New project announcements during Q4FY13 fell 75 per cent year-on-year to an eight-year low. New orders are a key parameter of corporate health. With morale for fresh investments being low currently, we see growth being impacted in the absence of incremental capex.

Earnings growth no longer broad-based: In 2008, two-thirds of constituent sectors contributed to Sensex growth, while in 2012 only a third reported positive growth. Currently, a third of the Sensex companies, contributing about half of the weight, are in structural pain. The low growth is the result of isolated pockets of growth seen in sectors such as fast-moving consumer goods and pharma. Till growth revives in other sectors, earnings growth will remain subdued.

Supply of large equity in FY14: Thanks to the Securities and Exchange Board of India's directive of minimum 25 per cent public shareholding, and government's new found aggression in divestment, we expect $14 billion of equity to be offered to investors in FY14, which is two-thirds of the $22 billion of net inflows into Indian markets in FY13. Such a large supply of equity is sure to cap any increase in stock prices.

Underperformance due to political fragmentation: Historically, fragmentation of votes among various political alliances has resulted in weak unstable governments and taken its toll on market performance (only four per cent CAGR in Sensex during 1996-99). Now, with several of Congress' allies distancing themselves from the UPA, we sense dejà vu in terms of a fractured verdict post-elections and consequent directionless markets.

Roadblocks to implementation: While the government has marvellously recovered from its 'policy paralysis' and has set in motion several reforms, we expect implementation to hit structural roadblocks. Until key roadblocks such as land acquisition issues, inordinate delays in formulation of policies (coal mining) and further delays by bureaucratic pace of decision making ($4 billion of construction companies' receivables stuck with NHAI) are resolved, growth will be impacted.

Alternative to emerging markets emerge: Day by day, the worst appears to be getting over for developed markets, which are stabilising and increasingly attracting investor attention. With the risk-reward ratio appearing skewed favourably towards developed markets, emerging markets (including India) would bear the brunt of investor disinterest.

We believe on-ground implementation will be the key underpinning the turnaround in Indian economy. With on-ground action expected to become visible in broad-based growth only over time, we recommend playing the interim uncertain period via stocks with assured certainty on growth (Dr Reddy's, Cipla, Glenmark, Axis Bank, ING Vysya, GCPL), structural plays (United Spirits, Bajaj Auto, Adani Ports, Petronet LNG, Cairn), mature industry, now bottoming out (Idea), and the '4am' stocks (Jain Irrigation, Jyothy Labs, DEN and Hathway Cables).

The author is managing director & co-head - research (equities), IDFC Securities Limited