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Discounting new risks, Kotak Securities revises Sensex target
In a regional context Kotak Securities remains `Overweight' on India. Even if in its the recently published report it has lowered its end-1998 Sensex target to 4300 from earlier published 4500, it believes that most of 1997's positives carry into 1998. However, taking into account two recently emerged risks - politics and investor sentiment to Asia - it has discounted the risks and lowered its Sensex target.Kotak had evaluated India as `Overweight' in 1997 on the basis of modest earnings and economic growth, reasonable valuation and liquidity, the first signs of more efficient use of capital and a surprisingly reform-minded government. Having exceeded 4,500 target, that Kotak had set last year, the market got hit at year-end by disappointing earnings, Asian turmoil and politics. It further adds that most of 1997's positives carry into 1998, but new risks have also emerged. A 4,300 target stems from mild optimism on profits and politics, but the upside may be limited until hard evidence of growth and
good governance removes investor disillusion. Taking stock of the economic outlook, the report is apprehensive whether growth will pick up without help. It goes on to state that economic growth has undoubtedly slowed in the past 18 months. Yet the slowdown is insufficient to justify some of the extreme gloom and demands for wholesale government pump-priming as a cure. It feels demand was never the problem. Rather, the issue is supply. Flush with optimism post liberalization, and overestimating an explosion of demand, companies overinvested in new capacity. Now, as higher demand gradually lifts capacity utilization, EPS growth should accelerate in a low inflation environment that should be good for equities. The Kotak report feels that the real problem for corporate India is high competition and low inflation. Capital's share of GDP is probably falling at the expense of consumers and a still-too-greedy government. In the short term, this is bad for shareholders. Yet it is also making firms use capital more
efficiently, a long-term positive. It feels that the ongoing shakeout makes a few themes critical to stock selection: global competitiveness, pricing flexibility and barriers to entry and the ability to restructure amid an unhelpful legal framework. India's key long-term challenges are structural reform and reduction of the fiscal deficit. The former will lift India's long-term growth rate, the latter will cut real long-term interest rates. Valuation Market has traded at 12X-19X historic earnings and 10X-15X forward, now at 13.6X historic, 11.9X forward. Aside from nightmare scenario (totally irresponsible governance) worse case of weak politics, poor funds flow, slower fiscal 1998 earnings leads to one-year target of 3,250 (12X historic). In bull case, it expects the sensex hit 4,800 (14X forward). As a central case, the target for Kotak is 4,300, 15X historic, and 12.5X forward. Trading range should be between 3,700 and 4,700. Sector preference and stock picks As winners of the
shakeout, the Kotak report favours restructuring theme, export earners, stocks with sustainable pricing power and barriers to entry. The favoured sectors are pharmaceuticals, consumer products and telecoms our three favourities. Cyclicals could outperform later in 1998 but only once evidence of recovery becomes clearer. Favoured stocks Ranbaxy Laboratories and ICICI are on Kotak's Asia Recommended List. Its market outperformers include Reliance Industries, Mahindra & Mahindra, Cipla and Dr Reddy Laboratories. (This is an extract from India Strategy report by Kotak Securities-Goldman Sachs)
Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.
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