JPM

Asia Pacific Equity Research
14 November 2011
India Equity Strategy

Stratoscope : Divestments Assessing the Opportunity
Divestment dilemma. Soft equity markets have put a question mark over the Government raising the budgeted INR 400 bn through divestments for FY12E. YTD, only INR 11 bn has been raised. What could be the options? Given the uncertain near term outlook for equities, alternative options are being discussed. These include cash rich state owned companies: 1. Paying out a substantial cash dividend to shareholders. 2. Partially buying back of the Governments stake in these companies. 3. Picking up Government stakes in other state owned companies. Investor reaction to these options would be varied. Option 1 would be preferred as it would put cash back into the hands of all shareholders. Options 2 and 3 however may not enthuse minority shareholders. Option 2 would entail selectively allowing the Government to tender stock. Pricing could also be a matter of debate as stock prices have corrected sharply. SEBI guidelines require the last six months average to be considered as a benchmark. Option 3 could be viewed with skepticism as well, given the limited near advantage to be derived from allocating capital to cross holdings. We believe considerable care will have to be taken in structuring these deals to protect minority share holder interest. Portfolio stance. Our sector strategy is premised on: 1) Our house view that global macro data points are likely to remain choppy over the nearterm and sentiment volatile as policy makers grapple with the issues on hand. 2) Growth in India is slowing as evidenced by a number of high frequency data indicators 3) Medium term outlook for inflation is also improving with the fall in global commodity prices. Consequently, our sectoral stance is biased towards local sectors vs. global sectors. We are not however shedding our defensive bias completely yet. The key risk to our sector strategy is higher commodity / energy prices.
J.P. Morgan India portfolio stance
CONSUMER DISCRETIONARY CONSUMER STAPLES ENERGY FINANCIALS HEALTHCARE INDUSTRIALS INFORMATION TECHNOLOGY MATERIALS TELECOM UTILITIES
Source: J.P. Morgan
India Equity Strategy Bharat Iyer

AC
(91-22) 6157-3600 bharat.x.iyer@jpmorgan.com J.P. Morgan India Private Limited
Bijay Kumar, CFA

(91-22) 6157-3586 bijay.kumar@jpmorgan.com J.P. Morgan India Private Limited
Gunjan Prithyani
(91-22) 6157-3593 gunjan.x.prithyani@jpmorgan.com J.P. Morgan India Private Limited
EM Equity Strategy Adrian Mowat

(852) 2800-8599 adrian.mowat@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited
MSCI India relative to MSCI EM

100 95 90 85 80 Nov 10
Mar 11
Jul 11
Nov 11
Source: Bloomberg, J.P. Morgan
Portfolio Stance Underweight Neutral Neutral Overweight Overweight Overweight Neutral Underweight Overweight Underweight
Picks Mahindra & Mahindra ITC Reliance Industries, ONGC HDFC Bank, Kotak Mahindra Bank, Indusind Bank Glenmark Pharma L&T, Siemens TCS, Wipro Hindalco, Tata Steel Bharti Airtel Tata Power, Power Grid
Avoids Maruti Suzuki, Titan, Pantaloon Hindustan Unilever, Dabur State owned R&M companies, Coal India IDFC, SKS, BoI ABB Infosys ACC, Ambuja, IPPs
See page 19 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.morganmarkets.com
Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com
Asia Pacific Equity Research 14 November 2011
Divestments Assessing the Opportunity

The Governments proposed Divestment program has been a matter of considerable debate over the recent past. In the Union Budget for FY2012E, the Government had targeted raising INR 400 bn under this head (0.5% of GDP), to among other aims, aid the fiscal consolidation process.
Soft equity markets imply the Government may have to consider indirect means to meet the INR 400 bn divestment target
But soft equity markets have resulted in only INR 11 bn being raised so far this fiscal. There are concerns over achieving the budgeted targets in the five months through to the end of the fiscal year. Yields on the benchmark 10 year bond have risen by nearly 60 bps over the recent past on expectations that the fiscal deficit target may not be adhered to. Market participants have been considering the other options available to the Government to achieve the budgeted target, in the event investor sentiment does not improve over the near term. These include Cash rich State owned companies: 1. Paying out a substantial cash dividend to shareholders, including the Government. 2. Partially buying back the Governments stake in these companies. 3. Picking up Government stakes in other state owned companies. We believe that investor reaction to these options would be varied. Option 1 would be most preferred, particularly over the near term, as it would put cash back into the hands of the Government and minority shareholders as well. Options 2 and 3 however may not enthuse minority shareholders.
Dividend payouts by cash rich state owned companies should be well received. but selective buy backs and increased cross holdings may not enthuse minority share holders
The response to Option 2 would largely depend on the pricing for the buyback. Current SEBI guidelines stipulate that the buyback price should be guided by the average market price prevailing for the last 6 months, the book value and the intrinsic value of the stock. Given the recent downward spiral in stock prices, these buybacks would in all probability have to be done at above current market prices. Also special permission may be required to allow only the Government to tender stock as part of the buyback program. These terms would prima facie appear unfair to the minority shareholders (unless specific care is taken to mitigate the adverse impact arising). Option 3 is likely to be viewed by minority shareholders with skepticism as well, given the limited advantage to be derived from allocating capital to cross holdings, at least over the near term.
Figure 1: PSU Index Relative to Sensex

130 120 110 100 90 80 70 Dec-09 Mar-10 Jun-10 Sep-10 BSE PSU INDEX
Source: Bloomberg
Dec-10
Mar-11 SENSEX
Jun-11
Sep-11
We present below a list of the large cash rich state owned companies, along with an assessment from our sector analysts on their ability to participate in the Governments divestment process.
Table 1: PSU Companies with relatively higher cash holding
Company Name Cash, Bank Balance + Investments as on Mar 31st 2011 ( INR mn) 469,260 297,931 285,301 181,951 173,637 126,892 100,693 82,636 72,299 65,313 57,575 53,855 51,269 2,018,612 Analyst estimate of deployable divestment fund ( INR mn) 350,000 178,758 0 0 NA 76,135 60,000 NA NA 50,000 0 NA 0 714,894 NALCO has capital expenditure plans including Ph III expansion and setting up smelter in Indonesia Comment
Coal India Ltd. Oil & Natural Gas Corpn. Ltd. N T P C Ltd. Steel Authority Of India Ltd. N M D C Ltd. Oil India Ltd. Bharat Heavy Electricals Ltd. N H P C Ltd. M M T C Ltd. Bharat Electronics Ltd. Power Grid Corpn. Of India Ltd. Neyveli Lignite Corpn. Ltd. National Aluminium Co. Ltd. Total
Source: J.P. Morgan, CMIE
Deployable divestment fund is c.75% of cash, as companies would keep a cash cushion, especially in respect of statutory liabilities (excluding non-cash OBR adj. of Rs146bn) Deployable divestment fund is c.60% of cash balance, as companies would keep a cash cushion, especially in respect of statutory liabilities like site restoration fund and funding overseas acquisitions Cash balances required to meet a) immediate debt repayment needs and b) equity commitments towards growth plans of 45GW / mining acquisitions SAIL has a large capital expenditure plan and was net debt as of Sep-11 NMDC has announced a plan to set up 3MT steel plant in Chhattishgarh Deployable divestment fund is c.60% of cash balance, as companies would keep a cash cushion, and it is also actively looking at overseas acquisitions Capacity expansions mostly done, but part of cash would be required for equity commitments towards JVs with state gencos Significant capital expenditure is over; a large part of cash can be invested. Internal funding needs are huge.12th Plan capital expenditure target of Rs. 1000 bn and their business will remain FCF negative over this period.
Table 2: Cash rich Government companies Government holding and Market

Company Name Oil & Natural Gas Corpn. Ltd. Coal India Ltd. N T P C Ltd. N M D C Ltd. Bharat Heavy Electricals Ltd. M M T C Ltd. Power Grid Corpn. Of India Ltd. Steel Authority Of India Ltd. Oil India Ltd. N H P C Ltd. National Aluminium Co. Ltd. Neyveli Lignite Corpn. Ltd. Bharat Electronics Ltd.
Source: J.P. Morgan, CMIE
Indian Govt. Ownership (%) 74.1 90.0 84.5 90.0 67.7 99.3 69.4 85.8 78.4 86.4 87.2 93.6 75.9
Market Capitalization ( INR mn) 2,274,049 2,061,030 1,432,237 872,238 793,267 642,400 486,353 436,418 310,054 291,528 154,377 131,029 126,260
Early this year, state owned companies that were expected to be part of the divestment program included ONGC, SAIL, IOC, Hindustan Copper, BHEL and NBCC.
Disinvestment Policy UPA II

The key features of the current divestment policy articulated after the UPA Government commenced its second term in 2009 are: Citizens have every right to own part of the shares of Public Sector Undertakings Public Sector Undertakings are the wealth of the Nation and this wealth should rest in the hands of the people While pursuing disinvestment, Government has to retain majority shareholding, i.e. at least 51% and management control of the Public Sector Undertakings
Approach for Disinvestment On 5th November 2009, Government approved the following action plan for disinvestment in profit making government companies: Already listed profitable CPSEs (not meeting mandatory shareholding of 10%) are to be made compliant by Offer for Sale by Government or by the CPSEs through issue of fresh shares or a combination of both Unlisted CPSEs with no accumulated losses and having earned net profit in three preceding consecutive years are to be listed Follow-on public offers would be considered taking into consideration the needs for capital investment of CPSE, on a case by case basis, and Government could simultaneously or independently offer a portion of its equity shareholding In all cases of disinvestment, the Government would retain at least 51% equity and the management control All cases of disinvestment are to be decided on a case by case basis
The Department of Disinvestment is to identify CPSEs in consultation with respective administrative Ministries and submit proposal to Government in cases requiring Offer for Sale of Government equity
Figure 2: Amount raised through disinvestment (Rs. bn)
400 300 200 100 0
INR bn
Budgeted
Source: Ministry of Disinvestment
Actual
Figure 3: Breakdown of disinvestment activity (FY92-11)

4% 6% 1% 6%
Sale of minority shareholding Sale of majority shareholding of one CPSE to another CPSE Strategic sale Receipts from other related transactions Sale of residual shareholding in disinvested companies
82%
Source: Ministry of Disinvestment
Table 3: PSU Index vs. Sensex Annual performance

% Return 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 YTD
Source: Bloomberg
BSE PSU Index -3 74 144 15 22 12 73 -50 81 -1 -20
Sensex -18 4 73 13 42 47 47 -52 81 17 -14
Relative Performance Vs. Sensex 15 71 71 2 -20 -35 26 3 0 -18 -6
Within the divestment process, the government initially tried various options including strategic sales, either of the corporation or specific assets i.e. privatization, sale of a majority stake to another state-owned company and minority stake sales to financial investors. However, given the political opposition to privatization, Governments across the political spectrum have over the last few years reconciled to minority stake sales to financial investors. Note that minority stake sales have accounted for 82% of the total fund raised via divestment. Majority stake sale from one CPSE to another There are only three instances where Government divested itself of a majority shareholding in a CPSE by selling the shares to another CPSE without going through a process of competitive bidding. Subsequently, it was felt that disinvestment by sale of shares to CPSEs did not result in any of the advantages normally associated with the block transfer of majority shareholding, since the public sector character of the company did not change. Thereafter, Government on 18th September, 2002 issued guidelines that the CPSEs should be prohibited from participating in disinvestment transactions, unless an exemption was specifically given in a particular case.
Table 4: Details of historical divestments (Amt. In IMR mn)

Year Budgeted receipt Sale of minority shareholding in CPSEs Sale of majority shareholding of one CPSE to another CPSE 13,172 Strategic sale Receipts from other related transacti ons 2,754 Sale of residual shareholding in disinvested CPSEs /companies Total Transactions
FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01
25,000 25,000 35,000 40,000 70,000 50,000 48,000 50,000 100,000 100,000
30,377 19,125 48,431 1,685 3,797 9,100 53,711 14,793 -
1,055 5,540
30,377 19,125 0 48,431 1,685 3,797 9,100 53,711 18,601 18,713
FY02
120,000
30,901
25,676
56,577
FY03
120,000
22,527
10,953
33,480
FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 *
145,000 40,000 No target fixed No target fixed No target fixed No target fixed No target fixed 400,000 400,000
127,416 27,001 18,145 235,529 227,630 11,446
3,421 -
648 21 -
24,637 15,676 23,669 -
155,474 27,649 15,697 0 41,814 235,529 227,630 11,446
Minority shares sold in Dec, 1991 and Feb, 1992 by auction method in bundles of "very good", "good" and "average" companies Shares sold separately for each company by auction method. Equity of 6 companies sold by auction method but proceeds received in 94-95. Shares sold by auction method. Shares sold by auction method. GDR -VSNL GDR -MTNL GDR-VSNL; Domestic offerings of CONCOR and GAIL; Cross purchase by 3 Oil sector companies i.e. GAIL, ONGC and IOC. GDR-GAIL; Domestic offering of VSNL; capital reduction and dividend from BALCO; Strategic sale of MFIL. Sale of KRL, CPCL and BRPL to CPSEs; Strategic sale of BALCO and LJMC. Strategic sale of CMC, HTL, VSNL, IBP, PPL, hotel properties of ITDC and HCI, slump sale of Hotel Centaur Juhu Beach, Mumbai and leasing of Ashok Bangalore; Special dividend from VSNL, STC and MMTC; sale of shares to VSNL employees. Strategic sale of HZL, IPCL, hotel properties of ITDC, slump sale of Centaur Hotel Mumbai Airport, Mumbai; Premium for renunciation of rights issue in favour of SMC ; Put Option of MFIL; Sale of shares to employees of HZL and CMC. Strategic sale of JCL; Call Option of HZL; Offer for Sale of MUL, IBP, IPCL, CMC, DCI, GAIL and ONGC; Sale of shares of ICI Ltd. Offer for Sale of NTPC and spill over of ONGC; sale of shares to IPCL employees. Sale of MUL shares to Indian public sector financial institutions & banks and employees Sale of MUL shares to public sector financial institutions, public sector banks and Indian mutual funds.IPO of REC and PGC.
Minority shares sold in SJVN, EIL, COAL INDIA , PGCIL, MOIL , SCI PFC
828,185
Source: Divestment Ministry
13,172
63,444
40,052
63,983
1,008,835
India Equity Market Review

MSCI India (US$) gained 4% over the last month and performed inline with the peer group. Globally, risk assets have been extremely volatile linked to developments in the EU. Macro data from the USA has however been surprisingly resilient. Locally, the Reserve Bank of Indias signal of a likely pause in monetary tightening has also helped stabilize investor sentiment. Corporate India has been reporting a mixed performance so-far over the 2Q FY12 reporting season. Top-line growth has been robust, but margins have disappointed across most sectors. FIIs invested US$ 346 mn into Indian equities over October. DIIs turned sellers over the month. Insurance companies sold US$423 mn, while domestic mutual funds sold a marginal US$43 mn over the month Telecom, Consumer Staples and IT Services outperformed, while Industrials, Energy and Health Care underperformed.
Table 5: MSCI Index performance
Telecom, Consumer Staples and IT Services outperformed...while Industrials, Energy and Health Care underperformed (%) World USA Japan Euro Emerging Markets (US$) India (US$) India Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials IT Services Materials Telecom Utilities
Source: MSCI, Bloomberg.
1 mth 2 4 (4) (2) 5 4 5 5 11 2 4 2 0 11 6 13 4
3mth 0 5 (7) (3) (4) (7) 2 13 11 5 (3) 3 (11) 14 (1) (3) (3)
6 mth (14) (8) (12) (26) (18) (17) (7) 17 15 (10) (8) 3 (22) (4) (19) (9) (11)
12 mth (7) 2 (11) (19) (16) (27) (17) 3 13 (18) (22) (7) (35) (5) (29) (52) (28)
Figure 4: Macro events and Sensex

20,000 19,000 18,000 17,000 16,000
4Q FY1 and 1Q FY 12 GDP growth print @ 7.8% & 7.7% resp.
S&P downgrade of US Long-Term Rating to 'AA+'
EU summit indicated commitment towards resolving soverign credit issues
RBI hiked benchmark rates by a cumulative 150 in last four policy meetings 8-Jun-11 7-Jul-11 5-Aug-11 5-Sep-11 4-Oct-11 2-Nov-11
15,000 10-May-11
Source: Bloomberg, J.P. Morgan
In our last monthly update, India Stratoscope - Valuations revisited (October 10th), we had opined that valuations had turned appealing and Indian equities could deliver returns of about 15% through to the end of the fiscal year. We maintain that view.
We remain positive through to the end of the fiscal year....but expect consolidation over the near term, after the sharp move up last month.
But near term, we expect the markets to trade sideways, with more volatility to come as: 1) Indian equities have rallied sharply by about 5% over the last month. 2) Near term data on growth is expected to be disappointing. The weak data on growth also has implications for tax collections and the fiscal deficit. 3) Considerable work remains to be done to achieve a resolution to the credit crises in Europe and the outlook for global growth remains patchy. From a local perspective, the RBI signaling a pause to monetary tightening should put a floor to market valuations. Also inflation is expected to roll over from December onwards, off a high base effect. Current policy rates provide the RBI with considerable flexibility to act in the event growth tails off sharply. A meaningful correction in global prices and / or progress on key progress reforms (the Winter session of Parliament starts on November 22nd) would be key re-rating triggers to look forward to.
Portfolio Stance
Our portfolio strategy is premised on the following key views: 1) Global macro data points are likely to remain weak over the near term and sentiment volatile as policy makers grapple with the issues on hand. Our Chief Asian and Emerging Market Strategist Adrian Mowat maintains an Underweight stance on Commodities and Energy.
Our sectoral allocation is biased towards local sectors vs. global sectors.
Our economics team is cautious on global growth outlook. Global real GDP growth is expected to moderate from 2.6% in CY2011E to 2% in CY2012E, with a large part of the forecast slowdown to be front ended. 2) Growth in India is slowing as evidenced by a number of high frequency data indicators IIP, PMI (both Industrial and Services), Auto sales, Cement dispatches, credit growth, etc. 3) The medium term outlook for imported inflation is also improving with the fall in global commodity prices. India, with its current account deficit and under investment in infrastructure is a major beneficiary of lower commodity prices. A better than forecast monsoon also augurs well for food inflation. Slower growth and moderation in inflation should with a lag mark the end of the tightening cycle. In the backdrop of the above, our sectoral stance is biased towards local sectors vs. global sectors. Valuations for some local sectors, particularly Financials and Industrials have almost reached levels seen during the global financial crises (please refer to Annexure 2 for sectoral valuation charts). We remain wary of the Discretionary space though as the extent of slowdown suggested by high frequency data points do not appear to be yet factored into earnings estimates. We view the space as a late cycle play. We are not however shedding our defensive bias yet as indicated by our continuing Overweight on Telecom and Healthcare as also our Neutral stance on Staples. The key risks to our sector strategy are higher commodity / energy prices.
10
Table 6: Portfolio stance

CONSUMER DISCRETIONARY CONSUMER STAPLES ENERGY FINANCIALS HEALTH CARE INDUSTRIALS INFORMATION TECHNOLOGY MATERIALS TELECOM UTILITIES
Source: J.P. Morgan
Portfolio Stance Underweight Neutral Neutral Overweight Overweight Overweight Neutral Underweight Overweight Underweight
Picks Mahindra & Mahindra ITC Reliance Industries, ONGC HDFC Bank, Kotak Mahindra Bank, Indusind Bank Glenmark Pharma L&T, Siemens TCS, Wipro Hindalco, Tata Steel Bharti Airtel Tata Power, Power Grid
Avoids Maruti Suzuki, Titan, Pantaloon Hindustan Unilever, Dabur State owned R&M companies, Coal India IDFC, SKS, BoI ABB Infosys ACC, Ambuja, IPPs
Table 7: Top Mid-cap Picks

Companies Yes Bank GSPL Prestige Tulip Telecom Havells Sintex BILT
Source: J.P. Morgan
11
Annexure 1 - Valuations
Figure 5: MSCI India - P/B and ROE
Valuations on a P/B basis are at a 20% discount to the last decades average. Forecast RoEs are expected to remain largely unchanged at about 17%.
6.5 5.5 4.5 3.5 2.5 P/B RoE (R)
24 22 20 18 16 14
1.5 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11
Source: MSCI, IBES, Bloomberg
Figure 6: MSCI India - 12 month forward PE

Valuations in terms of forward PE are lower than the long-term average level. The street now estimates earnings growth of 16% yoy for FY12E. J.P.Morgan estimates lower earnings growth of 10% for FY12E.
24
18
12
Mar-95
Mar-96
Mar-97
Mar-98
Mar-99
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10 Nov-09
Figure 7: 10 Year Bond Yield / Earnings Yield

Equities appear fairly valued in relation to bonds.
Nov-94
Nov-95
Nov-96
Nov-97
Nov-98
Nov-99
Nov-00
Nov-01
Nov-02
Nov-03
Nov-04
Nov-05
Nov-06
Nov-07
Nov-08
Nov-10
12
Nov-11
2.5 2.3 2.1 1.9 1.7 1.5 1.3 1.1 0.9 0.7 0.5
Equities Expensive
Bonds Expensive
Mar-11
Annexure 2 - Sensex India Valuations
Table 8: J.P. Morgan estimates and valuations

FY11 21 38 17 20 31 28 28 13 4 16 17.4 PE FY12(E) 13 34 14 19 26 22 24 10 12 16 15.0 RoE (%) FY12(E) 14 34 18 15 19 22 28 16 3 11 16.7 FY13(E) 12 29 12 16 21 16 19 10 16 14 12.9 FY11 67 13 24 7 22 26 14 24 (71) 0 17.8 Earnings Growth (%) FY12(E) FY13(E) 3 13 16 18 17 8 21 20 21 17 41 22 24 15 5 17 (23) 45 13 17 16.1 EV/ EBITDA FY12(E) 14.3 15.5 7.3 NA 15.3 8.8 15.2 6.9 7.3 10.9 9.5 15.9 FY11 1.8 10.4 2.3 2.5 5.3 4.0 5.9 1.8 0.5 1.7 2.7 PB FY12(E) 1.7 9.1 2.0 2.2 3.6 2.9 4.9 1.4 0.5 1.5 2.3 Div Yield (%) FY12(E) 3.7 2.0 2.2 1.4 0.9 0.6 1.1 1.7 1.3 1.2 1.3 FY13(E) 1.6 7.8 1.8 1.9 2.8 2.4 4.1 1.3 0.4 1.4 2.1
Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Telecommunication Services Utilities
Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Telecommunication Services Utilities
FY11 15 32 18 13 22 19 26 19 4 11 16.6
FY13(E) 15 34 17 15 17 21 26 16 4 12 16.9
FY11 15.0 18.2 7.9 NA 20.8 12.8 18.2 8.9 7.6 13.1 11.3
FY13(E) 12.1 13.2 6.8 NA 12.7 7.1 13.4 6.1 6.3 8.3 8.3
FY11 3.8 1.7 1.9 1.2 1.1 0.5 1.1 1.6 0.6 1.1 1.2
FY13(E) 3.8 2.1 2.4 1.6 1.1 0.6 1.0 2.0 2.5 1.2 1.5
Source: J.P. Morgan calculations, Bloomberg
13
MSCI India Sectoral Valuations Charts

Broad market valuations have de-rated sharply over the last year. Most sectors mirror the trend.
Table 9: Sectoral earnings and PE changes 12 M
(%) MSCI India Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Telecom Utilities
Source: IBES, MSCI, Datastream.
Figure 8: India 12 Month forward PE

24 20
12 M fwd EPS change 9 51 13 (1) 31 14 (14) 14 (12) (41) (6)
PE re/derating (23) (29) (1) (17) (40) (16) (23) (16) (14) (29) (23)
Performance (16) 8 12 (18) (21) (5) (34) (4) (25) (58) (27)
16 12 8
Source: IBES, MSCI, Datastream
Figure 9: Consumer Discretionary 12 Month forward PE

22 18 14 10 6
An analysis of historic valuation trends, over the last six years, indicates that current market valuations have derated to below one standard deviation lower than average levels. Key sectoral valuation trends can be summarized as follows: a) Most sectors are trading at between their historic average and one standard deviation lower.
b) Consumer Staples is the only sector trading at above one standard deviation higher than the historic range. c) Industrials, Financials and Consumer Discretionary are trading below one standard deviation lower than the historical range.
Figure 10: Consumer Staples 12 Month forward PE

30
25
20
15
14
Figure 11: Energy 12 Month forward PE

22 18 14
Figure 14: Industrials 12 Month forward PE

36 30 24 18
10 6
12 6
Figure 12: Financials 12 Month forward PE

30 24
Figure 15: IT Services 12 Month forward PE

26
20 18 14 12 6 8
Figure 13: Health Care 12 Month forward PE

28 24 20
Figure 16: Materials 12 Month forward PE

14 12 10 8
16 12
6 4
15
Figure 17: Telecom 12 Month forward PE

28 22 16 10 4
Figure 18: Utilities 12 Month forward PE

30 24 18 12 6
16
Annexure 3: Key Economics Indicators

Table 10: Key economic indicators
FY 11 Nominal GDP (US$ bn) Real GDP Growth rates WPI (%) (Avg) INR / US$ , (eop) 10 Yr - T Yield, (%, eop) Current A/C balance (% of GDP) Central govt. fiscal deficit ( % of GDP)
Source: J.P. Morgan Economics
FY 12(E) 1,895 7.4 9.4 44.5 8.75 (2.7) (5.3)
FY 13(E) 2,271 7.7 6.6 NA NA (2.2) (4.6)
1,601 8.5 9.6 44.5 8.00 (2.8) (5.1)
Figure 19: Quarterly real GDP growth trend (%oya)

Economic growth is expected to remain below trend levels for a few quarters. A meaningful acceleration is expected only in late 2H FY13E.
9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 6.4
9.4 % 8.6 8.8
8.9 8.3 7.8 7.7 7.3 7.9 7.2 7.1 7.4
7.3 6.3
7.6
09Q1 09Q2 09Q3 09Q4 10Q1 10Q2 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4
Source: J.P. Morgan estimates
Figure 20: Industrial production (%oya)

Growth in Industrial production for September at 1.9% was significantly lower-thanexpectations. The slow down has been fairly broad based across segments. IIP has been extremely volatile over the past few quarters on account of volatility in the capital goods segment.
% 70 60 50 40 30 20 10 0 (10) Jan 08
IIP
Jul 08
Jan 09
Capital goods
Jul 09
Jan 10
Consumer durable
Jul 10
Jan 11
Jul 11
Consumer non-durable
17
Credit growth (19% oya) has been moderating. Deposit growth at 16%oya, however continues to lag.
Figure 21: Commercial banks Deposit & credit growth (%)

36 30 24 18 12 6 Deposit Growth (%YoY) Credit growth (%YoY)
Figure 22: Inflation and treasury yield (%)

Headline WPI inflation rose 9.7% oya over September. 10 year treasury yields increased a significantly 50 bps to 8.90%, on fears of an overshoot in the fiscal deficit.
14 12 10 8 6 4 2 0 (2) Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 WPI ( % yoy)
10 9 8 7 6 5
10 Year Treasury Yld (%)
INR depreciated 2% vs. the US$ over the month. The move was largely led by heightened risk aversion and a strong USD. FX reserves remained largely unchanged over the month.
Figure 23: Foreign currency reserves and exchange rate

320 300 280 260 240 220 Mar-08 Sep-08 Mar-09 FX reserve
53 51 49 47 45 43 41 39 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11
INR/ US$
18
Companies Recommended in This Report (all prices in this report as of market close on 11 November 2011) ACC Limited (ACC.BO/Rs1218.60/Underweight), Ambuja Cements Limited (ABUJ.BO/Rs163.30/Underweight), Bank of India (BOI.BO/Rs331.80/Underweight), Bharti Airtel Limited (BRTI.BO/Rs395.60/Overweight), Dabur India Limited (DABU.BO/Rs98.75/Neutral), Glenmark Pharmaceuticals Ltd. (GLEN.NS/Rs333.40/Overweight), HDFC Bank (HDBK.BO/Rs464.05/Overweight), Hindalco Industries (HALC.BO/Rs128.70/Overweight), Hindustan Unilever Limited (HLL.BO/Rs395.65/Underweight), IDFC (IDFC.BO/Rs118.75/Neutral), ITC Limited (ITC.BO/Rs212.65/Overweight), IndusInd Bank (INBK.BO/Rs268.80/Overweight), Infosys (INFY.BO/Rs2775.70/Neutral), Larsen & Toubro (LART.BO/Rs1330.40/Overweight), Mahindra & Mahindra (MAHM.BO/Rs841.40/Overweight), Maruti Suzuki India Ltd (MRTI.BO/Rs1059.75/Neutral), Oil and Natural Gas Corporation (ONGC.BO/Rs265.65/Overweight), Pantaloon Retail (India) Ltd (PART.BO/Rs171.50/Neutral), Power Grid Corporation of India (PGRD.BO/Rs105.45/Overweight), Reliance Industries Ltd (RELI.BO/Rs885.35/Overweight), SKS Microfinance (SKSM.BO/Rs157.25/Underweight), Siemens India (SIEM.BO/Rs829.35/Overweight), Tata Consultancy Services (TCS.BO/Rs1131.00/Overweight), Tata Power (TTPW.BO/Rs102.10/Overweight), Tata Steel Ltd (TISC.BO/Rs429.85/Overweight), Titan Industries Limited (TITN.BO/Rs214.80/Underweight), Wipro Ltd. (WIPR.BO/Rs382.10/Overweight)
Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.
Important Disclosures
Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for HDFC Bank, Hindalco Industries, ITC Limited, Tata Power, Tata Steel Ltd, Power Grid Corporation of India within the past 12 months. Analyst Position: The following analysts (and/or their associates or household members) own a long position in the shares of Bharti Airtel Limited: Bijay Kumar. The following analysts (and/or their associates or household members) own a long position in the shares of HDFC Bank: Bijay Kumar. The following analysts (and/or their associates or household members) own a long position in the shares of Larsen & Toubro: Bijay Kumar. The following analysts (and/or their associates or household members) own a long position in the shares of Mahindra & Mahindra: Bijay Kumar. The following analysts (and/or their associates or household members) own a long position in the shares of Tata Power: Bijay Kumar. The following analysts (and/or their associates or household members) own a long position in the shares of Infosys: Bijay Kumar.
Beneficial Ownership (1% or more): J.P. Morgan beneficially owns 1% or more of a class of common equity securities of IndusInd Bank, Mahindra & Mahindra. Client: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients: Bharti Airtel Limited, Glenmark Pharmaceuticals Ltd., HDFC Bank, Hindalco Industries, IndusInd Bank, ITC Limited, Larsen & Toubro, Mahindra & Mahindra, Oil and Natural Gas Corporation, Reliance Industries Ltd, Siemens India, Tata Power, Tata Consultancy Services, Tata Steel Ltd, Wipro Ltd., Bank of India, Dabur India Limited, IDFC, Infosys, Maruti Suzuki India Ltd, Hindustan Unilever Limited, Pantaloon Retail (India) Ltd, Titan Industries Limited, Ambuja Cements Limited, ACC Limited, Power Grid Corporation of India.
Client/Investment Banking: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as investment banking clients: HDFC Bank, Hindalco Industries, ITC Limited, Tata Power, Tata Steel Ltd, Power Grid Corporation of India. Client/Non-Investment Banking, Securities-Related: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients, and the services provided were non-investment-banking, securities-related: Bharti Airtel Limited, HDFC Bank, Hindalco Industries, IndusInd Bank, Larsen & Toubro, Reliance Industries Ltd, Siemens India, Tata Power, Tata Consultancy Services, Tata Steel Ltd, Wipro Ltd., Bank of India, IDFC, Infosys, Maruti Suzuki India Ltd.
Client/Non-Securities-Related: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients, and the services provided were non-securities-related: Bharti Airtel Limited, HDFC Bank, Hindalco Industries, Larsen & Toubro, Reliance Industries Ltd, Tata Consultancy Services, Tata Steel Ltd, Bank of India, IDFC. Investment Banking (past 12 months): J.P. Morgan received in the past 12 months compensation for investment banking HDFC Bank, Hindalco Industries, ITC Limited, Tata Power, Tata Steel Ltd, Power Grid Corporation of India. Investment Banking (next 3 months): J.P. Morgan expects to receive, or intend to seek, compensation for investment banking services in the next three months from Bharti Airtel Limited, HDFC Bank, Hindalco Industries, ITC Limited, Larsen & Toubro, Oil and
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Natural Gas Corporation, Reliance Industries Ltd, Siemens India, Tata Power, Tata Consultancy Services, Tata Steel Ltd, Power Grid Corporation of India.
Non-Investment Banking Compensation: J.P. Morgan has received compensation in the past 12 months for products or services other than investment banking from Bharti Airtel Limited, HDFC Bank, Hindalco Industries, IndusInd Bank, Larsen & Toubro, Reliance Industries Ltd, Siemens India, Tata Power, Tata Consultancy Services, Tata Steel Ltd, Wipro Ltd., Bank of India, IDFC, Infosys, Maruti Suzuki India Ltd.
An affiliate of JPMS owns a significant stake in HDFC Securities Limited, a privately held subsidiary of HDFC.
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Asia Pacific Equity Research

India Equity Strategy

India Equity Strategy Bharat Iyer

(91-22) 6157-3600 bharat.x.iyer@jpmorgan.com J.P. Morgan India Private Limited

Bijay Kumar, CFA

EM Equity Strategy Adrian Mowat

MSCI India relative to MSCI EM

Source: Bloomberg, J.P. Morgan

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Divestments Assessing the Opportunity

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Figure 1: PSU Index Relative to Sensex

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Table 2: Cash rich Government companies Government holding and Market

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Disinvestment Policy UPA II

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Figure 3: Breakdown of disinvestment activity (FY92-11)

Table 3: PSU Index vs. Sensex Annual performance

BSE PSU Index -3 74 144 15 22 12 73 -50 81 -1 -20

Sensex -18 4 73 13 42 47 47 -52 81 17 -14

Relative Performance Vs. Sensex 15 71 71 2 -20 -35 26 3 0 -18 -6

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Table 4: Details of historical divestments (Amt. In IMR mn)

30,377 19,125 48,431 1,685 3,797 9,100 53,711 14,793 -

30,377 19,125 0 48,431 1,685 3,797 9,100 53,711 18,601 18,713

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 *

127,416 27,001 18,145 235,529 227,630 11,446

24,637 15,676 23,669 -

155,474 27,649 15,697 0 41,814 235,529 227,630 11,446

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

India Equity Market Review

1 mth 2 4 (4) (2) 5 4 5 5 11 2 4 2 0 11 6 13 4

Figure 4: Macro events and Sensex

4Q FY1 and 1Q FY 12 GDP growth print @ 7.8% & 7.7% resp.

S&P downgrade of US Long-Term Rating to 'AA+'

EU summit indicated commitment towards resolving soverign credit issues

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Table 6: Portfolio stance

Table 7: Top Mid-cap Picks

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

6.5 5.5 4.5 3.5 2.5 P/B RoE (R)

Figure 6: MSCI India - 12 month forward PE

Source: MSCI, IBES, Bloomberg

Figure 7: 10 Year Bond Yield / Earnings Yield

Source: MSCI, IBES, Bloomberg

Bharat Iyer (91-22) 6157-3600 bharat.x.iyer@jpmorgan.com

Asia Pacific Equity Research 14 November 2011

Annexure 2 - Sensex India Valuations

Table 8: J.P. Morgan estimates and valuations