INSTITUTIONAL EQUITY RESEARCH INDIA | STRATEGY | Quarterly …backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_Portfolio... · Portfolio Manager Style Guide Best of both

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INSTITUTIONAL EQUITY RESEARCH

INDIA | STRATEGY | Quarterly Update

Portfolio Manager Style Guide

Best of both value and growth: Growth at a reasonable price Markets expensive or undervalued: It’s a question of time-frame The most frequent argument against investing in India is the curious case of expensive valuations. However, valuations can create optical illusions if viewed in isolation. India MSCI currently trades at 19.7x one-year forward earnings, which is one standard deviation above its long-term mean – expensive, but not exuberant. But when valuations are adjusted for cyclicality using Shiller’s PER, then India trades at 21x compared to its 15-year average of 24x – indicating that market valuations are still reasonable. However, Shiller’s PE takes a rather longer-term view than most asset managers, and does not capture the short-term corrections or rallies. Nonetheless, it is a decent indicator of irrational exuberance, from which India seems quite distant. Value vs. growth: No clear winners yet but balance tilting towards growth Value and grow strategies based on MSCI indices delivered similar returns in the last one year on most time frames. However, current macro indicators (declining interest rates, stable global interest rates) tilt the balance in favour of growth – although very marginally. Commodity plays continue to do very well, while classic growth sectors (IT, pharmaceuticals) struggle. In the January edition of our PMSG, value backed by quality was the key theme – we highlighted that the trick to value investing in India is using quality filters. Our value investing screeners (Novy-Marx/Piotroski’s F-score matrix) have delivered alphas of 24%/20% while EV/DACF screener underperformed significantly. In this PMSG, we believe growth strategies are likely to have a slight edge and introduce key growth screeners that can deliver significant alpha. However, growth investing is more challenging: Value and quality have rather well-defined parameters and are easier to implement. A growth

strategy that has a credible record of beating markets can be challenging. Considering that the entire sell-side universe, more often than not, tends to overestimate growth potential, beating the market with better-than-market growth forecasting is generally difficult. While the market overshoots on growth prospects, it often underestimates the price it might be willing to pay if growth prospects materialise. This is even more evident in a stable-to-declining interest rate scenario (like ours). In this PMSG: we present three baskets of ideas using the growth-price framework, we keep one ‘value backed by quality’ that has delivered superlative returns, introduce ‘dividend aristocrats’. The following are our key ideas based on our growth-price frameworks. For growth, these capture financials, especially NBFCs and chemicals that have delivered solid growth in the last few years: Growth at a reasonable price (GARP): In this, we use

consistent growth parameters as screeners with filters for pricing such as PE. HCL Technologies, Aarti Industries, Meghmani and KEI Industries

Pure growth: Stories that could see further rerating. HDFC Bank, Bharat Forge, Shriram Transport, Ahluwalia, Cholamandalam.

PEG: More classic (similar to GARP) indicating underpriced growth. CEAT, Indusind Bank, Aurobindo.

Value-quality (Novy-Marx): Returns have far exceeded the benchmark. Hindalco, Nalco, Apollo Tyre, IRB, and NCC.

Dividend aristocrats in the Indian context: Stocks that have successfully delivered incremental dividend. HDFC Bank, ITC

Naveen Kulkarni, CFA, FRM (+91 22 6246 4122) [email protected] Neeraj Chadawar (+91 22 66679764) [email protected]

11 September 2017

PORTFOLIO MANAGER STYLE GUIDE | QUARTERLY UPDATE

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Global growth rebound? Global growth expectations have turned positive as ...in line with rising long-term inflation expectations across

PMI new orders pick up. Current PMI New Order Index the developed world

suggests global GDP growth of 3.8% ...

Note: Long-term inflation expectations are derived from 5-year forward 5-year inflation swap rates.

Global policy uncertainty is reducing... ..but slowing investment growth has dragged earning revision

into negative territory in recent months

Source: Bloomberg, PhillipCapital India Research

50

50

51

51

52

52

53

53

54

2.3

2.8

3.3

3.8

4.3

Sep/14 Apr/15 Nov/15 Jun/16 Jan/17 Aug/17

Global GDP growth (%yoy)

Global Manufacturing PMI new order, rhs

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5 US Europe Japan

0

100

200

300

400

500 Global Economic policy Uncertainty Index

*Rebased to 100 on Jan 2000

-15%

-10%

-5%

0%

5%

10%

15%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2010 2012 2013 2014 2015 2016 2017

MSCI world earning revisions

13wk 4wk, rhs


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Valuations: MSCI India is at a 45% 12-month forward P/E premium to MSCI EM Index – still below its long-term average premium of 55%.

On P/B, the market looks cheap: MSCI India trades at a three-year low (70% premium to MSCI EM) vs. its long-term average of 80% premium.

In absolute terms, MSCI India looks expensive – 19.7x one-year forward P/E vs. average 17x; trailing PE of 22x vs. average 18x. However…

On Shiller PE (cyclically adjusted ) – it looks cheap: MSCI India’s current Shiller PE is 21x vs. an average 24x (11% discount to long-term average).


80%

130%

180%

230%

280%

330%

380%

May/05 May/07 Jun/09 Jul/11 Jul/13 Aug/15 Aug/17

MSCI India 12m fwd PE rel Emerging market

Average (+/- stdev)

120%

150%

180%

210%

240%

270%

May/05 Oct/07 Mar/10 Sep/12 Feb/15 Aug/17

MSCI India price to book rel Emerging market

Average (+/- stdev)

8

13

18

23

28

May-05 May-07 May-09 May-11 May-13 May-15 May-17

MSCI india 1yr forward PE

Current PE - 19.7

Average - 17

8

13

18

23

28

33

38

43

48

53 MSCI India Shiller PE

MSCI trailing PE


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A case for growth investing now India has typically always been viewed as a growth market by all types of investors. Thus, a growth strategy has seen a much longer history of outperformance. While the difference between value and growth investing over a long period of 20 years is not very high, growth has completely dominated the last 10 years. The current scenario has increasingly become a mixed bag – with both growth and value performing in tandem.

Long-term trends CAGR 5y 10y 15y 20y YTD

Growth 13% 5% 14% 12% 20% Value 7% 3% 17% 10% 16%

Classic growth sectors – IT and pharmaceuticals – are seeing significant pricing and regulatory pressures, resulting in huge underperformance versus benchmarks. This has limited options for investors – and the focus is on sectors such as consumers, automobiles, private banks, and NBFCs. Mid-cap and small-cap investing is also largely growth-based, with a credible history of generating alpha. While growth sectors have seen regulatory challenges, commodities which is a value-sector has continued its strong run and are expected to maintain traction through this year. Presently, with GDP growth stalling, and stable interest rates (could even decrease if the Reserve Bank of India gives higher credence to growth woes than inflation challenges) growth stocks could re-rate further and trade at higher multiples. Thus, we believe the balance has slightly shifted towards growth stocks from value. Growth strategies of small-cap investing, IPO-investing, and passive screener-based investing will be in focus in forthcoming quarters. In this report, we hone in on passive screener-based investing – with the idea of buying growth at a reasonable price, or pure growth stories that could re-rate – or deliver returns in line with the ensuing growth as elevated valuations are more likely to sustain.

Bottom-line: In the short- to medium-term, growth is likely to beat value-based strategies

Value vs. growth historical trends

Source: Bloomberg

0.0

0.2

0.4

0.6

0.8

1.0

Aug-97 Nov-99 Feb-02 Apr-04 Jul-06 Sep-08 Dec-10 Mar-13 May-15 Aug-17

Value Outperformed

+23%

Value Outperfomed +2%

Growth Outperfomed

+20% Growth

Outperfomed +54%

Value Outperform

ed +26%

CAGR Growth Value Growth vs Value

3m 4.9% 4% 0.6%

6m 10.1% 7% 2.7%

1y 11.4% 11% 0.4%


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Value vs. growth – valuation differentials have narrowed

Value has been trading at a substantial discount to growth since the Great Financial Crisis of 2008. However, narrowing growth premiums due to industry-specific headwinds in IT and pharmaceuticals should lead to some reversal in this trend. We are already seeing early signs of a value recovery, with the P/B differential between MSCI India

Value and Growth is reducing and moving closer to its long-term average. While most of this outperformance could be attributed to unsystematic factors, we reckon that buying growth at a reasonable price (GARP) should work well in such circumstances, as this strategy has connotations of value.

Value vs. growth: P/B differential has seen some rerating… … and the same story is visible in the 12-month forward P/E

Growth and value performance in the last one year is neck and neck; but YTD, growth has won the race

Source: MSCI, Bloomberg, BSE, PhillipCapital India Research

0%

20%

40%

60%

80%

100%

120%

Jul/05 Apr/07 Dec/08 Sep/10 Jun/12 Feb/14 Nov/15 Aug/17

1-yr Fwd PB MSCI India Value rel Growth 12m fwd PB

Average (+/- stdev)

40%

50%

60%

70%

80%

90%

100%

Jul/05 Apr/07 Dec/08 Sep/10 Jun/12 Mar/14 Nov/15 Aug/17

1-yr Fwd PE MSCI India Value rel Growth 12m fwd PE

Average (+/- stdev)

100

105

110

115

120

125

Jan/17 Feb/17 Mar/17 Apr/17 May/17 Jun/17 Jul/17 Aug/17

YTD performance MSCI Value

MSCI Growth

MSCI India

CAGR Growth Value Growth vs Value

YTD 20.3% 16% 4.0%

3m 4.9% 4% 0.6%

6m 10.1% 7% 2.7%

1y 11.4% 11% 0.4%

5y 82.2% 42% 40.2%

10y 58.6% 39% 19.7%


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Growth’s performance has been challenged due to sector-specific headwinds in healthcare and consumer discretionary, but the MSCI growth

basket’s weight has changed significantly – financials is the biggest gainer (27% weight vs. 20% in January), followed by staples. Healthcare has

lost ground (13% vs. 20%). In value, energy increased significantly to 23% from 21%, based on stable oil prices. Consumer staples completely lost

ground in the MSCI value basket.


23%

21%

10% 10%

21% 22%

11%

6% 4%

0%

5%

10%

15%

20%

25%

MSCI India Value Index sector share (%)

Now (July 2017)

as of Jan 2017

27%

18%

13%

8%

2%

20%

15%

20%

12%

1%

0%

5%

10%

15%

20%

25%

30% MSCI Growth Index sector share (%)

Now (July 2017)

as of Jan 2017

Top-10 value stocks’ performance

Stock Sector Ytd 1m 3m 6m

Reliance Ind Energy 45% -3% 21% 33%

Infosys IT -10% -8% -4% -10%

Axis Financials 13% -5% 2% -4%

ICICI Financials 28% -2% 7% 15%

L& T Industrials 26% -4% 1% 14%

SBI Financials 12% -5% -1% 4%

M&M Cons disc 16% -1% 5% 5%

HCL IT 5% -4% 1% 3%

Indiabulls Hou Fin Financials 86% 5% 16% 40%

BPCL Energy 23% 9% 7% 9%

Top 10 Growth Growth Stock Performance

Stock Sector Ytd 1m 3m 6m

HDFC Financials 37% -3% 8% 26%

TCS IT 5% 0% -4% 0%

ITC Cons Stap 17% -3% -11% 8%

Maruti Suzuki Cons Disc 42% -1% 6% 27%

HUL Cons Stap 43% 3% 11% 37%

Yes Bank Financials 51% -5% 21% 20%

Sun Pharma Health Care -22% -11% -3% -28%

Eicher Motors Industrials 42% 5% 10% 28%

Ultratech Materials 22% -2% -3% 5%

Tata Motors Cons Disc -19% -14% -21% -17%


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MSCI India Value and Growth – both are trading at normal levels (not overbought or oversold) on price momentum (price deviation from 6mma)

MSCI Value vs. Growth – developed countries vs. emerging market: India’s performance is hovering around emerging markets performance;

both are highly correlated due to an almost similar sector mix in the index


-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50% Price momentum (% dev from 6mma)

MSCI Value rel MSCI India Average (+/- stdev)

-50%

-30%

-10%

10%

30%

50% Price momentum (% dev from 6mma)

MSCI growth rel MSCI India

Average (+/- stdev)

50

60

70

80

90

100

110

120

130 MSCI value rel growth price perf rebased to 100 on Jan 2008

World EM USA

Europe India


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Cost of money tilts the balance slightly in favour of growth In the developed market like US & Europe, Growth’s outperformance is highly correlated with bond yields – when bond yields decrease, growth

generally outperforms. (Bond prices and yields are inversely related, as yields fall, bond prices rise. Prices of long-terms bonds tend to be more

sensitive to yield changes than prices of short term bond, Growth stocks and defensives are viewed as proxy for long-term bonds and react more

to changes in bond yields)

We applied the same method on MSCI India growth vs India’s 10-year bond yield, they are also correlated. Second chart also shows close

relationship between MSCI growth and India’s yield spread (10 yr- 2 yr). In our view, India’s 10 year bond yield continuing to be around 6.5% in

short – term would create a stable environment for the outperformance of growth stocks.


1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5 50

100

150

200

250

300

Jan/03 Jun/05 Nov/07 Apr/10 Oct/12 Mar/15 Aug/17

US growth Index

US 10 year bond yield (%), rhs, inv -1.0

0.0

1.0

2.0

3.0

4.0

5.0 50

60

70

80

90

100

110

120

130

140

Jan/03 Jun/05 Nov/07 Apr/10 Oct/12 Mar/15 Aug/17

MSCI europe growth index

German 10 year bond yield (%), rhs, inv

5

6

7

8

9

10 0.8

0.9

1.0

1.1

1.2

1.3

1.4

2001 2003 2006 2009 2011 2014 2017

MSCI India Growth rel mkt price perf 10 year bond yield (%), rhs, inv

-2%

-1%

0%

1%

2%

3% 0.8

0.9

1.0

1.1

1.2

2006 2009 2012 2015 2017

MSCI India Growth rel mkt price perf

yield spread (10yr-2yr), rhs, inv


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Real GDP differential correlation with style – is it favoring value?

MSCI Emerging Market Value vs. Growth is highly correlated with the GDP differential between emerging and developed market. In the last one year, it has been disconnected from the trend (growth has outperformed value in EM). Based on IMF projections, this GDP differential will continue to be around the same level - that will bring value investing back on track in the longer term for EM. The second chart shows the close relationship between Value and Growth price performance - EM and India, In our view growth will continue to outperform in India in the short- to mid-term, while GDP differential suggests value investing could outperform growth over a longer period.

Valuations suggest that value is expensive vs. growth: Relative to growth, value is trading at a 25% discount (Average discount of 29% on trailing

PE), also value has looked highly expensive for the last five years vs. growth. The same story is visible in P/B – 58% discount (average discount of

54%) relative to growth.

Source: IMF Forecast, Bloomberg, PhillipCapital India Research

0.7

0.8

0.9

1

1.1

1.2

1.3

-2

0

2

4

6

8

1999 2002 2006 2009 2013 2017

Real GDP Differential EM vs DM (4q rolling, 4qtr lagged)

MSCI EM Value rel Growth (rhs) IMF forecast

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.85

0.95

1.05

1.15

1.25

1.35

Sep/09 Oct/10 Dec/11 Jan/13 Mar/14 May/15 Jun/16 Aug/17

MSCI value rel Growth Emerging market India, rhs

30%

40%

50%

60%

70%

80% MSCI value rel growth price to book

EM India

50%

60%

70%

80%

90%

100%

110%

120%

130% MSCI value rel growth trailing price to earning

EM India


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Large-cap vs. mid-cap – Midcaps continue to deliverMid-caps have outperformed large-cap stocks over the last three years and the mid-cap vs. large-cap performance is quite similar to growth vs. value. On yearly price performance, mid-cap has significantly outperformed large-cap in the last five years, with 2013

being the only exception. Mid-caps are typically growth stocks, and presently, when GDP has slowed down and interest rates are stable (could even decrease if the RBI gives higher credence to growth), mid-cap stocks could rerate and trade at higher multiples.

Price performance: Nifty vs. Nifty Midcap 100


0.4

0.6

0.8

1

1.2

1.4

1.6

Jan/01 Nov/02 Sep/04 Jul/06 May/08 Mar/10 Jan/12 Dec/13 Oct/15 Aug/17

Nifty vs Nifty MidCap

Nifty Midcap

outperformed

45.4%

Nifty Midcap outperformed

24.4%

Nifty outperformed

3.5%

Nifty outperformed

12.1%

Nifty outperformed

6.8%

Nifty outperformed

7.6%

Nifty outperformed

7% & 8%

80

90

100

110

120

130 Nifty rel Nifty mid cap yearly price perf (rebased to 100 for 1st Jan each year)

ytd 2016 2015 2014 2013 2012

Nifty Midcap Mid cap vs Nifty

ytd 21.1% 28.0% 6.9%

3m 2.9% 3.6% 0.7%

6m 11.1% 12.3% 1.2%

1yr 11.8% 17.6% 5.8%

5y 73.8% 134.3% 60.5%

10yr 73.8% 151.9% 78.0%


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One-year forward PE and PB trends: Mid-caps look expensive on both PE and PB front vs. large-caps, yet they have outperformed large-caps. This

outperformance will continue in the short- to medium-term, as we believe that the current Indian macroeconomic environment is leading to a

phase where growth stocks could gain momentum and trade at higher multiples

EPS growth: Nifty vs. Nifty Midcap 100

Nifty EPS YoY Growth (%) Nifty Mid Cap EPS YoY Growth (%)

FY2010 247.41 -6.5% 485.03 12.3%

FY2011 325.00 31.4% 503.90 3.9%

FY2012 350.32 7.8% 527.53 4.7%

FY2013 391.98 11.9% 474.62 -10.0%

FY2014 413.89 5.6% 583.61 23.0%

FY2015 457.13 10.4% 628.46 7.7%

FY2016 421.72 -7.7% 629.73 0.2%

FY2017 447.94 6.2% 654.34 3.9%

FY2018E 497.23 11.0% 784.49 19.9%

FY2019E 614.93 23.7% 1083.52 38.1%

Source: Bloomberg, PhillipCapital India Research Estimates

0.5

0.6

0.7

0.8

0.9

1

1.1

1.2

1.3

1.4 Nifty Midcap 12m fwd PE rel Nifty

Average (+/- stdev)

0.4

0.5

0.6

0.7

0.8

0.9

1 Nifty Midcap rel Nifty price to book

Average (+/- stdev)


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How to implement a growth strategy: GARP #Framework 1: Growth at a reasonable price To arrive at a list of superior growth quality and reasonably priced or undervalued stocks, we screened stocks based on EPS growth higher than the sector EPS growth (sector relative quartile of 3 or 4). For this, we divided the EPS growth between two periods (five-year historical,

three-year forward – FY11-16 and FY16-19). To identify undervalued or cheap stocks we screened based on FY18 PE of <25x. All Buy rated stocks.

Company Name Sector Reco Target (%) Upside Market Cap

(Rs Mn) EPS growth 11-16 Quartile rel to EPS growth 16-19E Quartile rel to P/B P/E

abs Sector Universe abs Sector Universe FY18E FY18E

HCL Technologies IT Services BUY 980 13.9 1228137 237.4% 4 69% 3 2.9x 14.2x Glenmark Pharma Pharma BUY 830 37.5 170331 212.0% 4 59% 3 2.8x 13.2x Meghmani Organics Ltd Midcap BUY 75 -5.1 20091 97.2% 3 125% 4 2.4x 17.0x Aarti Industries Midcap BUY 1150 34.7 70135 226.7% 4 78% 3 4.3x 19.9x KEI Ind. Midcap BUY 244 -4.5 19877 205.0% 4 66% 3 3.4x 6.8x

How to implement a growth strategy: Pure growth #Framework 2: Focus on pure growth Screen 1: To arrive at companies with higher growth potential than the market, we

screened for companies in our coverage universe (including financials)

that would deliver a FY14-19 EPS CAGR of >15% and sales CAGR of >10%.

To screen the stocks further on quality, we used FY14-18 consistent ROE

of >15% and incremental ROE for FY18 over FY17. All Buy rated stocks.

Company Name Sector Reco Target (%)

Upside

Market Cap

(Rs Mn)

EPS growth

14-19E

Sales growth

14-19E

ROE

Incremental

ROE

ROE>15

CAGR CAGR FY14 FY15 FY16 FY17 FY18E Check 1 Check 2

HDFC Bank Financials BUY 1930 10.2 4509075 18.6% 15.1% 21 19 18 18 18 1 5

Indusind Bank Financials BUY 1800 7.5 1002376 25.4% 27.7% 17 18 16 15 17 1 4

Ahluwalia Contracts Infrastructure BUY 415 48.0 18787 46.1% 15.0% 10 23 22 18 20 1 4

Camlin Fine Sciences Midcap BUY 120 61.5 7706 23.9% 14.0% 31 41 20 -4 20 1 4

Source: PhillipCapital India Research Estimates

HCL, Meghmani, Aarti, KEI are top picks

Here HDFC is our top picks


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Screen 2: In this screen, we chose a different period, including financials; stocks that have delivered FY14-17 EPS CAGR of >15% and FY17-19 expected EPS CAGR of >15%. As an additonal quality screen, we filtered FY14-18

ROE for consistently >10% and incremental ROE for FY18 over FY17. All the stocks that we screened are rated ‘Buy’ by our analysts.

Pure growth #2 Company Name Sector Reco Target (%)

Upside

Market Cap

(Rs Mn)

EPS growth

14-19E

Sales growth

14-19E

ROE

Incremental

ROE

ROE>15

CAGR CAGR FY14 FY15 FY16 FY17 FY18E Check 1 Check 2

Bharat Forge Automobiles BUY 1250 11.1 261859 37.4% 25.6% 16 21 18 14 19 1 5

Ultratech Cement Cement BUY 5000 25.1 1097477 28.1% 19.6% 13 11 11 11 12 1 5

Indusind Bank Financials BUY 1800 7.5 1002376 45.8% 20.1% 17 18 16 15 17 1 5

Shriram Transport Fin NBFC BUY 1300 21.6 242651 19.6% 19.9% 16 14 12 12 15 1 5

CIFC NBFC BUY 1360 19.8 177415 41.1% 15.8% 17 16 17 18 19 1 5

Shriram City Union Fi NBFC BUY 2450 17.5 137558 19.5% 21.2% 20 16 12 12 14 1 5

Ahluwalia Contracts Infrastructure BUY 415 48.0 18787 88.1% 21.5% 10 23 22 18 20 1 5


Bharat forge, Indusind Bank, Shriram Transport, Cholamandalam & Ahluwalia are top picks


Page 14

How to implement growth strategy: Pure growth #Framework 3: Pure growth with inexpensive valuation using PEG Screen 1: A strategy of picking lowest PE stocks in each sector will yield undervalued stock – a well-known market practice. Many portfolio managers and analysts compare PE ratios with expected growth rates to identify under- or over-valued stocks, i.e., PEG ratio. In this approach, firms with a PE ratio that is less-than the growth rate are viewed as undervalued, and those with PE equal to growth rate are seen as trading at fair value. We applied the same PEG ratio

approach to our coverage (including financials) to identify a few names that show growth characteristics have inexpensive valuations based on PEG. Here, we use a filter of FY14-19 EPS and sales CAGR of > 15%. We have calculated PEG ratio by dividing FY17 PE by FY17-19 EPS growth, screened further for undervalued stock based on PEG relative to sector (sector relative quartile of 1 or 2). All the stocks that we screened are rated ‘Buy’ by our analysts.


(Rs Mn) EPS growth Sales growth P/E 17 Growth rate PEG Quartile rel to 14-19 CAGR 14-19 CAGR

17-19E Ratio Sector Universe

Development Credit Bank Financials BUY 240 29.7 56925 15.7% 20.5% 26 34% 0.8 2.0 Indusind Bank Financials BUY 1800 7.5 1002376 25.4% 27.7% 35 32% 1.1 2.0 Ahluwalia Contracts Infrastructure BUY 415 48.0 18787 46.1% 15.0% 22 34% 0.6 2.0 KEI Ind. Midcap BUY 300 17.4 19877 22.3% 16.7% 8 21% 0.4 1.0

Screen 2: Filtered by FY12-17 EPS CAGR of >12%, FY17-19 EPS CAGR of >12%. Calculated PEG ratio by dividing FY17 P/E by FY12-17 EPS CAGR, further screened for undervalued stock based on PEG relative to

sector (sector relative quartile of 1 or 2). This basket is ex financials; all are rated Buy.


(Rs Mn) EPS growth EPS growth P/E 17 PEG ratio Quartile rel to 12-17 CAGR 17-19 CAGR

Sector Universe

Ceat Automobiles BUY 2000 17.1 69115 80.8% 14.5% 17 0.2 2 Cyient Limited IT Services BUY 560 5.3 59889 19.0% 14.2% 16 0.8 2 Aurobindo Pharma Pharma BUY 900 20.4 438006 53.8% 13.3% 19 0.4 2 Meghmani Organics Ltd Midcap BUY 75 -5.1 20091 81.3% 44.7% 29 0.4 2 Aarti Industries Midcap BUY 1150 34.7 70135 26.1% 20.2% 22 0.85 2 KEI Ind. Midcap BUY 300 17.4 19877 13.5% 21.1% 8 0.60 2


Ahluwalia is our top picks

Ceat & Aurobindo are our top picks


Page 15

#Framework 4: Dividend aristocrats Here we’re introducing new style of investing – Dividend Aristocrats in the India context Dividend aristocrats are S&P 500 constituents (large-cap US equities) that are consistent in giving dividends and have increased their dividend payout for the last 25 years. They are the best-of-best dividend growth stocks. The S&P 500 Dividend Aristocrats Index comprises of larger and well-known blue-chip companies – with durable businesses, earning growth, and market outperformance. In the longer run, S&P 500 dividend aristocrats have consistently generated positive alpha.

CAGR growth 1yr 5yr 10yr 15yr 20yr

S&P 500 Div Aritocrats Index 7% 11% 7% 8% 7% S&P Index 14% 11% 5% 7% 5% Alpha -7.10% 0.00% 2.60% 1.40% 1.80%

We borrow the same concept and apply it to the ‘Indian context’ – to our BSE 200 universe. Taking into consideration the limited history of the Indian stock market, we have screened a list of stocks that are consistent in giving dividends and have increased their dividend payout for the last 10 years.

The Indian ‘dividend aristocrats’

_______Price chg (%)_______

_______12m fwd PE_______

2017

2017 FCF

Sell side

reco

Name Sector Reco Target (%)

Upside

Market Cap

(cr)

YTD 6m chg 1yr chg abs industry rel to ind

(prem/dis)

Price to

book

yield (%) (1=Sell,

5=Buy)

Asian Paints Ltd Materials NEU 1215 1.6 115622 35% 18% 1% 45.1 14.4 212% 15.2 0.8 3.2

HDFC Ltd Financials NEU 1630 -7.2 282781 41% 30% 22% 19.2 13.9 38% 4.7 -5.1 4.2

HDFC Bank Ltd Financials BUY 1930 10.2 453174 46% 27% 35% 20.8 13.9 49% 4.9 4.6 4.6

ITC Ltd Consumer Staples BUY 345 21.9 335510 14% 4% 5% 25.5 33.9 -25% 7.2 2.5 4.2

LIC Hou Finance Ltd Financials NEU 702 3.8 34095 21% 19% 14% 11.0 13.9 -21% 3.1 15.0 3.6

Larsen & Toubro Ltd Industrials NEU 1220 7.9 156574 24% 13% 11% 19.8 23.4 -15% 3.1 1.8 4.2


All the stocks have given successful return YTD, out of which HDFC and ITC are out top picks


Page 16

How to implement a value strategy: Focus on the quality aspect of value #Framework 5: Applying the Novy-Marx profitability framework for inexpensive quality names “Buying high-quality assets without paying premium prices is just as much value investing as buying average quality assets at discount

prices.”– Professor Robert E Novy Marx, University of Rochester, Simon School of Business In his paper titled “The Other Side of Value: The Gross Profitability Premium” (June 2012), Professor Novy-Marx showed that profitability (measured by gross profits-to-assets) has roughly as much predictive power in identifying value winners as traditional value metrics like book-to-market. We borrow this academic concept and try to fit in the Indian context to identify stocks that offer both quality and value. We’ve applied this framework in our last report, published on

January 2017 Click here. Based on this conceptual framework, we

had presented few stocks that time and named them a quality basket – Apollo, Tata Steel, IRB, Shriram Transport, Reliance Industries, and Sintex. This quality basket has generated an alpha of 24% since then.

Styles Perf since Inception * BSE 100 Alpha

Quality 44.0% 20.2% 23.8%

Piotroski 40.4% 20.2% 20.2%

EV/DACF -3.7% 20.2% -23.9%

* Inception date 20/01/2017 Therefore, we continue to screen some stocks based on this concept – of quality investing – to arrive at a few names in our coverage that have delivered: 1. Consistently positive profitability: At least a 10-year history of

positive EBITDA/total assets 2. Cheap valuations based on one-year forward PC estimates: FY17

P/B < 1.6x and FY17E P/E is <16x 3. Rated BUY by us 4. Market capitalisation is > Rs 20bn

Companies with at least 10-years of positive EBITDA-to-assets history that look cheap on P/B (<1.6x) and P/E (<16x) M Cap EBITDA/Total Assets P/B P/E

Company Name Sector Reco Target (%) Upside (Rs. Mn) FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY18E FY18E

Hindalco Inds Metals BUY 280 15.7 542930 14.1% 9.3% 8.1% 6.5% 6.0% 6.3% 6.3% 8.8% 9.7% 10.2% 1.1x 15.7x

NALCO Metals BUY 85 15.1 142747 8.2% 10.7% 7.4% 5.6% 5.6% 10.5% 5.7% 6.2% 11.7% 12.7% 1.3x 12.4x

Apollo Tyres Automobiles BUY 345 37.7 127562 21.9% 13.2% 13.9% 17.1% 20.8% 22.4% 17.7% 12.1% 10.6% 13.1% 1.6x 13.9x

IRB Infrastructure Infrastructure BUY 290 36.0 74929 14.4% 13.7% 12.6% 12.4% 11.2% 5.6% 6.3% 6.8% 6.3% 7.0% 1.2x 8.6x

NCC Infrastructure BUY 110 28.8 47477 8.6% 7.1% 5.0% 5.8% 4.4% 6.9% 7.8% 7.2% 7.9% 8.5% 1.3x 14.8x

Source: PhillipCapital India Research. As of January 20, 2017. Note: For Financials, we use pre-provision profit as a proxy for EBITDA The Novy Marx framework is market-cap agnostic and presents a balance of both mid-cap and large-cap stocks. Hindalco is our large-cap pick while Nalco, Apollo Tyre, IRB, and NCC are our mid-cap picks.

http://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_Portfolio_Style_Guide__Quarterly_Jan_2017_20170124135813.pdf


Page 17

Model Portfolio: Add Aarti Industries and Sell Dish Tv

___________EPS (Rs)_____________ ________EPS Growth (%)________ ____________P/E (x)____________

Company Weight FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E

FMCG 10.0%

HUL 2.0% 20 24 27 3% 20% 12% 60 50 45

Colgate Palmolive India Ltd 2.0% 21 23 29 -6% 9% 24% 54.6 49.9 40

ITC 6.0% 9 9 11 11% 6% 14% 31.4 29.5 26

Automobile 8.5%

Maruti 3.0% 243 265 312 61% 9% 18% 32.8 30.1 26

Tata motors 3.0% 19 27 53 -46% 43% 101% 20.2 14.1 7

Bajaj Auto 2.5% 132 143 166 5% 8% 16% 22.0 20.4 18

IT 6.0%

Infy 6.0% 63 72 78 7% 14% 9% 14.1 12.3 11

Pharmaceuticals 6.0%

Sun Pharma 4.0% 29 14 20 20% -51% 42% 16.2 33.4 23

Aurobindo 2.0% 39 46 51 12% 17% 10% 18.8 16.0 15

Cement 4.0%

Ultratech 3.0% 99 118 169 19% 20% 43% 41.9 35.0 24

Dalmia Bharat 1.0% 39 74 99 81% 92% 33% 69.5 36.3 27

Metals & Mining 12.3%

Tata Steel 3.0% 41 71 82 326% 74% 15% 16.1 9.3 8

JSW Steel 2.0% 19.6 20.7 25.8 212% 18% 11% 13.6 12.9 10.3

Hindalco 2.0% 15 16 22 285% 12% 34% 17.1 15.4 11

NTPC 3.3% 13 14 16 5% 6% 19% 12.9 12.2 10

Vedanta 2.0% 15 26 39 43% 71% 52% 21.8 12.8 8

Industrial 4.0%

L&T 2.0% 42 51 58 43% 21% 13% 27.7 22.9 20

NCC 2.0% 5 7 8 17% 33% 25% 17.1 12.8 10

Finance 33.3%

Axis bank 4.0% 15 19 29 -55% 26% 51% 32.2 25.5 17

IndusInd bank 3.0% 48 64 83 25% 34% 29% 35.4 26.4 20

SBI 4.5% 13 10 17 3% -22% 66% 20.7 26.6 16

Cholamandalam Fin 2.5% 46 57 71 26% 24% 25% 25.3 20.3 16


Page 18


HDFC Ltd 5.0% 47 50 57 4% 6% 14% 38.0 35.8 31

LIC Housing Finance 2.0% 38 40 45 16% 4% 12% 17.2 16.5 15

HDFC bank 6.0% 57 69 83 17% 22% 20% 31.5 25.8 22

ICICI Bank 6.3% 17 12 15 1% -28% 27% 17.4 24.1 19

Oil & Gas 5.0%

Reliance Industries 5.0% 74 101 108 -19% 35% 7% 11.0 8.1 8

Telecom 7.5%

Bharti Infratel 2.0% 15 17 19 18% 13% 12% 25.0 22.1 20

Bharti Airtel 3.0% 13 10 23 37% -27% 132% 30.2 41.3 18

Zee Entertainment 2.5% 11 16 19 12% 47% 19% 48.6 33.2 28

Others 3.5%

Aarti Industries 2.0% 38 43 56 23% 12% 29% 22.3 19.9 15

Tata Comm 1.5% 10 15 26 -11% 50% 70% 64.2 42.9 25


Page 19

Disclosures and Disclaimers PhillipCapital (India) Pvt. Ltd. has three independent equity research groups: Institutional Equities, Institutional Equity Derivatives, and Private Client Group. This report has been prepared by Institutional Equities Group. The views and opinions expressed in

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performance is not necessarily an indication of future performance.

This report does not regard the specific investment objectives, financial situation, and the particular needs of any specific person who may receive this report. Investors must undertake independent analysis with their own legal, tax, and financial advisors

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No

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Page 20

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