Monday 18 February 2008

Sensex to be at 22,600 by Dec-end: UBS

There is good news for investors battered in the last two months following a heavy sell-off by foreign institutional investors in the backdrop of sub-prime losses and fears of a recession in the United States.

A UBS Investment Research report sees the Sensex at 16,000 points in the worst-case scenario, while continuing with 2008-end Sensex target of 22,600. The report adds that the correction in the Indian equity market is more or less over.

The report forecasts a mild recession in the US in 2008 with negative GDP growth in the first and second quarters. India is relatively insulated from the US slowdown as Indian exports account for 17 per cent of the country's GDP and the USA accounts for 15 per cent of India's total exports.

Even during the US recession of 2001-02, the impact on Indian economy was significantly less compared with that on the rest of Asia.

However, the Indian market (as represented by the Sensex) declined by 38 per cent then largely due to a heavy drop in IT services, telecommunication, engineering and automobile sectors. These sectors put together contributed 26 per cent of the 38 per cent fall in the Sensex.

Consumer durables, cement, metals and petrochemicals contributed another 11.6 per cent to the market decline in 2001-02. Except for consumer durables and cement, all other sectors suffered a severe shrink in profit before tax (PBT) margins between 1999-2000 and 2001-2002.

The Indian market today is significantly different from the one in 2000-02, the report says. The difference arises in the earnings structure, sector-wise contribution to market capitalisation and sector-wise valuation.

In 2000-02, the decline in the market's earnings was caused by IT services, metals, petrochemicals, engineering, automobiles and telecommunication. These sectors contributed 44 per cent to the market's earnings in early 2000.

Today, the risk to earnings appears significant only for IT, metals and petrochemicals, the export-oriented sectors and global commodities. These sectors constitute 36 per cent of the market's earnings today, implying that the risk to earnings is significantly lower today than in the past.

The other sectors that suffered a decline in earnings during 2000-02 -- auto, engineering and telecom -- are at a relatively low risk today.

The UBS report expects earnings growth in the engineering sector to remain stable in the 30-35 per cent range on the back of large order backlogs with key companies and the ongoing capital expenditure cycle.

The UBS sees earnings growth in the auto sector to accelerate in 2008-2009 following a peaking out of interest rates and a low base in sales volumes.

Telecom earnings should remain stable despite the competition becoming tough as superlative growth in the form of new subscriber addition continues unabated.

The risk to market capitalisation today is even lower. The sectors whose market cap declined 30 to 70 per cent during 2000-2002 occupied 72.3 per cent of the Sensex market capitalisation. These sectors were also richly valued, with their one-year forward price-to-earnings trading between 18 and 96 (except auto, metals and telecom).

None of the sectors today commands valuations anywhere close to the levels in early 2000. Power utilities, banks, telecom and engineering appear to be the sectors with some degree of valuation risk, though earnings estimates in banks and engineering, especially the latter, appear secure, the report adds.

The sectors with some valuation risk occupy 47 per cent of the country's market cap today.