August 30, 2015

Ambit Capital says high chance Sensex hitting 22000

Ambit Capital says that there is a high risk of the Sensex dropping to as low as 22,000, as the odds appear to be in favour of a continued yuan devaluation.

Exit the fantasy, enter the reality

As the fantasy of a ‘secular bull market’ fades, we cut not just our FY16 GDP growth estimate from 7% to 6.8% (driven largely by a drop in industrial growth) but also our end-FY16 Sensex target from 32K to 28K.

We further highlight that there is a high risk of the Sensex dropping to as low as 22K, as the odds appear to be in favour of a continued yuan devaluation. The combination of a enfeebled banking system, a sliding real estate sector and a PM determined to reset the way the Indian economy works makes India a risky investment destination. To mitigate this risk, we recommend that investors focus on financially robust, market leading franchises which are trading at sensible valuations.

High risk of the Sensex sliding to 22K

With a high likelihood of the Chinese central bank embarking on a continued devaluation of the yuan, the Indian stockmarket stands exposed to: (a) Indian products losing their competitiveness to their Chinese counterparts; and (b) rising risks to India’s $0.5tn of foreign currency debt. Such a scenario could be a catalyst for more pullbacks in the Sensex with the trailing P/E multiple likely to drop to 14x (as seen in the Lehman crises), implying a Sensex level of 22,000. 

Investment implications

Even after the 6% fall over the past nine days, there are no rational grounds for claiming that the Sensex has bottomed out. As Prime Minister Modi’s resets bite deep into the Indian economy, we expect GDP growth to slow down and we expect earnings growth to remain weak. In fact, as retail flows wane, the support system propping up the Sensex is likely to give away. Hence, the only way to invest in such a market is to focus on high-quality franchises which are available at reasonable valuations. Our ten baggers and coffee can portfolios continue to deliver exemplary results in this regard. More specially, ten high quality BUYS from our sector leads are given in Exhibit B.

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