1. Paul M. Kitney, PhD
BALLINGAL INVESTMENT ADVISORS
paul@ballingal.com
+852 2733 1000 (Main)
+852 2733 1031 (Direct)
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The Animal Spirits Report - Asia Pacific Investment Strategy
October 10, 2016
ANIMAL SPIRITS™ REPORT: India Equity Strategy -
Upgrade to Overweight as Patel’s Dovish Arm Twists
Investment Conclusions – Tactical View (3-6 Months)
1. Animal Spirits prefers an "overweight" stance on Indian equities.
2. Our macro baseline scenario is positive on emerging markets (EM) in Q4,
2016. We see improvement in commodities demand-supply balances, a
normalization of inflation expectations and a Fed that is prepared to run the
US economy "hot" for longer to allow the former to develop. All of these are
positive for EM.
3. iShares MSCI India ETF (INDA US) is an ETF play on the MSCI India index.
4. In sectors, we are "overweight" financials, consumer discretionary and
energy. We "underweight" utilities, consumer staples.
5. Our focus list of themes include a) the consumer; b) energy; and c) crop
yield enhancement.
6. Animal Spirits top picks are: Tata Motors Ltd (TTMT IN), Housing
Development Finance (HDFC IN) , Reliance Industries Ltd (RIL IN) , Oil &
Natural Gas Corp Ltd (ONGC IN) and UPL Ltd (UPLL IN).
Summary of Our Investment Thesis - "Overweight" India
• Valuation (negative) - Indian equities are richer than the EM peer group but
earnings growth is superior and current multiples are not stretched relative
to historic norms
• Earnings (positive) - The momentum of earnings growth is strong and
approaching peak cycle rates. Earnings revisions in India are leading the EM
peer group.
• Economic Policy (positive) - Monetary policy is more accommodative than
we expected as the Monetary Policy Committee (MPC) appears to be running
the RBI with a view to a more liberal inflation target.
• Macro (neutral) - Consumption continues to perform well as the
"demographic dividend" playbook would suggest but near-term there is likely
to be front-loading ahead of the Q1 2017 GST implementation. Investment
spending still is soft but we see fiscal policy flexibility freeing up once the GST
is in place and showing some results. This should pave the way for a new
infrastructure-led investment cycle.
INDIA EQUITY STRATEGY OUTLINE
1. Valuation Analysis
2. Earnings Profile
3. Economic Policy
4. Macroeconomic Drivers
5. Summary of Investment Thesis
6. Investment Conclusions
is owned by Paul M. Kitney, PhD, licensed to Ballingal Investment Advisors
and is pending registration.
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PAUL M. KITNEY, PhD
1. VALUATION – Richer than the EM peer group but earnings growth is
superior and current multiples are not stretched relative to historic norms
It is difficult to make a convincing case that Indian equities offer great value. We
pair India against China, Asia ex-Japan and Global Emerging Market (EM) MSCI
indices in Table 1 and it is clear on most measures there is a premium in India.
The most stark is price-to-book, where at just under 3 times, India is trading at
almost twice the China or EM multiple, while its ROE is only marginally higher
than its closest regional “comp”, China. In fact, the EBIT margin in China is
higher than India, while trading on lower multiples, based on several measures.
There is, however, some rationale for the “India Premium” and that is earnings
growth. India’s growth profile is not influenced by the global economic cycle to
any great degree. Earnings are driven ostensibly by domestic factors and the
impressive double digit earnings growth outlook for both 2016 and 2017
outshines the double digit decline in the current fiscal year, expected in China.
Corporate balance sheets are also unlevered with only 67 percent net debt to
equity, in comparison with the peer group (Table 1). Therefore, by taking on
some leverage there is upside to ROE in Indian corporates, which theoretically
supports a higher valuation. While there is some appearance of a valuation
premium currently versus EM peers, higher growth notwithstanding, Indian
equity valuations are not particularly high relative to their own history. Figure 1
shows that presently both price-to-book and EV/EBITDA multiples in India are at
their 15 year averages or slightly below. Nevertheless, on balance, we assign a
slightly less than pass grade on valuation for India in our country evaluation
matrix (Table 2).
Table 1 - India Valuations and Financials with Large Emerging Market Comps
Source: MSCI, Bloomberg, Ballingal Research. Note: Data as of 10/5/2016. Note: We included MSCI Asia ex-
Japan as a regional benchmark, despite being a blend of EM and DM. Earnings estimates are based on
Bloomberg consensus
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PAUL M. KITNEY, PhD
Figure 1 - India Historic Price-to-Book (PBR) and EV/EBITDA Ratios
Source: MSCI, Bloomberg, Ballingal Research.
2. EARNINGS PROFILE – The momentum of growth is strong and approaching
peak cycle growth rates. Earnings revisions are leading the EM peer group.
We have made mention the above average performance of earnings growth in
India, relative to EM peers. In Figure 2, it is clear that earnings momentum is
positive and is approaching growth levels seen at the peak of previous profit
cycles.
Figure 2 – India Earnings Growth History and Forecast (Net Profit)
Source: MSCI, Bloomberg, Ballingal Research. Note: Data as of 10/5/2016, Bloomberg Consensus Estimates
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PAUL M. KITNEY, PhD
There are two observations from Figure 3 as the discussion now moves on to
earnings revisions. The first is that India has led its EM peers in both the current
earnings cycle and the earnings revision cycle. The second is that India has
avoided the downside in earnings revisions that both China and EM have faced
during the revision cycle. This is a slightly different to a discussion of the
volatility of earnings per se. Rather it points to some downside resilience in the
recent pattern of Indian earnings. In our opinion this is largely due to lower
relative dependence of the earnings structure in India to global sectors. Both the
Indian growth model and the earnings profile is driven by domestic demand. As
argued earlier, this partly explains the “India Premium” since it helps describe a
“better quality of earnings”. Consequently, India scores well in our country
evaluation scorecard (Table 2).
Figure 3 – India Earnings Revisions versus Regional and Global EM Peers
Source : MSCI, Bloomberg, Ballingal Research, Data as of 9/23/2016. Note: Earnings revisions are based on a 3
period moving average of monthly changes in FY 2016 net profit estimates
3. ECONOMIC POLICY – Patel has his dovish arm twisted by the MPC
The first policy move by the new Reserve Bank of India governor, Urjit Patel to
lower the policy rate by 25 basis points, confounded the consensus view that he
was an inflation hawk. We carefully examine the press release for the "Fourth
Bi-monthly Monetary Statement, 2016-17 Resolution of the Monetary Policy
Committee (MPC), Reserve Bank of India (October 4, 2016)" and draw our own
conclusions.
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PAUL M. KITNEY, PhD
Prior to this MPC release, Animal Spirits had held back our enthusiasm about
Indian equities based on the expectation that the hawkish rhetoric of incoming
governor Patel would imply a more strict interpretation of inflation targeting by
the RBI. However, the language below indicates something different.
• Unlike the previous "Rajan Show", monetary policy is being driven by the
MPC and not by the governor alone, at least during the early stages of
Patel's tenure.
• A more liberal approach to inflation targets is being set with the 2-6 percent
"medium term" range. This is somewhat different from earlier indications
that the mid-point of this range, namely 4 percent was the 2018 target. The
statement below clearly displays this intent.
• An accommodative monetary policy provides more leeway for fiscal restraint
or reform (including the introduction of the goods and services tax (GST)).
The MPC has given itself leeway to remain accommodative based on:
(a) A perception of a weaker external economic environment with specific risks
associated with Brexit, Chinese debt, protectionist policies and the diminished
credibility of global monetary policy.
(b) The RBI viewpoint that oil prices will not be a source of inflationary pressure
near term (Animal Spirits disagrees).
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“Global growth has been slowing more than anticipated though 2016, with
weak investment and trade damping aggregate demand. Meanwhile, risks in
the form of Brexit, banking stress in Europe, rebalancing of debt-fuelled growth
in China, rising protectionism and diminishing confidence in monetary policy
have slanted the outlook to the downside (page 1).”
“Crude prices rose to a recent peak in Q2 of 2016, mostly on supply disruption in
various parts of the world…OPEC announced intentions of cutting back on
supply; but, the upturn has been curbed by higher inventories (page 1).”
“The decision of the MPC is consistent with an accommodative stance...with the
objective of achieving consumer price inflation (CPI) inflation at 5 percent by Q4
of 2016-17 and the medium-term target of 4 percent within a band of +/- 2
percent, while supporting growth (page 1).”

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PAUL M. KITNEY, PhD
(c) Signs are positive that the post-monsoon harvest will alleviate food inflation
concerns.
(d) Softer industrial production (manufacturing) also helps justify monetary
policy easing.
(e) Strong emphasis that food price inflation is a key policy swing variable.
Animal Spirits view on India monetary policy - Tactically positive but
strategically risky
• For our tactical 3-6 month view, the monetary policy outlook is easier than
expected and pushes our rating on policy in India to positive.
• However, there are risks of an abrupt tightening in 2017 H2 as we see upside
to global inflation expectations over the coming quarters, which should
adaptively shift up realized inflation, driven by the oil price base effect and
signs that excess supply is rebalancing in liquid fuels. See
“ANIMAL SPIRITS REPORT 1: Macro Backdrop - Base Jumping the Fed with Oil
and Inflation Expectations” and ”ANIMAL SPIRITS Update: OPEC Fuels Base
Effect - Oil, Inflation & The Fed, Yields, Financials and EM”.
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“On the domestic front, the outlook for agricultural activity has brightened
considerably…Kharif sowing has surpassed last year’s agreage…estimates of
kharif food grains production for 2016-17 by the Ministry of Agriculture have
been placed at a record level…(page 2).”
“The industrial sector…suffered a manufacturing-driven contraction in early
fiscal year Q2, after a sequential deceleration in gross value added…(page 2). “
“The committee expects the strong improvement in sowing, along with supply
management measures, will improve the food inflation outlook…a downward
shift in the momentum of food inflation…holds the key to future inflation
outcomes…This has opened up the space for policy action (page 3).”

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4. MACROECONOMIC DRIVERS - GST Introduction in April 2017 should help
smooth the pattern of Indian growth but near term "front-loading" provides
upside risks to consumption, inflation, and equity prices as the RBI will run
"hot" until the GST "teething" is complete
The demographic dividend in India is a secular driver of consumption and the
single biggest boost to the domestic demand-driven growth profile. The near
term pattern of consumption and consumer sentiment is tracking the longer-
term theme as seen in Figure 4. Animal Spirits applaud the direction of taxation
reform towards a broad based GST in India, which is scheduled to be
implemented in April 2017. The benefits include the simplification of the
taxation system, greater compliance and should stimulate foreign direct
investment. Importantly, it should provide a broader taxation base to help fund
other segments of the economy, when required. In particular, despite recent
injections of government spending to help stimulate private sector investment,
gross fixed capital formation (Figure 4) still remains in the doldrums.
Longer term, we envisage a greater use of public money spent on infrastructure
projects that will require private sector collaboration and should see the
divergence in the figure below reverse somewhat. Near-term Animal
spirits expects that there will likely be some "front-loading" of consumption
ahead of the implementation of the GST, so expects this divergence to continue
over coming months. Moreover, we believe that the "surprise" rate cut is being
used to keep monetary policy accommodative during the teething stages of GST
implementation to avoid macroeconomic disruption. Consequently, we see
upside risk for consumption, inflation (also due to oil-led inflation expectations
argument) and equities near term.
Figure 4 - Divergence of Indian Consumption and Investment Patterns
Source: Mastercard Advisors, Bloomberg, Indian Central Statistical Association, Ballingal Investment Advisors.
Notes: Quarterly data, constant 2011-12 prices for gross fixed capital investment data. Note: Mastercard Asia
Pacific Consumer Confidence Index used for sentiment indicator.
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PAUL M. KITNEY, PhD
5. SUMMARY OF INVESTMENT THESIS - "Overweight" India
• Valuation (negative) - Indian equities are richer than the EM peer group but
earnings growth is superior and current multiples are not stretched relative
to historic norms
• Earnings (positive) - The momentum of earnings growth is strong and
approaching peak cycle rates. Earnings revisions in India are leading the EM
peer group.
• Economic Policy (positive) - Monetary policy is more accommodative than
we expected as the MPC appears to be running the RBI with a view to a more
liberal inflation target.
• Macro (neutral) - Consumption continues to perform well as the
"demographic dividend" playbook would suggest but near-term there is likely
to be front-loading ahead of the Q1 2017 GST implementation. Investment
spending still is soft but we see fiscal policy flexibility freeing up once the GST
is in place and showing some results. This should pave the way for a new
infrastructure-led investment cycle.
6. INVESTMENT CONCLUSIONS
Macro, Index, and Sector Views
• Animal Spirits prefers an "overweight" stance on Indian equities.
• Our macro baseline scenario is positive on emerging markets (EM) in Q4,
2016. We see improvement in commodities demand-supply balances, a
normalization of inflation expectations and a Fed that is prepared to run the
US economy "hot" for longer to allow the former to develop.
• iShares MSCI India ETF (INDA US) is an ETF play on the MSCI India index,
which is our preferred benchmark for India.
• In sectors, we are "overweight" financials, consumer discretionary and
energy. We "underweight" utilities, consumer staples.
• Our focus list of themes include a) the consumer; b) energy; and c) crop yield
enhancement.
• Animal Spirits top picks are: Tata Motors Ltd (TTMT IN) , Housing
Development Finance (HDFC IN), Reliance Industries Ltd (RIL IN), Oil &
Natural Gas Corp Ltd (ONGC IN) and UPL Ltd (UPLL IN)
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PAUL M. KITNEY, PhD
Themes and Top Picks
• The Consumer - Tata Motors Ltd (TTMT IN) and Housing Development
Finance (HDFC IN) - As discussed in Section 4, the long-term outlook for
consumption in India is driven in large part by demographic factors and is
well known. Near term, the pattern of strong consumer sentiment is likely to
persist (Figure 4) due to the combination of both easy monetary policy and
front-loading of consumption ahead of the forthcoming GST introduction in
April 2017.
 Tata Motors Ltd (TTMT IN) is selected here as a key
consumer discretionary thematic play. It is trading at 12.07
times earnings and 4.85 times EV/EBITDA (FY 17, Bloomberg
Estimates). The secular growth of the Indian auto market,
together with rapid sales of luxury brands (Jaguar-Land Rover
(JLR)) in emerging economies, including China, is attractive in
our opinion. JLR will benefit from currency translation effects
of the weaker pound associated with Brexit (Tata Motors,
Analyst Presentation, August 26, 2016, page 15). According
to this report, JLR sells 80 percent outside the UK (Europe 24
percent, China 19 percent, US 19 percent), while 40 percent
of components are sourced from the EU with the balance
largely accounted for by the UK.
 Housing Development Finance (HDFC IN) - Housing
affordability (median property prices divided by annual
income) using large Indian metro city data is 4.1 times in
2016, down from 5.9 times in 2000, according to HDFC (June
2016, Analyst Presentation). With 66 percent of the
population under 35 and mortgage penetration a single-digit
percentage of GDP, there is secular growth in the housing
market as the "demographic dividend" plays out. Near term,
NIMs are set to rise as the RBI has recently cut the policy rate
and Animal Spirits foresees a global uplift in bond yields over
the period of November 2016 to May 2017, driven by base
effects in the oil market and its link with the formation of
inflation expectations. See ”ANIMAL SPIRITS Update: OPEC
Fuels Base Effect - Oil, Inflation & The Fed, Yields, Financials
and EM”. This is a large cap play on Indian housing and our
preferred consumer related financial idea in India.
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PAUL M. KITNEY, PhD
Themes and Top Picks
• Energy - Reliance Industries Ltd (RIL IN) and Oil & Natural Gas Corp Ltd
(ONGC IN) - Given our scenario of improved pricing power in the liquid
energy space over the coming months, Animal Spirits expects to see an uplift
to margins in both upstream and downstream energy companies, including
petrochemicals over this period.
 Reliance Industries Ltd (RIL IN) is our top pick in India in the
downstream energy space and is trading at 12.83 times earnings and
1.29 times book (FY17, Bloomberg consensus estimates).
 Oil & Natural Gas Corp Ltd (ONGC IN) is our preferred upstream
energy pick in India and is priced at 12.92 times earnings and 1.18
times book (FY17, Bloomberg consensus estimates).
Crop Yield Enhancement - UPL Ltd (UPLL IN) - A secular theme is a global need
to improve farm productivity, due to both expanding populations and rising
incomes in emerging economies. UPL is an Indian play on this theme as they
manufacture, distribute and export off-patent agrochemicals as well as
manufacturing herbicides, fungicides, and fumigants. Based on the Q1 FY17 data
from the UPL investor presentation, 29th July 2016, 30 percent of sales are
derived from India, with the balance exported to Latin America (20 percent),
Europe (16 percent), North America (18 percent) and Rest of the World (16
percent). The shares currently trade at 17.94 times earnings (FY17, Bloomberg
Estimates).
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Table 2 - Animal Spirits APAC Equity Tactical Views (3-6 Months)
Source: Ballingal Research, MSCI, Bloomberg. Note: Benchmark used is MSCI AC Asia Pacific Index. Note on symbols in table: single green (positive
view) , double green (very positive view), red (negative view), double red (very negative view), blue (neutral)
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