SSKI - Earnings preview (Q4FY07): 'Interest'ing times

Sensex earnings are estimated to register a 29.7% yoy increase in Q4FY07. Though lowest within FY07, we believe growth is still robust. Notably, an apparent slowdown in earnings growth of commodity stocks to 30.5% yoy in Q4FY07E – read oil & gas, due to lopsided subsidy sharing across quarters – has impacted reported earnings for both Sensex and the SSKI universe. While the reported earnings growth for the SSKI universe would be just 10.6% yoy, earnings ex-oil & gas would still grow at a healthy 29%. For non-commodity stocks, we expect earnings growth to stay largely on track (28.2% yoy), despite a slowdown for 2-wheeler stocks due to lower volumes. Our key result picks are Tata Steel, Maruti, Infosys, TCS, JP Associates, BHEL and KEC.

Over FY07-09, we expect 15.7% CAGR in Sensex earnings – significantly slower than in the past few years. While we continue to advocate a major slowdown in commodity stock earnings to 2.8% CAGR, we maintain a robust outlook for non-commodity earnings (23.2% CAGR). We maintain our Sensex target range at 14000-14600, which builds in a higher cost of capital. At 15x FY09E earnings, Sensex valuations still offer upside. We have revisited our model portfolio to reflect caution on "interest rate-sensitive stocks" as we believe the RBI would maintain its hawkish stance in the near term. While inflation and credit growth are likely to be reined in, the overhang of high core inflation and strong capital flows leading to liquidity beyond the RBI's tolerance level remains. However, there is significant valuation comfort in rate-sensitive stocks, primarily banks. We, therefore, have a Neutral stance on the sector with a preference for private banks. Our large cap top picks are BHEL, ONGC, Tata Motors, Infosys and Bharti.

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