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MOSL: BULLS & BEARS (February 2018)-India Valuations Handbook — Markets extend stellar gains of CY17

BULLS & BEARS (February 2018): India Valuations Handbook — Markets extend stellar gains of CY17; earnings recovery in sight in CY18; Mid-cap valuation premium unsustainable

 

Strategy: Markets extend stellar gains of CY17; earnings recovery in sight in CY18; Mid-cap valuation premium unsustainable

• Nifty continues its positive run in the new year: The Nifty has started CY18 on a positive note (up 4.7% in January) after delivering stellar 27% returns in CY17. India’ improving micros (earnings recovery), coupled with continued liquidity inflow, have driven a strong market performance – despite this, the three-year (CY15-17) CAGR returns for the Nifty stand at just 8.5%. In January, FIIs turned net buyers (USD2.0b) from net sellers in December (USD.7b), while DII flows were the lowest in 10 months (USD.1b). Midcaps (-1.6% in January) underperformed the Nifty after five months of continued outperformance, as muted DII flows and realignment of MF portfolios (large cap/midcap/small cap) took the centre stage. Midcap still command a rich premium of 66% v/s large caps. The 3QFY18 reporting season has begun on a strong note – 100 companies in our MOSL Universe have declared results so far, posting 13.5%, 10.8% and 13.6% YoY growth in sales, EBITDA and PAT, as against expectations of 14.3%, 10.1% and 11.2%, respectively. 31 Nifty companies have posted sales/EBITDA/PAT growth of 12.4%/9%/12.6% YoY v/s expectations of 14%/9.2%/10.4%, confirming our thesis of a 2HFY18 earnings recovery.
• Budget – shades of populism ahead of election year without being profligate: The FY19 Union Budget, presented on 1st February 2018, delivered a blend of pragmatic economics and electoral optimism, and placed primacy on Rural and Agricultural India without being profligate and not deviating much from the path of fiscal consolidation. The Indian government was expected to push its fiscal deficit target of 3% by one year, but it has actually been pushed forward by two years (to 2020-21). The much-speculated Long Term Capital Gains (LTCG) tax has been re-introduced, but with grandfathering provisions till 31st January 2018, providing a relief to equity investors. Overall, while we are enthused with the government’s focus on rural income (and, in turn, consumption), education and health, we believe the quality of fiscal spending could have been better (capital spending estimated to fall to 1.6% of GDP). Refer to our Rural Strategy notes Back on the saddle, Volume I and Back on the saddle, Volume II for more details on the rural recovery theme.