MOSL: BULLS & BEARS (January 2018)-India Valuations Handbook — A stellar finish to the year-all eyes on earnings recovery in CY18

​BULLS & BEARS (January 2018): India Valuations Handbook — A stellar finish to the year; all eyes on earnings recovery in CY18

Strategy: A stellar finish to the year; all eyes on earnings recovery in CY18

• Nifty ends CY17 at a high: The Nifty ended CY17 with stellar 29% returns, after gaining 3% in December 2017. Even as one gets excited about CY17 returns, we note that the three-year CAGR returns for the Nifty stand at 8.5%. In December, FIIs turned net sellers after two months (sold USD0.7b), while DII flows remained robust (USD1.3b). For CY17, MF flows stood at USD18b (2.5x of CY16 inflows), while FII flows came in at USD7.7b (> CY15+CY16 inflows). Midcaps (+6.2% in December) continued to outperform the Nifty (led by robust DII flows), commanding a rich premium of 72% v/s large caps.
  
• Macros weakening at the margin: The last three years were characterized by strong macros for India, with twin deficits under control, a stable currency, rising forex reserves and low inflation. However, as we enter CY18, rising crude prices and consequent higher inflation have taken some sheen off the macros, even as they still remain healthy. In fact, the 10-year bond yields have increased 80bp in CY17 to 7.3%, incrementally posing a threat to the prevalent “low cost of capital-led valuation premium” narrative. The possibility of the Indian government missing its fiscal deficit target owing to lower indirect tax collections is concerning the markets. The BJP’s sixth victory in elections (formed a government in Gujarat with a majority in December 2017) provided some stability from the policy perspective, but its inferior performance in rural Gujarat has initiated a debate about potentially higher rural spending in the CY18 budget – its last full-fledged budget before the General Elections in 2019. However, if the government indeed increases rural spending, it will augur well for consumption, which, in our view, is set for a strong recovery in 2HFY18 and beyond, as GST-related supply chain disruption normalizes. Refer to our Rural Strategy notes, (Back on the saddle, Volume I) and (Back on the saddle, Volume II), for more details.