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MOSL: BULLS & BEARS (July 2019)-India Valuations Handbook — Consolidation in June; Nifty valuations expensive

BULLS & BEARS (July 2019): India Valuations Handbook — Consolidation in June; Nifty valuations expensive

 

Strategy: Consolidation in June; Nifty valuations expensive

• Markets tested by elevated volatility, consolidate in June: The Nifty surpassed the 12,000 mark to hit a record high in June’19. However, the euphoria was short lived, with the benchmark consolidating in the 11,500-12,000 range thereafter to close at 11,789 (down 1.1%) in June. FII flows were muted in June (net inflows of USD0.1b), while DIIs remained buyers for the second consecutive month (USD 0.5b). Mid-caps underperformed large-caps, with the Nifty Midcap100 down by a steeper 1.7%. Notably, over the last 12 months, the Mid-cap index declined 3% v/s the Nifty’s rise of 10%, which, in our view, can be attributed to the preference for large-caps in a volatile environment amidst an uncertain earnings backdrop and expensive valuations of mid-caps to begin with.
• Polarized markets; valuation divergence continues: As the markets consolidate, the picture has turned more polarized, with a few stocks accounting for the gains in the Nifty. We had highlighted in our Mar’19 note about the prevalent divergence in both the large- and mid-cap indices. The Nifty index constructed of the top 15 stocks is up ~30% v/s Dec’17 levels, while the index of the other 35 stocks is down ~10%. As we usher into the 1QFY20 earnings season, expectations of FY20 earnings growth revival are high, despite prevailing economic slowdown and NBFC liquidity issues. We note that FY20 earnings revival is singularly dependent on BFSI, as it accounts for ~70% of incremental FY20 Nifty earnings. At the margin, consumption has moderated and the monsoon – albeit better than a fortnight back – is still in a big deficit.
• US and S. Korea top performers among global markets: In June’19, the US (+7%), MSCI EM (+6%), S. Korea (+4%), Brazil (+4%) and the UK (+4%) were the key global markets to close higher in local currency terms. On the other hand, India (-1%) ended lower. Over the last 12 months, MSCI India (+7%) has outperformed MSCI EM (-1%). Notably, over the last 10 years, MSCI India has outperformed MSCI EM by 96%. MSCI India’s P/E is at a premium of 87% to MSCI EM’s P/E, above its historical average premium of 49%.
• Sectoral trends for June – Utilities and Metals top performers: Utilities (+4%), Metals (+3%), PSU Banks (+2%), NBFC (+1%) and Private Banks (+1%) were the top performers in June, while Oil (-6%), Cement (-4%), Healthcare (-3%) and Autos (-3%) were the key laggards. Power Grid (+9%), Vedanta (+8%), Titan (+8%), Bajaj Finance (+6%) and NTPC (+6%) were the top performers on an MoM basis. Yes Bank (-27%), Indiabulls Hsg (-23%), GAIL (-14%), IndusInd Bank (-12%) and Tech Mahindra (-7%) were the top laggards. In this edition of ‘Bulls & Bears,’ we take a deep dive into the valuation metrics of the Healthcare sector.
• Nifty valuations expensive; slow grind ahead: The market performance was strong over March-May due to the election-related euphoria. However, with politics now behind, the focus has shifted to fundamentals, and as such 1QFY20 earnings will be viewed with keen interest for signs of earnings pick-up. Our 1QFY20 earnings expectations are modest, with 8%/10% earnings growth expected in MOSL Universe/Nifty and that too dominated by Financials. We are expecting a 5% YoY decline in earnings for Nifty-ex Corporate banks. Meanwhile, valuations for the Nifty remain rich at 19.5x FY20E EPS. We expect near-term upside to be capped by unsupportive Nifty valuations. Mid-caps, meanwhile, are now trading at a discount of 18% to the Nifty and offer reasonable bottoms-up opportunities, in our view. On the positive side, 10-year G-sec yields have corrected to 6.8%-6.9%, in line with the global yield correction and may provide some valuation support to equities.

Top ideas — Large-cap bets: ICICI Bank, HDFC, SBI, L&T, Coal India, Infosys, Bharti Airtel and Maruti. Mid-cap bets: Federal Bank, DCB, Indian Hotels, Crompton Consumer, KEC International, Ashoka Buildcon, ABFRL and Zensar.