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MOSL: BULLS & BEARS (May 2019)-India Valuations Handbook — Markets consolidate amid strong FII flows

BULLS & BEARS (May 2019): India Valuations Handbook — Markets consolidate amid strong FII flows; Domestic flows tepid in Apr’19

 

Strategy: Markets – Markets consolidate amid strong FII flows; Domestic flows tepid in Apr’19

• Markets consolidate after a sharp rally in March: Post an impressive finish to FY19 (Nifty rallied by 7.7% in March) and after a gap of eight months, the market logged in a life-time high of 11,856 points in Apr’19. However, it ended flattish with marginal gains of 1% in the month. FIIs remained net buyers (USD2.9b) for the third consecutive month, while DIIs were net sellers (USD 0.6b) for the third straight month. Mid-caps underperformed large-caps, with the Nifty Midcap100 down 3.8% in the month. Over the last 12 months, the mid-cap index has been down 13%, as against the Nifty’s rise of 9%, mainly due to the unsustainable valuation premium of mid-caps to large-caps, the preference for large-caps in a volatile environment, and the lack of pick-up in earnings growth.
• Macros stable; no fireworks in 4QFY19 earnings yet: Indian macros have been stable, with currency and 10-year bond yields moving in a narrow range. Brent crude prices increased 6.4% to USD72.8/barrel in Apr’19. Concerns over the US-China trade war, however, has brought Brent crude prices back in the USD69-70/barrel range over the last few days. GST collection for the month of Apr’19 came in at INR1.13t — the highest since implementation of this reform in Jul’17. 4QFY19 earnings season has begun on an expected note, with headline numbers meeting expectations for the 54 MOSL universe companies and 16 Nifty companies that have declared numbers so far. Commentaries on consumption have turned a tad weaker for both Automobiles and Consumer Staples. Banks, however, reported a further improvement in asset quality trends. The earnings season has been devoid of any fireworks as yet and broadly tracked the earlier quarter’s trend of earnings downgrades outweighing upgrades.

Valuation deep-dive for the month: Capital Goods

• Valuation multiples of Capital Goods companies have gyrated from the lows of 8.4x in FY05 to the peak of 51x in FY16 , this, when the average multiple for the sector stood at 24.5x. Such steep variance in the valuation multiple over FY05-19 is an indicator of the highly cyclical earnings of the sector and its dependence on the capital expenditure activity prevailing in the economy.
• The sector has witnessed multiple business cycles with valuation multiples following suit. Prior to FY05, the Capital Goods sector traded at a discount to the Nifty (in terms of P/E), given the weak capex activity in the country and poor earnings visibility of the companies. Over FY05-10, the sector saw massive re-rating and traded at a 37% premium to the Nifty, driven by infrastructure capex momentum, which led to strong earnings visibility for the sector. From FY10-14, valuation premium came off for the sector (traded at 30% premium to the Nifty) due to policy paralysis prevailing in the country. Post the FY14 general election, valuation premiums have expanded in anticipation of a revival in the capex cycle.

Sector valuations: Technology, Metals outperform in April

• Technology sector trades at a P/E of 20.6x, at a 25% premium to its historical average of 16.5x. Trends in revenue growth have been muted ever since the macro and consequently, demand for IT services turned the corner. INR depreciation during 1H acted as a tailwind for the sector, providing relief on the margin front. However, the recent INR appreciation has changed the course of cross-currency impact and has put some pressure on margins. Valuations for mid-cap IT has cooled off in comparison to its larger peers in FY19. Tier-II IT trades at a 16% discount to Tier-I’s P/E, after a high of 14% premium a year ago.
• Metals trade at 1.2x, near its historical average P/B of 1.4x. EV/EBITDA is at 6.4x, at a 12% discount to historical average. Domestic flat steel as well as long steel product prices were unchanged during the month at ~INR42,000 and ~INR37,000, respectively. Aluminum prices were lower by ~5%. Zinc prices have decreased 1% in the month. We remain positive on JSW Steel, as it benefits from higher steel spreads. Hindalco is well placed to benefit from higher aluminum prices and low-cost captive raw material.