Strategy: Fifth consecutive month of positive returns for Nifty; midcaps underperform
Fifth consecutive month of positive returns for Nifty: The Nifty has sustained its upward momentum and delivered 3.4% returns in May, the fifth consecutive month of positive returns. Strong domestic liquidity, good earnings season, progress on GST, and prediction of normal monsoon ensured that the momentum remained intact. Midcaps have underperformed the Nifty for the first time in five months, reflecting the expensive valuations in certain pockets (midcaps trading at 7% premium to large caps). Liquidity remains benign, with FII flows of USD1.5b and Domestic MFs flows also at USD1.5b in May.
Earnings season concludes; Nifty PAT 6% ahead of estimate: The last quarter of FY17 concluded with a modest beat v/s expectations. MOSL Universe delivered 13.9% sales growth (our estimate was 14.2%), 9.3% EBITDA growth (our estimate was 6.5%), and 28.7% PAT growth (our estimate was 23.3%). For the Nifty, sales grew 13.5% (our estimate was 13.4%), EBITDA grew 4.6% (our estimate was 3.4%), and PAT grew 15.2% (our estimate was 8.6%). We have marginally revised the Sensex EPS upwards by 3% to INR1,349 for FY17, by 0.6% to INR1,581 for FY18 and by 0.9% to INR1,922 for FY19. However, just four companies (Tata Motors, Tata Steel, L&T and Reliance) account for the entire INR50b delta in Nifty PAT over our estimate. The upgrade/downgrade ratio is skewed in favor of downgrades, with 69 companies’ FY18E EPS getting downgraded by 3%+ v/s 46 companies’ FY18E EPS getting upgraded by 3%+.
Indian markets best performing in YTD CY17: For CY17 YTD, India (+17%), MSCI EM (+17%), Korea (+16%), Taiwan (+9%) and Indonesia (+8%) were the best performers among key global markets in local currency terms. Among key markets, Russia (-18%) has delivered negative returns. MSCI EM (+25%) outperformed MSCI India (+13%) in trailing 12 months. However, over the last five years, MSCI India has outperformed MSCI EM by 91%.
Sectoral performance trends; Healthcare underperformance continues: In May, Pvt Banks (+8%), Consumer (+7%), Technology (+6%), Auto (+6%) and Telecom (+1%) delivered positive returns, while Healthcare (-10%), Media (-7%), Utilities (-5%) and PSU Banks (-3%) were laggards. Barring Healthcare, Technology, Oil and Utilities, all other sectors trade at a premium to their respective LPA. In this edition of ‘Bulls & Bears’, we take a deep dive into valuation metrics of the NBFC sector.
Valuation comfort lacking; downgraded ratings for 17 stocks in this earnings season: The Nifty has delivered ~17% returns in YTD CY17, led by confluence of positive factors, namely strong liquidity, progress on GST, prediction of normal monsoon, BJP’s strong performance in UP, and less than feared impact of demonetization. Barring the month of May, midcaps have outperformed the Nifty consistently and now trade at a premium of 7% to large caps. While the just-concluded earnings season was better than expectations on aggregate, the internals do not suggest strong underlying operating recovery, as yet. Going forward, we note that GST could result in material changes to our current optimistic 17% Nifty earnings growth forecast for FY18. We remain concerned on valuations. We have downgraded the ratings of 17 stocks (largely owing to expensive valuations) in this earnings season and have upgraded the ratings of five stocks. At current trailing P/E of 22.4x and forward P/E of 19x, we see limited triggers for further re-rating, unless accompanied by earnings revival. We prefer stocks with earnings visibility, pricing power and operating catalysts. Our top ideas include: Yes Bank, ICICI Bank, Tata Motors, Maruti, ITC, Britannia, Aurobindo Pharma, ONGC, Coal India, Hindalco, Amara Raja, and JK Cements.
Sectoral valuation trends; Consumer, Private Banks and Technology top outperformers: Consumer trades above its historical average valuations. At a P/Eof 39.3x, it is at 33% premium to its historical average, and at a P/B of 11.6x, it is at 22% premium. Sales seems to have recovered gradually after demonetization in 4QFY17, a lingering impact persists mostly for companies with greater exposure to rural regions and the wholesale channel. 1HFY18 will have some effect of GST implementation.
Private Banks are trading at 2.9x P/B, above their long-period average valuations (33% premium), driven by continued outperformance of retail lenders and improvement in return ratios. The sector was the bestperforming in May (+8% return MoM). Loan growth at 25%+ for mid-sized banks and 15%+ for larger banks is significantly ahead of system loan growth of ~6%.
The Technology sector trades at a P/E of 16.2x, near its historical average of 16.1x. 4QFY17 earnings started on a soft note, with TCS and Infosys both reporting below-expectation revenue growth. The end was no better, with organic growth guidance at HCLT weak and margins at TECHM a negative shock. Now that the seasonally weak bit of the year is behind, expectations are of a revival in BFSI gradually through the year.
Motilal Oswal was founded in 1987 as a small sub-broking unit, with just two people running the show. Today it has a 2000 member team with a networth of Rs7 bn and market capitalization as of March 31, 2008 at Rs19 bn.
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