Be Mindful Of Valuations

Daljeet S Kohli
Head – ResearchIndiaNivesh Securities

Q4 CORPORATE SCORECARD

The Q4FY13 results have seen no major surprises, either negative or positive. Topline growth is significantly down and will need some triggers like a sharp increase in government spending on large infra/other projects.

LIMITING THE DOWNSIDE

A high CAD, volatile international commodity prices, fluid global macro-economic conditions and higher food prices will limit a significant cut in rates. Also, the reluctance to transmit the benefit from a cut in policy rates to actual users will also discourage the RBI from being too bold.

The current market rally is driven by factors like global liquidity, a slight improvement in macro-economic conditions in developed markets, the perception that the Euro zone crisis has been taken care of (at least for the time being) and huge pumping in of money by the Japanese Central bank. On the domestic front, some policy action has been taken by the government but the ground reality will change after a much longer period. Corporate earnings are not likely to see any major revival. Macro-economic indicators will be benign, with no significant improvement.

India does not get funds directly allocated to ‘India-specific funds’ (most of the funds come into the basket of emerging market dedicated funds). Hence, we believe that the country faces a challenge from China in terms of inflows from foreigners, as China has yet not performed while India has already performed in CY12 as well as on a YTD basis. However, dataflows from China are still weak and we need to see a lot more improvement. A few other EMs like Malaysia, Philippines, Thailand, Taiwan, Turkey, etc. can be other contenders for funds from FIIs as global demand recovers.

The Q4FY13 results have been broadly in line with our expectations, with no major surprises, either negative or positive. From the results so far, it can be fairly concluded that topline growth is significantly down and will need some triggers like a sharp increase in government spending on large infra/other projects. In our view, GDP can be revived only by speedy implementation of policy initiatives announced in the last few months, speedy approvals and removing bottlenecks in execution.

On the profitability front, we think corporate India has already tightened its expenses and hence not much scope for further margins expansion. As for expenses, finance cost is an area that needs improvement. This can happen by reducing debt (reducing leverage on corporate balance sheets) and cutting interest rates. In Q4FY13, we have witnessed a lowering of raw material costs leading to a slight improvement in net profits.
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Inflation, as measured by WPI, is on a downward trajectory. However, it is important to dissect constituents of inflation indices and analyse the reasons for the indices going down. For eg., manufacturing inflation is lower due to poor pricing power with manufacturers. This is definitely not good for the economy and the markets. Food prices are likely to remain at elevated levels, which will limit the overall decline in inflation. Soft crude and commodity prices may aid the WPI. Another important factor to watch will be the wide gap between WPI and CPI. This gap is more important from the consumption perspective, and hence will be key driver of decision-making on policy rates by the RBI. We do not see very liberal/aggressive rate cuts happening in the remaining half of this year.

In line with this, we also do not foresee a major downtrend in interest rates. A high CAD, volatile international commodity prices, fluid global macro-economic conditions and higher food prices will limit a significant cut in rates. Also, the reluctance to transmit the benefit from a cut in policy rates to actual users will also discourage the RBI from being too bold. At the start of CY13, we had expected total rate cuts to the tune of 100 bps in the calendar year. As the RBI has already delivered 50 bps (in two tranches), we could see another 50 bps cut till the end of the year.

We are nearing the general elections along with elections in many states. Hence, a lot of news flows on the political front is likely to hit the markets and may impact their movement. We are not hopeful of any big bang reforms to be taken by the central government from now till the actual announcement of general elections. The court’s intervention in many corruption-related cases may impact the execution timelines of various ministries. Conjectures related to the outcome of elections will also impact the market direction. From the fundamental perspective, while we expect some improvement on macro-economic parameters, we do not see any revival in demand/capex cycle, etc., and hence, corporate earnings are likely to remain subdued in FY14. We foresee much less growth in Sensex earnings in FY14 than the consensus and expect downgrades in EPS estimates for FY14.

We are bullish on sectors like Oil & Gas, IT and Metal. However, at this juncture our advice is to be mindful of valuations as the markets reach new highs. Do not get carried away be irrational exuberance. Therefore, it is advisable that the investors invest their hard-earned money in companies that have strong fundamentals backing them. Stick to high quality managements, strong balance sheet/cash flows, attractive valuations and avoid high-debt companies. Do not get influenced by headline indices as there is a likelihood of high volatility. There are pockets of value outside the index, so broaden your investment universe.