Indian Indices have been scaling steadily, since 2014, when the current regime led by PM Modi came to power. Much of these gains can be attributed to the steady PE multiple re-rating witnessed by the markets, with overall corporate earnings recovery remaining modest.
In our opinion, the multiple re-rating has been driven on the back of several landmark reforms like the Bankruptcy & Insolvency Code, RERA, GST & the path of strict fiscal consolidation amongst others, which will have significant positive ramifications and multiplier effect going forward.
As a testimony of faith to the country’s economic policies and potential, India also saw a sovereign rating upgrade, which was hugely significant, as it came by in almost 14 years. The international rating agency Moody’s, gave a thumbs-up to the reform agenda, stating that the efforts to reduce corruption, formalize economic activity and improve tax collection and administration, including through demonetization and GST, both illustrate and should contribute to the further strengthening
of India’s institutions.
This upgrade has also happened at a time when India’s ranking in the World Bank’s “Ease of Doing Business Index” has moved up 30 places – which again is no mean feat. Overall, both are an endorsement of institutional and structural transformations ushered in by the Government in the last few years, while maintaining fiscal prudence.
As market participants and owning fiduciary responsibility as advisors to your capital, we continuously analyse the risk-reward framework and opportunities offered by the markets for long- term wealth creation. So far, markets have helped us generate not only strong alpha led by superior stock selection skills; but we have also benefitted from the overall re-rating of the markets that have contributed to superior risk adjusted returns.
The question that lies in front of us is – Whether corporate earnings recovery is around the corner or still a few quarters away?
We regularly observe the earnings over 3000 listed companies and specifically the constituents that comprise the benchmark indices. As per the data available, Sensex trades at ~24xs FY17. Assuming street estimates of 10-12% EPS growth in FY18 and ~18-20% EPS growth in FY19, it implies – Sensex EPS of ~ Rs. 1500/- in FY18 and ~ Rs. 1900/- in FY19, PE of 22.5xs FY18 and 17.7xs FY19. It is estimated that top 5 stocks would contribute ~70% of earnings growth in FY18 and ~55% of earnings growth in FY19.
Our in-depth understanding across sectors, supported by our extensive interaction with – corporates, economists, bureaucrats, industry associations, trade & channel indicates that on-ground recovery has been far stronger post the transition from demonetisation & GST than that reflected in the Oct- 2017 IIP growth of 2.2% YoY. In our opinion, the manufacturing growth should be strong driven by exports and auto sales, along with a recovery in mining output, which collectively will propel IIP growth going forward. Retail inflation at 4.88% for Nov-2017 vs. 3.5% in Oct-2017 was driven by higher food and fuel prices. Amidst the backdrop of rising crude, we reckon this to remain a tad sticky near ~5% in the months to come.
As we enter FY19, with the Gujarat poll verdict behind, we believe that the Union Budget 2018-19 would be extremely significant – being the last full Budget of the BJP-led NDA government before the 2019 General Elections.
We would attribute a high probability to the following events panning out in the upcoming Union Budget 2018:
- Greater focus on spurring rural demand, agri and farm incomes.
- Rationalisation of corporate tax rates and road-map going forward
- Rationalisation of direct taxes
- Further rationalisation of GST slabs
- Impetus on infra and construction sectors to continue, aiding job creation
- Sharp focus on NPA resolution & PSU banks recap
- Greater speed in PSU divestments
- More incentives to SMEs to enhance their viability
In our opinion, the various moving parts that drive India’s GDP, are now well greased and perhaps the coming times should see a broad-based earnings recovery. We would attribute a high probability to sequential recovery in corporate earnings and if this transcends, assuming all other things equal – markets should comfortably discount FY19EPS at about its long-term fair multiple of ~20xs implying index levels of ~ 38,000 which is an upside of ~16% over current levels.
While we are cognizant of the fact that upcoming general elections will breed in, its share of volatility, we would strongly advise investors the following:
- Remain invested in high quality businesses
- Use every correction as an opportunity to add /build portfolio
- Maintain investment discipline with the objective of wealth creation through long-term investing & power of compounding
- Remain invested in a portfolio of high-conviction businesses, avoiding concentration towards few stocks/ sectors bought on hearsay and tips
To conclude, we expect that continued progress on economic and institutional reforms will, over time, enhance India’s high growth potential. On the fiscal front, efforts to improve transparency and accountability, including through the adoption of a new Fiscal Responsibility and Budget Management (FRBM) Act, are expected to enhance India’s fiscal policy framework and strengthen policy credibility. Net-net, this should offer strong fundamentals for the Indian economy which will enable it to attract high quality long-term capital and steady support to valuations.