Year-to-date, the BSE Sensex is the second-best-performing market in Asia. With no material change in earnings estimates and no visible evidence suggesting the risk of consensus earnings downgrades—seen over the last three consecutive years—which is now firmly behind us, the liquidity driven expansion in valuations looks unlikely to sustain.
Surging domestic inflows and post-Budget pick-up in foreign institutional investor flows have led the BSE Sensex higher by 10% (in US $ terms) and 8% (in absolute terms). Year-to-date, the BSE Sensex is the second-best-performing market in Asia. With no material change in earnings estimates and no visible evidence suggesting the risk of consensus earnings downgrades—seen over the last three consecutive years—which is now firmly behind us, the liquidity driven expansion in valuations looks unlikely to sustain. While we remain excited about the roll-out of the GST in July, we see this impacting consensus earnings in second half following the rollout. The BSE Sensex is now trading at a 12-month forward P/E of 17x (consensus), which is in line with its past five year average.
In fact, 55% of our coverage universe is currently trading either at or above five-year average valuations. Following the sharp run-up in the market, we looked at our coverage universe for sectors where valuations have expanded and correspondingly at sectors where valuations are firmly below past five year averages. Private sector banks, select NBFCs, cement and staples stand out, with most companies in these sectors trading at valuations significantly higher than the past five-year average. Pharmaceuticals appear to offer value with five out of eight companies under coverage trading sharply below the past five-year average valuations.
Bajaj Finance, Yes Bank, Whirlpool India, Bharat Forge and Indraprastha Gas stand out with valuations far above mean. Sun Pharma, Jubilant Foodworks, Cipla, ICICI Bank and Wipro trade at valuations below mean.
Pharma has seen a severe derating over last 12 months due to multiple headwinds including: (a) The ongoing US FDA regulatory issues across Indian pharma companies over the past 18 months; (b) heightened pricing pressure in the US; (c) Department of Justice-related concerns; (d) currency volatility in emerging markets which offset underlying growth; (e) a slowdown in Indian formulations’ market growth, impacted by price controls/FDC ban.
Over the last three months, large Indian pharma firms (Lupin, Cadila, Aurobindo, Glenmark and Cipla ) have received fewer observations and have successfully resolved their outstanding USFDA issues. While regulatory risks will always persist, the inspection outcomes seem to be less severe and should allay investor concerns around USFDA inspections. We believe that Sun Pharma’s valuation de-rating appears excessive (stock trading at valuation which is 31% below past five-year average) and worries overdone. Near-term headwinds are likely for Indian FIs. We increase the underweight on financials even more and the sector remains the biggest underweight in our model portfolio.
– Edited extracts from Deutsche Bank Markets Research Report – India Equity Strategy (March 1, 2017)