Market expected to deliver 10-15% returns in CY19; valuations reasonable on a top-down basis but hide vast dispersion in multiples.
We expect around 10-15% returns from the Indian market in CY2019 on the back of (i) strong earnings growth, (ii) possible modest de-rating of overall market multiples on global slowdown concerns and a potential de-rating of ‘quality’ stocks and (iii) a broadly stable macro. However, we see potential risks from a global slowdown and China-US trade issues, oil prices and national elections. We favour a mix of ‘quality’ stocks in financials and IT services and ‘value’ stocks in other sectors.
Noisy first half but earnings revival would be the most important driver
We see earnings revival as the most important driver of the Indian equity market for CY2019 despite several global and domestic events in 1HCY19 which may create volatility. Steady earnings revival could face noise from India’s general elections in April-May, 2019, China-US trade negotiations and renewed brouhaha over Iran-US oil sanctions (as the 180-day exemption granted by the US expires in early May).
Expect 27% growth in net profits of the Nifty-50 Index in FY2020
We model net profits of the Nifty-50 Index to grow 27% and of the broader KIE coverage universe to grow 31% driven by (i) robust growth in net profits of certain banks on back of lower loan-loss provisions, (ii) strong growth in net profits of pharma companies driven by launch of US generics and specialty products and (iii) moderate growth across consumption sectors led by moderate GDP growth.
Supportive macroeconomic conditions in CY2019
We expect macroeconomic conditions to be supportive of the market in CY2019 with (i) low inflation (4.1% average CPI inflation for FY2020) and possible 50 bps rate cut in 1HCY19, (ii) mild depreciation in the INR with manageable CAD (2.6% of GDP for FY2020 at $72.5/bbl crude price) with possible downside risks and (iii) continued strong GDP growth at 7.2% for FY2020. We do note global risks stemming from tighter global monetary conditions, higher-than-expected crude oil prices and an escalation in China-US trade hostilities.
Valuations reasonable on top-down basis
Valuations for the broader market with Nifty-50 Index trading at 16X FY2020e ‘EPS’ may appear reasonable, especially when viewed against recent historical valuations (18-20X 12-month forward P/E) and bond yields (gap has closed with the recent sharp fall in 10-year bond yields). However, we would note that valuations of the ‘quality’ stocks are quite expensive while those of ‘value’ stocks are very inexpensive. Also, the reasonable multiples are based on our estimated 27% growth in the profits of the Nifty-50 Index in FY2020.