‘Despite fall, Nifty index valuation still expensive’

Continued economic slowdown, as manifested in the GDP print, clearly points toward a challenging grind ahead for the long-awaited recovery in earnings, said Motilal Oswal Financial Services in a recent report.

In the India Valuations report, it said the Nifty extended July 2019 losses with a decline of 0.9% in August 2019. The market sentiment has deteriorated to an extent that the benchmark has wiped off the majority of its gains for the year.

“This is a clear indication that after the election euphoria, investors have been dealt with a ‘reality check’. High frequency data (auto numbers, IIP data, core sector growth) and the GDP print (5% for 1QFY20, and more importantly, the internals – private final consumption expenditure, or PFCE growth of 3%, manufacturing growth of 0.6% and nominal GDP growth of just 8% – was well below expectations) point toward a tough near-term macro. Another distress is that FII selling has continued ($1.9 billion in July, $2.2 billion in August) even post the rollback of FPI surcharge. DII inflows, however, remained robust at $2.9 billion in the month,” the report said.

According to the stock brokerage firm, the government announcements to drive growth have not really pulled sentiment as yet, even though it augurs well from liquidity viewpoint. Multi-year-low 8% nominal GDP growth in 1QFY20 underscores several challenges ahead – government missing its FY20 tax collection targets, and continued moderation in top-line and earnings growth momentum for the corporate sector.

“Commentaries from the 180 companies that participated in our 15th AGIC was muted, barring a few sectors like insurance, retail and cement. In particular, the emerging worries in asset quality take some sheen off the banking earnings and point toward elevated risks of earnings downgrades ahead. The sharp underperformance of mid-caps versus the Nifty does provide some respite in stock selection. We believe that the Nifty is still expensive at 19.4x FY20E earnings, despite several of its constituents trading at a substantial 30-40% discount to their respective long-period average valuations,” the report said.

The Motilal Oswal report also said that midcaps continue to underperform benchmark index. In August, the Nifty Midcap100 was down 1.7%, as against the Nifty’s fall of 0.9%. Over the last 12 months, mid-caps were down 21.4%, as against the Nifty’s fall of 5.6%.  The Nifty Midcap100 price to earnings (P/E) ratio has corrected from 25.6x in August 2018 to 14.9x in August 2019. Mid-cap premium to the Nifty (13% in August 2018) has turned into a discount of 18% in August this year.

India’s share in the world market cap is also at 2.5%, at its historical average of 2.5%.  Over the last 12 months, the world’s market cap has decreased by 3.9% ($3.1 trillion), while India’s market cap is down 14% year on year.

The report also said that valuations of Indian equities are near their long-period averages. The Nifty trades at a 12-month forward P/E of 18.2x, just a 1% premium to its long period average of 18.0x. The Nifty’s price to book (P/B) of 2.5x is also near its historical average.

“At the current trailing P/E of 21.4x and forward P/E of 18.2x, we see limited triggers for a further re-rating, unless accompanied by a material surprise in earnings,” it said.