Strategy: Race against time - By Sanjeev Prasad, Co-Head and Managing Director at Kotak Institutional Equities

Race against time. The recent slippage in India's macroeconomic parameters (CAD, GDP growth, inflation) may dampen investment sentiment unless earnings surprise positively. We have been hopeful about India's strong 'macro' translating into economic and earnings over the past 2-3 years but (1) earnings have generally disappointed and (2) economic recovery faces cyclical and structural issues. Current rich valuations across sectors would require earnings support with the macro turning less favorable.

The best of macro may be over

Recent macroeconomic data suggests a weakening of India's macroeconomic position with (1) CAD rising to 2.4% in 1QFY18; we raised our FY2018E CAD estimate to 2% from 1.3% earlier, (2) CPI inflation rebounding to 3.4% in August from historical-low levels and set to cross 4% in the next 2-3 months and (3) GDP growth slowing to 5.7% in 1QFY18 pulled down by a combination of cyclical (demonetization, GST) and structural (low investment) factors; we are not sure how investment component of GDP (30%) can accelerate suddenly given structural issues. India's fiscal deficit continues to be high and could worsen (without one-off asset sales by the government) if taxation revenues disappoint.

The best of 'micro' is yet to come but it sure has been a long wait

We model FY2019E and FY2020E 'EPS' of the market (Nifty-50 Index) to grow 24.7% and 16.3% with the rebound led by our assumptions of (1) domestic economic recovery, (2) favorable resolution of stressed assets leading to lower loan-loss provision for banks, (3) sustenance of historically high margins and profitability in several domestic consumption sectors high global commodity prices. We focus on FY2019E and FY2020E EPS since our fair valuations (and they are still falling short of current stock prices in several cases) are now based on June or September 2019 EPS.

Fair degree of uncertainty around FY2018E earnings; see low growth for now

We note the high degree of uncertainty around FY2018E earnings given ambiguity around (1) the level of LLPs in the banking sector; we model a decline for most banks under our coverage, (2) the amount of adventitious gains for the downstream oil companies; we see some upside to refining margins as a result of hurricane-related short-term disruptions for US Gulf Coast refineries and adventitious gains from higher crude oil prices and (3) the extent of R-Jio's losses that will influence RIL's consolidated profits; we build in telecom-related losses, which may partly explain our lower estimates versus consensus estimates for the market as a whole.

Sentiment still strong broadly but weakening macro may test that

The Indian market's rich valuations will require earnings support given India's weakening macro. India's strong macro over FY2015-17 probably made up for earnings disappointments. In particular, (1) strong debt inflows due to high positive real interest rate in India and (2) a strong currency reinforced each other and boosted investment sentiment. However, the INR has weakened considerably against non-USD currencies over the past three months. Also, India's overweight position in GEM funds has declined over the past 2-3 years reflecting better opportunities for FPIs elsewhere.

Retain our Model Portfolio

We retain our large-cap. Model Portfolio. We note that our paper portfolio is a 'static' one in that we don't adjust the weight of individual stocks in the portfolio up or down depending on stock prices. In reality, the position in outperforming stocks (such as metal stocks) will increase to bigger positions and positions of underperforming stocks (INFO, TTMT) will shrink along with the relative movement in their share prices.

Source : Equity Bulls

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