Strong foreign appetite for Indian assets, especially after the Federal Reserve kept US interest rates unchanged, is driving share prices to dizzy heights and triggering concerns about valuations. The worry is deepening and some brokerages have begun to lower their weightings.
Foreign funds bought $610 million (Dh2.2 billion) of stocks this week, taking the total inflow since the beginning of January to almost $7 billion. Bullish markets are also drawing cash into thriving initial public offerings (IPOs), underpinning growing investor confidence in the country’s economic outlook.
ICICI Prudential Life Insurance’s IPO to raise as much as Rs. 60.6 billion, or more than $900 million, received bids for 10.5 times the stocks on offer. The sale was the biggest since Coal India went public in 2010, and the demand signalled that money would not be a problem if there is a good story to tell. Notably, it was the first public offering by an insurance company in India.
Overseas investors are ploughing cash into India because of the country’s robust growth potential. The $2 trillion economy, Asia’s third-largest after China and Japan, is expanding at around 7.5 per cent — the fastest pace among major economies while much of the developed world is struggling from slipping into recession.
Still, the stocks rally is stunning since hitting a 2016 low in February, and well ahead of earnings growth. The top-30 Sensex, which has leapt by a quarter over seven months, trades at 16.4 times projected 12-month earnings, near the most expensive level since January 2011, according to Bloomberg.
A gauge for medium-sized companies trades at 33 times reported earnings, higher than the five-year mean of 21. The 12-month trailing price-earnings ratio for the S&P BSE SmallCap Index is a record 80.5 times, the news agency calculated.
Red flags
What that means is stocks are too richly priced, making them vulnerable to big corrections if earnings do not match up to high expectations. Even otherwise, small-cap companies have limited scope for further gains as they are already at record levels. So much so that caution would be advisable.
Credit Suisse this week reiterated its “underweight” call on Indian stocks, saying they were expensive along with the Philippines, Indonesia and Malaysia. CLSA, another foreign brokerage, cut its overweight stance on India by two percentage points, and removed property developer DLF Ltd from its model portfolio and added textile company Arvind.
Morgan Stanley slashed India’s weightage in its banking portfolio to 20 per cent from 32.5 per cent, citing a sharp jump in prices of bank stocks — 30 per cent in the last six months. The run-up could be short-lived as loan and deposit growth remains near a three-decade low, the investment bank said in report on Thursday.
Among the four Indian lenders in its banking portfolio, Morgan Stanley cut the weighting of HDFC Bank to 10 per cent from 12.5 per cent, slashed Axis Bank to 7.5 per cent from 12.5 per cent, kept IndusInd Bank unchanged at 2.5 per cent and exited Kotak Mahindra Bank from five per cent.
In a separate report, Morgan Stanley downgraded Indian consumer goods to “in-line” from “attractive”, noting that weaker revenue and profit growth would temper outperformance of stocks.
“Valuation multiples for consumer staples are closely correlated with volume growth and visibility. If markets are less confident of a recovery in volume growth, we see risk of a steady valuation derating, which is currently only partly captured in our intrinsic value on stocks,” analysts Nillai Shah and Indira Badrinarayan wrote in a report.
Valuations of consumer goods stocks are currently at a 20-year high. In the last five years, consumer sector stocks grew 24 per cent, outpacing an 11 per cent rise in the Sensex. The “in-line” rating pegs the sector on par with the relevant market benchmark over the next 12-18 months.
The investment bank downgraded Hindustan Unilever and Marico to “underweight”, but kept ITC “overweight”. It also upgraded the rating for Asian Paints and reiterated “overweight” rating on Titan, Jubilant, United Spirits and Coffee Day Enterprises.
Keep faith
While both the blue-chip Sensex and the broader Nifty index came off their highs, they still ended with weekly gains, indicating the bulls were in the driver’s seat. The Sensex gained 0.2 per cent to 28,668.22 and the Nifty added 0.6 per cent at 8,831.55. Foreign funds have gobbled up shares worth $4 billion since the start of July, putting benchmark indices on track to post their first quarterly gain since March 2015.
Among the top gainers were Shreyas Shipping & Logistics Ltd, which leapt 31 per cent over the week to Rs. 345.45, Prabhat Dairy Ltd soared 25 per cent to Rs113.10, Tata Steel was up 3.6 per cent at Rs. 371.90 and Reliance Industries gained 2.5 per cent to Rs. 1,102.95.
Some pundits believe that valuation is a subjective call because it’s based on perceived earnings, which could swing on many factors. For instance, bountiful rains should boost rural incomes and trigger greater demand for consumer goods as well as for other items.
“This economy is not slowing down, it is accelerating,” Prashant Jain at HDFC Mutual Fund told ET Now television channel. “At the bottom of the earning cycle, the PE multiples will always appear to be very high because the profitability itself is so weak and that is why it becomes difficult to buy into these companies but that is where you have the best opportunities in my opinion.”
“I think the opportunity in this market lies where the earnings are stressed and that is basically not in the consumer, IT or pharma space. I think these are spaces where earnings expectations are high to my mind and other than these sectors, I think there is greater value for the patient investor.”
Spectrum auction
One of the key events in the coming week would be the auction of airwaves by the government to telecom operators. New Delhi aims to collect as much as $83 billion from the auction that starts on Thursday, a target that many analysts say is very ambitious. However, an abrupt announcement by Vodafone Plc that it has injected $7.2 billion in equity into its Indian unit, promises strong bidding in the auction.
“The equity infusion will enable Vodafone India to continue its investments in spectrum and expansion of networks across various technology layers,” Vodafone said in a statement, a week before the auction begins.
Home to the world’s fastest expanding cellular services market, India is a hotbed for companies vying for a big slice of the pie. Reliance Jio Infocomm Ltd, a unit of energy conglomerate Reliance Industries Ltd and controlled by India’s richest man, Mukesh Ambani, this month announced its commercial launch of 4G services, including free voice calls.
The entry of Jio has already led to tariff cutting by market leader Bharti Airtel and No. 2 player Vodafone as well as by others such as Idea Cellular and state-controlled BSNL.
Vodafone needs to buy airwaves to compete in the growing market for data services. Airtel has acquired smaller firms and got hold of spectrum, Jio has countrywide access to airwaves as also an optic fibre network. So the general perception is that the bidding would be rational, but that is easier said than done.
“Rationality has not been the hallmark of the Indian wireless sector for the past many years, and hence, how much ever we would like to call out a rational outcome for the 2016 auctions, we would stay shy of doing so,” analysts at Kotak Institutional Equities said in note to clients.
In other words, the man who could laugh all the way to the bank would be Finance Minister Arun Jaitley, if the auction lives up to the government’s expectation.
The writer is a journalist based in India.
