Yield Play-Largely Done
Kotak Securities
Two out, third shaky.
We believe (1) the 'yield' story (multiple expansion) is largely done with global central banks unlikely to cut short-term rates further; in fact, global bond yields have started to harden and (2) the 'cost' story (margin expansion story) is also over; commodity prices have rebounded and are stable now. The third driver of domestic volume growth may come into play but its impact on stock prices is far more muted compared to that from (1) multiple re-rating and (2) higher profitability.
The global 'yield' compression or multiple re-rating story is largely done
We see limited scope for re-rating for large parts of the Indian market as (1) global bond yields start to move up (see Exhibit 1) and (2) valuation multiples are at high levels (see Exhibit 2) post their significant re-rating over the past 5-6 years mirroring the fall in global bond yields. The recent hardening of global bond yields suggests that markets have finally started to (1) appreciate the limited ability of global central banks to reduce short-term rates further and (2) price in an increase in US Fed rate in December 2016 (see Exhibit 3).
We expect flows to be less supportive; EM flows have reversed in the past 2-3 weeks (see Exhibit 4) perhaps reflecting outflows from passive macro funds on the back of higher global yields and a stronger US dollar. We do see scope for further rate cuts in India (50-75 bps by 1QCY18), which may drive re-rating of regulated utilities (bond 'proxies').
The 'cost' or margin expansion story may also be largely over
We see low possibility of further expansion in gross and EBITDA margins of domestic companies as (1) global commodity prices have firmed up or are stable in the past six months (see Exhibit 5) and (2) gross and EBITDA margins in several sectors are already at very high levels (see Exhibit 6). The key question that investors will have to grapple with is whether companies will (1) be able to sustain the margins at higher levels of commodity prices; higher input costs, in other words and (2) have to reduce margins to grow volumes if economic recovery disappoints.
The 'volume' story is somewhat shaky; volume growth is still very patchy
We note that economic recovery is still quite patchy (see Exhibit 7) with only parts of urban discretionary consumption holding up well. The ongoing results season has not provided any signs of an incipient economic recovery and management outlook on demand for the next 2-3 quarters is generally subdued. We note that 2QFY17 volume data was muted for a number of cement and consumer staple companies. We believe volume growth will become very relevant as a driver of profits as the gross margin expansion-led earnings growth is largely over.
2QFY17 results: so far, so good and loads of variety
The 2QFY17 results season has seen very diverse results with certain companies such as ADSEZ, MSIL, ONGC and YES exceeding our estimates by a reasonable margin and certain companies such as ACC and AXSB missing our estimates by a wide range (see Exhibits 8-9 for 2QFY17, 2QFY17E, 1QFY17, 2QFY16 EBITDA and net profits of the Nifty-50 stocks that have reported so far). On an overall basis, net profits of the Nifty-50 companies that have reported so far have grown 7.3% yoy and exceed our estimates by 5.4%. We have seen some upgrades for our FY2017E and FY2018E net profits.
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