India's ROE: Dust yet to settle - MS
The ROE for MSCI India constituents was down another 60bps YoY in 2015 to 12.1%, its lowest level since the data series started two decades ago breaching the 1998 Asian Financial crisis low
Relative Performance: ROE gap vs. EM, BRIC and APXJ narrowed to a 4-year low. The key drags for the narrowing gap were the fall in financial leverage effect (down to a 10-year low), asset turn (down to a 2-year low). Net margin gap improved marginally from a 12-year low point in 2014. The ROE gap vs. the world improved a tad during the year.
Dark Clouds: a) This drop in ROE was driven by a steep fall in asset turn to a 5year low to 64.8%, down 331bps YoY, or 5%. This level is just 34bps higher than the historical low seen in 2010 (i.e FY2011). b) Earnings quality (operating cash flow to net profit) worsened a tad vs. the previous year's multi-year high.
Silver Linings: a) After falling to record lows in 2014 (i.e., F2015), net profit margins improved 40bps in 2016; b) For four years there has been a fall in the capital stock as capex declines relative to depreciation. This should ensure the correction of the investment excesses of the previous cycle creating a floor for ROE; c) Free cash flows were at multi-year highs, rising for the third year running; d) The net debt to equity ratio slipped to a five-year low during the year. Financial leverage effect declined for the fourth year running; e) The ROE fell less than the 10-year yield for the first time since 2009.
Sectors Drags and Drivers: Across sectors the drag on ROE levels was fall in asset turn offset partly by a rise in net margins. Five sectors observed a decline in year-on-year ROE with Consumer Discretionary and Energy seeing a reduction of 525bps and 447bps, respectively. Both sectors saw sharp falls in asset turn ratios. Four sectors reported a rise in ROE levels. Consumer Staples (up 291bps) and Materials (284bps) saw the most increase. The ROE for the Materials sector improved from -6% to -3%. Net margin expansion was seen the most for Consumer Staples and Materials while Healthcare saw the most contraction. Leverage (asset to equity) fell sharply for Consumer Discretionary and Industrials. Consumer Staples (at 35% ROE) and Technology (at 27%) enjoy the best ROE levels, while Materials (-3%) and Energy (at 8%) report the worst return ratios.
Outlook: Top down, the correction in the current account, troughing of the investment rate, the likely boost to capital productivity due to project approvals, stability in the fiscal deficit versus a sharp decline in F2015 and positive real rates and their impact on the mix of household savings (from physical to financial) are setting the stage for better corporate profitability and ROE in the coming months. Indeed, the market is also pricing in a better ROE in the coming quarters. The risk to our view is that global growth slows further
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