As the curtain rises over the June quarter results, the mood on the Street is pensive. Investors have turned risk-averse. Brokerages have forecast the lowest profit growth in the last four quarters. Indian industries are battling margin contraction on account of spiralling costs and weak pricing power, along with rising interest costs.
Consensus points towards an 8.5% downgrade in Sensex earnings per share (EPS) to Rs 1,190 for fiscal 2012 (FY12). Growth in the gross domestic product (GDP) fell to 7.8% in the March quarter from 9.4% a year ago, signalling a slowdown.
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As a result, Indian benchmark indices came off 10-12% from their November peak levels and have been range-bound since. Indian equities are trading at reasonable valuations of around 16 times FY12 and 12 times FY13 earnings.
Although another correction cannot be ruled out, is it time for bottom fishing? Are we at the inflection point where negative news has peaked and any positive news could be a trigger?
“Contrarian buying happens when the long-term story is intact, but the near-term return ratios are at a low,” said Manish Sonthalia, vice-president/fund manager, advisory, Motilal Oswal Securities Ltd. “Given the huge capital investment that took place in the last two years, one must take cognizance of back-ended cash flows.”
Cash flows are for now indeed strained as working capital needs of Indian firms have risen since FY11 and interest costs have climbed by around 10-12% in the private sector from a year ago. A report by India Infoline Ltd points out that returns on equity in 13 of 17 sectors have declined steeply. Other data also suggest that negative news on growth and inflation is likely to continue for some more time.
Nevertheless, the hope is that we have bottomed out. The first ray of hope is softening global commodity prices, down about 13% from peak levels last year. Analysts say that about two-thirds of our inflation is imported. The end of second quantitative easing in the US could spell lower liquidity, curb speculation and bring commodity prices in track with demand and supply. If that is true, a slowdown in China and GDP growth stumbling in the US and the euro zone may sustain lower commodity prices. Of course, monsoon would tell how soon we could tame domestic consumer-driven inflation.
The resilience of the market despite a spate of bad news suggests the worst has been discounted. All eyes are, therefore, on the second half of FY12. If the trend towards uncertainty of rising inflation and commodity prices is addressed, then a contrarian approach of a calibrated exposure to equity markets could pay off well.
Consensus estimates point to a 16-18% growth rate in Sensex earnings between FY12 and FY13. More importantly, the watered down earnings estimates for FY12 should be sustained.
Indian markets have long since been driven by foreign institutional investments, which in the last three quarters have barely been a trickle, although they appear to have picked up recently. Domestic institutions, too, have shied away from equities. Speaking of equities as an asset class, a Citigroup report says, “The MSCI AC (All Country) World Index trades at 12.4 times 2011E and 10.9 times 2012E EPS (earnings per share). Valuation measures suggest equities are now as cheap as the early/mid 1980s.”
Time to start buying cautiously, perhaps.
Graphic by Sandeep Bhatnagar/Mint