The markets have risen nearly 10% since Bajaj Auto Ltd’s shares stopped trading on 13 March. But few analysts expected the company’s shareholders to gain when its demerged entities relisted.
The outlook for its core auto business has become worse, with high inflation ruling out any possibility of an interest rate cut in the near future. Bajaj Holdings and Investment Ltd, which holds a 30% stake in both the auto business (Bajaj Auto) and the financial services business (Bajaj Finserv Ltd), and which ended with a majority of the group’s cash and investments, hasn’t shown much progress with its business plans.
Still, few analysts expected Bajaj Auto’s shareholders to lose as much as 18% on relisting. The value of the three demerged entities adds up to Rs1,715, compared with Rs2,101 before delisting. Much of the negative surprise came from the auto business, which ended its first trading session at Rs600.
Adjusted for cash and investments worth nearly Rs100 per share, the auto business is valued at only about nine times of its earnings. The company’s main competitor, Hero Honda Ltd, trades at about 14 times earnings.
Before the delisting, the cash and investments of the auto business, after adjusting for the value of the insurance subsidiaries, was valued much higher, and the discount to Hero Honda was negligible.
Bajaj Auto recently reported its March quarter results, which are not strictly comparable because of the demerger process, but based on the segments, operating profit for the automotive business fell as much as 33% due to a drop in volumes and a 280 basis points dip in margin.
Hero Honda, on the other hand, reported a more than 50% jump in profit on the back of growing margins. Analysts expect this divergent trend to continue in the near future, which is the reason why Bajaj Auto’s auto business trades at a wider discount to Hero Honda’s.
Analysts’ views on the valuation of the financial services subsidiary are varied, largely because valuation of insurance companies in India is at a nascent stage. In some cases, the listing price of Bajaj Finserv is way below analysts’ expectations.
Even Bajaj Holdings has disappointed. One analyst, who declined to be quoted, says that the holding firm’s plan to start a special economic zone has made little progress, with the government being cautious about approvals. This has impacted its valuation. It now trades at a big discount of more than 40% to its book value.
Earnings growth will slow further
Even the most pessimistic forecasts of earnings growth for Indian companies assume that it will be around 15%. A simple calculation will be to assume GDP (gross domestic product) growth at 7% per annum and add another 7% as inflation. Estimates from IBES (Institutional Brokers’ Estimate System) puts the growth in earnings per share for companies included in the MSCI India index at a high 20.4%, but Bloomberg data puts earnings growth for the ben-chmark index of the Bombay Stock Exchange, the Sensex, at a conservative 15.5%.
A new strategy report on Asian markets outside Japan by Citi Investment Research looks at the impact on earnings and return on equity (RoE) during the downturns of 1990-91 and 2000-01.
For India, the average RoE for companies was 19.6% last month, according to Citi’s calculations.
During the 1990-91slowdown, RoE had fallen to 15.4%, while it was at 14.5% during the 2000-01 lows. If the current downturn resembles that in 1991, earnings growth for the Indian market could fall up to 22% from current levels, and if it’s more like the 2000-01 recession, earnings growth could move down 26% from current levels.
By way of consolation, that’s much better than the average impact on Asian markets, where earnings growth came off 31% in 1990-91 and 52% in 2000-01. In fact, if the current slowdown mimics what happened in 2000-01, India’s earnings growth is likely to be the least hit among all the Asian nations.
The moot point, of course, is whether India is better placed to ride out the current downturn.
The Citi report sees the Indian market as overvalued compared with what the price-earnings multiple should be based on a 10-year average—it calls this a mid-cycle estimate.
But Indian markets had soared on the assumption that the country is witnessing a structural change. There are a few points in India’s favour—a much higher savings and investment rate, and a much stronger corporate sector. But that structural shift is at present being overshadowed by cyclical factors such as higher inflation and political uncertainty.
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