Domestic macros to triumph over political uncertainty…
CY18 can be conveniently termed as a rollercoaster ride for equities as a flurry of factors ensured that “uncertainty” remained a key theme across the globe. On the global front, during 2018, US fiscal stimulus & trade war increased US asset appeal vs. other assets. However, trade wars dented global GDP growth. Moreover, a surge in crude oil prices along with escalating trade wars kept current account balances on weakening trend for most key emerging markets pushing their currencies lower and resulting in record FII outflows of ~US$42 billion
|Stock Picks for 2019|
|Company||CMP (Rs)||Target Price (Rs)||Upside (%)|
|Astral Poly Technik||1116||1250||12|
|City Union Bank||185||225||22|
However, as we move towards 2019, the catalysts for declines in 2018 seem to be ebbing. While US economic growth is likely to normalise to trend levels of ~2%, emerging markets, including India, are expected to remain on a healthy growth trajectory. The trade war rhetoric also seems to be fading out as US and China have indicated a truce. Most importantly, crude has cooled off and is expected to remain in a range as US oil production is likely to keep the supply side of equation strong despite Opec production cuts.
Amid the above-mentioned background, we expect domestic macro to be a key catalyst for market performance in 2019.
Domestic growth momentum to remain upbeat…
On the domestic GDP front, a common thread in both FY19E and FY20E growth is strong traction from gross fixed capital formation (GFCF), especially on the government front. The private consumption lever is likely to remain stable whereas government consumption is likely to moderate. We expect GDP growth to be around 7.3% in FY20E.
We also notice signs of a private capex recovery on the back of demand supply drivers (sharp improvement in capacity utilisation & order book), improvement in balance sheet and a favourable business environment. This lends us comfort that an improvement in GFCF is sustainable, going forward.
…amid benign macroeconomic factors
Trade deficit is likely to hit a decadal high of US$193 billion in FY19 but then subside to US$180 billion in FY20 as we expect the benefits of relatively lower crude oil prices to flow in FY20. Soft food and lower crude are likely to keep inflation at ~4%, comfortably within RBI’s range. Domestic financial savings are likely to increase, going forward, in 2019 as higher real interest rate aided by low inflation will attract household savings into financial instruments.
Political realignments/coalition equations remains key risk…
Amid the domestic macro stability, one of the key risks for the market would be the possibility of a weak and unstable coalition government, which could slow down economic growth, as seen historically. Another risk factor is on the crude front, where a further supply disruption from Venezuela, political instability and uncertainty in some of the Middle East and North Africa (MENA) regions, along with stricter sanctions on Iran by the US can be potential threats to oil supply.
Nifty earnings CAGR of 18.5% in FY18-20E
The last four quarters have been phenomenal for the oil & gas as well as metals space primarily driven by an increase in commodity price globally with consequent higher double digit topline as well as bottomline growth. However, we would highlight that ex-commodity space; topline and PAT growth at Sensex companies (ex-banks) has also been encouraging, specifically in the capital goods, FMCG space and lately in the IT pack. This depicts more structural legs to the earnings recovery, which is broad based and has the potential to sustain, going forward.
We expect the Nifty to witness a healthy 18.5% earnings CAGR in FY18-20E. Earnings growth will be led by index heavy banking & NBFC space amid resolution of stressed assets and supported by defensives sectors.
Valuing Nifty at 19x FY20E EPS to arrive at fair value of 12100
Indian markets look undervalued vs. their global counterparts as currently we are in the midst of strong a corporate earnings recovery primarily led by improving asset quality in the banking & NBFC space. In other markets, earnings growth looks muted or faces uncertainties like Brexit (UK). Domestically, our two year earnings CAGR is pegged at 18.5% with consequent PEG ratio at 0.9x vs. global average of 1.8x.
Our long term (14 years), across cycles, one year forward P/E multiple works out to 15.2x with corresponding standard deviation placed at 2.6x.With average + 2 standard deviation placed at 20.3x (cap) we are comfortably placed in valuing the Nifty at 19.0x, which is ~average + 1.5 standard deviation. Therefore, we, assign a P/E multiple of 19.0x on FY20E EPS of Rs 636, to arrive at a fair value of 12,100 for the Nifty.