[T.S.R:17437] Citi: India PE Multiple To De-Rate; FII Holdings At $280 Bn Equal Nation's FX Reserves

Citigroup

India Equities-Such Gloom.....

 

India has been a difficult market. It is down 9.3% YTD and is about the worst performing regional and global market, and investor sentiment – global and domestic – is fairly pessimistic. While market performance is often a cause for investor disenchantment with the market, there are a slew of real macro and micro issues that justify the bearishness.

 

These include risks to growth, a challenging macro environment, with high and rigid inflation and rising interest rates, and the stalled investment cycle. This is in large measure because of a lack of policy making/execution standstill at the government's end, and the infrastructure deficit, which is stoking inflation. These pressures are being compounded by the growth/investment challenges that higher Interest rates bring. There is not surprisingly an extrapolation to earnings, which are perceived to be at meaningful risk. 

While a few of these pressures are global – cost pressures and the risk of inflation –the majority of them are India specific in nature and the reason for the India bearishness. In addition, there is the overhang of the funds outflows – India received almost $30bn in 2011 (167% of its previous net inflow peak), and even though the market is down 9.3%, only about $356mn has moved out…suggesting there remains meaningful risk of substantial outflows (we estimate the value of foreign equity ownership in India at about $280 bn). 

We do however believe India's structural problem lies in profitability, and its relatively high ROE structure, which we believe will be under threat and will erode over the medium term. Our view is premised on what we believe is a) excessive competition – both from domestic players as also global ones, which only get exacerbated as the growth differential with developed markets gets entrenched, b ) easier access to capital (medium term, rather than in the immediate term) – which will drive capacities and growth, but lower returns structures, c) and return thresholds being relaxed by incumbents and new entrants, as they seek market share and presence and are prepared to trade off profitability. Over the longer term, we believe the cost of capital differential will also moderate as capital chases some of India's relative growth differential, but that is not for now. 

This is already visible in market ROEs – India's recent lows (after an aggressive bout of capital raising) are lower than its previous lows. And we believe going forward, India's ROE's will turn down well short of their previous highs. This is already visible in relative ROEs – with India's premium to peers at a relative low. 

We also believe this fundamentally means that India will de-rate over the medium term, or a 2-4 year period, as its historically high (absolute and relative) multiples no longer have the support of relatively high multiples. We do not however believe it will happen in the next 6-18 months – as ROE's are on leverage and cyclical upswing post capital raising and capacities, but they will catch up.

 

 

Safe Harbor Statement:

Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

 

Nothing in this article is, or should be construed as, investment advice.

 

 

 

 

 

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