Market valuation too demanding; divestment target may not be met: Nomura

Valuation of Indian stock market at 22.5 times fiscal 2021-22 (FY22) earnings is too demanding, said analysts at Nomura in their 2021 Asia economic, currencies & equities mid-year outlook call on Monday. Within the region, they expect north Asian markets, particularly China and Japan, to do well in the remaining part of calendar year 2021 (H2-CY21). The Rs 1.75 trillion divestment target for FY22, according to them, may not be achieved.

“Global investors are emotional and not rational. The traditional valuation parameters such as price-to-earnings ratio (PE) suggest that Indian equities are trading at 22.5x FY22 earnings, as compared to Japan (16.5x) and China (15x),” said Jim McCafferty, Joint Head of APAC Equity Research during the outlook call.

Among stocks, they prefer Hindustan Unilever Limited (HUL), given the company's ability to pass on the rise in input costs to consumers. “That said, even HUL is trading at a high valuation,” McCafferty cautioned.

A key driver for Indian markets going ahead, according to Nomura, remains growth in corporate earnings despite inflation risks.

The Indian market, according to their recent report, is factoring in a 26 per cent compounded earnings growth (CAGR) in earnings between fiscal 2020-21 and 2022-23 (FY21-23) with banks, autos, metals, oil and gas, and information technology (IT) services being the key contributors to incremental earnings over the period. On the other hand, consumer, telecom and financial sectors face potential risks to current estimates that can lead to a 5-10 per cent cut in overall FY23 earnings estimates, it said.

“Even considering a 10 per cent cut, it would imply a CAGR of 19 per cent over FY21-23, higher than the high-single-digit to low-double-digit growth recorded in the past,” Nomura had said.

Besides Nomura, other research and broking houses, such as HSBC, Jefferies and Motilal Oswal Securities, have also cautioned against the rich valuation of Indian equities.

“Indian equities are trading at 21x FY22E earnings. The US is the only market trading at a premium, while other key markets continue to trade at a discount to India. In P/E terms, MSCI India is trading at an 88 per cent premium to MSCI EM, above its historical average of 57 per cent,” wrote Gautam Duggad, head of research at Motilal Oswal Institutional Equities.

(Image source: MOSL report)

For FY22, Nomura expects gross domestic product (GDP) growth to come in at 10.4 per cent, marginally lower than the 10.8 per cent projected earlier. Inflation is also a risk. Consumer price inflation (CPI) for the current fiscal, according to their estimates, is likely to remain elevated at around 6 per cent, which is also close to the RBI's upper inflation projection band.

“Global growth will have a rub-off effect on India though the pace of vaccination will remain a key monitorable. By 2021-end, we expect 50 per cent of the total Indian population (70 per cent of the 18+ population) to get vaccinated. The Reserve Bank of India (RBI) will have to be patient as regards policy normalisation and we expect the government's divestment proceeds to undershoot the target in FY22,” said Sonal Varma, Nomura's chief economist for India and Asia ex-Japan.

The Budget for 2021-22 had set a disinvestment target of Rs 1.75 trillion. Of the Rs 1.75 trillion, Rs 1 trillion is to come from selling government stake in public sector banks and financial institutions. Rs 75,000 crore would come as CPSE disinvestment receipts.