Markets in the bubble zone

With only a few companies' EPS growth at over 26 per cent, the index seems grossly overvalued

Every one of the Nifty set of 50 large companies has declared results for the June quarter (Q1), 2017-18. A look through the numbers is illuminating, given the breadth of the index and the fact that all are market leaders. Overall, revenue growth is at nine per cent year-on-year (y-o-y) and net profit growth is 0.9 per cent. There are two turnarounds. Tata Steel has moved from a loss in the corresponding quarter of the last financial year to a profit in Q1, FY18. Sun Pharmaceutical, on the other hand, has moved from profit to loss in the same period. 

Banking and financials are among the most volatile sectors. Banks can manipulate net profits by reducing or raising provision for bad debts. Private banks have done much better than public sector banks but even they have seen bad loans rising. State Bank of India (SBI) has non-comparable results due to its merger with associate banks. Around 10 per cent of the consolidated loan book consists of bad loans. It’s apparent that SBI will take a while to absorb the impact of the mergers.  

Energy is another volatile sector due to a constant shift in global prices. India has been lucky since crude oil prices have been low since late 2014 and that has enabled the government to raise duties without raising retail prices. But, the last year wasn’t great. Bharat Petroleum, Indian Oil and Oil and Natural Gas Corporation have seen reduced profits, while Coal India’s profit fell on flat revenue. GAIL India, a gas transporter-marketer, has seen reduced profits. Down the chain, utilities like NTPC and Tata Power have seen improvement in net profits, while Power Grid has seen double-digit growth in both revenue and net. 

Health care has taken a hammering, with only Cipla producing decent results out of the Nifty set of five companies. The US continues to be a tough market with stringent FDA inspections. India’s attempts to widen the drug pricing mechanism will hurt domestic profits. 

Information technology, another major export industry, has struggled with no company producing double-digit gains in either revenues or net profits. The telecom industry representative in the Nifty, Bharti Airtel, has struggled with a lower revenue and lower profits due to the advent of Reliance Industries’ subsidiary, Jio. Bharti Infratel saw a marginal rise in revenue and falling net profits. 

Reliance Industries (RIL) is also a special case due to Jio. The refining business delivered excellent results. Gross refining margins (GRM) are high because crude oil prices are low and it has a premium over the benchmark Singapore GRM. But, it has also sunk over Rs 2 lakh crore into telecom, and it’s unclear what the returns on that investment will be, and in what timeframe.

There have been reasonable results in the metals and cement sectors. Apart from Tata Steel, Steel Authority of India (not part of the Nifty), some other steel companies have seen a revival on the back of protective import duties that have staved off competition. In turn, this might help banks recover stuck loans in this sector. Vedanta has also done better. Non-ferrous metal players like Hindalco have been helped by better global commodity prices. Cement companies (ACC, Ambuja) have seen double-digit revenue growth. Results have been mixed in the automobile sector. The two-wheeler players have not done well, except Eicher Motors. Maruti has seen significant volume expansion. The fast-moving consumer goods (FMCG) sector seems to be flat, going by the results of Hindustan Unilever and ITC. Perhaps FMCG has been hit by competition from the unlisted Patanjali. Industrials present a mixed picture. Larsen & Toubro (L&T) has seen a 10 per cent rise in revenues and 50 per cent rise in net profit. Adani Ports has seen revenues jump 60 per cent but profits are down. 

There isn’t one sector with a really standout performance. Metals and cement have acceptable results. Others have delivered so-so or poor results. The mismatch between valuations and fundamentals is startling.  

The index is trading at a weighted price-to-earnings of 25.5. Excluding financials, ACC, Vedanta, Tata Motors, L&T, RIL and Tata Power have delivered earning per share growth rates that exceed 26 per cent. If these results are replicated across sectors in smaller firms, valuations are already well into a bubble territory.