No de-rating for India in FY12, as markets have factored in weakness in Q1, Q2 earnings.
Last week may have closed on a positive note due to positive global cues. The Nifty ended the week with gains of about 1.67 per cent, on positive earnings reports. While policy makers seem to be making the right noises in the US and Europe, sovereign risks remain. With Moody's Investors Service cutting its ratings on Greece's foreign and local currency bond ratings by three notches on Monday, the spectre of sovereign defaults remains.
According to global equity market strategists at Citi, economic prospects for many advanced economies are worsening, with soft second quarter (calendar year) data, worsening prospects for third quarter, heavy fiscal drag and heightened sovereign risk premia in some countries, plus widespread and escalating fiscal uncertainties that deter risk-taking and investment.
When viewed in light of global macro-economic risks, India looks relatively better placed even though equity markets underperformed other emerging and developed markets in the last one week. According to Macquarie Equities Research, the weakness in the Indian market was primarily due to the ongoing earnings season, which has been on the weaker side so far.
Undoubtedly, some sectors may have disappointed on the earnings front in the first quarter as is reflected in macro-economic data as well. The weak June PMI, subdued auto sales and moderating credit demand only highlight the soft patch in the economy. However, none of this calls for a de-rating yet, believe analysts. Current trends appear to be more reflective of a soft patch, as incremental policy momentum has been positive believe most analysts. In addition to fuel price rises, progress on resolving environment-related issues has increased. This bodes well for a moderate pick-up towards the latter half of the financial year. According to Citi’s India economist Rohini Malkani, FY12 will be a year of two halves, with first half GDP in the 7.5-7.8 per cent year-on-year range and second half GDP at 8.2-8.5 per cent.
If the Q3 and Q4 numbers disappoint, then valuations could come under stress. Despite India’s macro-economic challenges (high inflation, rising rates, slowing growth and widening fiscal deficit) high equity market valuations can be justified by a likely mix of high ROEs, sustainable growth rates and robust domestic demand. Going forward, companies are expected to turn FCF positive and businesses will de-leverge. The biggest naysayers (read foreign institutional investors) have now shifted the derating debate to FY13 now. Given that corporate earnings this year are expected to stay on course, despite macro challenges, the de-rating/premium contraction risk lies beyond the current year, says one report.
