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Sensex, Nifty overvalued by around 10%, says Kotak’s Sanjeev Prasad

LiveMint logoLiveMint 20-08-2017 Ami Shah

Mumbai: The Indian market is overvalued by around 10% as far as benchmark indices such as Sensex and Nifty are concerned, while some segments are highly overvalued, said Sanjeev Prasad, senior executive director and co-head of Kotak Institutional Equities.

“In pockets such as consumer staples and discretionary stocks, the overvaluation is in the range of 15-25%,” Prasad said in a phone interview from Singapore on Friday.

“This does not mean that the market will correct to that extent, unless some big negative global event happens,” he added.

Benchmark equity index Sensex touched a record 32,686.48 points on 2 August, and is down 3.55% since then.

It now trades at 20.42 times one-year forward earnings, compared with five-year and 10-year average of 16.52 and 16.36 times. Responding to a question, Prasad said that some parts of the market were in a bubble territory, but not the entire market. 

“Consumer-related sectors such as consumer staples and discretionary sectors—this is where valuations are super-rich,” said Prasad.

He said many of the consumer discretionary companies have weaker business models than what the market believes and their valuations suggest.

“They don’t have any great ‘moats’ in the form of brand or technology. Their business models will be significantly challenged by several long-term developments in the economy including formalization of the economy and disruption to traditional distribution channels,” he added.

Apart from unforeseen geo-political events, lack of earnings growth poses the biggest risk to Indian markets, Prasad said. 

“Investors have been rather kind in ignoring weak earnings growth for the past three years. I wonder how long it will continue,” he said.

Consensus earnings per share (EPS) estimates for Sensex and Nifty have fallen to Rs1,545.17 and Rs498.09 for the fiscal year 2018, and to Rs1,920 and Rs613.26 for fiscal year 2019, the lowest since 1 April, Bloomberg data showed.

“(June quarter) earnings were bad, and the underlying situation has not changed for many sectors,” said Prasad, pointing to the pricing pressure and revenue disappointments in export sectors such as IT and pharma, and the impact of destocking ahead of the implementation of Goods and Services Tax (GST).

“But, I think this is all only masking the underlying weakness in the economy. It is not as if we were seeing inherently strong demand, through strong economic growth, job creation, etc,” said Prasad.

“Also, private sector investment is not taking place. I doubt this is going to change in a big hurry as underlying demand conditions continue to be fairly subdued,” he said.

Corporate earnings were expected to look up in the fiscal year 2017, on the back of good monsoon after two straight years of drought and implementation of the recommendations of the seventh pay commission, which would leave more money in the hands of consumers.

However, the consumption story took a back seat following the government’s surprise move to demonetize high-value notes in November.

Also, GST, touted as the biggest tax reform since independence, was implemented this July, and is also expected to be disruptive to economic growth in the near term, as businesses adjust with the new tax regime.

The pain is not yet over, and earnings downgrades are expected to continue.

“Earnings downgrades from here should be highest in domestic sectors, such as autos, consumer durables, building components, cement and industrials where margins or profitability are very high; in fact, at historically high levels,” said Prasad.

“ If volumes disappoint due to weak domestic earnings recovery, we could see pressure on margins too,” he added.

According to Prasad, all global equity markets will correct if things worsen on the geo-political front as valuations are rich everywhere and implied equity risk premium is quite low. 

“Risk premium could rise on the back of any negative geo-political development,” he added.

He said India is performing along with most other world markets—both developed markets and emerging markets, for at least a year now, and sentiment has been supported by low interest rates globally given the low inflation, despite modest economic recovery and improving labour markets in developed economies. 

“Also, there is dollar weakness since the beginning of CY17, which prompts investors to look at more riskier asset classes including emerging market equities,” he said.

“So, if a correction does happen, it is likely to be a global one,” Prasad added.

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