We make a few changes to our recommended large-cap. Model Portfolio given the dramatic changes in stock prices over the past 2-3 months led by a combination of (1) sharp depreciation in the Indian currency and (2) positive sector- and company-specific developments. Despite the bottom-up positive developments, the top-down market view remains cautious given continued high global (politics, trade) and domestic macro (oil, politics) challenges and expensive valuations.
Global and domestic macro offer little respite
Any deterioration in global challenges led by escalation in China-US trade issues and higher global oil prices due to imposition of hard sanctions against Iran oil exports will put further pressure on India’s macro. Both China and the US have threatened to impose tariffs on another $200b of mutual imports by end-September and the US will impose sanctions against Iran oil exports (2.1m b/d in August 2018) from November 5, 2018. From India’s perspective, the former will hit EM sentiment further (whatever little is left) while the latter will affect India harder given oil’s large influence on its CAD/BoP/currency, inflation/interest rates and fiscal deficit/bond yields.
India’s economy is vulnerable to oil supply ‘shock’ but less to ongoing EM ructions
India’s macro position would worsen if oil prices were to shoot above $80/bbl. We note that a $10/bbl change in crude oil prices results in (1) 50 bps impact on CAD/GDP; we model 2.8 per cent CAD/GFD at $72.5/bbl Dated Brent crude price; (2) 30 bps impact on inflation; we model 4.4 per cent average CPI inflation for FY2019; and (3) modest impact on GFD through higher subsidies on kerosene and LPG; we model gross under-recoveries at Rs 460b versus the government’s provision of Rs 265b; GFD could rise if the government was to reduce taxes on diesel and gasoline in order to mitigate the impact of higher oil prices.
Rupee probably fairly valued based on current macro but macro itself is at risk
The recent rapid decline in the rupeehas probably brought it to around its fair value on REER basis. Of course, the rupee can overshoot its fair value on sentiment or weaken further on further deterioration in India’s macro due to higher oil prices.
We would not overly worry about the recent decline in the rupee—it was overdue. The rupee has a history of long periods of overvaluation (thanks to ‘flows’ and sentiment) and short periods of sharp corrections at times of global crises, which swiftly bring the rupee to its true level.
We note that the rupee has depreciated about 35 per cent over the past 10 years or 3 per cent per annum.
This is pretty much in line with the trajectory suggested by interest rate/inflation differentials between India and its trading partners. It is just that the downward ride has been quite erratic.
Expensive top-down market valuations, macro and political uncertainty
We note that top-down market valuations are quite expensive versus historical levels, bond yields and our bottom-up fair valuations of stocks.
In addition, the market has to contend with macro (oil) and political (three crucial state elections by December 2018 and national elections by May 2019) uncertainty over the next few months.
Bottom-up earnings recovery and sector- and company-specific developments can offset some of the risks but only to a limited extent.
Changes to Model Portfolio
We include NTPC (200 bps) at the expense of Dabur. Dabur stock has run quite sharply over the past few months (40 per cent + over the past six months) and trades at an expensive 50X FY2019E EPS and 44X FY2020E EPS. NTPC trades at ex-growth valuations (11.3X FY2019E EPS and 10.8X FY2020E EPS), largely reflecting the market’s concerns about regulatory changes, which could lead to lower regulated returns (RoE on regulated equity base). We note that curre t high government bond yields may preclude a sharp cut in regulated returns.
Also, we note that NTPC could be a potential beneficiary of the ongoing fire sale in the Indian power generation sector. NTPC has so far been a silent spectator in the resolutions (a few have taken place) and sale of power assets.
It may not have wanted to enter intobilateral arrangements with banks or acquire coal-based thermal plants of private companies given the potential risks of government enquiry into purchase price of assets acquired by it from private sector companies. However, NTPC can pick and choose assets as and when some of the 34 stressed power plants come before the NCLT. It seems that most will head to the NCLT shortly. We also reduce weight in RIL stock (100 bps cut to 610 bps) and allocate the same to SBI (100 bps increase to 560 bps).
— Kotak Institutional Equities