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Time to sit back and... - Views on News from Equitymaster
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  • Dec 24, 2003

    Time to sit back and...

    Indian equities are on a roll with the indices having gained approximately 65% in 2003 so far. The number become far more impressive if one considers the recovery in the indices from their lows in April this year, which is at over 90%! But then, the then prevailing valuations of the Indian stock markets distinctly suggested that a re-rating of the Indian stock markets was imminent. Valuations of about 11x-12x earnings in early 2003 was clearly out of sync with the past track record of India Inc. and the future prospects of the Indian economy. Just to put things in perspective, over the 7 years until FY03, the bottomline of the BSE-Sensex companies grew at a CAGR of 17%!

    Source: Statistical Outline of India 2002-03
    Note: December 2002 onwards, P/E is derived

    Year 2003 is coming to an end and the current valuation of the Indian stock markets is at about 17x its trailing twelve months earnings. Further, according to various estimates, forward earnings of the index companies are likely to bring down the P/E multiple, back in the region of about 14x-15x. However, this is on the assumption that the earnings will continue to register respectable growth going forward into the next financial year.

    This is based on the fact that the economy is improving, thanks to the normal and evenly spread monsoons this year. Further, it seems that much of the impact of good monsoons has already been factored into the stock prices of various sectors and stocks, which are likely to see the benefits of good monsoons flow into them with a lag effect of 6 months to 1 year. However, just a quarter away from hereon, and we will be back into the period wherein speculation about monsoons will start to surface. And god forbid, just in case if the monsoons fail to oblige India, India Inc. could once again be facing tough times.

    Further, another factor that could have a serious impact on the 'E' of the P/E is the rising commodity prices, which seem to be showing no signs of subsiding yet. On the back of the huge consumption by China, many commodities are already currently trading at their multi-year highs. Commodities like coal, steel, sponge iron, copper, nickel, zinc, iron, alumina, pulp, crude oil, etc. have all gained substantial ground, some to the extent of 80%-90% over the prices prevailing last year. This rise in commodity prices could play a significant role in deciding the growth in fortunes of many sectors dependant on these commodities.

    This is because, since many of the above commodities form the raw material in the production of other metals, it could create a dent in the operating margins of the user industries. For e.g. rise in prices of sponge iron could affect its user industry, steel, which could in turn affect the costing of automobiles, which have about a 15%-20% steel component in the final product. Similarly, coal, whose prices have surged by more than 25% in the current year, is a negative for its user industry, cement. It must be noted that while much of the raw materials purchasing is done at pre-determined semi-annual and annual contract prices, the spot purchases and re-negotiations of future contracts could lead to an upward revision in prices while buying the raw materials. While India Inc. has continued on its drive to improve efficiencies and rationalize costs, this exercise, which is being carried out since the last 2-3 years, will tend to lose its YoY effect. Till there is clarity as to whether the rise in raw material prices can be passed on to the consumers, this issue remains a cause of concern.

    To conclude, while we are certain that India Inc. (on a broader scale) will continue to perform well in the medium to long-term, it is time to sit back and re-look at stock specific fundamentals and valuations, especially which have outperformed the benchmark indices by huge margins and make sure if their current valuations justify their growth prospects.



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