4QFY17 results: Different sectors, different reactions

We note that the market's reaction to 4QFY17 results has been quite varied depending on the sector. 'Favored' sectors among banks and cement have been rewarded handsomely for low-quality and modest 'beats' or even in-line results while 'unloved' sectors such as IT have been punished (other factors such as stronger INR and visa issues have also contributed to the sour mood in this sector). We use the 'divergence' point to highlight two points-(1) valuations have perhaps stopped mattering given the 'linear' extrapolation of incremental news and (2) investors are actively rewarding or punishing stocks despite the oft-repeated argument of 'liquidity' driving the market and stocks.

The bogus argument of 'liquidity'; see our April 12, 2017 note for more details

We are a bit perplexed by the refrain among investors of "too much liquidity in the market". If investors are making 'active' decisions, they should also be deciding the fair value of stocks based on fundamental factors and not on 'liquidity' (whatever that means). A key question to ask is whether 'liquidity' changes the fundamental value of a stock through changes to earnings or cost of equity. Clearly, earnings are not going to change despite our best wishes, which would suggest that the market ascribes a lower cost of equity (expected returns) on higher 'liquidity' alone. The latter does not hold in the context of higher domestic yields and unchanged risks. It seems to us that 'more' money reduces 'vigilance' among investors.

Meanwhile earnings cuts continue; more to come

We have reduced our earnings estimates in a few sectors to factor in (1) a stronger INR and (2) weaker volume/realization assumptions. We expect further downgrades due to these factors. We model FY2018E net profits of the Nifty-50 Index to grow 17%, largely driven by our assumptions of (1) recovery in commodity prices and (2) lower loan-loss provisions in the banking sector. Both these assumptions are at risk based on current trends. We expect higher NPLs/provisions in FY2017 (not yet factored in our estimates) due to the recent RBI regulations on NPL recognition, which would also affect FY2018 LLP numbers.

Guess the stock!

We use the example below to illustrate the principle of "when bad news is no news, no news is good news and good news is great news" for certain stocks and sectors. This stock has reported FY2017 EPS at Rs96 versus our estimates of Rs130 at the same time last year (4QFY16 results). The stock price has meanwhile gone up to around Rs4,250 from around Rs3,200 in late April 2016. Our FY2018E EPS now stands at Rs126. The stock trades at 3.2X F2020E BV on our expected RoAE of 15.3% after a doubling of net profits over FY2017-20E.

Changes to Model Portfolio

We add M&M (200 bps) to our large-cap. Model Portfolio as a play on recovery in the rural economy. We expect the government to increase rural spending over the next two years in line with its objective of boosting rural farm incomes. Our concerns about M&M's faltering UV business had restrained us earlier from taking a positive view on the stock but we note that the UV business accounts for only 20% of M&M's standalone EBITDA currently. The tractor business accounts for the balance and we expect tractor volumes to grow at 8% each in FY2018 and FY2019. This could be conservative if the government increases rural spending aggressively. Our 12-month SoTP-based fair valuation (FY2019E basis) is Rs1,400.

We cut 200 bps in Infosys to 700 bps. We have no 'exposure' to other Tier-1 IT companies.

Source : Equity Bulls

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