Strategy: First macro, then politics, now earnings - Kotak

First macro, then politics, now earnings. Macro and political uncertainty remains high and earnings uncertainty has also increased of late following the recent negative events in (1) global trade and (2) Indian banking system. Broad market valuations represent a mishmash of (1) 'high' valuations of private banks and consumer stocks and (2) 'low' valuations elsewhere broadly, reflecting high general uncertainty. The valuation 'gap' is quite high between 'growth' and 'value' parts of the market.

Large gap between 'growth' and 'value' parts of the market

The market's overall valuation is still on the higher side despite the recent correction, held up by (1) high valuations of the 'growth' stocks and newly discovered 'value' in IT stocks. The major market indices have held up much better than most sectors, which mask deeper corrections in stocks. Valuations of the 'value' part of the market have become even more 'inexpensive' although the earnings uncertainty has also increased for the stocks given recent developments. However, we would clarify that 'growth' and 'value' are merely epithets and one should look at the value in a stock relative to the price of the stock.

There is value nowhere or somewhere depending on how things pan out

If (1) domestic and global macro factors were to improve over the next few months and (2) the Indian banking system were to see positive events (no fresh disclosure on frauds, successful resolutions of NCLT1 cases by end-April 2018), we could see some normalization in valuations of the so-called 'value' stocks ('corporate' banks, metals, gas and power utilities). On the other hand, if macro factors were to worsen further, high P/E or P/B 'growth' stocks may also correct. Their high valuations are unlikely to sustain in a scenario of higher domestic and global bond yields and increased earnings (weaker economic growth), macro and political uncertainty.

More value in 'value' stocks after recent correction

The steep correction in the so-called 'value' stocks in the banking and metal stocks over the past two months reflects the market's concerns about the impact of the recent developments on their earnings-(1) imposition of high import duty in the US on aluminum and steel imports, leading to further escalation in trade conflicts and (2) higher provisions in case of the banking sector after the RBI's directive to effectively remove all forms of dispensations for resolving bad loans other than the IBC/NCLT process. Several banks are trading at 'low' P/B, adjusted for the value of their non-bank businesses and metal stocks are discounting much lower prices and profitability (EBITDA/ton) versus implied by spot prices.

FY2019 earnings see some cuts; likely to be cut further

We have seen modest cuts in our FY2019 earnings estimates over the past week to factor in (1) higher provisions for banks and (2) lower revenues for telecom companies (including RIL's telecom business). However, we do not rule out further cuts as banks will likely accelerate provisioning in 4QFY18 and 1HFY19. The breakdown of the net profits and incremental net profits of the Nifty-50 Index and KIE universe coverage by sectors.

Model Portfolio

Revised Model Portfolio: We remove ITC (300 bps earlier) from the Model Portfolio and replace it with Dabur (200 bps) and add LICHF (200 bps) following its sharp correction over the past 12 months. We reduce 100 bps from TTMT.

Also, we now adjust the weights of stocks in the Model Portfolio on a 'dynamic' basis to reflect the changes in stock prices unlike earlier when we used to keep the weights of the recommended stocks constant (unless we changed the weights actively). This will better capture the 'NAV' performance of the portfolio, not that there is much to capture these days.

Source : Equity Bulls

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