BNP Paribas sees value in Indian stocks even as indices hit new highs

Predicts Sensex will hit 37,500 by 2018-end, as gains from reforms in past 18 months are likely to start flowing in

By at least one measure, Indian equities look attractive relative to their regional peers even after posting new records in the new year.

That’s the view of BNP Paribas, which forecasts the benchmark S&P BSE Sensex to post its third annual gain in 2018, helped by a revival in company earnings and economic growth.

The euphoria in equity markets worldwide has left the Sensex trading at 3.2 times book value, not cheap in absolute terms. But with the MSCI Asia Pacific Index trading at 1.73 times -- the highest level since 2008 -- the gap between the two gauges’ ratio is the narrowest in about a year.

“India has traditionally traded at a premium to Asian peers because of a better return-on-equity profile, but the price-to-book premium that India enjoyed has narrowed,” Abhiram Eleswarapu, head of India equity research for BNP Paribas, said in an interview in Mumbai. “It’s difficult to make a statement that India is expensive to its Asian peers.”

The Sensex will likely end the year at 37,500, up 7.6 percent from Monday’s close, he said. The index rallied 28 percent in 2017 in one of Asia’s best performance as a slew of economic reforms including implementing a nationwide sales tax and a funding plan for state lenders prompted Moody’s Investors Service to boost the nation’s rating to the highest since 1988.

If stocks maintain the upward trajectory, it won’t be a “smooth line of returns,” Eleswarapu said. There’ll be “a few shallow corrections, with the year likely to end with positive returns,” he said, maintaining an overweight stance on the nation’s market.

Earnings of companies in the MSCI India Index may rise by 15 to 20 percent in the financial year starting April 1, as businesses have recovered from the disruption caused by the new sales tax implemented in July, he said. BNP expects a profit growth of just under 10 percent in the current fiscal year.

Here are some highlights from Eleswarapu’s interview:

What is your view on 3Q earnings?

This quarter is important from the perspective of earnings estimate changes. A better-than-expected second quarter slowed down the pace of downgrades. And the October-December results will set the path ahead.

If we take a two-year CAGR into consideration, we are likely to see an improvement, for instance in the consumer sector, both discretionary and staples. Financial services will show better numbers than last year.

In the past year, we have seen significant improvement in the growth outlook across most developed and emerging markets. India hasn’t participated in it due to transient factors like demonetization and GST. It is reasonable to assume that there will be some growth catch up.

Are expensive stock valuations a big concern?

The disconnect between earnings and valuations is probably because investors are looking a year or two ahead. We’ll see this big divergence narrowing over the next couple of years. 

In the past 18 months, we have seen intense policy reform action and the benefits of these measures tend to come with a lag, after probably an immediate adverse reaction. Most investors looking at India understand this.

NOTE: The Sensex trades at 18.8 times blended forward 12-month earnings, near the highest in a decade.

Which sectors do you prefer?

The sector that is healthy and growing is consumer discretionary. This includes segments like automobiles and jewelry. 

Financials, more on the private side but also selective public sector banks. The government’s recapitalization plan should help them to resume lending and regain some market share.

What are the key risks facing Indian markets?

Consensus estimates are calling for a 20 percent growth in FY19 and much higher in FY20. We can have a risky situation if for some reason the numbers are not delivered. 

Inflation is also one aspect to worry about.

Rural economy’s performance so far hasn’t been convincing and we haven’t seen the sort of pick-up in spending despite good consecutive monsoons.”

What’s your outlook on overseas inflows?

Flows into EMs will remain positive as long as global central bank balance sheets are expanding, which is happening despite announcements from the Fed and the ECB. Also, flows into EMs come with a lag of a few quarters to this expansion. We expect FII flows to be positive until the second half of this year.