Valuations concerns real? UBS downgrades India rating in just three months

A sharp rise in valuations has limited the risk-to-reward gains from the current levels

With earnings belying the rising valuations and the benchmark indices Sensex and Nifty logging a series of fresh highs in the last two months, UBS has flagged concerns and cut its rating on India to ‘neutral’ from ‘overweight.   

It cited a sharp rise in valuations which has limited the risk-to-reward gains from the current levels.

Risk-to-reward ratio is a multiple which compares the possible returns of an investment against the amount of risk undertaken to capture these returns.

The downgrade came after the global investment bank in February upgraded India’s rating to Overweight with the demonetisation fears beginning to recede, and earnings estimates appearing to hit the bottom. 

“The downgrade is more reflective of India’s valuation relative to the region. In emerging markets, we are seen positive earnings momentum, but in India, we are still seeing earnings cut,” Gautam Chhaochharia, Head of India Research, UBS said in an interview with CNBC-TV18. CLICK HERE FOR THE FULL REPORT 

“We still haven’t changed our Nifty target. Out base case still remains at 8,800 while our upside case is 9,700 which in absolute terms means that we don’t see any more upside in markets for current levels,” he added.

Meanwhile, in a separate report UBS Securities India also sounded caution on the valuations of small and midcap companies, saying the valuation gap between small, midcaps and large caps is still high despite a recent correction in former over the past month. The gap has continued to increase based on hopes of growth acceleration and continued inflow from domestic mutual funds, it added. 

"Over the past few months, we have downgraded some ratings, as we didn't find comfort at their valuations, despite being positive on their business models and long-term growth outlook. We maintain our top-down strategic view that a growth recovery will be gradual and disappoint the Street," said UBS in a report dated June 8.

For the near term, the brokerage has advocated a bottom-up approach in the small and midcap space. 

Meanwhile, the S&P BSE Midcap and the S&P BSE Smallcap indices are trading at a current price-earnings (PE) valuation of 31.53 and 72.23, respectively, 

For the Sensex and Nifty, the trailing PE multiple stood at 22.62 and 24.43, respectively.