India Strategy : A few years is long enough by Kotak Institutional Equities
The valuations of most consumer-facing companies fail all major valuation tests—(1) absolute, (2) relative to history and (3) relative to global peers. The first two are quite obvious, but the third is a major surprise. The market has continued to pay high multiples for stocks for a while, hoping for a turnaround. Hope alone cannot sustain valuations forever.
Valuations fail all tests
We have long struggled with the valuations of consumer companies in India, both discretionary and staples. The multiples of stocks make little sense in the context of (1) likely ‘low’ absolute growth in earnings in the future, (2) far lower near- and medium-term earnings growth in the future versus in the 2010s decade; multiples are higher or similar to pre-pandemic levels despite far lower near-term and medium-term growth and (3) similar near-term earnings growth, but large valuation premium to their global peers.
Absolute valuations do not make much sense
In our view, the absolute multiples of consumer stocks based on any sensible DCF framework will be far lower than their current multiples. The market clearly expects a strong recovery in the earnings of companies over the medium term. However, the ongoing dilution of brand and distribution moats does not provide much ground for such optimism. It is obvious that multiples should be far lower in the context of anemic near-term growth, especially if near-term historical growth rates were to persist in the medium term as well.
Relative valuations versus history makes little sense either
In our view, the multiples of consumer companies should be lower than historical levels, given (1) much lower revenue and earnings growth in the future versus historical levels and (2) higher cost of equity due to higher disruption risks in the future from more aggressive competition and market fragmentation. We would note that multiples have stayed at pre-pandemic levels, even as growth has collapsed across categories and companies. In our view, multiples need to be aligned to the new reality of lower growth, likely lower profitability and higher risks.
Relative valuations versus global peers are quite stark
We note that the valuations of Indian companies are far higher than those of their global peers, despite (1) likely similar growth in earnings in the near term in many cases, (2) similar earnings growth in the past five years in most categories and (3) lower-to-similar growth in several discretionary categories in the past decade; in other categories, Indian companies delivered higher growth.
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