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All is well (just don’t look at earnings and valuations)

The Indian market may see a modest rally on de-escalation of the conflict between India and Pakistan over the weekend. We note that the market has gone up in the past few weeks, with the market looking through (1) near-term escalation in tensions and (2) US trade issues. 4QFY25 earnings have been muted, while valuations of most sectors and stocks continue to be rich.

Indian markets were resolute over the past one month

Indian markets have delivered a strong performance over the past one month, despite elevated global and local uncertainty (see Exhibits 1-2). The strong market performance suggests that markets were pricing in (1) the rapid resolution of ongoing trade and tariff issues with the US and (2) geopolitical risks being under control. In this context, the de-escalation of the conflict between India and Pakistan may provide a limited boost to investor sentiment, with the risk-reward being precariously balanced between (1) an improving macro, (2) a weak earnings growth outlook, (3) further earnings downgrades and (4) elevated valuations. 

FPI inflows driven by active flows, while SIP flows buffered MF inflows

The sharp increase in FPI inflows in recent weeks reflects positive sentiment for India among active and passive investors (see Exhibits 3-4). We attribute the sharp change in FPI positioning to (1) a 2.5% depreciation in DXY over the past one month and (2) high conviction among investors of India being a relatively ‘better’ market, in light of global growth challenges. Meanwhile, April mutual fund data suggests further weakening of retail inflows into mutual funds, as the trailing 12-month returns turned weaker, with gross SIP inflows providing a buffer to the weakening flows (see Exhibits 5-6).

4QFY25 earnings season has been broadly muted

We note that the 4QFY25 earnings season has been broadly muted, with (1) Nifty-50 earnings growing 4.8% yoy, (2) KIE coverage earnings growing 8.2% yoy and (3) bulk of the earnings’ outperformance being driven by banks and downstream oil marketing companies (see Exhibits 7-8). Most sectors saw a varying mix of growth and profitability challenges, with (1) consumer companies reporting weak volume growth, margin headwinds and muted demand commentary, (2) investment companies reporting margin challenges, (3) banks reporting weak credit growth and (4) IT services companies indicating weak demand (see Exhibits 9-15).

Valuations remain elevated, despite headwinds to earnings

We note that KIE’s projections of FY2026E/27E net profits of the Nifty-50 Index have seen 6%/5% cuts CYTD24, with larger cuts in consensus estimates (see Exhibits 16-19). Meanwhile, most sectors are trading at lofty valuations, with even banks and telecoms trading near full valuations (see Exhibits 20-25), which could lead to a possible derating in multiples across sectors in the case of further earnings disappointments. Valuations of the Nifty-50 Index appear high, while those of mid- and small caps remain uncomfortable (see Exhibits 26-28).

Model portfolio changes

We increase weight on INDIGO by 100 bps (to 250 bps) and on PIDI by 40 bps (to 190 bps)—see Exhibit 29. Both are dominant players in their respective categories and have a long runway of growth. Additionally, both have several specific but similar near-term tailwinds—(1) reasonable demand relative to most other consumer categories, (2) low RM prices (ATF in the case of INDIGO and crude oil derivatives in the case of PIDI), (3) strong pricing power, given the nature of the industries they operate in, weak competitors in the case of INDIGO or distracted competitors (due to challenges in their core portfolios) in the case of PIDI and (4) a potentially stronger INR.

We remove DABUR (140 bps earlier) from the model portfolio. DABUR has struggled to execute well for the past few quarters and has been unable to turn around its performance despite (1) improving rural demand and (2) its strong rural presence and product portfolio with a large rural salience.

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