India holds a good hand in game of Trumps

The underlying Indian equity market may have underperformed during the first quarter, but if foreign fund flows are any guide, then the second quarter is looking strong say Indian specialists.

The believe the equities market has reached a pivot point, whereby underlying economic strength and global trade concerns will increasingly play in India’s favour after a first quarter marred by volatility and continuing EPS downgrades.

On the plus side, India was on the receiving end of strong net foreign portfolio inflows amounting to $2.25 billion during the first quarter. Only Malaysia also recorded positive inflows across the rest of Emerging Asia (ex-China.).

As Jon Thorn, co-founder of India Capital, told FinanceAsia: “Money is flowing back into India because investors are worried they’ll miss the next leg up. If global growth slows as trade wars pick up, India will be a net beneficiary because it’s an inwardly focused economy.

“The currency will rebound if oil prices fall,” he added.

This would mark a turnaround from the quarter’s negative data points including a fall in the currency, which dropped 2% against the dollar. The India MSCI Index was also Asia’s second worst performing country index after the Philippines, falling 6.2% in the year to end-March.

Strong primary markets

But the soft tone of the underlying equity market did not appear to crimp a strong three months for IPO and follow-on activity (see table 1).

India dominated Asia’s IPO league tables (ex-China, ex-Japan). It not only executed the two largest IPOs of the quarter (Bandhan Bank’s $686 million deal, plus Hindustan Aeronautics $635 million deal), but a total of seven of the region’s top 10 flotations by size.

The country also topped the league tables for secondary market issuance thanks to the Tata Group - a $1.96 billion rights offering by Tata Steel and a $1.38 billion divestment in Tata Consultancy Services (TCS) by Tata Sons.

Both deals are up from their ex-rights and execution price despite wider market volatility. In fact, Indian follow-ons have scored more hits than misses in the after-market, beating the rest of the region with the exception of China (ex-A shares).

Citi’s Indian ECM head, Arvind Vashistha says one reason is because, “all the deals met with good demand and had fair pricing.”

With the exception of TCS’s deal, which carried a 5.9% discount to close, most of the other larger Indian deals averaged 1% to 2%. Typical is the example of National Mineral Development Corp (NMDC), which raised $153.5 million at a1.2% discount to close in mid-January.

However, that deal is also the quarter’s worst performer among the bigger transactions. Since then, it has fallen nearly one-third below its execution price, partly because the government has begun auctioning off more mines.

Vashistha forecasts that, overall, second quarter issuance volumes may not be able to match the first given the size of the Tata deals. But he believes there should be a similar number of transactions and a balanced mix between sell-downs and companies raising new cash.

“Indian deals performed in line with the underlying market during the first quarter and that’s a very good sign for investor receptivity should market conditions stay settled,” he commented.

“There could be more volatility and that means we’re probably not going to see uninterrupted market access for the rest of this year,” he continued. “There’ll be plenty of windows, but activity may get bunched up in two quarters rather than spread out evenly over four.”

Whither consensus EPS estimates?

One key issue, which has been playing havoc with investors, is EPS consensus estimates.

As Credit Suisse highlights in a recent research report, “while there is always a risk that investors may want to hide in domestic markets like India given Trump’s tariffs and potential trade wars, we highlight the state of India’s consensus EPS.”

Indian companies are about to begin reporting their first quarter 2018 earnings and the Swiss bank points out that there have not only been four consecutive months of EPS downgrades, but also now four years of them too.

However, India Capital’s Thorn says the EPS figures have been all over the place for two very specific reasons, which are about to play themselves out.

“When the Indian government cancelled 85% of the currency through de-monetization in 2016, earnings forecasts entered a black hole,” he stated. “Then one year later there was another one-off historical event, GST, which made it almost impossible to predict revenues and profits once more.

“These were unique historical events, which we’ll never see the like of again,” he concluded.

Thorn argues that investors are acutely aware that the winners and losers from both are starting to become evident, providing outsized opportunities for investors which position themselves correctly.

Vashistha also agrees that valuations have become more appealing to buy and hold investors following the market’s recent correction. The MSCI country index is now trading around 17.2 times current year consensus earnings compared to a five-year average around the 16.6 level.

He also downplays fears about the impact of rising domestic treasury yields and the imposition of a long-term capital gains tax, which kicked in at the beginning of April.

“It’s been overblown,” he said. “The tax is net negative for holders, but given the strength of the economy and the growth it offers, the market can take this in its stride. On its own it’s not enough to cause a sell off.

“India is also far more resilient to rising US Treasury rates compared to other markets in the region,” he concluded. “Yields on 10-year bonds peaked at 7.75% in early March and have been falling since then.”