Covid-19 Impact on India: Equity Valuations Reasonable; Supply Chain Disruption Expected

03 MARCH 2020

In line with major global indices, Indian equity markets lost ~7% in the past week following FII sell-off on reports of rapid spread of Covid-19 virus outside of China. Total portfolio outflow of over USD 2.5bn from both debt and equity markets in the last week has reversed much of the ~USD 3.3bn inflow seen in the early part of the year till mid-Feb 2020.

While the virus outbreak significantly limits visibility into future market trends, Citi analysts believe that from a valuations perspective, equities present an improved risk/reward scenario post the recent correction. Citi analysts lower their December 2020 Nifty target to 12,200 (from 12,700 earlier) implying a ~9% upside from current levels. They lower their 1yr-forward P/E multiple target to 15.5x (from 16x earlier) to account for elevated uncertainties in addition to risk of earnings downgrades. Widespread panic and a sharp pickup in infection incidences in India may pose further downside risks.

Absolute Nifty valuations have now eased to 16x 1yr-forward P/E multiple (a post-demonetization low), from >18x earlier, trending closer to the long-term average of 15x. Citi analysts also believe that in relative terms, Indian equity markets seem reasonably priced when compared to other Emerging Markets. Earnings Yield Gap (10yr bond yields - Earnings/Price) has now fallen 1sd below mean, suggesting upsides in equities.

Source: Bloomberg, Citi Research Note: Bond Yield Gap = 10yr GSec – 1yr fwd. E/P

Assuming containment restrictions persist in China through the end of March 2020, Citi analysts expect supply-chain disruptions to affect Auto, Industrials, Electronic goods and Pharma companies. With the contagion spreading outside China, export businesses (Gems & Jewelry, Textiles) may see further slowdown. IT companies may also see an impact in certain market segments. Online travel agencies and Airlines may see pressure on the topline as well.

While India’s economy remains predominantly driven by domestic consumption, it remains vulnerable to a global slowdown through possible capital outflows and heightened trade uncertainty. Citi analysts estimate a 20-30 bps downside risk to their FY21 GDP growth estimate of 5.9% YoY in case of a rise in reported cases in India, or a delay in containment of the global spread of Covid-19. Citi analysts have lowered their Global GDP growth expectations by 20bps to 2.5% YoY for CY 2020.

Further spread of Covid-19, preventive measures taken by administrations and Central Bank actions to support markets will remain key to watch out for, as per Citi analysts.

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