Most consumer-facing firms see their valuations falter, when tested at all levels: absolute, relative to history, and relative to global peers. The first two are quite obvious, but the third is a major surprise, said Kotak Institutional Equities' Sanjeev Prasad, in his usual scathing fashion. "The market has continued to pay high multiples for stocks for a while, hoping for a turnaround. Hope alone cannot sustain valuations forever."
The brokerage said it has 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 likely ‘low’ absolute growth in earnings in the future, far lower near- and medium-term earnings growth in the future versus in the 2010s decade.
Further, the multiples are higher or similar to pre-pandemic levels despite far lower near-term and medium-term growth. While also likely to see similar near-term earnings growth, domestic consumption firms have a large valuation premium to their global peers.
In the note, Kotak added that domestic consumption companies have seen lower growth in earnings compared with their global peers over the past few years in several product categories, despite the usual arguments of India’s favorable demographics and low penetration and usage.
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"In fact, consensus estimates show similar-to-lower growth for Indian companies relative to their global counterparts in several categories in the near term," said the note.
Therefore, the current valuations do not make much sense to the brokerage, which indicates that the market clearly expects a strong recovery in the earnings of companies over the medium term. "In our view, the absolute multiples of consumer stocks based on any sensible DCF framework will be far lower than their current multiples."
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, added Kotak.
In the brokerage's view, the multiples of consumer companies should be lower than historical levels, given much lower revenue and earnings growth in the future versus historical levels and higher cost of equity due to higher disruption risks in the future from more aggressive competition and market
fragmentation.
The report said, "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."
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