July 28, 2014

Back to the future: A Glimpse of India Inc. 2019

A conservatively optimistic saga of Indian markets

INDIAN INVESTOR
3.5x

SENSEX

86,000

NIFTY 50

26,000

INDIA FY19

Vikas Gupta

[email protected]

Kshitij Gupta

[email protected]

Viraj Vajratkar

[email protected]

The goal of the non-professional should

not be to pick winners neither he nor his
helpers can do that but should rather
be to own a cross-section of businesses that
in aggregate are bound to do well
-Warren Buffett
Source: 2013 Annual letter to Berkshire Hathaway shareholders

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Figure 1: Strong, yet conservative

fundamentals (CAGR FY 15-19)
40%
32%
24%
16%
8%
0%

35%

28%

27%
24%

20%

17%
19% 15%

30%

Book Equity
Best

Base

19%

23%

Earnings
Worst

17%

Sales
CAGR FY05-09

Source: Arthveda, Reuters

Figure 2: NIFTY50 price projections

Best 26,038
Base 17,320

27,000
22,500
18,000
13,500
9,000
4,500
0

2003
2005
2007
2009
2011
2013
2015
2017
2019

11,681
Worst

Figure 3: Sensex projections

1,00,000
80,000
60,000
40,000
20,000
0

Best 85,571
Base 56,921

2003
2005
2007
2009
2011
2013
2015
2017
2019

Worst

38,388

Source: Arthveda
Note: All charts are for Fiscal Years

Table 1: Market Returns

Returns
CAGR 15-19

Best

Base Worst

NIFTY TRI
(incl. divi.)

29.9% 20.0% 11.3%

NIFTY 50

28.0% 18.0% 9.0%

Sensex

27.1% 17.1% 8.3%

We estimate Nifty to reach 26,000 and Sensex 86,000 by FY19 in our best
scenario which is based on a rather conservative forecast of improvement
in fundamentals. Our best case projections for Nifty and Sensex imply
compounded per annum returns of 28% and 27% respectively from current
index levels. Scaling of the benchmark indices to new highs will be driven
primarily by improvement in fundamentals and to a very limited extent
by valuation re-rating. We forecast a 20% FY15-19 CAGR sales growth
resulting in a 24% CAGR profits growth in our base case scenario and a more
stellar 23% and 30% respectively for our best case. The two major pillars
of improving fundamentals are recovering EBIT margins and Asset turnover
which we believe should normalize to their historic levels. On the valuations
front, we expect a re-rating of 9-26% of the various valuation metrics (10-12%
in earnings based and nearly 20% in other multiples) in our best case (from
10-July levels).
Temporal similarity between FY05 and FY15: We find a strong parallel in
terms of qualitative socio-economic factors (change of government) Pent-up
demand in the last couple of years prior to FY05 had been released post
elections, resulting in strong real GDP growth of about 10% p.a. causing a
boost in top-line growth. We expect a similar situation for the current times
as well wherein the economy is likely to be bolstered by pent-up demand and
resultant revenue expansion.
Fundamentals improvement to be the main champion of returns: We
project 20% sales CAGR and 24% earnings CAGR over FY15-19 in our base
case.Our best case points toward a 23% sales CAGR and 30% earnings
CAGR. We believe that this is quite conservative when compared to the sales
and earning CAGR of 28% and 27% during FY05-09, respectively.
EBIT margin and Asset turnover to be the major pillars of improving
fundamentals: We expect the impetus from pro-business government policies
to translate to improving sales growth, higher capacity utilization and therefore
a higher asset turnover ratio. The current YTD asset turnover average of
only 73% is significantly below the FY05-09 average of 84%. On the back
of improving sales growth and impact of operating leverage, we expect EBIT
margins to expand by 40bps p.a. over the next 5 years which is conservative
vs the 60bps p.a. expansion during FY05-08 (excluding FY09 due to the US
crisis). Our optimistic projection factors a 75bps p.a. improvement in EBIT
margin to recover to FY05-09 average levels of 20%. Further, intrest rate
burden should also reduce going forward in light of cooling inflation.
Valuation re-rating to additionally bolster returns: Though absolute market
levels are breaching their previous highs every day, valuation metrics such
as P/E, P/BV, EV/Asset are below their top-quartiles. Valuations can attain
their previously established highs only if underlying fundamentals improve
spectacularly. Given that our best case for fundamental improvement is
conservative, a re-rating in multiples is possible. For our best case, we build in
a conservative multiple expansion to top-quartile levels, which are themselves
28-45% below their all-time highs.
NIFTY @ 26,000 & Sensex @ 86,000 by FY19: We expect market returns of
28% p.a. (as of 10-July) driven largely by improvement in fundamentals. For
instance, we expect EV/EBITDA multiple to grow at 9% p.a. and EBITDA to
grow by 20% p.a. for our best case.
Key risks to our views: Our thesis rests on the foundation of improving
fundamentals driven primarily by a recovery in the Asset turnover ratio and a
healthy improvement in EBIT margins. A recovery in these may not materialize
over the next 5 years if a) pent-up demand in the economy over the past
couple of years does not kick in resulting in depressed capacity utilization,
lower revenues (lower asset turnover) and lower EBIT margins and b) there
occurs a slowdown in the global economy and global external shocks which
may impact NIFTY 50 companies given their increasing global character and
global dependence.

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Table of Contents
Markets expensive as per headline index numbers but not valuations

A market proxy for the economy NIFTY 50 stocks

NIFTY 50 fundamentals drive expectations of an improving economy

Can history repeat itself?

Outlook on fundamentals for FY15-19

Valuations Outlook

The final confluence of fundamentals and valuations RETURNS!

10

How to ride the bull?

12

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Markets expensive as per headline index numbers but not valuations

India a star among the emerging nations: Modi-led euphoria has caused the Indian markets to run up significantly
in the recent past so much so that over the last few months India has been one of the best performing markets amongst
key emerging markets. MSCI India has over the last 3, 6 and 12 months in local currency beaten almost all MSCI
Emerging Markets indices.
Table 2: Strong performance of MSCI India vs other emerging markets indices (local currencies)
Prices as of 10th July 2014

3 month

6 month

12 month

Brazil

4.9%

7.9%

15.2%

China

0.3%

2.3%

15.4%

India

10.5%

18.5%

26.9%

Indonesia

9.0%

23.6%

18.9%

Malaysia

1.1%

2.5%

4.8%

Mexico

7.7%

2.7%

9.2%

Philippines

3.9%

19.0%

11.8%

Russia

9.0%

0.7%

10.7%

Taiwan

9.6%

16.8%

21.4%

Thailand

8.0%

17.8%

6.3%

Turkey

7.4%

17.3%

12.9%

#1

#3

#1

India Rank
Source: Arthveda, Reuters

Similarly, Nifty 50, the marquee index for domestic Indian investors has touched an intra-day high of 7,809 on 8-July
following Modis victory (16-May). Post 16-May, the day of election results, Indian markets have rallied 8% and 10% in
local currencies and USD respectively. Post April end, Indian markets have returned a spectacular 14% return. Nifty
50 TRI which includes the returns contributions of corporates actions such as dividends as well, has touched an even
higher level of 10,208 on 7-July.
Though the markets may be at all-time highs in terms of their absolute levels, we assert that the absolute levels are hardly
any measure of the true price of the markets. The true price should be gauged w.r.t the underlying fundamentals such
as earnings, assets, book value or dividends by using valuations metrics such as P/E, P/BV or EV/EBIT.
At the first glance, the table shown below indicates that current valuations are certainly expensive w.r.t to markets own
history. For example, earnings based multiples (P/E and EV/EBIT) are above their median values, though asset based
multiples (P/BV and EV/Assets) are roughly at par with median values. However, we would like to point that the current
valuations are not the peak of the valuations and that markets have traded at a premium of as high as 40-100% over and
above the current levels. However, we do not suggest that the markets are cheap because they have not yet reached
their all-time high valuations. On the contrary, we believe that markets can be cheap/expensive even at the peak/trough
of valuations and that they can move beyond their last recorded peak/troughs if the changes in fundamentals warrant
so. Therefore current valuations should be introspected in light of expected changes in fundamentals, albeit with a
conservatism.

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Table 3: Historical valuations: Current Asset based Valuations of Nifty 50 are below Top Quartile & Median
Current (10-July)

Top Quartile

Bottom Quartile

Median

Min

Max

P/BV

2.8x

3.5x

2.5x

3.0x

1.6x

6.0x

EV/Assets

1.6x

2.0x

1.4x

1.7x

1.0x

3.4x

P/E

18.0x

20.1x

12.2x

15.9x

7.5x

28.6x

EV/EBIT

13.7x

15.1x

9.2x

12.4x

6.1x

20.8x

We believe that markets chase expected changes in fundamentals in the short-to-medium term and eventually revert to
Source: ArthVeda Research

the true fundamentals of the underlying businesses in the long term.

The current seemingly high valuations, therefore, warrant a further investigation into what lies ahead for the underlying
market fundamentals in the long run, and much more so in light of huge expectations of strong growth from the Modi-led
government. However, we would raise a voice of caution in predicting the future in that the market fundamentals cannot
improve drastically and abruptly because of a change in government. The health of the businesses will take their own
inherent time (18-24 months) to normalize and revert to its true potential provided right actions are undertaken by the
new government.
Analysts estimates of expected changes in fundamentals have been proven wrong time and again and the fact has been
very well documented by various academic studies. As value investors, we, therefore, try to be conservative in predicting
the future. We believe that the market history can serve as the best guide to understand the extent of improvement
in market fundamentals from current levels. We would rather be happily proven wrong while being conservative than
proven wrong while being optimistic. Not surprisingly, we restrict our discussions to trailing valuations and fundamentals
because they represent the proven reality of the underlying businesses and not a castle of expectations built around
interesting stories.

A market proxy for the economy NIFTY 50 stocks

Before moving ahead to building conservative expectations about the future based on history, let us have a close look
at NIFTY 50 stocks a basket of stocks that closely mirrors the changes in the broader economy. Collectively, NIFTY
50 stocks account for ~60% of the FY13 organized GDP (30% of total GDP), ~70% of total Indian market capitalization,
span across 22 sectors and are generally either #1 or #2 companies in their domain. These figures are nothing but a
connotation of the truly ultra large cap nature of these stocks. Because of such a large representation, any changes in
the economy will be reflected in the fundamentals of these stocks to a very large extent. As a result, we would highly
recommend owning such a diversified basket of securities to investors but not necessarily with stock weights as per
free-float-market cap, as is the case with Nifty 50. In the words of Warren Buffett in his 2013 letter to Berkshire Hathaway
shareholders: The goal of the non-professional should not be to pick winners neither he nor his helpers can do that
but should rather be to own a cross-section of businesses that in aggregate are bound to do well.

NIFTY 50 fundamentals drive expectations of an improving economy

Any changes in the fundamentals of the NIFTY 50 companies for the purpose of value creation for their shareholders
results in improving returns on equity. Now, given the strong degree of fair representation of the NIFTY 50 stocks
of the economy, it is reasonable to expect that any improvement in the economy going forward should be driven by
improvement in the NIFTY 50 company fundamentals. Furthermore, we assert that these changes in the economy can
be attributed to the changes in the ROE for these companies.
Return on equity can be decomposed to five (nearly) mutually exclusive and collectively exhaustive factors 1) asset
turnover, 2) EBIT margin, 3) interest burden, 4) tax burden and 5) leverage. Changes in tax policies, interest rate
environment, inflation, GDP growth and other macro-economic factors will be essentially captured by the 5 factors
illustrated above. Our analysis, therefore, focuses on DuPont components to estimate changes in underlying market
fundamentals while using history as a guide. Analysis of the components of fundamentals shown below reveals that
2

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

asset turnover, EBIT margins and interest rate factor (EBT/EBIT) are currently lower than FY05-09 levels. The 5 factors
that we have examined are:

Asset turn over: has been analysed in terms of historical trends, both long term as well as in the reference FY05-09
period. A key observation unearthed has been that asset turnover averaged about 84% in FY05-09, while
current (fiscal) year to date turnover stands at only 73%. This signals a pick-up as mean reversion is likely to
kick in here primarily from a trigger in the release of pent-up consumer, industrial and government (public) demand
and the resulting multiplier effects on sales and capacity utilization.

EBIT margin: The main factor influencing EBIT margin is operating leverage. With respect to our reference period,
EBIT margins improved 60bps p.a. from FY05 to FY08 (excluding the weak FY09 impacted by US crisis), helped by
a favourable macroeconomic environment then (with the exception of FY08/09, CPI remained fairly low and GDP
growth remained robust). YTD EBIT margins stand at 16.4% while FY05-09 averaged 20%.

Interest burden (pre-tax earnings/EBIT): has been analysed on the basis of the cost of debt experienced by
companies against the back drop of cooling inflation and possible interest rate cuts by RBI in FY15, FY16 and
onwards.

Tax burden (net profit/pre-tax earnings): Has been analysed in terms of historical levels for FY15-19.

Leverage: in terms of equity multiplier and Debt/Equity in turn depending on the interest rate backdrop and historical
trend levels. In this regard, leverage increased only modestly from FY05-09

Table 4: Historical trend of Nifty 50s DuPont factors

FY

ROE

NP/EBT

EBT/EBIT

EBIT
Margin

Sales/
Assets

Leverage
(A/E)

Net D/E

CPI

Cost of
Debt

2003

21.7%

0.72

0.92

16.6%

100%

1.96x

0.19x

3.9%

16.0%

2004

25.2%

0.73

0.93

19.7%

91%

2.07x

0.20x

3.8%

12.4%

2005

25.7%

0.73

0.94

19.7%

97%

1.95x

0.10x

4.4%

21.0%

2006

21.1%

0.74

0.95

17.9%

88%

1.89x

0.11x

7.3%

12.8%

2007

22.2%

0.72

0.95

19.3%

85%

1.97x

0.16x

6.1%

9.7%

2008

20.8%

0.73

0.93

22.0%

69%

2.02x

0.30x

8.9%

8.2%

2009

15.2%

0.74

0.88

15.3%

72%

2.12x

0.41x

13.0%

7.3%

2010

16.0%

0.72

0.91

18.3%

66%

2.02x

0.35x

10.5%

7.2%

2011

17.2%

0.72

0.91

18.1%

69%

2.08x

0.37x

9.6%

6.8%

2012

16.6%

0.72

0.90

16.4%

75%

2.08x

0.30x

10.2%

10.3%

2013

15.3%

0.71

0.87

16.3%

73%

2.07x

0.34x

9.5%

10.6%

2014

15.8%

0.71

0.90

16.4%

73%

2.06x

0.28x

8.0%

10.1%

FY15 YTD

15.8%

0.71

0.90

16.4%

73%

2.06x

0.29x

7.5%*

10.0%

Long Term Peak

26.2%

0.82

0.96

22.4%

112%

2.23x

0.43x

13.0%

30.6%

Long Term Average

19.7%

0.73

0.91

17.9%

83%

2.01x

0.26x

7.9%

11.8%

Long Term Trough

15.0%

0.71

0.85

13.5%

65%

1.86x

0.06x

3.8%

6.8%

05-09 Peak

26.2%

0.74

0.96

22.4%

101%

2.12x

0.41x

8.9%

30.6%

05-09 Average

22.4%

0.73

0.94

19.9%

84%

1.96x

0.17x

6.7%

13.5%

05-09 Trough

15.2%

0.72

0.88

15.3%

65%

1.86x

0.06x

4.4%

7.3%

Source: ArthVeda, Reuters, IMF.*As per RBI CPI inflation to reach sub- 8% levels by January 2015 and to 6% by January 2016

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Can history repeat itself?

Temporal similarity between FY05 and FY15: We find a strong parallel between the current socio-economic
environment and that of FY05. The parallel exists in terms of qualitative factors such as change of the government. Like
FY15, FY05 also saw a change in the government from Vajpayee-led NDA government (ending its term in May 2004) to
UPA government, though the in-coming and out-going parties have interchanged places this time. Additionally pent-up
demand in the last couple of years prior to FY05 had been released post elections, resulting in strong real GDP growth
of about 10% p.a. causing a fillip in top-line growth. We expect a similar situation for the current times as well wherein
the economy is likely to be bolstered by pent-up demand and resultant revenue expansion.
Factors for FY05-09 growth: Growth in FY05-09 period was led by several factors such as MNREGA (spur for rural
consumption), implementation of 6th Pay Commission (urban and semi-urban consumption increment), low inflationary
environment and fiscal prudence (boost to consumption, industrial, government demand and capital investments). We
believe that similar other factors are at play currently which can bring about a similar economic growth and therefore
history can repeat itself.
(Potential) Factors for FY15-19 growth: Factors such as 1) clearing of infra & power projects and their multiplier
effects, 2) possible next revision in Government salaries due in the next 1-2 years (7th Pay Commission), 3) easing of
input cost inflation, 4) kick-starting of the manufacturing industry, 5) rationalization of MNREGA for asset creation, 6)
boost to agro and food processing industries, 7) favourable policies for the real estate sector, insurance and defense
and many other factors paint a fairly rosy picture for the economy going ahead. Further, with global markets reviving and
Indian markets opening to foreign investments, India can see large amounts of FDI, this time from Japan as well (Indias
Look East Policy and potential Modi-Abe synergies).
The following tables present our base, best and worst case scenario of our outlook on how the economic growth may
reflect as changes in 5 factors of the DuPont decomposition.
Table 5: Base Case Scenario
Base (FY)

2015

2016

2017

2018

2019

Commentary

Asset
Turnover

78%

81%

83%

86%

86%

As per FY05-09, mean reversion driven primarily by release

of pent-up demand dictates an improvement from current YTD
levels of 73% to FY05-09 average of about 85%.

EBIT
Margin

Forecasted sustained YTD figures in FY15. We expect sales

growth to outpace input cost inflation post FY15. This should
16.4% 17.5% 18.0% 18.3% 18.5%
percolate down to margin improvement thanks to strong
operating leverage.

EBT/EBIT

0.89

0.90

0.90

0.91

0.91

Modeled on the basis of cost of borrowing in turn dependent on

the interest rates set by RBI which also has appeared to tame
inflation.

NP/EBT

0.71

0.72

0.73

0.73

0.73

Expect the tax burden to alleviate slightly in FY17. Should

remain fairly stable thereafter in-line with history.

2.01x

Has remained fairly stable in last 5 years and we expect

minimal variations going forward, in-line with LT history as well.
As interest rates can be expected to decine, companies could
look to maintain leverage levels.

Leverage
(A/E)

2.01x

ROE

FY15 YTD ROE's have been depressed (near all-time lows

16.2% 18.3% 19.8% 21.1% 21.2% in FY13), though have already started recovering. We have
modeled a rebound in ROE to about FY05-09 average levels.

Source: ArthVeda

2.01x

2.02x

2.02x

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Table 6: Best Case Scenario

Base (FY)

Asset
Turnover

EBIT
Margin

2015

80%

2016

83%

2017

86%

2018

89%

2019

Commentary

89%

As per FY05-09, mean reversion as well as pent-up growth

from infra projects, power segments and resulting multiplier
effects dictates an improvement from current YTD levels of
73% to a bullish 5 percent points above FY05-09 average,
yet conservative in the sense is below that periods highest
turnover.

Forecasted a modest 20 bps increment from YTD figures in

FY15 on the back of buoyant 23% sales growth in FY15 (which
16.6% 17.8% 18.5% 19.6% 20.1%
should translate to EBIT margin improvement due to good
operating leverage).

EBT/EBIT

0.90

0.90

0.91

0.92

0.92

Forecasted on the basis of cost of borrowing in turn dependent

on the interest rates set byRBI (guidances for rate cuts ahead
as inflation appears to simmer down on the back of favourable
CPI readings).

NP/EBT

0.72

0.73

0.74

0.74

0.74

Expect the tax burden to improve in FY16 itself. Should remain

fairly stable thereafter in-line with history.

2.02x

Has remained fairly stable in last 5 years and we expect

minimal variations going forward, though increasing debt on
books due to possible rate cuts going forward in FY16/17 could
see a spike here.

Leverage
(A/E)

2.02x

ROE

FY15 YTD ROE's have been near all-time lows in FY13 and
17.3% 19.8% 21.9% 24.1% 24.7% have already started recovering since. We have modeled a
rebound in ROE to near FY05-09 peak levels.

2.03x

2.04x

2.03x

Source: ArthVeda

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Table 7: Worst Case Scenario

Worse
(FY)

Asset
Turnover

EBIT
Margin

2015

77%

2016

78%

2017

2018

80%

82%

2019

Commentary

82%

As per FY05-09, mean reversion dictates an improvement

from current YTD levels of 73% to a very conservative case of
stabilizing at 2 percent points below FY05-09's average levels.
We have modeled an almost flat real sales growth in FY15 (9%
nominal growth) which paints a modest picture for turnover
improvement.

Forecast a -10 bps decrement from YTD figures in FY15 on the

back of weaker sales growth (only 9% nominal sales growth
16.3% 17.0% 17.5% 18.0% 18.1%
in FY15), though operating leverage could boost margin in the
longer term.

EBT/EBIT

0.88

0.89

0.89

0.90

0.90

Forecasted on the basis of cost of borrowing in turn dependent

on the interest rates set byRBI and inflation remaining sticky.

NP/EBT

0.71

0.71

0.71

0.71

0.71

Expect the tax burden to remain status quo, with in fact a slight
1 bp decrease from current YTD values should the Govt. focus
on further reducing fiscal deficit.

1.98x

Has remained fairly stable in last 5 years and we expect

minimal variations going forward, though increasing debt on
books with possible rate cuts going forward in FY16/17 could
see a spike here.

Leverage
(A/E)

1.90x

ROE

YTD ROE's have been near all-time lows in FY13 and have
14.9% 16.5% 17.7% 18.9% 18.8% already started recovering since. We have conservatively
modeled a rebound in ROE to sub FY05-09 levels.

1.98x

2.00x

2.00x

Source: ArthVeda

Fundamental improvement further corroborated by unsustainable diminishing (ROE rf) spreads: We can yet
again look back at history and observe that the excess return premium for equities (i.e. return on equity risk-free rates)
has over the years been declining from a maximum of 19.5% in FY04 to 6.4% in FY14. We find this trend unsustainable
in light of the above factors and hence a correction here can be expected going forward. The bulk of the correction has
to come from an increase in returns on equity since the fluctuations in risk free rates are relatively lesser in magnitude
and can account for not more than a 3% contribution (should they drop).
Figure 4: Possible mean reversion for excess equity returns over risk-free rate
30%

Best

25%

ROE

Base

20%
15%

Worst

19.5%

6.4%

10%
5%

rf (8+ yrs. G-sec yield)

0%
2003
Source: ArthVeda, Reuters, NSE

2005

2007

2009

2011

2013

2015

2017

2019

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Outlook on fundamentals for FY15-19

Book equity and margins: In terms of the above fundamentals, we have backed out a book equity growth of nearly 17%
FY15-19 in our base case, while our best case accounts for 19% appreciation in book value growth. EBIT margins in our
base case have improved nearly 40bps annually from 16.4% in FY14 to 18.5% in FY19. This is conservative looking at
the EBIT margin boom in FY05-08 (FY09 was impacted by the one-off US sub-prime crisis), wherein we witnessed a 60
bps annual progression from 19.7% in FY04 to nearly 22% in FY08. We expect the strong boost in margins to be driven
by better operating leverage. Given the healthy revenue projections, we estimate that majority of incremental top-line
should percolate down to profits (thereby increasing margins) as companies degree of operating leverage (DOL) has
over the past couple of years remained fairly solid.
Figure 5: Relation between DOL and margin
progression

Table 8: DOL and margin progression

FY
6

EBIT Margin Progression (% points, RHS)

2%

0%

3
2
1

4%

-2%

DOL (LHS)

-4%

-6%

-1

-8%

-2
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Nominal
EBIT
Sales
Growth
Growth

OL at
start of
the year

Margin Progression till end of

the year

2004

23.3%

46%

1.98

3.1%

2005

37.0%

37%

1.00

0.0%

2006

20.5%

10%

0.47

-1.8%

2007

30.1%

40%

1.34

1.4%

2008

30.6%

49%

1.59

2.7%

2009

20.3%

-16%

-0.80

-6.7%

2010

5.2%

26%

4.96

3.0%

2011

20.6%

19%

0.92

-0.2%

2012

26.9%

15%

0.55

-1.7%

2013

-2.4%

-3%

1.09

0.0%

2014

15.5%

29%

1.90

0.1%

Source: ArthVeda, Reuters. Note: DOL = % change in EBIT/% change in sales.

Earnings: Growth had remained particularly buoyant during FY05-08 (excluding the weak FY09) primarily boosted by
expanding EBIT margins. Consequently, FY05-08 recorded a stellar 38.5% earnings CAGR. In our best case, we model
a 30% earnings CAGR (NIFTY earnings to reach INR 1,533 by FY19) mainly powered by improving EBIT margins (75
bps CAGR) and improving asset turnover (3.2 percent point CAGR FY15-19) as we expect the latter to strongly recover
to prior historic levels of nearly 90%.

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Table 9: Index earnings FY15-19

Earnings

NIFTY Price Index

FY

Best

Base

2014

Worst

410

2015

513

476

433

2016

689

622

548

2017

908

790

677

2018

1,220

998

842

2019

1,533

1,192

974

Source: ArthVeda, Reuters

Sales: We find that w.r.t our reference period from FY05-09, sales growth has progressed with a CAGR of 27.5%. While
this was a period of exceptional performance thanks majorly due to the favourable domestic macro-economic conditions
particularly at the start of that period, we take a conservative stance even in our best case scenario modelling a FY15-19
CAGR sales growth of nearly 23.4%.
Figure 6: Book equity growth comparison

60%
50%

Figure 7: EBIT margins performance

2008

2005

25%
20%

40%
2006

30%

2007
2009

0%
2015

2016

Best

Base

2017
Worst

2018

2019

2009

10%

0%
2015

Historic

Figure 8: Earnings growth comparison

Best

40%
2007

2006

Best
Source: ArthVeda, Reuters

Base

2018

2019

Historic

2008

2006

2009

10%

0%
2016

Worst

2007

20%

2015

Base

2017

2005

30%

2008

40%
20%

2016

Figure 9: Sales growth comparison

2005

60%

2008

5%

10%

-20%

2006

2007

15%

20%

80%

2005

2017
Worst

2018
Historic

2019
2009

0%
2015
Best

2016
Base

2017
Worst

2018
Historic

2019

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Valuations Outlook
The valuation gap between 2004 and 2014 is huge. Markets were a lot more pessimistic back in 2004 after the formation
of UPA government. However, the good news is that over the next 3 years (FY05-07), Indian economy grew at a real
GDP CAGR of close to 10%, perhaps the highest ever growth for the Indian economy.
As per our analysis of the historical long-run of P/E, P/BV, P/Sales, EV/EBITDA, EV/EBIT, EV/Sales and EV/Assets,
we forecast base case valuation multiples in-line with their long term medians. In our best case scenario, we remain
conservative and assign the top-quartile valuation multiples as market multiples. While for the worst case scenario, we
assume the bottom quartile valuations as trading multiples.
Table 10: A look at valuations and our assumptions
Scenarios Statistics

P/E

P/BV

P/Sales

EV/EBITDA EV/EBIT EV/Sales EV/Assets

Current (10-July)

18.0x

2.8x

1.9x

11.1x

13.7x

2.3x

1.6x

Best

Top Quartile

20.1x

3.5x

2.4x

12.1x

15.1x

2.7x

2.0x

Worst

Bottom Quartile

12.2x

2.5x

1.5x

7.6x

9.2x

1.8x

1.4x

Base

Median

15.9x

3.0x

1.8x

10.0x

12.4x

2.2x

1.7x

Min

7.5x

1.6x

0.8x

5.1x

6.1x

1.0x

1.0x

Max

28.6x

6.0x

4.3x

17.0x

20.8x

4.6x

3.4x

Source: ArthVeda, Reuters

Figure 10: Historical P/E

Figure 11: Historical P/BV

30x

7x

25x

6x

20x
15x

5x
4x
3x

10x

2x

5x

1x

Figure 12: Historical P/Sales

5.0x
4.5x
4.0x
3.5x
3.0x
2.5x
2.0x
1.5x
1.0x
0.5x

Figure 13: Historical EV/EBITDA

18x
16x
14x
12x
10x
8x
6x
4x

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Figure 14: Historical EV/EBIT

Figure 15: Historical EV/Sales

5x

23x
21x
19x
17x
15x
13x
11x
9x
7x
5x

4x
3x
2x
1x
0x

25x
15x
5x

Figure 16: Historical EV/Assets

3.5x
3.0x
2.5x

Valuation Multiple

Top Quartile

2.0x

Bottom Quartile

Median

1.5x

Min

Max

1.0x

Current/FY14
Source: ArthVeda, Reuters

The final confluence of fundamentals and valuations RETURNS!

Target Index Levels: Based on our prior fundamental projections and valuation multiple forecasts, we arrive at estimates
for NIFTY TRI and NIFTY50 price index for the years FY15-19. For each year we have 3 scenarios base, best and
worst for which we forecast price levels on the average of the results obtained from the above 7 valuation metrics.
Figure 17: NIFTY TRI estimates

Table 11: NIFTY TRI FY15-19 forecasts

40,000

Best 36,677

35,000
30,000

Base
24,688

25,000
20,000

Worst

15,000

16,936

10,000
5,000
0
2003

10

2005

2007

2009

2011

2013

2015

2017

2019

Targets

Best

2014

Base

Worst

8,740

2015

13,691

10,412

7,603

2016

17,451

13,066

9,493

2017

22,349

16,254

11,665

2018

29,219

20,441

14,392

2019

36,677

24,688

16,936

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Figure 18: NIFTY50 price estimates

Table 12: NIFTY 50 FY15-19 forecasts

Best 26,038

27,000
24,000

Base
17,320

21,000
18,000
15,000
12,000

Worst

9,000

11,681

6,000
3,000

Targets

Best

2014

Base

Worst

6,704

2015

10,324

7,830

5,695

2016

12,973

9,658

6,968

2017

16,366

11,804

8,386

2018

21,058

14,583

10,124

2019

26,038

17,320

11,681

0
2003

2005

2007

2009

2011

2013

2015

2017

2019

Figure 19: Sensex estimates

Table 13: Sensex FY15-19 forecasts

Best 85,571

90,000
80,000
70,000

Base
56,921

60,000
50,000

Worst

40,000

38,388

30,000
20,000
10,000

Targets

Best

2014

Base

Worst

22,386

2015

33,928

25,731

18,717

2016

42,634

31,741

22,900

2017

53,787

38,792

27,559

2018

69,206

47,927

33,272

2019

85,571

56,921

38,388

0
2003

2005

2007

2009

2011

2013

2015

2017

2019

Source: ArthVeda. Note: Sensex projections calculated on the basis of historical relationship between Sensex and NIFTY 50 prices.

Market returns summarized below for our scenarios:

Best Case: Market returns during our reference period were clearly driven by fundamentals. Barring a poor FY09
(during which markets were impacted by sub-prime crisis in the US) which witnessed a multiple de-rating, TRI (i.e.
NIFTY index with dividends reinvested) returns were a handsome 30% CAGR FY05-08. This is very much in-line with
our current best case forecasts, where we model a robust 30% p.a. return on NIFTY TRI till FY19. This is driven by a
28% p.a. price appreciation (from NIFTY50 index, 27% from Sensex) and a 1.6% p.a. dividend yield (as of 10-July).
Figure 20: NIFTY Dividend yields

Figure 21: NIFTY50 Price returns

80%

60%

3.0%
2.5%

60%

40%

2.0%
1.5%

40%

20%

1.0%
0.5%

20%

0%
2015 2016 2017 2018 2019

0.0%
2015 2016 2017 2018 2019
Best

Base

Source: ArthVeda, Reuters

Worst

Figure 22: NIFTY TRI returns

0%
-20%

-20%
Best

Base

Worst

2015 2016 2017 2018 2019

Best

Base

Worst

11

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Base Case: Our current base case forecasts, model a robust 20% p.a. return on NIFTY TRI till FY19. This is driven by
a 18% p.a. price appreciation (from NIFTY50 index, 17% from Sensex) and a 1.8% p.a. dividend yield (as of 10-July).
Worst Case: Our worst case forecasts, model a 11% p.a. return on NIFTY TRI till FY19. This is driven by a 9% p.a. price
appreciation (from NIFTY50 index, 8% from Sensex) and a 2.1% p.a. dividend yield (as of 10-July)..
Table 14: Projected Market Returns CAGR FY15-19 (as of 10-Jul-14)
Returns

Best

Base

Worst

NIFTY TRI

29.9%

20.0%

11.3%

NIFTY 50

28.0%

18.0%

9.0%

Sensex

27.1%

17.1%

8.3%

Source: ArthVeda

Better than the best: Should we see a further contribution from a valuation re(de)-rating in our best(worst)
case, we have modelled a stronger(weaker) bull(bear) case wherein we expect valuations to re(de)-rate to
average levels of their top(bottom) quartiles from their top(bottom) quartile levels i.e. we expect a 13-28%
further upside in valuation multiples from our best case and a 14-27% further downside from our worst case.
Under these better than best and worse than worst conditions, we expect the following returns as detailed
below.

Table 15: Snapshot of target index levels

Scenarios
P/E multiple
NIFTY 50 Price Index
Sensex

Better than Best

Best

Base

Worst

Worse than Worst

22.8x

20.1x

15.9x

12.2x

9.7x

31,099

26,038

17,320

11,681

9,030

1,02,204

85,571

56,921

38,388

29,676

Source: ArthVeda

How to ride the bull?

Active management may not always yield sustainable results : While it is the imperative of fund managers to
beat the market returns and thereby achieve even higher capital growth than the market, research across the globe and
across timeframes suggest that majority of (active) fund managers fare poorly in even achieving benchmark returns over
long run. Investment in benchmark indices such as Nifty 50 and Sensex, therefore, looks like the best bet for an average
investor to create long term wealth.
though rules-based value investing philosophy stands tried and tested: It is possible to beat the markets
with lower risks if one follows a sound investment philosophy and avoids the pitfalls of active fund management
rules based value investing. A rules-based approach eliminates the behavioural biases which are the major causes of
underperformance of active mutual fund managers. A value investing philosophy is known to create wealth over the long
term while beating the markets and is followed by the likes of great investors such as Warren Buffet, Peter Lynch and
John Templeton.
ArthVedas flagship equity investment strategies Alpha L50 and Alpha L10 adopt the same principles of investing
discussed above. Going by past historical outperformance of L50 and L10 in our reference period, we expect that their
returns should likely beat the markets for FY15-19 as well. For FY15-19, we summarize the results as shown.
12

Back to the future: A Glimpse of India Inc. 2019

July 28, 2014

Table 16: Performance scenarios for markets and ArthVeda Alpha strategies
Returns

CAGR FY15-19
Best

Base

Worst

NIFTY 50 Price Index

31.2%

20.9%

11.7%

Sensex

30.8%

20.5%

11.4%

Alpha L50

33.8%

23.5%

14.5%

Alpha L10

41.8%

31.6%

22.5%

Source: ArthVeda, Reuters

Note: Alpha strategy returns have been forecasted on the basis of past historical outperformance vs benchmark indices.
* It is consequently mandatory to see Disclaimer section.

We acknowledge that market levels can be volatile responding to news (noise) flow and in the long run, they revert to
underlying business fundamentals. Consequently, it would be prudent for an investor to remain invested in the market
as long as fundamentals look promising, with possible exits at scenarios such as unsustainable bubble periods.
Key risks to our views: Our thesis rests on the foundation of improving fundamentals driven primarily by a recovery in
the Asset turnover ratio and a healthy improvement in EBIT margins. A recovery in these may not materialize over the
next 5 years if a) pent-up demand in the economy over the past couple of years does not kick in resulting in depressed
capacity utilization, lower revenues (lower asset turnover) and lower EBIT margins and b) there occurs a slowdown in
the global economy and global external shocks which may impact NIFTY 50 companies given their increasing global
character and global dependence.
A focus on fundamentals rather than speculation: We reiterate that our base case alone represents a fairly strong
outlook scenario (we forecast a 18% FY15-19 price return (as of 10-July) on NIFTY 50 price index vs long run historical
14% FY05-14 returns) and has its foundations on robust fundamental forecasts rather than speculation on absolute
price levels.
To yet again quote Buffett:

Focus on the future productivity of the asset you are

considering. If you dont feel comfortable making a rough
estimate of the assets future earnings, just forget it and
move on. No one has the ability to evaluate every investment
possibility. But omniscience isnt necessary; you only need to
understand the actions you undertake. If you instead focus on
the prospective price change of a contemplated purchase, you
are speculating. There is nothing improper about that. I know,
however, that I am unable to speculate successfully, and I am
skeptical of those who claim sustained success at doing so.
-Warren Buffett
Source: 2013 annual letter to Berkshire Hathaway shareholders
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Back to the future: A Glimpse of India Inc. 2019

About ArthVeda
ArthVeda Capital is the equities vertical of ArthVeda Fund Management Pvt. Ltd. At ArthVeda, we specialize in creating
investment solutions which are designed to generate high risk-adjusted returns for Ultra HNIs, Pension Funds and
Family Offices.

Value investing approach: ArthVeda believes in value investing as followed by renowned investors like Warren
Buffett, Peter Lynch, Ben Graham, John Templeton etc.

Introducing Smart Beta equity investing in India: Smart beta investing is the most popular trend of the decade. Total
AUM tracking these strategies has crossed USD 500 bilion and is growing at 60% per year.

Research driven approach: Very strong research and product development team having qualified professionals
from premier Indian (IITs, IIMs, ISB) and foreign universities (Columbia University USA, EDHEC France, ESC
Toulouse France) and having CFA and FRM charters.

Products delivering best in class returns over long periods of time.

ArthVeda Fund Management Pvt. Ltd. is in the business of asset management with a focus on alternative investment
funds covering asset classes such as real estate, infrastructure, fixed income, traded markets, agriculture, debt and
unlisted equities. ArthVeda is an associate company of Dewan Housing Finance Ltd (DHFL). DHFL is the third largest
housing finance company in India and is listed on the Bombay Stock Exchange and National Stock Exchange.
The objective of ArthVeda is to manage funds (designed by our in-house research team) that offer ample opportunities
for extracting alpha, i.e. high risk-adjusted returns, from asymmetric risk-return opportunities. The company believes in
Value Investing and predominantly follows this principle in all its investment-decisions across asset classes. ArthVedas
investor-focused approach is guided by its belief in transparency and high standards of corporate governance.

Disclaimer
This document is not an offering document for any securities or units of any kind and should not be seen as solicitation for investments. The document
is intended for illustration and information purposes for intended user only. Further, the contents of this document are provisional and may be subject
to change.
This document is produced solely to the specified recipient for the purpose of its internal use. This document may not be transmitted, reproduced
or made available to any other person. The information contained herein is proprietary and confidential and may not be disclosed to third parties or
duplicated or used for any purpose other than the purpose for which it has been provided. Any unauthorized use, duplication or disclosure of this
document is prohibited by law.
Certain information included in this document is based on information obtained from sources considered to be reliable, however, the accuracy of such
information cannot be guaranteed and further such information may be incomplete or condensed. No liability is assumed for the relevance, accuracy,
or completeness of the contents of this document.
This document is subject to the more detailed information specified in the disclosure documents and client service agreement. Investors must read
and agree to the contents of the documents, including all risks highlighted therein, prior to making any investment related decisions. Before making
an investment, each potential investor should make its independent assessment and inquiries.
Document may include predictions, estimates or other information that might be considered forward-looking while these forward-looking statements
represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially.
Investors are cautioned not to place undue reliance on these forward-looking statements.
Neither ArthVeda Fund Management Ltd., nor any person connected with it, accepts any liability arising from the use of this material. The recipient
of this material should rely on their investigations and take advice from their professional advisors opinion, if any, expressed are our opinions as of
the date appearing on this material only. We endeavour to update the material on a regular basis. However there is no regulatory compulsion for us
to do so.
Past historical equity market returns are not a guarantee of and may not reflect future performance. Actual results may differ materially from those
suggested by the forward looking statements due to risk or uncertainties associated with our expectations with respect to, but not limited to, exposure
to market risks, general economic and political conditions in India as well as other countries globally.
Investments in equity markets are subjected to market risk and there is no guarantee that the investment objective of the strategy will be achieved.
Please read the strategy related documents (Disclosure and Client Service Agreement) carefully. Investors should consult their tax and investment
advisors before investing.

14

July 28, 2014

Back to the future: A Glimpse of India Inc. 2019

Wealth from Wisdom

ArthVeda Fund Management Pvt. Ltd.

Grd. Floor, HDIL Towers, Anant Kanekar Marg, Bandra (E),
Mumbai 400051, Maharashtra, India
Contact no.: +91 22 67748558/500; Fax: +91 22 67748585
Email: [email protected]
www.arthveda.co.in
www.arthvedacapital.com