Churn in constituents to have negligible impact on Nifty's fundamentals

A man walks past the NSE building in Mumbai | Photo: Reuters
Grasim Industries, Titan, and Bajaj Finserv will enter the Nifty50 index from April 2, replacing Ambuja Cement, Aurobindo Pharma, and Bosch.


Following the rejig, weight of the consumer discretionary sector on the index will increase by 82 basis points (bps), while that of non-banking finance companies (NBFCs) will go up by 61 bps and cement by 60 bps, analysts said.


On the other hand, the exits will lead to a fall of 55 bps, 47 bps and 34 bps, respectively, in the weight of auto, pharma and private banks. The number of financials will increase to 11 and their weight will increase to 36.6 per cent from 36.4 per cent.


During FY11-16, weight of the cyclical stocks (sectors other than IT, pharma and consumer staples) had declined from 75 per cent to 67 per cent due to their underperformance and the exclusion of three such stocks. After April 2018, the Nifty50 index will have a representation of 39 cyclical stocks and their weight will be 77 per cent — the highest since 2011.


The churn will lead to a minor deterioration in the Nifty50 fundamentals, said Ravi Muthukrishnan and Pankaj Chhaochharia of Elara Capital.


While the Ebitda (earnings before interest, tax, depreciation and amortisation) margin will remain unchanged (16.9 per cent in FY19 estimates and 17.6 per cent in FY20 estimates), the Nifty FY19 estimated earnings per share (EPS) is likely to dip from Rs 567 to Rs 565 and FY20 estimated EPS would decline from Rs 676 to Rs 674.


The analysts expect the net debt to equity to increase marginally (0.39 to 0.40 in FY19 estimates and 0.30 to 0.32 in FY20 estimates); and return on equity (RoE) to fall marginally (14.9 per cent to 14.6 per cent in FY19 estimates and 15.7 per cent to 15.6 per cent in FY20 estimates).


During a calendar year, a maximum of five stocks can be replaced and those to be included in the Nifty50 should have a free float market capitalisation, at least 1.5 times higher than the smallest constituent in the index.


Analysts at Elara expect Avenue Supermarts and Shree Cement to be the likely entrants during the September 2018 review of the index constituents, replacing Lupin and Bharti Infratel. The September churn, they said, would further increase the weight of the cyclical sector stocks, while that of telecom and pharma would dip.


Should one buy any of the new entrants ahead of their inclusion?


Elara Capital’s analysis of the stock performance after their inclusion in the Nifty50 reveals that in 16 of the 24 instances these stocks generated incremental positive returns on the day of their inclusion. However, after that the performance lacked clear trends.


G Chokkalingam, founder and managing director of Equinomics Research, advises investors to look at the company’s fundamentals before investing rather than inclusion in the Nifty50 index. “Based on fundamentals, I prefer Grasim,” he said.


Though the finance space is getting overcrowded, Deepak Jasani, head of research at HDFC Securities still feels Bajaj Finserv deserves a look given the pedigree and the way its finance subsidiary has delivered so far in the face of a stiff competition from banks and older NBFCs.


“Though the valuations ascribed to the company are high, it could continue to trade at premium multiples with sustained delivery and visibility of high growth and high RoE. However, given the current market conditions and valuations given to the scrip, investors willing to buy could look at staggering their entry over the next few quarters,” he said.


Analysts at ICICI Securities remain positive on Bajaj Finserv with a 12-month price target of Rs 6,000 per share. “We are positive on the stock due to a sustained healthy performance of Bajaj Finance; strong profitable growth in general insurance business and traction in individual new business premium. We maintain our target price at Rs 6,000 per share, based on SOTP (sum of the parts) valuation, implying a multiple of 19.8 times on FY20 estimated consolidated earnings,” they said.