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India Losing ROE Edge – Morgan Stanley

September 30, 2008

In a report released just a while ago, Morgan Stanley has expressed its displeasure over India losing its ROE Edge and expects it to slip further down.

India lost its edge over the average EM ROE in 2007. The ROE gap to EM fell to a seven-year low of 4.3% in 2007. This is the second-worst gap since 1995.Second, unlike in the past when India’s ROE edge came from superior asset turns, it now comes from a fragile net margin superiority. India’s asset turn is now below the averages in the rest of the world for the first time since 1999.

Further, Corporate India’s balance sheet has deteriorated. At the end of 2007, Indian companies had an average net debt equity that was higher than in both emerging markets and Asia-Pac. Earnings quality remains suspect – free cash flows are lower than in the rest of the world.

Capex Cycle and Rising Interest Rates a dampener:
Apart from causing a relative rise in debt/equity and thus higher interest cost, the big capex cycle of the past two years has also elevated depreciation expense. The rise in average interest rates is putting further pressure on financial statements.

India’s ROE superiority versus the region and the emerging market universe will likely come under pressure.This will cause India’s relative multiples to contract.

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