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Vaccinated to grow!

Earnings set to accelerate; macro backdrop improving

* FY22 commenced with an odd sense of déjà vu as the second COVID-19 wave swept across the country over Apr–May’21, resulting in localized lockdowns and restrictions. Nonetheless, after peaking in May’21, active COVID cases have already declined 88% from the peak and restrictions are gradually being eased since Jun’21. The pace of vaccinations has also picked up – India administered 4m vaccines daily, on average, in Jun’21, double the average of 2m vaccines daily in May’21; this is expected to improve further on increased availability. The equity markets have largely looked through the turbulent period of April/May’21 and have shown strong resilience, with indices trading near alltime highs – buoyed by best-in-decade earnings delivery in FY21 and the expectation of an even better FY22. The midcap and smallcap indices have sharply outperformed the Nifty and reset several benchmarks, as discussed in our recent strategy note. The primary markets are also seeing a flurry of activity with several IPOs lined up. Amid this positive setup, rising commodity costs, higher inflation prints, and a potential rate increase are key headwinds.

* Corporate commentary has turned positive once again from Jun’21. Several high-frequency macro indicators have also recovered – such as power consumption, e-way bills, exports, and auto fuel demand. Quarter-end updates from several corporates (such as HDFC Bank, Bajaj Finance, Marico, GCPL, Titan, and DMart) indicate a healthy revival in Jun’21 after a subdued April and May.

* After FY21 ended with a solid 15% EPS growth, we expect FY22 to commence with a bang and expect a further buildup over the remainder of FY22. 1QFY22 earnings are estimated to be strong despite the restrictions imposed, albeit benefitting from the deflated base of 1QFY21. Even on a two-year CAGR basis, we expect double-digit earnings growth owing to the resilience seen in underlying economic activity. The key drivers of the 1Q performance are: a) Metals – this would be on the back of a strong pricing environment and higher exports to offset the decline in domestic volumes; b) IT – the strong performance would continue as we expect median USD organic growth of 3.3% CC QoQ in 1QFY22 on the back of a strong demand environment and healthy YoY margin expansion; c) BFSI – despite muted asset growth, lower provisioning costs would drive strong earnings YoY; and d) Consumer – it is expected to post a healthy performance with 23–25% EBITDA/PAT growth, despite rising commodity cost pressure.

* Nifty / MOFSL Universe to see 114%/94% YoY profit growth in 1QFY22: We expect PBT/PAT to grow 110%/114% for the MOFSL Universe in 1QFY22. Sequentially, though, earnings should moderate 19% each for both the MOFSL Universe and the Nifty. The MOFSL Universe is expected to post a PBT/PAT CAGR of 12%/15% over 1QFY20–1QFY22. On a two-year basis, Metals, Technology, and Private Banks are likely to contribute 104% to incremental 1QFY22 PAT v/s 1QFY20. Nifty sales/EBITDA/PBT/PAT should grow 48%/38%/89%/94% YoY in 1QFY22E. Over 1QFY20–1QFY22, the Nifty should post a sales/EBITDA/PBT/PAT CAGR of 2%/11%/12%/16%. The MOFSL Universe, ex-OMCs and Financials, is expected to post a 350bp YoY expansion in operating margins to 23%.

* Marginal downward revision in Nifty FY22 EPS: Nifty FY22E EPS estimates have seen a downgrade of 2% to INR733 (prior: INR748), while FY23 EPS is stable at INR868 (prior: INR870). As the economy reopens and vaccinations gain momentum, demand recovery could strengthen. After best-in-decade EPS growth of 15% in FY21, we expect earnings to accelerate and estimate an FY21– 23 CAGR of 26% for Nifty EPS. This would be driven by Metals, BFSI, IT, and Auto, which are likely to account for 29%, 31%, 11%, and 8%, respectively, of incremental earnings in FY22. For the MOFSL Universe, we are building in chunky 35% earnings growth in FY22. The market faces headwinds from the advent of a possible third COVID wave, persistent inflation readings prompting a potential rate increase, and volatility around the US Fed taper talk.

* Key model portfolio changes: Our model portfolio construction reflects our growing conviction in accelerating the earnings trajectory, led by cyclicals. However, given the recent sharp outperformance of midcap and smallcap indices, we have shifted some of the weight from the midcaps to largecaps, wherein we are finding better relative value. We maintain our OW stance on BFSI, IT, Metals, Cement, and Capital Goods. We maintain our Neutral positions in Consumer, Auto, and Healthcare. We remain UW on Energy and Utilities and reduce weight in Telecom. We add further weight to Capital Goods. In BFSI, we increase allocation in SBI Life, which has delivered steady improvement in operating metrics over FY21, while trading at attractive valuations of 2.1x FY23E EV, the cheapest in the Life Insurance space. In Consumer, we introduce Godrej Consumer – for which our Consumer team has upgraded the rating to BUY post the management change. We add further weight in Tata Consumer. In Capital Goods, we introduce KEC. We like KEC’s diversification strategy into the Railways and Civil segments, leading to decreasing concentration risk from the Power T&D segment. In Metals, we replace JSPL with SAIL – we expect a significant debt reduction in SAIL, with net debt/EBITDA expected to decline to ~1.1x by Mar’23E. Among the midcaps, we introduce Solara, Deepak Nitrite, and Orient Electric.

Top picks

* Largecaps: ICICI Bank, SBI, Infosys, HCL Technologies, UltraTech, M&M, HUVR, Titan, Divi’s Labs, SAIL, SBI Cards

* Midcaps: Max Financials, Chola Finance, JK Cements, Indian Hotels, Deepak Nitrite, L&T Technology, Endurance Tech, Orient Electric, Solara, ABFRL

Key sectoral trends/highlights

* The Metals Universe should post a two-year PAT CAGR of 128%, aided by strong price realization and higher exports. Although the recent measures taken by the Chinese government have cooled down steel prices, these are still higher v/s QoQ. The Metals Universe would post the highest absolute profits in 1QFY22 at INR339b, representing 13% growth QoQ.

* MOFSL Technology Universe is likely to post median USD organic growth of 3.3% CC QoQ in 1QFY22. Despite the high base effect in 2HFY21, a strong demand environment and deal wins should result in continued strength across largecap and midcap IT companies (with a few exceptions). We expect Tier I IT to grow at 4.3% QoQ in USD terms. In the Midcap IT space, we expect COFORGE, MTCL, and PSYS to lead revenue growth. We are expecting 25% PAT growth for the universe.

* The Private Banks Universe should report 6%/31%/28% YoY growth in PPOP/PBT/PAT. The two-year profit CAGR over 1QFY20–1QFY22 should stand at 14%. Earnings may be impacted by high credit cost and likely moderation in business growth / fee income, offset by lower opex.

* Our NBFC Coverage Universe is likely to post PBT/PAT growth of 19%/13% YoY. The two-year PAT CAGR stands muted at 8%. Across product segments, disbursements are likely to be muted due to the lockdown. We expect credit costs to be front-ended in 1HFY22 and estimate steady recovery in both demand / asset quality through 2HFY22. Collection efficiency (CE) is likely to be higher for housing financiers, relative to other segments. For Vehicle Financiers and MFIs, we expect CE to be in the range of 70–90%.

* PSU Banks would deliver NII/PPOP growth of 7%/6% YoY and PAT growth of ~89% YoY (on a low base). Within PSBs, we expect SBIN to report a healthy performance, supported by recoveries and modest opex.

* The Consumer Universe is expected to report sales/EBITDA/PAT growth of 19%/23%/25% YoY (-2% profit CAGR over 1QFY20–1QFY22), aided by a low base. 16 of 18 companies are expected to post double-digit growth in sales YoY. Britannia is an exception due to the high base of 1QFY21. Most companies would experience some degree of material cost inflation and – despite price increases taken during the quarter – are likely to experience gross margin pressure.

* Our Auto Universe is expected to post profits on an aggregate basis despite the impact of the regional lockdowns seen over Apr–May’21. On a two-year CAGR basis, wholesale volumes grew robustly for Tractor (+7% CAGR; -8% QoQ), while PV posted a 7% CAGR decline (-26% QoQ). Declines were also seen in 2W (-24% CAGR; -38% QoQ), LCV (-9% CAGR; -16% QoQ); and M&HCV (-38% CAGR; -66% QoQ). The EBITDA margin is likely to decline 420bps QoQ on higher commodity prices and operational deleverage.

* The Healthcare Universe is expected to see continued strong earnings momentum – it would grow 14% YoY, resulting in the sixth consecutive quarter of strong double-digit earnings growth YoY. 11 of 21 companies in our Coverage Universe are expected to post double-digit YoY profit growth.

* The Cement Universe should report a two-year EBITDA/PBT/PAT CAGR of 1%/8%/7%. EBITDA margins are likely to decline 50bps to 23.1% QoQ (from 23.6% in Mar’21). Demand declined over Apr–May’21, while June saw a strong uptick in demand, led by the gradual unlock and the easing of restrictions on movement.

* The Oil and Gas Universe should post a two-year sales/EBITDA/PAT CAGR decline of 7%/3%/5%. All companies, except GSPL, are likely to post QoQ decline in PAT.

* The Consumer Durables Universe should report a two-year sales/EBITDA/PAT CAGR decline of 14%/25%/25%. However, the recent lockdowns were not as disruptive as last year’s nationwide lockdown. Hence, on a YoY comparison, sales are likely to be up 49%.

* The Telecom Universe should report loss for the 16 th straight quarter, largely led by Vodafone Idea.

* The Capital Goods Universe should report profit of INR18b v/s loss of INR6b in 1QFY21. However, the two-year PAT CAGR is likely to decline 6%. BEL and L&T are likely to post modest two-year PAT CAGRs of 10% and 3%, respectively.

* The Utilities Universe should see PBT/PAT growth of 35%/21% YoY, aided by a low base.

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