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Fourth consecutive quarter of higher earnings beat improves profit cycle outlook; environment for capex cycle continues to improve

Q4FY21 is turning out to be the fourth consecutive quarter of earnings beat exceeding misses (led by cyclicals), which has resulted in PAT/GDP rising further to 2.8% despite upward revision to FY21 GDP base. ‘Look through earnings’ of NIFTY200 portfolio has risen sharply by 120% driven by cyclicals in Q4FY21. Latest GDP print indicates economic recovery is led by investments as the real investment rate rose to a 2-year high of 34.3% driven by robust construction and manufacturing sector along with higher government spending.

It is also corroborated by robust quarterly results of sectors such as metals, cement, building material, capital goods, auto as well as the resilience shown by merchandise exports. We believe the environment for capex cycle is turning conducive at a macro level. Pick up in contact-intensive consumption will be with a lag and depends on consumer confidence. Rising demand driven moderate inflation and improving pricing power of manufacturers reflected in rising WPI is positive for corporate earnings and stocks in general. Risk emanates from inflation going out of hand and demand outlook falling which looks unlikely currently.

Rolling forward earnings by one quarter, our one-year ahead (June’22) NIFTY50 target stands at 17,250. Our Top picks: SBI, Axis Bank, HDFC Bank, NTPC, PTC India, L&T, Ultratech, Bharti Airtel, Tata communications, GAIL, Tata Motors, TVS Motors, Motherson Sumi, and Jyothy Labs

Markets and Flows: INR has remained resilient at 73 vs US$ as external environment remains comfortable (record high forex reserves of around US$600bn, trade deficit under control and FPI+FDI inflows continuing). FPI outflows were limited to just April, while MayJune have seen net positive flows. DII inflows have also started picking up along with improving retail participation. The past one month has seen India outperform most global equity markets including EMs and DMs.

P/E expansion unlikely: Normalising of interest rate in US and eventual FED tapering will cap and potentially reverse the record high P/E expansion seen in segments of the market. Latest data points which indicate further improvement in profit and capex cycle:

* Fourth consecutive quarter of beats exceeding misses leading to upgrades: Beats in Q4FY21 surge overtaking misses, largely driven by cyclicals, as earnings season enters its last stage of reporting in June’21. ‘Look through earnings’ of NIFTY200 portfolio has risen sharply by 120% driven by cyclicals in Q4FY21.

* PAT to GDP ratio improves further to 2.8% driven by cyclicals in FY21 despite upward revision of nominal GDP by 0.8% to Rs197trn. Currently, PAT to GDP ratio is rising from a two-decade low level of 1.6%.

* Investment, construction and manufacturing led economic recovery: Investment rate continued to rise in Q4FY21 and is at a 2-year high of 34.3% in real terms and 7- year high of 31.2% in nominal terms. Construction (14.5% YoY), manufacturing (6.9% YoY) and electricity (9.1% YoY) growth were robust in Q4FY21 as evidenced by GDP print, corporate results and robust merchandise exports. Also, MoM expansion of PMImanufacturing (>50 reading) in Q1FY22 so far is a positive surprise as April-May’21 may be the worst affected period in the second Covid wave with June expected to witness the reopening of the economy from the partial lockdown. GST collections also remained relatively robust at Rs1.1trn.

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