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Cyclicals to drive earnings once again!

Macro backdrop improving:

As FY22 commenced, the second COVID-19 wave swept across the country over Apr–May’21, resulting in localized lockdowns and restrictions. Nonetheless, the active COVID cases have already declined 88% from the peak in May’21 and restrictions are gradually being eased since Jun’21. The pace of vaccinations has also picked up – ~4m vaccines have been administered daily in Jun’21, vs. ~2m in May’21; this is expected to improve further on increased availability.

Earnings set to accelerate:

Corporate commentary has turned positive once again from Jun’21. Quarter-end updates from several corporates indicate a healthy revival in Jun’21 after a subdued April and May, while several high-frequency macro indicators have also recovered. After FY21 ended with a solid 15% EPS growth for Nifty, 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.

Key drivers for 1QFY22:

The key drivers are: a) Metals – strong pricing environment and higher exports to offset 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 – expected to post a healthy performance with 23–25% EBITDA/PAT growth, despite rising commodity cost pressure.

94%/114% YoY profit growth expected for Nifty/MOFSL Universe in 1QFY22:

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

Market strategy:

The equity markets have largely looked through the turbulent period of April/May’21 and have shown strong resilience, with indices trading near all-time 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. The primary markets are also seeing a flurry of activity with several IPOs lined up. Amid this positive setup, 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. We estimate Nifty FY22E/ FY23E EPS at INR733/INR868 (FY21–23 CAGR of 26%). As the economy reopens and vaccinations gain momentum, demand recovery could strengthen. We maintain our OW stance on BFSI, IT, Metals, Cement, and Capital Goods, while we are Neutral in Consumer, Auto, and Healthcare. We remain UW on Energy and Utilities and reduce weight in Telecom.

Top ideas

Large-caps: ICICI Bank, SBI, Infosys, HCL Technologies, UltraTech, M&M, HUVR, Titan, Divi’s Labs, SAIL, SBI Cards

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

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