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Earnings drought ending, finally!

Cyclicals to drive 4QFY21 earnings; rising COVID-19 cases a headwind

* FY21 has been a stellar year for the markets as all the mainstream indices have delivered solid returns on the back of sharper-than-expected economic and corporate earnings recovery. The Nifty is expected to end FY21 with healthy 13% earnings growth, the highest since FY11, despite the challenges posed by the COVID-19 pandemic. a) Broad market share shifts toward organized corporates across sectors and b) prudent cost optimization measures catalyzed this 13% earnings growth in a year when nominal GDP is expected to decline 4% YoY. 4QFY21 is likely to be another strong quarter as high-frequency data points indicate decent economic recovery. However, toward the end of 4QFY21, a spike in COVID-19 cases in the second wave has started somewhat muddying the outlook. The daily cases in the second wave have already exceeded the peak of the first wave and forced state governments to introduce various restrictions and localized lockdowns. The interplay of resurgence in COVID-19 cases and the pace of vaccination would decide the trajectory of economic recovery going ahead, in our view.

* After two consecutive quarters of solid earnings beats and upgrades, we expect another strong quarter, aided by a deflated base of 4QFY20 and healthy demand recovery for the large part of 4QFY21 – as attested by high-frequency indicators. Performance is expected to be healthy despite headwinds of commodity cost inflation in various sectors. The key drivers of the 4QFY21 performance include: a) Metals – on the back of a strong pricing environment and higher volumes; b) Private Banks and NBFCs – on moderation in slippages and improved disbursements / collection efficiency; c) a continued strong performance from IT – as deal wins translate into higher revenues; d) Autos – as operating leverage benefits offset commodity cost pressures; and e) Consumer Staples and Durables – on strong demand recovery despite commodity price inflation. MOFSL and the Nifty are expected to post a healthy two-year profit CAGR of 16% and 14%, respectively, over 4QFY19–4QFY21.

* 65%/76% YoY profit growth expected for Nifty/MOFSL Universe in 4QFY21: We expect PBT/PAT to grow 98%/76% YoY for the MOFSL Universe in 4QFY21, aided by continued economic recovery and low base. 14 of the 20 sectors are expected to post >20% YoY earnings growth. Metals, Private Banks, and Automobiles are expected to drive ~60% of the incremental 4QFY21 PAT growth. Consumer Durables, Cement,Healthcare, Consumer Staples, and Technology are likely to post earnings growth of 62%, 59%, 43%, 19%, and 16% YoY, respectively. Nifty sales/EBITDA/PBT/PAT should grow 18%/26%/77%/65% YoY in 4QFY21E. Over 4QFY19–4QFY21, it should post a CAGR of 6%/10%/12%/14%. The MOFSL Universe, ex-OMCs and financials, is expected to post a 300bp YoY expansion in operating margins.

* Minor tweaks to FY21E/FY22E Nifty EPS: FY21E/FY22E Nifty EPS estimates have seen minor tweaks. Nifty FY21 EPS has seen a marginal 1% cut to INR533 (prior: INR541), while Nifty FY22/FY23 EPS is stable at INR726/INR861 (prior: INR719/INR857). Overall, despite the unprecedented challenges of FY21, the Nifty should end the year with healthy 13% EPS growth. While the expectation for FY22 remains buoyant, resurgence in COVID-19 cases may pose a risk to estimates.

* Key model portfolio changes: Our model portfolio changes reflect our growing conviction in cyclical recovery and acceleration in earnings growth going ahead. We maintain our OW stance on IT, Metals, and Cement. BFSI is now marginally OW from Neutral. We have added weight to Capital Goods and made it OW. We have reduced our allocations in Telecom and Healthcare from OW to Neutral. We have maintained our Neutral stance in Consumer and Autos, while staying UW on Energy and Utilities. In BFSI, we have added Chola and SBI Card in the Diversified Financial space. We have further increased the weight in SBI given the attractive valuations and improving operating performance. In Consumer, we have re-introduced Britannia after the rating upgrade by our Consumer team. In Healthcare, we have introduced Gland Pharma, while maintaining our allocation in Divi’s Labs. In Capital Goods, we have added weight in L&T to partake in the cyclical and capex recovery at reasonable valuations. In the Mid-caps space, we have introduced Federal Bank, Whirlpool, Gujarat Gas, and LTTS.

Top picks

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

* Mid-caps: SAIL, IEX, L&T Technology, Chola Finance, Gland Pharma, Emami, Gujarat Gas, Orient Electric, Varun Beverages, Federal Bank

Key sectoral trends/highlights

* The Metals Universe should post a ~4x YoY jump in PAT, aided by a demand surge for metals globally and a strong uptrend in realizations. The Metals Universe would post the highest absolute profits in 4QFY21. Profit for our Metals Universe would exceed that for our IT Universe for the first time since the Jun’12 quarter.

* The Technology Universe is likely to deliver revenue (USD) / adjusted EBIT / PAT growth of 8%/19.7%/16.2% YoY in 4QFY21. Growth in 4QFY21 continues to be driven by a supportive demand environment and large deal wins. In Tier I IT, we expect strong sequential growth trends across companies. We expect Tier I IT to grow at 3.6% QoQ in USD terms, aided by cross-currency tailwinds. In Tier II IT, we expect COFORGE and LTTS to lead the growth trends in the Midcap IT space.

* Private Banks Universe should report 18%/110%/109% YoY growth in PPOP/PBT/PAT. The two-year profit CAGR over 4QFY19–4QFY21 should stand at 30%. The improved earnings outlook is led by a continued uptick in economic recovery and abating concerns around asset quality.

* The NBFCs under our coverage are likely to post PBT/PAT growth of 60%/66% YoY. Across product segments, MoM improvement is expected in collection efficiency (CE). Companies are also witnessing movement to the lower DPD segment from the higher DPD segment, leading to a lower provisioning requirement. Capital market players have continued to witness strong traction, led by an uptick in transactions in 4QFY21.

* PSU Banks would deliver NII/PPOP growth of 27%/15% YoY and PAT growth of ~110% YoY (on a low base). Within PSBs, we expect SBIN to report a healthy performance, supported by the resolution of stressed assets.

* The Consumer Universe is likely to report sales/EBITDA/PAT growth of 20%/27%/19% YoY (10% profit CAGR over 4QFY19–4QFY21). Ex-ITC, the Consumer Universe is expected to post 45%/41% PBT/PAT growth. Performance is expected to be led by strong buoyancy in the rural areas, good winter season demand, and continued momentum in healthcare products.

* 4QFY21 PBT for our Auto universe is expected to grow to INR147b, from INR6b in 4QFY20; PAT, on the other hand, is expected to come in at INR114b v/s loss of INR19b in 4QFY20. Tata Motors is expected to drive 80% incremental PAT for the sector. On a two-year CAGR basis (v/s 4QFY19), wholesale volumes grew strongly for Tractors (+20.3% CAGR, -10% QoQ), while PVs (+2.4% CAGR, +9.3% QoQ) and 2Ws (+0.3% CAGR, -7% QoQ) recovered to 4QFY19 levels.

* The Healthcare Universe is expected to continue its strong earnings momentum; it would grow 43% YoY, resulting in the 5th consecutive quarter of strong double-digit earnings growth YoY. 16 of the 20 companies in our Coverage Universe are expected to post YoY profit growth.

* The Cement Universe should report 34%/67%/59% YoY growth in EBITDA/PBT/PAT. EBITDA margins are likely to increase to 22.6% YoY from 20.2% YoY. On a two-year basis, the profit CAGR is expected to be 19%.

* The Oil and Gas Universe should report 23% YoY growth in PAT, led by gains from heavyweights such as ONGC and HPCL – which would post PAT growth of 207% and 78% YoY, respectively. Reliance Industries would post PAT growth of 18% YoY.

* The Consumer Durables Universe should report 62% YoY PAT growth. Revenue is likely to rise 35% YoY as demand recovery has been faster than expected. On a two-year basis, the profit CAGR is expected to be 17%.

* The Telecom Universe should report loss for the 15 th straight quarter, largely due to Vodafone Idea. Sectoral EBITDA margins are likely to expand 590bps YoY to 45.5%.

* The Capital Goods Universe should report PAT growth of 84% YoY, largely on account of BHEL’s performance. Ex-BHEL, the Capital Goods Universe should post a tepid 7% profit growth in 4QFY21. Sectoral revenue is likely to grow 20% YoY. ABB/Siemens would post PAT growth of 442%/91% YoY on a low base. L&T is likely to post 2% growth in YoY profits. BHEL is expected to post profit of INR8.2b v/s loss of 15.3b in 4QFY20.

* The Utilities Universe should see 26%/10% YoY decline in PBT/PAT, largely dragged by Coal India.

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