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Bullheaded resilience

Cyclicals leading from the front, once again

* Nifty ended CY21 with an impressive 24% YoY gain and outperformed most of the global markets, despite severe COVID-related challenges and multiple headwinds on the supply side. Resilient corporate earnings, consistently strong domestic inflows in the equities and a highly successful COVID-19 vaccination program drove the outperformance, in our view. The last quarter of CY21, albeit, did witness elevated volatility and some pull-back with the influx of a new COVID variant (Omicron) as well as selling of USD4.8b in 3QFY22. The domestic vaccination drive acquired momentum steadily to end CY21 with a mammoth 1.45b administered doses (1.48b vaccine doses administered to date). While the third wave of Covid-19 is creating havoc throughout the country and daily cases have spiked ~10x within three weeks to 87K per day from below 10K, the impact of the new variant has mostly been mild with very low hospitalization and mortality rates, so far. State governments, however, have reintroduced some restrictions on movements and leisure activities to contain the spread of Omicron. Meanwhile, the high-frequency data (such as GST, e-Invoices, Power demand, Toll collections, etc.) have consistently improved in 2HCY21. CY22 budget can be built on this economic momentum and it can act as an important catalyst amid rising hopes for reforms, asset monetization, PSU divestments and capex spending in the economy.

* On the macroeconomic front, exports continued to impress with USD300b of merchandise exports in 9MFY22. GST collections have been robust and averaged INR1.3t/month in 3QFY22. However, what had prevented further recovery was the low government spending that clocked 9% growth in 8MFY22. Meanwhile, the US Fed’s shifting focus to combat inflation by doubling the tapering and potential rate hikes in CY22 has led to heightened volatility in emerging markets. With Omicron spreading worldwide, it will be interesting to see how global Central Banks navigate monetary policies in the short term.

* On the corporate earnings front, the quarterly updates from companies have been a mixed bag. While major banks and NBFCs (HDFC Bank, IndusInd, Bajaj Finance, AU, HDFC Ltd, Federal Bank, etc.) reported strong quarterly operating updates, automobile wholesale volumes fared badly (mainly 2W and tractors) due to poor demand during the festive season. Discretionary players such as Titan witnessed continued strong consumer demand while Avenue Supermarts posted muted SSSG of 3-4%. Channel checks on consumer durables too indicate a weaker demand environment due to high prices.

* After two strong quarters of earnings growth, we expect MOFSL Universe to register another healthy quarter of 22% YoY growth in 3QFY22 on a high base of 33% YoY growth in 3QFY21. While the aggregate growth is impressive, it is narrow and driven by just four sectors – Metals, BFSI, O&G and IT. Two-thirds of the incremental growth is steered by Metals and Oil & Gas (O&G) sectors, with the Financials sector driving the remainder. However, the breadth of earnings remains weak with 42% of companies likely to post YoY decline in earnings while 38% are expected to post>15% earnings growth. The key 3QFY22 drivers are: a) Metals – likely to post 60% YoY profit growth and contribute 35%/35% to incremental MOFSL/Nifty earnings growth for 3Q, respectively; b) O&G – high Brent crude prices and demand led to higher GRM’s and volumes for OMCs; c) BFSI – higher loan growth due to improved economic activity and lower slippages leading to asset quality improvement and d) IT – strong demand backed by multi-year growth tailwinds on Cloud migration to drive topline growth. The key inhibitor is Autos – likely to drag down the earnings aggregate as it is impacted by semiconductor shortages for PVs amid demand concerns for 2W and tractors.

* Nifty/MOFSL Universe to register 26%/22% YoY profit growth in 3QFY22E: We expect 3QFY22 PBT/PAT to grow 24%/22% for the MOFSL Universe, respectively. Metals, O&G and Financials are likely to contribute 102% of incremental PAT in 3QFY22. Ex-Metals and O&G, 3QFY22 MOFSL Universe earnings are projected to record a modest 10% YoY profit growth. MOFSL Universe sales are likely to grow 29% YoY, led by higher commodity and energy prices. The Universe, ex-OMCs and Financials, is likely to post a 120bp YoY decline in operating margins to 21.7%. Nifty sales/EBITDA/PBT/ PAT should grow 29%/17%/27%/26% YoY in 3Q, respectively. Ex Metals and O&G, 3QFY22E Nifty profit would grow at 11% YoY.

* Nifty FY22E EPS has seen an upgrade of 2% to INR743 (v/s INR730), while Nifty FY23E EPS has remained almost unchanged at INR872 (v/s INR873). We introduce FY24E earnings and estimate Nifty FY24 EPS to be at INR993. Nifty’s EPS upgrade for FY22E is entirely led by Metals and O&G and dragged by Autos and Cement. India’s earning cycle has turned around after almost a decade and we expect this to sustain as the economy recovers from the aftermath of a pandemic leading to broad-based corporate earnings growth. Especially, continued improvement in asset quality in Financials, strong demand visibility in IT, market share-driven gains in Consumer Discretionary and support from Commodity sectors will drive medium-term earnings in our opinion and support the underlying rich market valuations. FY22E/FY23E earnings have remained largely stable at elevated levels throughout CY21, despite headwinds from second wave of COVID-19, supply disruptions in multiple sectors and input cost inflation. For the MOFSL Universe, we build in 37%/18%/14% earnings growth YoY for FY22E/FY23E/FY24E, respectively. We believe the market is now discounting the potential monetary tightening in CY22. Any potential restrictions due to the third wave, will pose downside risks to our estimates. Higher-thanenvisaged rate hikes can constrict the equity multiples.

* Key model portfolio changes: Our model portfolio positioning remains largely unchanged and continues to reflect the twin framework of earnings acceleration and visibility. We maintain our OW stance on BFSI, IT, Consumer, Metals and Cement. We retain Neutral positions in Auto and Healthcare and maintain our UW stance on Energy. In Consumer, we add Devyani International as we believe QSR is the largest gainer from an incremental opportunity perspective, post-COVID, in our Consumer Universe. We also introduce Indigo Paints in our model portfolio given the attractive opportunity in Paints and likely margin uptick from hereon. It is the only successful new entrant in two decades in a fiercely contested Decorative Paints market. We raise weights in Bharti Airtel given the improving underlying operating conditions for Telecom sector. We replace Gland Pharma with Apollo Hospitals in Healthcare. We are positive on AHEL based on: a) its differentiated business model in online pharmacy through its omni-channel presence, b) ramp-up in other digital services on the 24x7 platform such as diagnostics, tele-consultations and c) improving profitability of the hospital segment with new hospitals continuing their journey towards maturity. In Midcaps, we introduce: [1] Angel One: We believe it is a perfect play on: a) financialization of savings and b) digitization. It has also remained at the forefront of Technology investments that has been the key driver of its market share gains and [2] TCI: It is a long-term play, backed by: a) a diversified client base (with no reliance on anchor customers), b) improving share of highmargin Less than Truck Load (LTL) business in the Road Freight division, and c) strong presence in the high growth 3PL and Seaways segment.

Top picks

* Largecaps: ICICI Bank, SBI, Infosys, HCL Technologies, Reliance, Titan, Apollo Hospitals, Hindalco, Bharti Airtel and Larsen & Toubro.

* Midcaps: APL Apollo Tubes, Chola Finance, Indigo Paints, Devyani, TCI, Orient Electric, Solara, Ashok Leyland, and Angel One.

Key sectoral trends/highlights

* The MOFSL Technology Universe is expected to register a median USD revenue growth of 4.2% QoQ in constant currency (CC) in 3QFY22. Strong demand is likely to continue in 3Q, with Tier II players again outgrowing Tier I counterparts within our coverage universe. Ten out of 13 companies are likely to post doubledigit profit growth YoY. Among Tier I companies, Infosys would be leading the pack in terms of revenue growth (+4.8% QoQ CC) followed by HCLT (4.5% QoQ CC). Profits of MOFSL IT universe is expected to grow 12% YoY.

* The Metals Universe should post 60% YoY profit growth led by higher YoY commodity prices. Metals’ profits, albeit, are likely to fall 14% sequentially. Steel companies’ EBITDA margins would be under pressure on higher coal prices.

* The Private Banks Universe should report 10%/24%/25% YoY growth in PPOP/PBT/PAT, respectively. Banks’ business outlook continues to improve as credit growth picks up with increase in economic activities. We estimate slippages to moderate sequentially, resulting in an overall asset quality improvement – barring the mid-sized banks, which could see stable/marginal deterioration.

* Our NBFC Coverage Universe is likely to post PBT/PAT growth of 21%/22% YoY, respectively. The two-year PAT CAGR of the universe stands muted at 8%. We expect most of the Affordable Housing and Vehicle Financiers to report a decent improvement in disbursement volumes in 3QFY22 sequentially. For Vehicle Financiers, or MFIs, we estimate collection efficiency (CE) in the 95-100% range. Asset quality, however, is likely to deteriorate QoQ for most of the lenders after incorporating the RBI guidelines on NPAs.

* PSU Banks would deliver NII/PPOP/PAT growth of 1.3%/-0.9%/~66% YoY, respectively. PSBs are likely to see continued traction in operating performance, aided by modest business growth and a gradual reduction in provisions.

* The Consumer Universe is expected to report sales/EBITDA/PAT growth of 13%/8%/7% YoY, respectively. The discretionary category is likely to post strong growth aided by an upbeat festive season, pent up wedding demand and improving mobility. Rural demand, however, is set for a slowdown as indicated by higher demand for MGNREGA jobs. Among large companies, we expect APNT/PIDI to report 30%/25% YoY sales growth, respectively, aided by sharp price hikes taken to counter the steep rise in material cost. Both Alcobev stocks under our coverage – UBBL and UNSP – are likely to post healthy topline growth of 28% and 21%, respectively.

* MOFSL Autos Universe is projected to report 47% YoY aggregate profit decline as weak demand and supply-side issues weigh on earnings. While supply-side issues affected premium 2W, PV and MHCV sales, lower demand impacted 2W volumes. The EBITDA margin for our Autos Universe is likely to contract 370bp YoY to 10.7% in 3QFY22E, dragged down by higher commodity prices.

* Our Healthcare Universe earnings are likely to moderate and come in flat YoY, lowest in 15 quarters. Intensified competitive pressure on the US business is anticipated to drag down the overall 3QFY22 sector performance. Of the 23 companies in our Coverage Universe, 11 are expected to report YoY profit decline. Apollo Hospitals/Gland Pharma/Divis/Dr. Reddy’s are likely to post 80%/55%/41%/40% YoY profit growth, respectively.

* The MOFSL Cement Universe should report EBITDA/PBT/PAT decline of 15%/18%/18%, respectively. Aggregate EBITDA margin is likely to contract 470bp YoY to 18.7%. The rise in imported coal and petcoke prices would impact the margins of cement companies, with all of them likely to post YoY profit decline barring Grasim.

* The O&G Universe is anticipated to report a sales/EBITDA/PAT growth of 64%/ 42%/38% YoY, respectively. Higher Brent crude prices, stronger demand and improved GRMs are likely to support earnings. CGD margins will be impacted by higher spot LNG prices during 3QFY22E, despite steep price hikes by companies.

* The Consumer Durables Universe should report a sales/EBITDA/PAT growth of 12%/4%/4% YoY, respectively. A large portion of revenue growth is inflation led, while volume growth is projected to be muted across categories. There were no major surprises in the festive season, and the high base of last year is likely to limit volume growth in 3QFY22E.

* The Telecom Universe should report loss for the 18 th consecutive quarter, largely led by Vodafone Idea. However, the sector’s EBITDA margin is likely to improve 270bp to 46% in 3QFY22E, aided by tariff hikes.

* The Capital Goods Universe should report a 6% YoY profit growth in 3QFY22E. BEL, Engineers India, ABB and Siemens are likely to report profit growth of 66%, 30%, 15% and 13% YoY, respectively. Conversely, L&T is anticipated to post a profit decline of 6% YoY.

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