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Braving the storm!

India Shining amidst a challenging backdrop

* India has emerged as a shining star in CY22 with healthy outperformance amid varied global headwinds on macros, inflation, rates, currency and geopolitics. While most global equity markets are down 20-25% in YTD’CY22, India is flat and steady (in local currency).

* This outperformance is driven by several key factors such as: a) strong corporate earnings growth over the last two years (Nifty profits up 70% during FY20-22) and expectations of a healthy performance over FY22-24; b) resilient domestic equities inflow (YTD DII equity inflow of USD29b) and c) deft macroeconomic management by the RBI and the government that has helped India stand out in an otherwise volatile and panic-stricken world.

* The 2QFY23E corporate earnings will be reported amid this volatile environment.

2QFY23E earnings highlights

* We expect MOFSL earnings to decline 17% while Nifty earnings to remain flat YoY in 2QFY23. The aggregate performance is adversely impacted by a sharp drag from global commodities. Excluding Metals and O&G, we expect MOFSL and Nifty to post a solid 30% earnings growth each, fueled by BFSI and Autos. Apart from Metals & O&G, the earnings will be dragged by Cement and Healthcare.

* Sectors focused on domestic consumption/investments are likely to outperform the sectors dependent on global demand/cyclicals/commodities.

* Margins are projected to decline 310bp YoY for MOFSL Universe (ex-OMCs). With softening of commodity prices, 2HFY23 should see a good rebound.

* We have reduced our FY23 Nifty EPS estimate by 3% to INR817 (earlier: INR843), driven by cuts in Metals and O&G earnings. We now expect the Nifty EPS to grow 11%/21% in FY23/FY24, respectively. Financials alone are likely to account for two-thirds of the incremental FY23E earnings in Nifty.

Volatility to remain high; trends to emerge better

* Going forward, as we enter the festive season, we expect domestic demand recovery to continue and propel discretionary consumption in India after a pandemic-induced hiatus of two years.

* Coordinated rate hike cycle across the globe is now moving closer towards its final leg, in our view, as we expect inflation to peak barring a major unforeseen spike-up in geopolitical dynamics.

* We expect the RBI to hike repo rate by another 60bp over the next two MPC meetings with terminal repo rate at 6.5%. Commodity costs have moderated since July’22 and augur well for a commodity consumer such as India. That said, given the multiple moving parts (rates, currency, bonds, and geopolitics), we expect volatility to remain elevated but directionally, we believe, trends will get better.

* In this context, we expect domestic equity inflows to remain robust and at the margin, as global climate gets better, FII selling can moderate too.

Valuations at LPA but premium v/s EM at a new high

* Nifty is now trading at a P/E of 18.8x 12-month forward earnings, in line with its long period averages (LPA). However, the premium v/s emerging markets has expanded notably (MSCI India trading at a premium of 141% v/s MSCI EM) given the relative strength in corporate earnings as well as better macro management (rates/currency/fiscal spending) by the RBI/government, in our view.

* Valuations are at a multi-year high premium over EM countries and thus could induce volatility backed by global developments. That said, the context has changed meaningfully and thus the relevance of looking at relative country valuations on the lens of LPA has diminished.

* Our preferred ideas are a combination of companies: a) which can benefit from consistent earnings growth, b) which can address bigger market size with longterm growth runway and favorable industry structure as well as some inherent moats and c) where valuations have corrected meaningfully and offer an attractive risk-reward equation.

Model portfolio

* We maintain our OW stance on BFSI, AUTO, Consumer & IT and UW stance on Energy, Pharma and Utilities. In Financials, we are further raising our weights in ICICI Bank and IndusInd Bank while we reintroduce Federal Bank. IndusInd’s business growth is likely to accelerate as key businesses, viz. Vehicle and MFI, undergo recovery. Federal Bank’s loan growth is gaining momentum while robust liability franchise along with high mix of retail deposits remains a key enabler. In Non-Lending Financials, we are adding CAMS to the model portfolio. CAMS is a leader with 70% market share in the duopoly industry of MF RTA.

* CONSUMPTION: We maintain our OW stance and further raise weights in ITC and add Metro Brands while keeping weights intact in HUL, Titan, JUBI and GCPL. Metro offers a long runway for growth and has demonstrated ability to run an efficient footwear ‘Retail’ network.

* INVESTMENTS/CAPEX: We further raise our weights in L&T, Ultratech and Macrotech by 100bp each as they would benefit from the incipient capex revival. In Autos, we are adding Motherson Sumi Wiring, the market leader in the Indian wiring harness industry. The company offers a linear growth story as it leverages on structural trends in the automotive market to drive strong growth, sustain high capital efficiency (>40%) and high dividend payout.

* We replace Hindalco with Coal India. Energy crisis in Europe has spiked global thermal coal prices as Europe increased thermal coal purchases manifold in the last six months. In Midcaps, we are adding Mahindra Lifespace (MLDL) and Zee. Mahindra group’s renewed vigor for growth and new management's focused business development strategy would enable continued scale in MLDL. In Zee, we see the potential for value accretion given the high ROCE and growing linear business as well as strong wherewithal in the OTT business.

* We have carried out the aforementioned additions/weight increases by reducing weights in Energy and Healthcare.

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