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Gaining strength

Macro and micro tangoing well; Metals to drive 2QFY22

* Markets continued their upward momentum in 2QFY22 – the Nifty crossed the 17k mark and the Sensex touched the 60k milestone – buoyed by the decline in COVID cases, a significant pickup in the pace of vaccination, and the consequent sharp recovery in economic activity. India ramped up its vaccine distribution, administering more than 920m vaccine doses cumulatively. The pace of vaccination, more importantly, averaged 7.9m doses/day in Sep’21 (up from 4m doses/day in Jun’21). The country witnessed the third consecutive year of normal monsoon, with the southwest monsoon season ending 0.7% short of the long-period average.

Macroeconomic trends saw good recovery, with highfrequency indicators (GST collections, e-way bills, PMI readings, fuel demand) improving month-on-month. Exports have emerged as a growth engine – India reported more than USD100b worth of exports in 2QFY22, the highest ever in a single quarter. Non-oil, non-gold imports grew 40% YoY to USD88.7b in 2QFY22, indicating strong domestic demand. The normal monsoon is likely to further spur rural demand, and with the government balance sheet in good stead, we expect the government to press the fiscal pedal to drive growth in 2HFY22.

* At our recently concluded 17th MOFSL Annual Global Investor Conference – wherein 18 CEOs presented in the CEO Track session and 151 companies participated in investor meetings – corporate commentaries remained singularly upbeat across sectors, with managements across sectors (barring Auto) alluding to demand recovery well ahead of expectations. This is well-corroborated by the quarter-end updates from various corporates (such as HDFC Bank, Bajaj Finance, IndusInd Bank, Titan, Marico, DMart, and Sobha).

Amid this buoyant demand backdrop and positive sentiment, rising crude and energy prices (coupled with global supply disruptions in some commodities) are acting as near-term headwinds to margins. Meanwhile, the narrative around the US Fed tapering and normalization of surplus liquidity and interest rates in India is getting stronger. This would remain a key monitorable and could pose some headwinds to equity valuations, given the sharp re-rating witnessed post Mar’20. Therefore, earnings delivery, against elevated expectations, becomes crucial, in our view.

* After commencing 1QFY22 with a bang (123% YoY growth on a low base), we expect the MOFSL Universe to post 27% YoY earnings growth in 2QFY22 on a normalized base (20% growth in 2QFY21). Even on a two-year basis, we expect a 23% CAGR. The key drivers of 2Q performance are a) Metals – it is expected to post 3.4x YoY profit growth and contribute 70%/60% to incremental MOFSL/Nifty earnings growth for the quarter; b) IT – the strong performance would be led by a robust deal environment, leading to the expectation of median revenue growth of 5.4% CC QoQ in 2QFY22; c) BFSI – the pickup in economic activity is resulting in healthy demand in the Retail and SME segment – this is despite muted growth in corporate credit activity; and d) Autos – the segment is likely to drag down the earnings aggregate as the semi-conductor shortage continues to hurt supplies in PVs / premium 2Ws, with 2Ws also seeing slower demand recovery.

* Nifty / MOFSL Universe to see 25%/27% YoY profit growth in 2QFY22E: We expect PBT/PAT to grow 32%/27% for the MOFSL Universe in 2QFY22. Even on a two-year basis, MOFSL PBT/PAT is likely to see a CAGR of 26%/23%. Ex-Metals, 2QFY22 MOFSL Universe earnings are expected to post modest 9% YoY growth and 11% CAGR over 2QFY20–2QFY22E. MOFSL Universe sales are likely to grow 25% YoY, led by demand revival and higher commodity prices.

Metals, Technology, and Private Banks would contribute 86% to incremental PAT growth YoY. Nifty sales/EBITDA/PBT/PAT should grow 25%/20%/31%/25% YoY in 2QFY22E. Over 2QFY20–2QFY22E, the Nifty should post a sales/EBITDA/PBT/PAT CAGR of 8%/14%/22%/21%. The MOFSL Universe, ex-OMCs and Financials, is expected to post an 80bp YoY expansion in operating margins to 22.3%.

* Minor tweak in Nifty FY22 EPS: Nifty FY22E EPS estimates have seen minor tweaking to INR730 (prior: INR732) and INR874 (prior: INR865) for FY22 and FY23, respectively. FY22 earnings for Oil & Gas have seen upgrades on the back of higher crude and gas prices, offset by downgrades in Autos. Earnings estimates for FY22/FY23 have remained largely stable at elevated levels for the past two quarters, indicating strong earnings visibility.

Metals, BFSI, and Oil & Gas are likely to account for 34%, 25%, and 13% of the total incremental earnings, respectively, in FY22E. For the MOFSL Universe, we build in chunky 35%/21% earnings growth for FY22/FY23. The market faces possible headwinds from rising commodity and energy (oil, coal, natural gas, etc.) prices, global supply-side disruption, and potentially unfavorable bond-equity yield dynamics.

* Key model portfolio changes: Our model portfolio construction continues to reflect our growing conviction in accelerating the earnings trajectory, led by cyclicals. We maintain our OW stance on BFSI, IT, Metals, Cement, and Capital Goods. We raise Consumer from Neutral to Overweight given the improving underlying demand backdrop. We retain Neutral positions in Auto and Healthcare. While we maintain our UW stance on Energy, we have reduced the extent of the UW position. In BFSI, we add IndusInd Bank, which is showing strong traction in advances. The liability franchise is improving consistently, and we expect growth momentum to accelerate as critical segments such as CVs and MFI see total normalization. In Consumer, we add Jubilant FoodWorks as we believe QSR is the largest gainer from an incremental opportunity perspective post-COVID in our Consumer Universe.

In our view, JUBI – with its deliverybased high-ROCE business model and technology that is far superior to that of peers – has the strongest engines to capitalize on this opportunity. In Midcaps, we introduce APL Apollo Tubes. Steady capacity additions, an increase in penetration, and gains from unorganized players are expected to improve market share from current levels (~50%). We expect a very strong 20%/35% revenue/PAT CAGR over FY21–24E, led by increasing EBITDA/MT and the higher sweating of assets.

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