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Below The Monthly Equity View – Sept 23 by George Thomas, Fund Manager – Equity Quantum Mutual Fund

Equity Outlook - September 2023

The S&P BSE Sensex declined by 2.3% in the month of August. Weak monsoon, spike in inflation and US yields hardening led to the marginal correction. S&P BSE Midcap Index & S&P BSE Small cap Index increased by 2.7% and 6.3% respectively. The divergence in performance is also a reflection of institutional flows into respective categories. Small and mid cap biased domestic funds has been receiving higher inflows on the back of recent superior performance of these categories.

IT, consumer durable, telecom and capital goods sectoral indices recorded positive returns. Likely revival in private capex along with the current momentum of infra spends benefited capital goods sector. Relatively attractive valuations and potential improvement in operating parameters led to gains in the IT Sector. Hopes of a demand revival with the advent of festive season translated to gains in consumer durables sectors. Oil & Gas, Banks, FMCG and Auto sectoral indices recorded negative returns. Market is cautious about a probable burden on OMCs (Oil Marketing Companies) to absorb some portion of potential fuel subsidies ahead of upcoming elections. Banks have seen a moderation in spreads as the cost of funds is recalibrated to the prevailing rates. We remain positive on the banking sector due to reasonable credit growth and favourable asset quality trends. Sectors linked to rural consumption have seen some pressure, triggered by spike in inflation and sub-par monsoon season.

Most of the economic activity indicators remained reasonable for the recent period. Spike in CPI inflation and shortfall in monsoon is worrying investors. While shortfall and uneven distribution of rains could have a bearing on spike in food price inflation, part of it could be speculative. The speculative part of the inflation can see a quick moderation. The average reservoir level across the country is 9% lower than the average of last 10 years. In case the monsoon doesn’t revive in the next few months, this could have an implication on sowing and food production.

In terms of flows, FPI flows were positive for the sixth successive month with inflows of USD 1.5bn. Domestic institutional investors were buyers to the tune of USD 1.3 bn. Valuation within the large cap bucket remain marginally higher than long term average whereas valuation within mid/small caps remains elevated given the sharp rally in the past few months. The domestic flows have been particularly strong in the Mid/Small category for the past several months. Hence, caution is warranted within this bucket. 

Quantum Long Term Equity Value Fund (QLTEVF) saw a decline of 0.9% in its NAV in the month of August 2023; Tier-I benchmark S&P BSE 500 and Tier-II Benchmark S&P BSE 200 declined by 0.6% and 1.3% respectively. QLTEVF performance is reflective of the performance trend observed in large cap stocks which has a share of more than 80% in its portfolio. Financials, Consumer Discretionary and      Industrials negatively contributed to the performance. Health care, Energy and IT positively contributed to the performance. The portfolio is valued at 13.5x consensus earnings vs. the S&P BSE Sensex valuations of 17.6x based on FY25E consensus earnings. While the valuation is at a discount of 23%, annual earnings growth over the next two years based on consensus estimates is at discount of only 8% compared to Sensex. These characteristics are indicative of the value style. Cash in the scheme stood at 5.5% as of month end.

Pockets of Earnings Resilience Remain Amid Range Bound Markets

Though there are excesses in certain pockets of markets, few names with potential of earnings resilience are available at attractive valuations. The fund has recently added a position in a cement name. The player has certain cost improvement levers compared to peers, which could lead to superior earnings growth compared to the sector. The balance sheet strength is likely to improve as the earnings recovery gains steam. Though sector utilisation doesn’t point to a case of high pricing growth, a consolidated market could limit the chances of a deterioration in the pricing environment.

Another sector which is likely to see an improvement in operating metrics is two wheelers where the fund has an overweight position. The following table shows change in key metrics of prominent two-wheeler companies over FY19-FY23. Most companies have passed on the cost inflation which is evident in high growth of unit realization. Unit profitability (Refer EBITDA Per Vehicle column) has improved albeit at a slower pace, despite a decline in utilization.  Sales volume has understandably declined for most names barring the premium segment where sensitivity to price hikes is relatively lower.

There are couple of factors which could support companies to harness operating leverage in the medium term:

• Input cost inflation is likely to be contained in the medium term leading to limited price hikes and an improvement in affordability.
• An improvement in utilization, as volume growth comes back , can aid operating leverage (Growth in profitability to be higher than revenue growth).

Key Metrics of Two-Wheeler Companies- Good chance for a pick-up in operating leverage

Though factors mentioned in the initial part could keep the markets range bound in the near term, a reasonable earnings growth trajectory is likely to prevent a material correction. Investors with a long-term horizon may consider investing in a staggered manner to benefit from persistence of the current earnings upcycle

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