Strategy : A barbell rally; ditch some deadweights by Kotak Institutional Equities
A barbell rally; ditch some deadweights
The recent rally in the market seems to be a combination of (1) fundamentals and (2) sentiment. On the one hand, the rally in BFSI stocks has driven the rally in large-cap. indices while the revival in ‘narrative’ stocks has largely driven the rally in mid- and small-cap. indices. We do not find value in most parts of the market and earnings have seen downgrades in the past fortnight.
Different stocks for different folks
The rally of the past fortnight seems to be an odd mix of (1) fundamentals and (2) sentiment; see Exhibits 1-2 for performance of various indices and sectors over different periods of time. We can only speculate on the reasons for this odd rally—(1) some investors may have found value in BFSI stocks, (2) some may have rediscovered value in ‘narrative’ stocks, (3) others may have taken solace from reducing FPI selling in the past month and inflows in the past week (see Exhibit 3) and (4) FPIs may have returned to EMs with the ‘Trump’ trade disappointing (see Exhibit 4 for performance of global markets).
Banks, NBFCs and insurance drove large-cap. rally
The BFSI sector has been a large contributor to the rally of the large-cap. indices in the past month (see Exhibit 5 for contribution by key stocks in the MSCI India Index). This is despite Street concerns around (1) moderation in credit growth, (2) compression in NIMs, especially of private banks, on lower policy rates and (3) higher credit costs. Valuations still seem reasonable (see Exhibits 6-7), although the scope for re-rating is lower in Tier-1 banks and NBFCs. We struggle to find value in most other sectors and stocks (see Exhibits 8-11) and the market also feels the same way given the muted performance of the sectors.
‘Narrative’ stocks drove mid-cap. rally
‘Narrative’ stocks have seen a revival following the sharp correction in their stock prices in the previous 6-9 months (see Exhibit 12) and have been one of the key contributors to the rebound in mid- and small-cap. indices (see Exhibits 13-14). We have long struggled with the disconnect between the market caps and the fundamentals of the ‘narrative’ companies (see Exhibit 15). As an example, IRFC (see Exhibit 16 for key financials) trades at 3X FY2026E BV and 25X FY2026E EPS (extrapolating recent quarterly results), while BOB, CBK, PNB and UNBK trade at 0.8X-0.9X FY2026E BV and 5-7X FY2026E EPS.
Earnings have seen some downgrades meanwhile
We have seen moderate cuts to earnings estimates (see Exhibit 17) over the past two weeks with the cuts stemming from (1) consumer staples on continued weak demand conditions, (2) IT services (on demand uncertainty) and (3) oil, gas & consumable fuels (on lower crude oil price assumptions). We would not rule out further earnings downgrades over the next few months. 4QFY25 quarterly operating updates from companies over the next few days will be critical apart from 4QFY25 results. We expect net profits of the Nifty-50 Index to grow 13.2% in FY2026 and 14.4% in FY2027 (see Exhibits 18-19)
Recommended portfolio: Minor changes
We add Dr Lal Pathlabs (DLPL; 150 bps) to our recommended portfolio and reduce weight on Indigo Aviation (40 bps to 150 bps) and Zomato (110 bps to 150 bps). DLPL stock is trading at 41X FY2026E EPS, which seems reasonable in the context of its strong revenue and earnings growth prospects. We expect FY2026E and FY2027E EPS to grow 14% and 14%. The stock is down 25% in the past six months and 14% in the past three.
The company has withstood new competition remarkably well and is poised to lead the growth in demand for better healthcare services. We reduce weight on our preferred discretionary consumption plays (INDIGO and ZOMATO) on (1) growing sings of a possible slowdown in high-end consumption demand and (2) sector-specific issues in the form of continued aggressive competition in the quick commerce space for Zomato.
Exhibit 20 is our recommended portfolio. We have a combined portfolio now for large-caps and midcaps. We still do not have a mid-cap. portfolio, as we do not find much value in most parts of the midcap. space other than the BFSI sector. We have plentiful exposure to the BFSI sector through the largecap. names. We have added DLPL to the hitherto large-cap. portfolio given more options from the midcap. space and limited options in the large-cap. space.
Indian indices have given decent returns over the past one month
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