Siddhartha Khemka, Head, Retail Research, Motilal Oswal Financial Services expects the market to remain rangebound in the near term, with bouts of high volatility.
A lot of sector and stock-specific action is likely to continue, he says and asks investors to take advantage of the volatility to pick quality stocks as the medium-term thesis remains unchanged. The buy-on-dip strategy will work the best in this kind of market for long-term investors, says the analyst.
In an interview to Moneycontrol’s Sunil Shankar Matkar, Khemka says once vaccination picks up and daily cases subside the narrative will shift from COVID-19 to growth, cyclical recovery and fundamentals. Edited excerpts:
Is it still a buy-on-dips market and why?
Equity markets have been rangebound for the last three months due to the resurgence of COVID pandemic and increased restrictions in various states. Also, the rising bond yields, commodity prices and risk of inflation are impacting sentiment.
While the market is looking beyond the short-term impact, if the pandemic doesn’t subside soon, it opens up downside risks. Q4FY21 earnings are progressing largely in line with our expectations but earnings downgrades are now rising, given the widespread restrictions in various states, which is hurting mobility and economic recovery.
Global commodity prices have been on the rise over the past few months. While this has helped few sectors like metals & sugar to report record profits, it could impact margins as raw material costs for various sectors increase. It also raises a risk of high inflation, leading to higher interest rates, which could be negative for equities.
The Nifty currently trades at a 12-month forward P/E of 20x, around 7 percent above its historical average of 18.8x. However, the market cap-to-GDP ratio is at a new year-end high of 106 percent.
We expect that the overall market may continue to remain rangebound in the near term, with bouts of high volatility. However, a lot of sector and stock-specific action is likely to continue. Hence, we would recommend investors to take advantage of this volatility as the medium-term thesis remains unchanged. Once the availability and the pace of vaccination picks-up and daily cases start subsiding, we expect the narrative to gradually shift from COVID-19 and restrictions back to growth, cyclical recovery and fundamentals. Hence, we expect buy-on-dip strategy would work the best in this kind of market for long-term investors.
India has been reporting the highest daily cases in the world. Are you worried about your portfolio and do you think it is COVID-proof?
The advent of the second COVID wave has dented sentiments and weakened FY22 earnings estimates visibility. With multiple states entering into extended lockdowns and restrictions, we see downside risks to our FY22 earnings estimates. Q4FY21 earnings are progressing largely in line with our expectations but management commentaries in BFSI/consumer/auto have turned cautious even as it remained upbeat in IT and metals. The interplay of the resurgence in COVID cases and the pace of vaccination would decide the trajectory of economic recovery going forward. GST collections continue to rise and hit a record high of Rs 1.41 lakh crore in April, the seventh consecutive month of collections above Rs 1 lakh crore mark, pointing to strong economic activities before the second wave of the pandemic.
While the index has corrected a modest 6 percent from its recent highs, many stocks have undergone a chunky 15-20 percent decline. We believe this correction is a buying opportunity and it doesn’t change the medium-term thesis of recovery in corporate earnings, which would be led by underlying macro pick-up with the focus on the investment cycle. We are positive on IT, metals, and pharma. The IT sector is likely to sustain double-digit topline growth in the medium term, led by larger deals on a full-scale digital transformation, projects focused on increased workplace management, and higher spend on cloud migration by large corporates. The healthcare and pharma space will continue to be in focus as a sharp rise in COVID-19 cases is leading to increased demand for various medicines, including vaccine and medical services.
The continuing surge in global demand and tightness in supply due to supply-side issues and production curbs in China would continue to support metal prices.
On the other hand, BFSI could be a loser if localised restrictions and lockdown continue for a prolonged time as it might adversely affect the collection efficiency and thus, the asset-quality stress may aggravate further.
Regional lockdowns and uncertainties due to the second wave of COVID-19 have already led to a slowdown in the demand momentum of automobiles in April 2021. This is likely to continue till restrictions stay. Retail is another sector for which the second wave has displaced recovery trends. Travel, tourism, leisure and entertainment continue to remain affected.
Thus from the next 12 months’ perspective, apart from being positive on IT and healthcare, we also prefer some cyclicals within metals, cement, capital goods, including durables, oil & gas and PSU space.
Which are the ‘COVID-proof’ sectors that one should consider for investment?
As highlighted earlier, we believe that two key sectors— IT & healthcare—could help create a COVID proof portfolio.
IT: Recent commentary from both largecap and midcap IT Services companies point to continued optimism on their CY21 growth outlook, even after adjusting for a low base YoY. A healthy order pipeline, large deal signings, and the absence of headwinds should drive the outperformance of the sector. Multiple mega-deal wins in cloud and captive should add incremental growth to an already buoyant organic growth momentum.
IT offers relative earnings comfort coupled with solid balance sheet, cash flow, RoE and payout metrics in such current volatile and disruptive times.
Healthcare and pharma: Increasing traction in CRAMS, better growth trajectory in DF, increased capacity utilisation, strong ANDA pipeline provide a better outlook for the pharma sector and we feel the overall sector would deliver good returns from short to medium-term perspective.
Strong brands have been gaining market share due to the inability of small players to supply medicines. The ANDA pipeline remains healthy, providing growth avenues going forward. The vaccine is also providing new opportunities.
The healthcare universe is expected to continue its strong earnings momentum; it would grow around 40 percent YoY, resulting in the fifth consecutive quarter of strong double-digit earnings growth YoY. Hence we expect the healthcare sector to continue to deliver healthy returns for investors from a medium to long-term perspective.
What is your take on the March quarter earnings? What are the hits and misses?
Twenty-seven Nifty companies (comprising 75 percent of the index weight) had announced their results as of May 10, 2021. They have reported sales, EBITDA, and PAT at 17 percent, 25 percent and 50 percent YoY (versus estimates 17 percent, 23 percent and 49 percent YoY) respectively. Eight of them have beaten our PAT expectations, while nine have missed. On the EBITDA front, seven have exceeded, seven have missed, and 13 have met our expectations.
The Q4FY21 earnings season has maintained the momentum of the Q3FY21 results season. It has been another strong quarter, aided by the deflated base of Q4FY20 and healthy demand recovery for the large part of Q4FY21, as attested by high-frequency indicators.
Among these 27 companies, Axis Bank, SBI Life Insurance, HUL, Hero MotoCorp, and Reliance Industries have exceeded our profit estimates. On the flip side, Tata Consumer, Maruti Suzuki, Britannia Industries, HCL Technologies and Kotak Mahindra Bank have missed our expectations.
Key drivers of the Q4FY21 performance:
1 Metals: As expected, Tata Steel reported strong margins in India Steel operations.
2 Private banks and NBFCs: The healthy performance was attributable to moderation in slippages and improved disbursements/collection efficiency. However, management sounded cautious about collection efficiencies/asset quality ahead.
3 IT: It has continued to post strong performance, with robust deal wins and order book.
All rating agencies and experts lowered the economic growth target for FY22, citing the second coronavirus wave. Have you also lowered the FY22 target?
As of now, we expect India’s overall GDP to have declined by 8 percent in FY21 and see a recovery in FY22 to a growth of around 11 percent. However, the severity of the second wave poses downside risks to our estimates.
A sharp spike in the second wave of COVID-19 has led to increased restrictions in various states, impacting the overall economic activities. This is likely to continue till cases stabilise and vaccination picks up. India is going through a resurgent second wave of COVID-19 pandemic as the daily new confirmed cases have shot up from 10,000-11,000 in the first half of February to around 2 lakh at the start of April 2021 to around 4 lakh by April-end. To contain the pandemic, several states have announced localised restrictions or lockdown over the last few weeks and have extended it further where the need was.
Key government authorities and policymakers are also pushing the Centre for the strongest national steps, including curtailing economic activity to contain the spike in COVID-19 cases in the country. The shortage of vaccines has further aggregated the situation and dented sentiments.
We expect these restrictive measures to impact near-term economic recovery till cases stabilize. However, once the vaccination drive starts in full swing, as the approvals for more vaccines are now in place, we expect the economy to stabilise and return to its growth path.
What is your take on the banking and financials segment after the RBI announced several liquidity measures to support the economy and business that hit by the second wave?
The RBI recently announced various relief measures on account of the resurgence in COVID-19 cases and subsequent lockdown announced by various states. Key measures are: a) extension of loan restructuring for individuals, small businesses, and MSMEs having an aggregate exposure up to Rs 25 crore and were standard as on March 31, 2021, b) utilization of floating provision buffer by Banks towards loan loss provisions, c) on-tap special liquidity window of Rs 50,000 crore to enable Banks to build a ‘COVID-19 loan book’, and d) liquidity facility of Rs 10,000 crore to SFBs for fresh lending up to Rs 10 lakh per borrower.
On the asset quality front, an extension of the restructuring scheme is a step in the right direction to help most borrowers affected by the COVID-19 pandemic rather than announcing a blanket moratorium, which is not required for all borrowers and comes with other complexities (interest waiver, moral hazard, operational challenges, etc.).
We note that the bulk of the slippages in FY21 have come from retail and MSMEs. The higher restructuring was also availed by both these segments. Among banks, large ones have seen sub-1 percent restructuring of loans, while midsize private banks/SFBs have seen higher loan restructuring.
On the liquidity front, the special liquidity window announced to the tune of Rs 10,000 crore for Small Finance Banks (SFBs) constitutes around 10 percent of its current loan portfolio, which is a sizable lending opportunity. This will provide strong impetus to SFBs for on-lending, given the sizeable differential in funding cost.
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