Daily Voice | Valuations offer some room to accommodate with financials, industrials that remain relatively cheaper: Shibani Kurian of Kotak AMC

Market Outlook

Shibani Sircar Kurian, Senior EVP & Head- Equity Research at Kotak Mahindra Asset Management Company, feels banking sector earnings growth trajectory is likely to continue to improve from here on.

“Asset quality pressures have been abating even in the retail segment which had seen some deterioration post the second Covid wave,” she says in an interview to Moneycontrol.

“While India’s aggregate valuations remain at elevated levels and at a premium to the region, at the sector level valuations offer some room to accommodate, with Financials, Industrials etc. remaining relatively cheaper,” says Shibani who has close to 17 years of experience in the Indian equity markets.

Q: We are at the fag end of September quarter earnings season. What is your reading on the earnings and have you seen more upgrades than downgrades?

The Q2FY22 earnings season is underway. The Q2FY22 earnings so far has been largely in line with consensus expectations as the companies benefited from a) strong revenue growth (eg.- in the technology sector), b) steady recovery in loan growth (seen in the case of private sector banks), as well recovery and upgrade in the asset quality of most private sector banks, c) higher commodity prices and volume growth in the energy and metal sectors, and d) opening up of the economy which boosted consumer and retail growth. On the other hand, due to higher commodity and inputs costs, EBITDA margin (ex-financials) have seen some degree of pressure which was partly offset by the higher top line growth on the back of strong demand recovery. Overall so far, the consensus Nifty EPS for FY22 and FY23 remains largely unchanged.

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Q: Have you seen any big risk pointed out by the September quarter earnings season? What are the other risk factors that one has to aware of now?

One of the key risks to quarterly estimates is that of higher input costs and commodity prices on margins. Due to higher commodity and input costs, EBITDA margins (ex-financials) have seen some degree of pressure. A key factor needed to offset the margin pressure is the continued growth momentum. Further pricing power is also a key variable.

By and large management commentary post the quarterly earnings, seemed to suggest that companies do have the ability in the current demand environment to pass on some of the higher input costs and thereby protect margins. There would, however, be a lead and lag in the same.

The other key risk to earnings and equity markets includes the trajectory of global inflation, policy response of global central bankers and any credit related event in China.

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Q: Have you spotted sectors/themes that one has to consider for portfolio now or continue holding in portfolio, after the September quarter earnings season?

Some of the key themes and sectoral trends which we are positive on include:

The theme of consolidation and market share gains within sectors and sub sectors continues to play out. We seek to focus on sectoral leaders, companies which are gaining market share in their sectors or sub sectors; the shift from the unorganised to the organized continues and company balance sheets by and large are stronger now than a few years ago.

Some of the sectors where we are positive includes :

1) Domestic cyclicals: Capital goods, cement, infrastructure, and banks (especially private sector and large PSU banks)

a) Domestic capex cycle is likely to improve from here on: Corporates are sitting on cash as profitability has picked up in the post pandemic period. They are looking to invest in order to capture available opportunities of increased government spending, divestment, consumer demand revival and export market.

b) PLI (production-linked incentive) scheme and revival of real estate and housing will likely make a positive impact on the investment and manufacturing cycle.

2) Real estate and allied home building sectors (Tiles, pipes, cement, ceramics, consumer durables etc): the improvement in real estate demand is being boosted by:

a) Interest rates on retail home loans are at an all-time low
b) Low interest rates and improved affordability has resulted in spurring demand in residential real estate

c) Policy initiatives have been supportive including implementation of RERA and the stamp duty cuts.

3) Supply chain shifts away from China is another dominant theme –the sectors which benefit include chemicals and consumer durables etc.

4) Opportunities in the Digital space – IT services, fintech etc.

Q: Do you expect strong earnings growth in banking sector from third quarter (Q3FY22) onwards, considering the current credit growth trend and asset quality factor?

Banking sector earnings growth trajectory is likely to continue to improve from here on. Asset quality pressures have been abating even in the retail segment which had seen some deterioration post the second Covid wave. The opening up of the economy and improvement in activity has resulted in a sharp improvement in collection efficiency across most segments. Corporate asset quality has been by and large under control with focus of corporate India on strengthening their balance sheets. Recoveries under NCLT are also expected to pick up.

The key factor apart from credit costs which would be a differentiator among banks and their earnings growth going forward in our view is the level of credit growth. While the system level credit growth has been stagnant at around 6 percent, a few banks especially the large private sector banks have been growing faster leading to continued market share gains. The growth in the retail and MSME segments are showing signs of improvement and these banks are leveraging technology to grow faster while ensuring risk assessment remains under control. Herein, banks which have a strong liability franchise and capital positions are better placed to capture the opportunities on the lending side.

Q: Do you expect the market to consolidate now, till the Union Budget 2022 and state elections (Punjab and UP)?

With earning growth likely to remain healthy, in the medium to long term, we remain constructive on Indian equities. Corporate balance sheets have improved significantly with lower debt as well as improvement in cash flows. Demand momentum remains strong aiding the underlying earnings growth momentum. Profits to GDP ratio appear to have significant room for improvement over the next few years.

In the near term, despite India having amongst the highest earnings outlook in the region, given the valuations at the current level in the near term, it is possible that we witness some consolidation on the back of rich valuations, and a strong IPO pipeline.

We do believe that the market is fast turning into a stock focused market. However, we also recognise that while India’s aggregate valuations remain at elevated levels and at a premium to the region, at the sector level valuations offer some room to accommodate, with Financials, Industrials etc. remaining relatively cheaper.

Q: Do you think macros & micros both are firing on all cylinders?

Economic activity and macro indicators continued to improve, boosted by the festive season as seen in the high frequency economic data. The number of active Covid cases have now returned to levels seen before the start of the second Covid wave. As of November 2, 2021, 24.9 percent of the population had received both doses of the vaccine while 54.7 percent had received at least one dose of the vaccine.

In terms of most high frequency economics and macro indicators, improvement in demand trends is visible. Manufacturing PMI improved to 55.9 in October 2021, up from 52.7 in September 2021, supported by strong order inflow although employment generation remained under some pressure. Services PMI accelerated to 58.4 in October (versus 55.2 in September) marking the highest reading since April 2011. E-way bill generation was up 8.2 percent MoM in October 2021, supported by festive demand.

GST (Goods and service Tax) collection in October 2021 stood at Rs 1.3 lakh crore (around $ 17.38 billion) – the second highest level since inception and up by 23.8 percent YoY and 11.2 percent MoM. Exports were up by 5 percent MoM and 42.3 percent YoY in October 2021 while non-oil, non-gold imports were up by 40.1 percent YoY and 5.9 percent MoM. Bank credit growth stood at 6.5 percent YoY. Mobility indicators improved as well. Air passenger traffic for Sept is tracking at 102 percent of February 2021 levels.

CMIE’s weekly unemployment rate stood at 7.2 percent similar to pre-pandemic levels. India witnessed 99 percent of its long period average rainfall (normal) in the monsoon season for 2021.

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