Varun Lohchab is the Head of Institutional Research at HDFC Securities.
It’s not the time to rush for auto stocks when the Ukraine crisis is on the boil, threatening further crunch in semi-conductor chip supply, believes Varun Lohchab, Head of Institutional Research at HDFC Securities.
Russia accounts for 40 percent of the global palladium supply. It is used in memory and sensor chips. Ukraine, too, is an important source for the metal as well as a supplier of semiconductor-grade neon used in chip production.
The equity market specialist, seasoned in leading buy-side and sell-side firms such as Fidelity, Franklin Templeton and Jefferies, shares with Moneycontrol that there shouldn’t be any significant earnings cut at overall level as approximately 70 percent of the earnings for the coverage universe is derived from four large sectors that are unlikely to see any meaningful earning downgrades because of the commodity price rally.
Excerpts from the interaction:
Do you think we have hit the bottom?
Driven by sharp inflation in key commodities like metals and oil and gas amid demand recovery, companies across most sectors saw unprecedented pressure on operating margins for the last two quarters. This had led to earning cuts and de-rating of expensively valued stocks.
The current war scenario is just fuelling the prevalent correction in the market. We believe it would be speculative to say that we’re at the bottom of the market as stabilisation of key commodity prices will be essential to see a relief in the market, which is difficult at this time, given the geopolitical uncertainty.
Hence, we suggest bottom-up stock picking, rather than attempting to predict bottom of the market.
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After a double-digit correction, do you think we are still trading at high valuations?
The market cap of the BSE-listed universe is Rs 248 lakh crore, while the projected GDP for FY22 is Rs 232 lakh crore. Hence, the Indian market is trading at 106 percent of the GDP. Compared to long-term average of 79 percent, our market may look expensive. Also, the market is trading at slightly higher level than its historical average when measured on the P/E (price-to-earnings) scale.
However, if we look deeper, we notice that the quality of GDP growth has been improving through the last few years. Corporate profit to GDP ratio which had been falling consistently from 6 percent in FY10 to decadal low of 2 percent in FY20, has started rebounding and now stands at 4 percent. This upward trajectory of corporate profitability offers explanation on seemingly higher current valuation of Indian markets.
Is the current geopolitical tensions delaying IPO launches? Ans, do you think companies are waiting for the LIC public issue to go through first?
IPOs tend to wait for favourable market conditions, which is something we are not witnessing currently. Continuous FII selling in the Indian market for the past six months, especially in February and March so far suggests a risk-off environment. It will not be surprising if many IPOs are shelved for longer than a month.
The sheer size of the LIC IPO will attract most of the remaining primary market investment appetite. Hence, various other companies queued for listing will most likely wait for LIC to go through first, and then test the water.
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Most of sectors as well as stocks, barring few, are trading way below their highs. Where do you want to put your money?
There are few subtle long term themes in action in economy currently, which can throw interesting investing ideas. Driven by sustained growth delivered by IT companies and burgeoning startup eco-system over the last few years, urban disposable income has been rising. It is leading to low ticket consumer discretionary growth such as food and beverages, apparels and retail.
Further, rising disposal incomes of IT sector employees are leading to real estate growth in cities like Pune, Bangalore and Hyderabad. This has multiplier effects on growth of building materials and household appliances. We are bullish on growth of all these mentioned sectors.
Also, with structurally falling interest rates in India (with minor blips), investment avenues have been reducing making direct & indirect equity as clear winners for long term. It is also evident with rising SIP figures over the months. Hence, we remain positive on insurance and capital market companies.
Are you revising your earnings estimates downwards for FY22 as well as FY23 especially after elevated commodity prices?
In our review of recently concluded Q3FY22 corporate results, we witnessed marginal earning cuts in many sectors which are facing sharp raw material and freight cost inflation. This was offset by metal and energy sector earnings which account for substantial portion (around 35 percent) of overall profit pool. Hence, there was no significant impact at overall coverage level.
As, approximately 70 percent of the earnings for the coverage universe is derived from four large sectors- energy, metals, financials and IT – that are unlikely to see any meaningful earning downgrades. Hence, we believe there shouldn’t be any significant earning cut at overall level.
Other commodity consuming sectors would witness earning downgrades as they would need to live with subdued operating margins for little longer while they pass on rising commodity prices to end consumers in tranches.
How do you approach equity markets in current scenario?
The crude oil rally, FII outflows and resultant pressure on currency have historically been key concern areas of Indian markets. However, current Indian scenario is much different owing to below developments:
a) IT services exports have been rising over the years which have been instrumental in alleviating the pain of crude oil import bill suffered by the country. In FY22, IT exports are expected to touch $ 150 billion which will more than offset overall oil import bill of around $ 115 billion. IT services exports have grown from $ 82 billion in FY15 to $ 150 billion in FY22, supporting the economy and currency in the process.
b) Growing significance of domestic investors has been helping neutralise adverse impact of FII outflows. So far in FY22, FII have sold $ 17 billion across primary and secondary markets while DIIs have bought $ 26 billion worth equity during same period. Monthly SIP collections have grown to Rs 11,000 crore in FY22 as compared to Rs 6,000 crore in FY18. These factors have helped our markets to be more resilient.
Is it the time to go overboard on auto space that has lost 16 percent since January’s high?
In our opinion it wouldn’t be prudent to aggressively buy auto stocks just yet, especially given how the current Ukraine-crisis will likely prolong the semi-conductor chip shortage around the world. Before war, chip manufacturers were approaching nearly 90 percent of the levels auto OEMs needed to restore normal production. This recovery will now be impacted by the ongoing war.
Russia accounts for 40 percent of the global palladium supply, a metal used in memory and sensor chips. Ukraine as well is an important source and supplier of semiconductor-grade neon used in chip production. Hence, it is more than likely that the chip supply shortage will continue for longer and affect auto manufacturers.
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