Bhawana Chhabra of Elara Capital
Tech stocks seem to have run into a bad sector, trading in the red for the last four sessions, and hitting a three-week low on Tuesday. High valuations and shrinking margins are believed to be the major perpetrators of the slump for IT companies in the market.
Bhawana Chhabra, who is the vice-president of India Equity Strategy at Elara Capital, believes more headwinds are in the offing for marquee IT stocks as valuations continue to remain high and a weakening economic growth threaten to take a toll on IT spends of clients across the world. “Some more pain on the cards for the sector,” she shares in an interaction with Moneycontrol.
Talking of the fundamentals affecting the global economic growth, she says that inflation remains the biggest bother for the market and points out that commodity price corrections remain segmented, providing only partial prospective relief to global inflation while other segments continue to stay high.
Excerpts from the interaction:
Do you really think the market has built a lot of optimism with hope on sharp domestic recovery, given weakening external growth levers?
Before correcting for last two days, the Nifty had run up about around 12.5 percent in prior 35 days (as of August 18). This run up happened in the despite earnings miss in recently concluded earnings season, which led to about around 3 percent downward earnings revision in FY23 and FY24 estimates. This implies that markets have been hopeful of recovery.
To understand the recovery better, we look at sectoral indices. IT has been one of the biggest underperformers CYTD (current-year-to-date) while Autos, FMCG have done well, indicating markets shift in expectations. As global economy is expected to see a slowdown (concerns recession in US, Europe), globally exposed sectors’ earnings levers are expected to wane while domestic demand is expected to drive earnings.
Also read – Nilesh Shah says India a contra bet for world, lists 6 sectors to invest now
Hence, the recent rally has been based on hopes of sharp domestic recovery. Now coming to the optimism part, we try to break down and see what earnings expectations are telling us. We run a quantitative model called “What’s in price”, which breaks down price of a security ascribing it to current EPS (current business value), consensus forecast for next two years (Short term growth value) and long-term growth potential (long term growth value). At this moment, the model is pricing in peak range value for long term potential, which is not in earnings numbers yet, indicating a lot of optimism has been built in.
What are the two key levers that the market is watching out for and where do you see the Nifty by December 2022?
With a lot of hopes placed on domestic recovery, we believe markets will treat upcoming festive season sales and Kharif season output as key dipstick measures for demand, especially for rural India as that lever lagged last year and recovery there would be key to provide a fillip to the earnings.
In terms of Nifty, we believe the best is already priced in on a lot of earnings-related parameters and valuations remain on higher end. In light of receding liquidity and precarious geo-political backdrop globally, we expect equity markets to consolidate in next few months. Hence, they may remain rangebound, albeit at a larger range, like they have been since start of CY22.
Do you see lot of opportunities in the banking and financial services space?
The recent run-up was driven by financials, after long. The sector had been due for run up given strong earnings for the past 3-4 quarters. Despite the run up, on our “What’s in price” model, the sector remains at average valuation, with good names still trading away from their peak long-term valuation they command.
Along with availability of under to fairly valued opportunities, the earnings outlook of the sector looks good too – buoyed by recovering loan growth, low credit cost, robust asset quality, despite cost of funds bottoming out. Hence, we remain positive on space, especially private banks and well rated NBFCs.
What is reason behind a cautious stance on the IT space and do you expect some more pain in the space?
The Nifty IT index has corrected about 24 percent year-to-date. Usually, one would tend to think that worst is not already in the price. However, when we analyse numbers on our “What’s in price” model, we see that on earnings expectations are simply close to what we had at end of FY22.
Also read – TCS says no delay in variable payout process, 100% being paid out in Q1
Valuation of marquee stocks remains high and headwinds to the sector are set to intensify as weakening economic growth could lead to IT spend cuts across global clientele of the sector. Given that earnings downgrade levers are strengthening, valuation still remains rich, we believe that the sector may be in for some more pain.
Do you really think industrials are richly valued now?
On our “What’s in price” framework, Industrials’ long-term expectations are at peak range while near term earnings expectations have been getting revised downwards. Consequently, current business value and near term earning value of the sector are at lowest end of range, indicating the best is being priced in. Given that capex recovery we have seen so far remains segmented and slowing global growth, rising cost of funds would prove to be headwinds to the sector. This would make current valuations unsustainable.
Why do you see the margin of safety remaining low in materials space?
Materials sector also saw a run up recently led by metals (NSE Metal index was up 15 percent in last one month) as few European Aluminium smelters halted production on account of rising energy costs. Commodities are at an interesting juncture as energy prices remain strong on supply concerns, metals have been broadly weak on account of weakening global growth (barring recent supply related news pieces).
Also read – SpiceJet board to meet on August 31 to approve pending financial results
Even though supply chain disruptions are unpredictable, metals demand is expected to remain weak fundamentally owing to weaker global growth. This clubbed with high energy prices, would mean weaker earnings. Long term growth value of the sector on the other hand remains at higher end of last four-year range, while short-term earning component at lowest end in last 10 years. Earnings downgrade potential along with high valuation implies, margin of safety is low in the sector.
Do you still think globally we are not out of woods yet on the inflation front?
While crude has corrected from peak and metal prices are down, natural gas prices remain stubborn as Europe prepares for a tough winter ahead. The price conundrum gets further accentuated by with drought in Europe, Ukraine war led grain supply disruption and weak sowing progress in India, pushing agri-commodity prices up, amid shortage.
Hence, commodity price correction remains segmented, providing only partial prospective relief to global inflation while other segments will remain high. Moreover, labour market indicators in the US still remain strong, reflecting wages-led demand-side inflation. Hence, we may not be out of the woods yet on inflation front and that’s what seems to be bothering markets too.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
