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“The demand outlook for the auto sector continues to remain buoyant for H2FY23 led by anticipation of higher festive season sales, strong order book backlog, especially in passenger vehicles,” Manish Jain of Mirae Asset Capital Markets (India) says in an interview with Moneycontrol.
The institutional business head (Equity and Fixed Income) at Mirae Asset with around two decades of industry experience believes that double-digit growth is possible for the auto sector as several things are currently working in favour. However, exports is one area which could remain subdued due to the high base in FY22 and global issues, he says.
Considering the current global environment, to visit the market June lows once again, five things must happen including the pressure on USDINR, consistent rise in US bond yields, and oil prices marching towards a new high again, Jain says.
Edited excerpts:
Do you expect the Federal Reserve to remain aggressive in 2023 as well, to bring inflation at the 2 percent target at the cost of economic pain?
If the need arises then yes. Federal Open Market Committee (FOMC) has raised rates by 75 bps this September, taking the FFR (Federal funds rate) to 3.25 percent and signalled that more rate hikes are likely to follow through. The dot plot suggests that FFR could rise to 4.40 percent by the end of 2022.
Fed Chair Jerome Powell indicated that he wants inflation to be behind and there is no painless way to do it. Fed’s Neel Kashkari also said that there is a lot of tightening in the pipeline. While we discuss this it is important to pay close attention to the recent steps taken by the Bank of England.
Amid quantitative tightening (QT), it intervened with temporary quantitative easing (QE) “to restore orderly market conditions”. The issue Bank of England (BoE) faced could be local for them in nature as pension funds there were losing huge in their bond portfolios. However, these kinds of policy changes are not the first by a central bank. In 1980, FFR swung from 20 percent to 8.5 percent and back to 20 percent; all in a year. The dramatic changes in FFR happened during 1974 and 1975 also.
Economic conditions, factors and events in the 70s and 80s may not have co-relation with what’s happening today but we need to have an open mind approach when it comes to central banks like Fed or BoE. They may come up with exceptions, swings in policies and rates which would be situation dependent and could vary from managing inflation, recession and of late market conditions.
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Also, do you think the US inflation will fall to 2 percent from current 8.3 percent levels by end of 2023?
Fed officials see inflation of 5.4 percent at the end of 2022; 2.8 percent for 2023; 2.3 percent for 2024; 2.0 percent for 2025. Whether they will be able to achieve it within this timeline is another debate. During 1974/75 inflation in the US was in double digit (~11 percent) and high single digit (~9 percent) respectively. It took around 12 years for inflation to fall to around 2 percent. As per IMF and BoFA Global Research, once inflation is above 5 percent in advanced economies, it takes on an average of 10 years to drop to 2 percent. So while the peak inflation may be behind us, 2 percent by next year may be a tough ask especially now when there are QEs within QTs.
Do you think the correction in global counterparts, especially the US, can drag the Indian equity benchmarks to June lows?
The US markets have already touched June lows, the Indian markets have not yet. For this to happen, Nifty must correct another 9-10 percent from here to meet June lows.
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In my view, for Nifty to visit June lows, the following must happen:
a) Trade deficit remains elevated at around $ 28-30 billion per month.
b) Hence, pressure on USDINR and say inching towards 85 and sustains.
c) Sustained rise in US treasury yields especially in a situation where the differential between US and Indian 10-year government bond yields is at a historic low. It would be interesting to note who blinks first
d) Crude oil starts inching towards new highs again.
e) Earnings are not able to justify the valuations.
So, let’s be guided by the above factors to take a call on market levels.
Another important factor is domestic money flow. Between April 2021 and June 2022, FPIs withdrew around $ 55 billion and DIIs infused around $ 45 billion. Five years back, SIP used to be around Rs 5,600 crore. In FY22, it was around Rs 16,000 crore and may touch around Rs 18,000-19,000 crore in FY23. This data suggests strong domestic money is readily available to buy the dip.
Nifty 1-year forward PE was trading above mean (post-Covid basis) before this correction. Currently, it is trading at ~19.7x versus a mean of ~22.1x. Minus 1 Standard Deviation (SD) is at ~18.7x. Some emerging markets (EMs) and advanced economies (AEs) are already well below the mean, and some are below minus 1SD. India has performed very well relatively and on a standalone basis.
Do you see one more rate hike in the next policy meeting after the increase in rates for September?
Change in FFR by the end of 2022 (earlier 3.4 percent versus 4.4 percent now) suggests another 125 bps may come in this calendar year. The Fed has always maintained that its decision will be data dependent around parameters like GDP, inflation and unemployment.
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I would now add one more very important parameter “market conditions”. Each central bank will have its own definition of “market conditions, which can lead to exceptions, swings in policies and rates and this would be the most difficult to predict parameter as each country would have its own tipping point. BoE is a recent example. However, at the same time, it’s not justified to extrapolate BoE’s move to other central banks. Here, we must just wait and watch.
Are you gradually looking at opportunities in the IT space that was the biggest loser this calendar year, or is it better to avoid them till the global environment is stable?
Though the pace of tech spending is correlated to GDP growth/macro, the managements of IT services firms have been witnessing a broadly stable demand environment across verticals, except for a few certain pockets, and a robust deal pipeline despite deteriorating macro factors.
Further, increasing focus on cost take-out programmes by the enterprises during the slowdown phase will create opportunities for the Indian IT services industry which can negate the reduction in discretionary spending.
We believe margins of most IT services firms are likely to be bottomed out in Q1FY23 and expect gradual improvement in the medium-term despite the elevated cost of delivery, aided by a reduction in sub-contractor expenses, improving utilisation, pyramid rationalization and currency tailwinds.
On the valuation front, CNX IT index has underperformed the broader indices by 26 percent on a year-to-date (YTD) basis owing to the deteriorating macro factors, possible recessions in developed economies and a high inflationary environment. The correction in CNX IT was primarily driven by a sharp contraction in multiples (down to 22.6x from 30.9x on YTD basis) with around 5 percent downward revision of consensus earnings estimates.
Stock prices of largecap companies have corrected in the range of 20 percent to 44 percent, while the stock prices of quality mid-tier companies have corrected in the range of 34 percent to 48 percent.
With this correction, Tier-I IT companies are trading at 5-year average multiples with higher dividend yields and a few good quality mid-tier companies are trading at a premium to their 5-year historical average because of strong growth outlook, robust deal total contract values (TCVs) and operating resilience.
Hence, we remain selective with picks in the IT space, considering the strong growth outlook, scope for margin improvement and efficient capital allocation policies. The IT services sector is expected to perform relatively better in uncertain times because of its defensive characteristics.
Do you expect double-digit growth in the auto sector given the likely margin expansion tailwinds?
On the demand front, after a mixed FY22, all segments showed healthy recovery except 2-wheelers (2W). Domestic passenger vehicle sales (PVs) are up 13 percent, commercial vehicles (CVs) are up ~26 percent, 2W are down ~11 percent. Of late, 2W sales, which have been struggling over the last three years, started showing healthy recovery with April-August FY23 sales up 33 percent.
The underlying demand continues to remain healthy, led by overall economic recovery, ease in semi-conductor shortage and strong pent-up demand. The overall industry has seen volume growth of 33 percent in April-August FY23 with PVs at ~30 percent. The demand outlook continues to remain buoyant for H2FY23 led by anticipation of higher festive season sales and a strong order book backlog, especially in PVs.
Healthy demand recovery, easing key raw material prices, price hikes and better mix would translate to better financial performance and profitability for original equipment manufacturers (OEMs) led by higher volumes leading to operating leverage.
All key raw material prices, including steel, aluminium, copper and rubber, have witnessed reasonable correction from their recent highs which would aid margin improvement for companies.
OEMs are in a much better situation to pass on increased cost pressures due to a robust demand environment. Additionally, change in the mix such as PVs shifting towards UVs, premiumisation in two-wheelers and higher sales of cyclical M&HCV volumes bode well for profitability.
So looks like double-digit growth is possible for the auto sector as a number of things are currently working in favour. Exports is one area which could remain subdued due to a high base in FY22 and global issues.
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.
