Why Gautam Duggad of Motilal Oswal Finance thinks BFSI, auto will drive Q4 earnings growth

He said that a narrow growth focus has led to a 1.5-2 percent earnings downgrade for FY24 and FY25, with the EPS revised down from 990-odd levels to 978. This growth is expected to face volatility in the coming months.

Edited excerpts:

India Inc will soon report earnings for the final quarter of FY23, which has been rather volatile. Which segments do you think will do well? What kind of earnings growth can we look at from those sectors?

For the quarter, we put out our strategy note just last evening. What we are estimating is about 14 percent earnings growth for Nifty and 15 percent for our coverage universe, which is 230-odd stocks.

This is quite healthy, I would say, given the context that we are going through. There is a banking crisis in the West. Interest rates have gone up, and there is a macro slowdown in India also, wherein we had just about 4.5 percent GDP growth last quarter. So the context is quite challenging. And of course, we are also seeing a lot of FII outflows over the last three months.

Given that context, for the first nine months, we had seen about a 12-13 percent earnings score for the Nifty. This quarter, we see it at 14 percent. So, basically, we will lend somewhere about 14 percent for FY23, which is very healthy because it is coming on a very high base of 38 percent growth, which Nifty earnings saw in FY22.

The only sore point is it is very narrow and led by the same two sectors. This time again, it is financials which are doing the heavy lifting. The auto sector is joining. So, financials account for 70 percent of the incremental growth that we're talking about, and auto about 20 percent growth in MOFSL's universe.

Between financials and auto, you're seeing 90 percent of the incremental earnings growth. There are 4-5 heavyweight stocks which are driving 82 percent of incremental Nifty earnings, YoY, for Q4FY23 -- stocks like SBI, ICICI Bank, Tata Motors and ONGC.

These stocks typically command a lower PE and are driving the bulk of the growth for the quarter. So it is very skewed and very narrow, led by a few stocks. Even within that, a few heavyweight stocks are doing the trick. Outside of banking and auto, we are seeing decent growth in consumer and IT, at about 10-11 percent.

On the downside, you have metals, which are declining at 35 percent, which is quite big actually, that we saw even in the third quarter. Cement is also declining at about 8-9 percent. So, net-net, you're talking about a 14-15 percent earnings growth, but led by a few sectors and very narrow in that sense.

Our forward earnings revision is also a bit muted. We are seeing a 1.5-2 percent earnings downgrade for FY24 and FY25. So, for the next year, the EPS stands revised down from 990-odd levels to 978. That will still be a 20 percent growth, but that growth can change quite significantly in the next couple of months as we go through this period of heightened volatility.

I'm just going to place the focus right now on new-age companies. That’s where the reality check has come in, right? Today, there was a Q4 update coming in even for Nykaa. Do you think Q4 would be a complete wash-out quarter for new-age companies?

We don't cover any of these new-age digital names. We were not comfortable with valuations last year. So, we still don't have coverage. Of course, prices have corrected 50-70 percent. Depending on which stock you talk about, prices have corrected 50-70 percent from the top.

Business-wise, some of them are very dominant in their respective domains, whether it is Zomato or Paytm or Delhivery or even Nykaa for that matter. Specific to Nykaa, while we don't have coverage, I think the segment, discretionary consumption segment, has been going through a bit of moderation in the last 2-3 quarters.

And it's not just specific to Nykaa. Even if you look at the old-age companies, for want of a better word, they are also going through a bit of a slowdown, whether it is QSR, retail, or staples. DMart's update came in yesterday. A large part of the growth is driven by store addition. So it's quite a well-spread slowdown in the consumption segment. Only very few companies are bucking that trend.

So, I don't want to pick out one company and say there is a problem there. Problems are across the board in the consumption space. As far as some of these new-age companies are concerned, they have corrected in terms of price. Valuations are still quite expensive, in my view, given that they are still not showing consistent profitability and the market caps are still quite high.

So while one might get tempted, given the extent and magnitude of price correction, you have to keep an eye on the underlying valuations, because the context has changed. You've seen a 300 basis point kind of interest rate hike, almost. If I factor in today's potential 25 basis point hike, it's 275, almost 300 basis point rate hike. So, the context for equity valuations has clearly changed, and therefore, the same set of cash flows two years back was attracting different multiples.

Today, they will attract a very different sort of multiples, which is what played out, to an extent, in the last 14-15 months, and it can continue in the near term as well. So, you'll have to take a dispassionate view while looking at some of these companies.

Let’s touch base on the financial space. The RBI’s monetary policy committee decided to keep the repo rate unchanged at 6.5 percent on Thursday. For the entire financial year, we've seen good performance from PSU banks. How do you think the performance is going to be now?

On financials, we've been very clear that the fundamental performance has been the strongest in the last 15 years. When we look at the trajectory of the profit over the last five years, the profits of financials belonging to the Nifty index are five times in five years.

There are 11 companies in the Nifty, which belong to the BFSI domain. Profits are up from Rs 45,000 crore in 2018 to about Rs 2.1 lakh crore in 2023. You have seen credit growth pick up in the last year. Margins are almost at their peak so they might see a 20-30 basis point decline.

You've seen the quarter-end updates from most of the financial companies. At least 10-11 companies have put out their quarterly updates. Across the board, you have seen very strong credit and deposit growth. Banks like HDFC Bank have collected deposits to the tune of Rs 1 .5 lakh crore in the quarter that has gone by. This is outstanding, right?

You've seen very strong growth from IndusInd Bank and some of the other names like Bajaj Finance and Mahindra Finance, which have put out their updates. Fundamentally, there seem to be no issues there. In fact, even on this high base, for the next two years, we are expecting earnings to compound at 20 percent.

So, we are expecting the profits of financials alone to reach Rs 3 lakh crore in Nifty in FY25, right? Till about four years back, that used to be the number for the entire Nifty. About Rs 3-3.5 lakh crore was the profit number for FY19 and for FY20 also.

That is the journey financials have travelled in the last 4-5 years. Coming to stock performance, it's a very different ball game altogether. It's dependent on many things. More importantly, FII flows have been very challenging. In fact, we've seen outflows in the last 2-3 months. The March number, obviously, gets a bit distorted because of one particular trade, which happened at the beginning of the month. Otherwise, in January, February and March 2023, and in the entire CY22, you've seen FII outflows.

Financials are a large part of the FII portfolios, about 37-38 percent. So it's quite natural that when you see an outflow in that segment, financials will build the brand. When you compare it to a price value equation [inaudible], the valuations are looking extremely attractive.

Banks, which are trading at 4-4.5 times, are today available at 2.5-2.6 times, while their ROEs have increased to about 17-18 percent. The provision coverage ratios are 85-95 percent. So, it's a matter of time before the underlying stock price movement or market cap movement catches up with earnings.

In between, you will always see a lot of turbulence because it's a macro sector, at the end of the day. Right now, we are going through a lot of turbulence at the macro level. So macro is right now overwhelming the micro as far as financials are concerned. So, yeah, it's a game of patience and waiting.