BFSI tops in optimism, but valuation concerns trigger pessimism over other sectors

Pessimism towards JSW Steel, the topper on this list, seems to be led by its valuation and debt levels. (Photo by ROMAN ODINTSOV/Pexels)

Banking, financial services and insurance (BFSI) companies dominate the list of stocks that analysts are most optimistic about, though the list was led by an infrastructure company, Larsen and Toubro (L&T).

The stocks that analysts are most pessimistic about are from myriad sectors, with analysts largely concerned about their rich valuations. Despite its operational improvements, JSW Steel tops this list, from the Analyst Call Tracker for December.

Also read: JSW got maximum downgrades over the last year. Which stock got the maximum number of upgrades?

The BFSI sector is expected to do well on the back of credit growth and financialisation of savings. In its report on the outlook for 2023, HDFC Securities’ Institutional Research unit has picked BFSI as the top sectoral pick in anticipation that strong credit growth (mid-teens in the previous two quarters) will continue in FY24.

The analysts stated that while retail credit has been robust, they expect wholesale credit demand to pick up as well because of capex recovery. The brokerage forecast the net profit of banks and NBFCs in their coverage to grow at 26% CAGR from FY22 to FY24.

Insurance is seen to benefit from a structural shift of Indians choosing financial products for their savings, versus their traditional preference for real estate and gold, after bank deposits. A recent study by rating agency Crisil noted that life insurance has the largest share (39%) in the managed investments industry, which has total assets under management (AUM) of Rs 135 trillion. Mutual funds come second with around 28% of the total AUM.

Capex revival sparks optimism

Like banks, infra major L&T is benefiting from hopes of capex revival. According to a December 20 report from Jefferies, which has a ‘buy’ call on L&T, the company’s power transmission and distribution and railways verticals are expected to do well in the next twelve months with renewable-energy and railway capex push. In the quarter to date, 21% of the company’s orders came from Railways, 20% from oil and gas, and 10% each came from industrial construction and power transmission and distribution.

Another factor working in L&T’s favour is its improving return ratios, especially through sale of loss-making assets such as L&T IDPL, an infra-asset ownership entity. In the report, Jefferies’ analysts noted that the company has been working to improve its ROCE and ROE. Going by the brokerage’s estimates, ROCE is expected to rise from 8% in FY22 to 10.7% in FY25 and ROE is forecast to rise from 10.9% to 15.9% over the same period.

Asset monetisation has played an important role. The analysts expect L&T’s EPS for FY24-25 to see an addition of 1.5-2% from the sale of IDPL. This is because L&T does not have to carry IDPL's annual loss, which is approximately Rs 1 billion to Rs 1.5 billion, through JVs. And, the company would have earned around Rs 2.4 billion to Rs 2.9 billion (after reducing L&T’s Rs 11 billion investment in IDPL) from the sale. The brokerage also believes that Nabha Power and Hyderabad Metro will also be monetised over the next 12 to 36 months.

Stocks inducing maximum pessimism

Pessimism towards JSW Steel, the topper on this list, seems to be led by its valuation and debt levels. Analysts at ICICI Securities, in their December 22 report, did note the operational efficiencies the company has introduced and the focus on digitisation and sustainability, but retained their Sell call. They pointed to the high valuation of 7.5x FY24E, which is the highest among its peers, as a key deterrent and noted that the high net debt/EBITDA of 2.3x (FY24E) relative to peers is a concern.

Analysts at Kotak Institutional Equities (KIE) too upgraded earnings and fair value (FV) estimates, after a visit to the company’s Dolvi (Maharashtra) plant, and believe that the company “has crossed a critical scale such that its internal cash flows can now sustain its aggressive growth ambitions”. They estimate that the company would need a capex of Rs 450 billion over FY2023-25E for capacity expansion and that it could generate free-cash flow (FCF) of ~Rs 600 billion over the same period, thanks to strong volume growth and deleverage. But KIE’s analysts retained their sell call on rich valuations of 7x EV/EBITDA FY2024E, in a December 16 report.

Wipro follows JSW on the ‘Maximum Pessimism’ list, which shouldn’t be that surprising considering how it has been the Nifty stock to deliver the worst performance in 2022. While the headline index went up by nearly 3% in 2022, the IT major’s stock has fallen by more than 40% over the same period. The company’s exposure to a slowing consulting business with its $1.5-billion acquisition of Capco is also a matter of concern, as are its lacklustre revenue and profit figures for the past few quarters.

In general, investor sentiment towards domestic tech stocks have worsened with fears of a recession in the US, where the retail market has shown signs of weakening. Wipro’s exposure level to retail is among the highest in the industry (19% of revenue in Q2FY23 versus 8.1-16% for its Tier-I IT peers, according to a Nomura report).

Also read: Why investors hate this stock but analysts love it? Also, why investors love this stock but analysts hate it?

Two surprises in the pessimism list

The stocks that analysts are most pessimistic about are Asian Paints and Adani Enterprises. Asian Paints has long been a market darling with its undisputed leadership in the paints segment. But in December, only 43% of the 40 analysts covering the stock gave it a ‘buy’ call. While 12 analysts have given a ‘hold’ call, 11 have tagged the stock a ‘sell’.

The Street is concerned about increasing competition in the paints segment. Asian Paints has announced big capex plans of Rs 6,750 crore over the next three to four years for more pricing power. Meanwhile it may have to sacrifice earnings in favour of growth, and that makes the rich valuation look undesirable.

Adani Enterprises, which has delivered a 124% increase over the last year, has only one of the two analysts covering it giving a ‘sell’ call. The other, which is DAM Capital, has issued a ‘hold’ call. Moneycontrol has reached out to the analyst for the report and this article will be updated on receipt