COVID-19 likely to trigger change in market leadership, de-rating likely for BFSI

COVID-19 is widely seen as a black swan event by market experts and investors which can bring a change in market leadership and trigger de-rating for many sectors.

While the long-term outlook remains positive, there is a unanimity among experts and brokerages that the near to medium-term impact of the pandemic will be immense in many sectors.

Some sectors appear to be in terrible shape as compared to others. Aviation, hospitality, travel & tourism, NBFCs appear to be in serious trouble. Others such as automobiles, metals, mining, transportation, too, are likely to witness significant challenges in the coming months.

"Companies in sectors related to discretionary spent like travel, hotels and luxury will be affected significantly. There may not be any lasting impact in the long term (say 24 months or more), however, in the near-term to medium-term (3-12 months), there will be significant de-rating as well as earnings decline," said Satish Kumar, Head of Equities, Equirus Securities.

The probable candidates of derating

Rusmik Oza, Executive Vice President and Head of Fundamental Research at Kotak Securities highlight paint, cement, consumer durables and retail sectors may see de-rating owing to their high valuations amid weak underlying demand.

"Paint stocks are trading at more than 50 times on a forward valuation which seems to be on the higher side. Paints being a discretionary item could take a back seat which could impact demand and earnings,"
Oza said.

"Top four cement companies trade at very rich valuations at 22-30 times. We expect cement demand to decline by 15-20 percent in FY21 due to slowdown in infrastructure, construction and real estate segment.
Consumer durable stocks will also see lower demand due to scale down in discretionary spending. Most of the consumer durable stocks trade between 25-70 times, which may not sustain in the slowdown scenario.
Retail companies also trade at very rich valuations which may see some kind of derating," Oza said.

There is a change in constituents of Nifty50 twice in a year with companies with higher market-cap and profitability are added while weaker companies are excluded.

As per a report by the brokerage firm Motilal Oswal Financial Services, in the Nifty50 index, the weight of the auto sector is at its lowest in a decade at 5 percent. Metals' weight in the Nifty basket has halved since December 2017 to less than 2 percent now. BFSI’s (Public, Private and NBFCs) weightage is down 580 bps from end-December 2019 and now has a weight of 36.2 percent.

Can the falling weightage of these sectors trigger their de-rating?

Aamar Deo Singh, Head Advisory, Angel Broking said when the likes of Tata Motors, Hero MotoCorp, Mahindra & Mahindra and Maruti Suzuki from the auto space, Hindalco, JSW Steel, Coal India and Vedanta from the metals pack and Bajaj Finance and Bajaj Finserv from the NBFC space, lose so much value over the years, the weights are bound to get impacted.

Oza of Kotak Securities pointed out that automobile and metal stocks have grossly underperformed the broader market and Nifty50 in the last two years so any major decline in their weightage in the near future is unlikely.

"Valuations of automobiles and metal sector seem to look expensive from a medium-term mainly due to the hit in earnings. However, from a long term perspective, they trade at attractive valuations and hence we don’t expect any major de-rating in them in future," Oza said.

However, the BFSI sector may see a de-rating.

"The weight of the BFSI sector had gone up disproportionately in the past three years before the fall. As the BFSI sector is most sensitive to the economy we can expect some more de-rating and decline in its weight in the Nifty. The fear of rising NPAs and steep fall in lending activity will distort the future earnings estimates of BFSI stocks," Oza said.

Kumar of Equirus Securities said uncertainty in the BFSI sector is the highest and hence it will not be surprising that its weightage comes down further.

"However, I don’t see any other sector, present in Nifty, which can see a fall in weightage and derating due to significant price correction," Kumar said.

Vikas Jain, Senior Research Analyst at Reliance Securities said the sharp correction in the sector like autos and metals declining to multi-year low has reduced their weights in the overall basket.

"BFSI's weight, from the high of 40 percent, is down as we have witnessed a sharp erosion in NBFCs and public sector banks' share price performance. We may witness a further decline in weights in the BFSI sector as the outlook is weak for NBFCs and select banks while other sectors like Consumer, IT Services and Pharma would see incremental addition in weights as sectors are outperforming the broader markets," Jain said.
"The ratio of Nifty to Bank Nifty which used to be at 2.8-3.1 levels has also come to 2-2.1 levels witnessing a strong underperformance in the last few weeks. The metal sector will take more time to revive as the sector is more exposed to global factors," he said.

Road ahead

Pointing towards the hazy tomorrow, Singh of Angel Broking said the future of most sectors is more dependent now on the handling of the COVID-19 scenario, because now, industry and humanity, will have to learn to live with COVID-19 while at the same time, work towards kickstarting the economy.

"Things cannot be at standstill for long as that is beginning to have a serious and colossal negative impact on the companies, across the board. A further decline from the current levels seems to be less likely, as the index also needs to be broad-based and have coverage across sectors. However, in case the COVID-19 case shows signs of abating, both globally as well as domestically, that could stall the further decline and the likely pullback of the economy," Singh said.

"We would recommend avoiding vulnerable sectors and invest in high-quality businesses in 3-4 tranches. So sectors to focus this year include the likes of FMCG, Healthcare & Pharma, Chemicals & Agrochemicals, apart from a few Telecom stocks," he said.

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