"Auto sector does look slightly overvalued," Nitin Bhasin, Co-Head of Institutional Equities and Head of Research at Ambit said in an interview to Moneycontrol.
He advised being selective within the auto OEM space. Ambit prefers stocks which have cycle-independent drivers of earnings and cash flows (like deleveraging, and margin improvement triggers).
Nitin with over 16 years of experience says healthcare stands out on Ambit's sectoral attractiveness framework. He believes headwinds appear to be gradually easing for the industry and expects the industry backdrop to be more favourable in FY24.
On the equity market, he feels it can consolidate, but overall expects Nifty to move towards 21,000 by crossing the earlier-touched levels of 18,600-19,000.
Q: Factors that can spoil the current bulls' party?
Acceleration in earnings downgrades and global liquidity tightening!
In FY21-22, Nifty delivered earnings estimates which were forecasted at FY start. In FY23, Nifty delivered Rs 835 EPS Vs Rs 880 at FY start! Looking from a decadal perspective, this is an exceptional performance. In FY24, there is a risk of higher cuts to earnings estimates as BFSI's contribution to incremental earnings growth tapers down to 43 percent!
We see risks to earnings estimates in IT, and Metals. And if rates are cut in 2HFY23, even the bank’s earnings can come under pressure. And as such Nifty consensus earnings estimate of Rs 982 (FY24) can be at risk.
In addition to this, acceleration in global central banks’ balance sheet contraction will impact liquidity and spoil the current bulls’ party.
Q: Do you expect time correction in the equity markets and consolidation considering more than 11 percent rally since March lows?
The markets can consolidate, but overall, we expect markets to move towards 21,000 by crossing the earlier touched levels of 18,600-19,000. We don’t expect a market correction. We compare macro/market parameters across 3 episodes (October 2021, December 2022, May 2023) when Nifty touched 18,600-19,000. We conclude that the market seems to be strongest this time: valuations are most reasonable, and so is the breadth of participation in the rally.
Earnings surprise was also reasonable compared to other episodes. Yield is higher than in the October 2021 episode, but the rate hike cycle had not even begun in October 2021.
Also read: Rajesh Kothari of AlfAccurate identifies 3 compelling investment themes for FY24
Directionally, the market is placed favourably on yield, crude, and inflation! Macroeconomic stability is improving with the narrowing CAD (current account deficit) & fiscal deficit. FII flows that drive markets have returned & are expected to sustain. And if both macro & micro are better, there is a high likelihood that Nifty will scale “Wall of Worry”!
Q: After reading the latest commentary by Jerome Powell, do you see two more rate hikes in second half of 2023?
While acknowledging that FED has undertaken large rate hikes, Fed President believes the full effect of monetary policy tightening measures is yet to be seen. The governor believes it would be appropriate for further rate hikes in the second half of the calendar year.
A possible reason could be an impressive number of job additions (339k) seen in May 2023 while core inflation has only eased by 20bps in the last 3 months indicating sticky inflation. According to FOMC projections, the projected Fed rate has increased from 5.1 percent in March 2023 to 5.6 percent in June 2023. This means there is a possibility of two 25bps hike in the Fed rate in CY23.
Also read: Will strive to get CPI down to 4%; El Nino a challenge for food inflation: Das
One rate hike could be expected as early as July 2023 & the other one before the year ends. The Fed projections suggest rate cuts of at least 80bps in CY24.
Q: Do you think most of negatives fully priced in in the IT space? Will the rally start after a quarter?
We do not believe all the negatives in the sector are priced in. Our view is that growth will decelerate to below pre-Covid in FY24 & recover only modestly in FY25. So, it is a slower growth for longer periods. Secondly, we see margins staying below pre-COVID levels versus street hopes of margin recovery in both FY24/25.
Thirdly, cash generation is weaker than past. In such a scenario where growth, margins & cash generation is weaker than the pre-covid period, valuations are materially above pre-covid, which can see moderation.
It’s important to be stock specific in the IT space. Our top pick has been HCL Technologies, which has outperformed the index by more than 15 percent over the last one year. We also like Tech Mahindra for margins likely to recover.
Q: One sector where you don't want to miss out on the investment opportunity?
Healthcare stands out. Headwinds appear to be gradually easing for the industry, and we expect the industry backdrop to be more favourable in FY24. Key positive drivers include an improved US pricing environment and faster commercialization of pipelines as regulatory inspections pick up, chronic growth pick-up in India, and opportunities for CDMO payers from global supply-chain diversification initiatives.
Normalization of channel inventory across markets/segments and lower input costs should also help. Pronounced recovery in APIs (+23 percent YoY) was the standout feature in the Q4FY23 reporting season. The valuations are also reasonable, and this sector stands out on our sectoral attractiveness framework.
Q: Your take on the consumer durables space?
Consumer durables space is seeing turbulence in terms of demand. Whilst the underlying growth prospects can't be ignored, most of the positives are baked in the numbers already. However, we are positive on GoI's PLI scheme and import substitution plans and hence are positive on some EMS (electronic manufacturing services) companies which are part of the same basket. There is an opportunity for Indian EMS companies to scale up and become global exporters.
Q: Is the auto and auto ancillary sector looking expensive a bit now?
Nifty Auto index trades at ~20x forward earnings and is slightly higher versus the 10-year average of 16.4x. Auto stocks have had a great FY23 with 20 percent+ growth volumes led by easing supply chain challenges & pending order backlogs. At the same time, Auto OEMs margins expanded significantly led by easing input commodity costs pressures.
However, growth in FY24 across auto segments is expected to be muted on a high base & margin expansion is also set to be limited as the bulk of the fall in input costs has been factored in.
In light of this, Auto sector does look slightly overvalued. Remain selective within the auto OEM space, & we prefer stocks which have cycle-independent drivers of earnings and cash flows (like deleveraging, and margin improvement triggers).
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.
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