Daily Voice: Pharma should be part of investment portfolio, but significant re-rating looks difficult, says Milind Muchhala of Julius Baer

The FPI flows in the Indian markets have been quite muted in the past 4 years, with total inflows of US$12-13 billion since CY21, and most of the flows have gone towards IPO/FPO and QIPs. The weakness in flows can be partly attributed to US Fed rate hikes and strengthening USD during the period, coupled with weak EM flows amid significant underperformance of Chinese markets. Consequently, the ownership of FPIs in the Indian equity markets have consistently declined over the period from 25 percent+ to around 17 percent currently.

The tide is expected to turn for the better, aided by the recent start of the rate cut cycle by the US Fed which should be supportive for EM flows, although predicting the timing for it would be difficult. The Indian equity markets remain an attractive investment destination with its healthy economic and earnings growth momentum, and some bettering of valuations through intermittent corrections should result in FPI flows coming back in the country, hopefully starting from the coming calendar year.

Do you see the RBI cutting the repo rate by only 100 bps by 2025?

While the US Fed has started with its rate cut cycle and indicated of more rate cuts in the ensuing policy meets, the RBI has refrained from following that path as yet. Softening growth and optimism around the inflation trajectory, coupled with widening real rates have raised expectations of rate cuts by the RBI. However, we expect the rate cuts by the RBI to be shallower than that in the US amid sustained geopolitical tensions and rising inflationary pressures from food prices.

We believe the first rate cut could likely be in December or February policy, which in totality could be restricted to around 75-100bps by end-2025, although there could be various factors in play influencing the rate cuts decision, including the growth-inflation dynamics and the stance by the US Fed and other major global central banks.

What themes have you identified in the bullish segment in India?

The themes where we maintain a positive stance largely remain the same. We continue to like the BFSI sector, which is a quasi-play on India’s economic recovery, and the credit growth is expected to remain supported with the recovery in the capex cycle and focus on domestic manufacturing. Also, the balance sheets for a lot of banks/NBFCs are quite healthy, while the valuations remain reasonable.

We are also positively biased towards Domestic Consumption (including Discretionary Consumption, Auto and Home Improvement) with structural drivers such as favourable demographics, improving income levels and increasing aspirations. Lastly, Industrials & Infra (including Cement) and Domestic Manufacturing are the other segments that we like, benefiting from revival of the capex/Real Estate cycle and continuing support by the Government, although the current valuations may not be too supportive, and hence, we would be on the look-out for better entry opportunities.

Do you think the pharma sector will be a significant gainer in the coming years and should it be part of an investment portfolio?

We continue to remain structurally positive on the Healthcare sector, which includes Pharma as well as Healthcare Ancillaries such as Hospitals, Diagnostics, etc, and believe it should be a part of one’s investment portfolio. The sector has done reasonably well over the past one year, aided by new product launches, benign US generic pricing environment, steady domestic growth, improving profitability and easing of some regulatory concerns related to pricing (for Hospitals). The recent passing of the Biosecure Act in the US also further aided the positive sentiment, especially for some CDMO players.

However, post the recent run up, most of the companies have started trading at premium valuations compared to their historical averages. Hence, while the growth opportunities continue to remain healthy for the players, a significant re-rating from here looks difficult. Moreover, one will need to be selective in the names considering the differing business models (Formulations, API, Domestic, Regulated markets, Specialty portfolio, Ancillaries, etc.) and varying growth drivers/visibility.

Is there a possibility of no rate cuts from the US Federal Reserve in November-December meetings, given the strong economic growth?

While the retail sales and consumer spending data in the US came in better than expectations, the economic environment could still be a bit patchy, while the inflationary dynamics have remained comforting as compared to the US Fed’s anticipated range. Considering the commentary post the last Fed policy meeting, we would assign a very low probability to the scenario of no rate cuts in the ensuing meetings in the coming couple of months. Our global desk expects at least one, if not more, rate cuts in the November-December meetings.

Do you expect some slowdown in overall September quarter earnings compared to the June quarter? Will the growth of large-cap companies be restricted to single digits?

We could see some possible slackening of the growth momentum in Q2FY25 results as compared to the Q1FY25 results. This has already started getting visible in the early set of results announced and the accompanying commentaries by a couple of companies in the IT, Auto and FMCG sector. While the hopes remain of a recovery in the domestic demand environment, including rural demand, amid healthy monsoon, start of the festive season and the continuing spends by the government on infrastructure, the pick-up in demand still seems to be relatively soft till now. The inflationary pressures have also started building up a bit from the benign scenario we witnessed over the past few quarters. Globally also, the macro uncertainties continue amid the geopolitical scenario. Hence, while the past couple of years witnessed a healthy earnings growth momentum, we could be getting into a phase of softening of the growth in the near term.

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