Daily Voice: Pick up FMCG, pharma stocks in current market, says R Venkataraman of IIFL

CY2023 witnessed strong residential demand (+31 percent YoY) on a high base with sales (in units sold) now at a 15-year peak. The top seven cities (excluding NCR & Kolkata) of India witnessed a 30-50 percent YoY growth. Housing prices across the top seven cities in CY23 witnessed the highest growth in the last decade; appreciating on an average by 15 percent YoY; ranging from 10-24 percent across cities.

We believe that the overall residential demand continues to be positive for the next couple of years. Luxury housing demand is likely to remain robust and Grade A/ Listed developers continuing to further consolidate their market share.

Do you see any major risk for the market from the general elections considering the trend in the last three phases, as the volatility has risen significantly in the recent past?

Currently, the market is expecting that the ruling party would continue to remain in power and will provide the political stability. Low voter turnout is a concern but that is likely to be due to the heatwave in many states. Over the first two phases, the BJP is the incumbent party on 92 seats (of the total of 189 seats polled so far), and only four seats have seen a voter turnout drop higher than the victory margin. This implies that BJP could possibly retain most of these seats even if we assume that the entire decline in turnout was for the incumbent party.

Phase three has been the strongest for the ruling party with a hit ratio of 76 percent in the 2019 elections. However, an unexpected election outcome could disrupt market sentiments in the short term which would provide an opportunity to buy quality stocks for the long term as we expect the equity market to continue to trend with a positive bias in FY25.

Are you taking exposure to FMCG stocks in the hope of strong revival in the coming quarters and also as a defensive bet in the rising equity market risk environment?

Commentary from FMCG companies suggest that the demand environment has remained steady on a sequential basis and there has been no material green shoots visible in the rural demand. Urban markets are expected to outperform the rural markets. Yet again, food companies are expected to outperform the HPC (home and personal care) companies.

We believe one should take exposure to FMCG stocks in the current market as they have low beta, whose earnings and cash flows are relatively stable thereby providing stability to the stock prices. Also, recent management commentary of FMCG companies suggest that they are expecting recovery in rural demand on the back of improving macros, increased government expenditure and forecast of normal monsoons. These are likely to benefit the FMCG stocks.

Which are the top themes that you are playing for FY25?

Capital goods

Notable data points on government spending highlight acceleration in cash flows and capex outlay in 11MFY24 (is this 11 months of FY 24? If yes, please spell it out), a front-ended trend especially ahead of the general elections in 2024. Defence capex attained 80 percent of the FY24 Revised Estimate to Rs 1.3 lakh crore up to February 2024. Further, indigenisation levels have risen sharply to the 65-70 percent range versus 54 percent reported in FY19, with 100 percent indigenisation in certain categories like tank engines, ship data network etc.

Railways spend topped the infra vertical with focus on rolling stock continuing to drive growth as total wagon production reached 17,566 YTD (year-to-date). Exim data continues to highlight a robust jump in electronic component imports to drive import substitution and 40–50 percent CAGR in the domestic EMS market. We think these trends should reflect strong execution (revenue) trends for FY25.

Banks

We believe that the perception of Jan-Dhan deposit accounts being low-balance, largely inoperative, focused only on financial inclusion and immaterial to the  banking system — needs to change. The PMJDY (Pradhan Mantri Jan-Dhan Yojana) scheme was launched in 2014, with an aim to provide banking facilities to the unbanked. However, it has made significant strides in recent years, with 520 million beneficiaries (35 percent of India’s population) holding US$27 billion of deposits (three percent of the system savings deposit). PMJDY deposits have grown at 18 percent CAGR in the last five years versus 10 percent for the system; balance per account is also growing at a 3x faster clip than that for the system.

While the banking system has been grappling with a sharp slowdown in CASA, PMJDY has contributed 10 percent to incremental system savings deposits in the last two years. This underscores its stickiness, lower rate sensitivity and benefit of low-cost funds for the banks. PSU banks are the key beneficiaries with PSU+RRBs having a 97 percent market share, and no competition from the private banks.

Are the valuations attractive for technology stocks? Are you taking exposure to the space or do you still want to be in wait and watch mode?

The Indian IT sector is now underperforming broader markets (by 5 percent YTD), after a hope rally in January. Valuations remain elevated at 15 percent above last 10-year average, given the anticipation of pickup in growth in CY24; leaving limited potential upside across the board in the near term.

We uphold our view that while Indian IT will continue to be a beneficiary of the multi-year digital transformation journey, the pace of recovery will be gradual in CY24 given the uncertainties around macro and US elections.

Hence, we forecast sector revenues to grow at 6.4 percent/10 percent constant currency in FY25ii/26ii versus the pre-Covid 5/10year average at 8 percent/9 percent respectively. Supply side should face deflationary pressures, even as hiring picks up post a headcount decline in 2023. Hence, we forecast 14 percent PAT CAGR over FY24ii-26ii for the sector. Given the modest near-term outlook, valuations are rich and are poised for time correction.

Have you seen any sector that is showing signs of revival after reading the March quarter earnings season, and should be part of the portfolio?

In recent years, there has been a sharp increase in drug shortages around the world. This is due to several reasons- supply chain constraints due to the Russia-Ukraine war and stockpiling of drugs under shortage are some of them. US active drug shortages have further increased to 323 drugs in the first quarter CY24 (as per ASHP data). Such high shortages were last seen almost a decade back in the third quarter of CY14, when 320 drugs were in shortage in the US.

We believe that export-focused Indian generic companies are likely to benefit from this situation. Our analysis suggests that among the Indian generic players – Aurobindo and Sun Pharma have the highest exposure to products under shortage in the US. Aurobindo’s US injectables sales (generic & branded) account for 25- 26 percent of its US sales and 12-13 percent of its overall sales. Sun Pharma’s nine products, out of the 15 short supply products which Sun is currently supplying, are under the essential products list for hospitals.

Pharma, also being a defensive bet, can also provide stability to the portfolio amidst the current volatility. Hence, we believe that pharma can surprise and it should be a part of the portfolio.

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