Daily Voice | Possible slowdown in FII flows & stretched valuations to limit market upside, says Varun Lohchab of HDFC Securities

In the current earnings season, we have noticed an obvious pressure on NIM (net interest margin) for most banks due to the need for deposit mobilisation to fund credit growth. While ~50 bps NIM compression for most banks is expected in FY24, any incremental NIM decline due to deposit scarcity could be a probable risk.

Another monitorable cluster that could throw possible risks would be commodity-consuming sectors such as cement and consumption. We have not witnessed any meaningful pricing power among large players. As Brent crude has already gone above $80 per barrel, it could mean inflation inching up again. In such a situation, commodity-consuming players without pricing power will find it difficult to pass on the input cost rise and hence will face pressure on their operating margins.

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Additionally, pressure on IT sector revenue growth and demand outlook for FY24 is evident. While the subdued performance of FY24 is priced in, the demand outlook for the sector is expected to recover in FY25. Any further delay in this recovery is a noteworthy potential risk.

Lastly, we believe the current expensive valuation of Nifty happens to be another key risk factor. Currently Nifty is trading at ~20.7xFY24E and there are limited justifications available in earning prints of various companies for this lofty valuation.

Q: Your take on IT earnings... Are you still worried about their earnings outlook?

As per our observations, the end-user industries of BFSI and Hi-tech in the USA & Europe are facing macro headwinds and hence demand outlook for the IT sector remains weak for FY24. Having mentioned this, we believe IT sector earnings may not decline so significantly any further unless any deeper slowdown is witnessed in the USA and Europe economies.

On the other hand, clarity with respect to the IT sector demand outlook for FY25 led by improving macro indicators has the potential to lift up the sector gradually. So, all in all, we believe IT sector earnings are not looking at any steep decline hereon provided US & Europe macros remain resilient.

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Q: Do you expect healthy growth to continue in the entire banking sector?

While we believe credit growth would still be healthy at ~13 percent for FY24 but incremental loan growth would come at the expense of lower margins. As RBI has taken pause with respect to interest rate hikes for the time being, asset yields are capped but competition intensity for deposit garnering is here to stay.

Hence, we believe while the banking sector will report healthy growth but it will come with NIM compression, so earnings and returns of the sector would be moderate henceforth.

Q: Is it the time to bet high on FMCG space or is it overvalued?

We don't think there are any obvious bargains in the FMCG space; most of our coverage companies are trading at fair valuations or are currently overvalued. There are some tailwinds for the sector going forward, primarily lower input prices and a steadily reviving rural economy, but these seem to be already priced into the respective stocks.

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One must be very company specific in order to play the FMCG space today.

Q: Themes that you cannot avoid for portfolio?

We continue to remain bullish on the infrastructure investment theme; public and private investment numbers are indicative of a strong and continuing CAPEX cycle in India. Infra companies' order books continue to remain strong, and cement volumes have been following suit.

Industries such as infrastructure, cement, utilities, building materials, and logistics will be direct beneficiaries of the current CAPEX cycle. Regardless of the strong tailwinds being enjoyed by these industries, it is imperative to conduct bottom-up analysis to find companies at reasonable valuations.

Q: Do you think the market has done with a healthy rally or another 10 percent run is possible from here on before getting into a major correction?

The current market rally is attributable to FII flows finding their way into emerging markets, ex-China; such a rally is inherently more sensitive to exogenous factors. A possible economic recovery in China might be on the cards as a result of fiscal stimulus and policy changes.

In addition, the expectation of a steady recovery in the Taiwanese and South Korean economies might see incremental FII flows reduce in India. Intrinsically speaking, our valuations do seem stretched; the Nifty is trading at ~20.7xFY24E. Earnings so far in the season have largely been in line, with nothing spectacular that could justify the current valuations.

We believe that a slowdown in FII flows, coupled with stretched valuations will put a cap on the upside from the current levels.

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