Daily Voice | Setup for capital goods companies quite optimistic; may see revival in consumption, says this expert

Here, I would like to be very selective, especially for Banks & NBFCs, and not paint the entire sector with the same brush. A restoration of corporate credit is long overdue, however, remains at a nascent stage owing to the availability of other non-bank funding avenues & strong corporate balance sheet. Hence, we expect the larger banks with their large equity bases and lower funding costs to grab any potential opportunity.

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In addition to this, the recent regulatory changes by RBI to increase the risk weights and caution on asset quality stress in pockets of consumer lending could lead to a slowdown in unsecured consumer credit. This will hurt both the growth and profitability of smaller banks and NBFCs that are more exposed to this segment. Further over-ownership in the sector, NIM compression, rising competition, and expected moderation in return ratios will weigh on the sector.

Do you expect a significant uptick in consumption space if inflation moderates further from current levels and remains low for the current year?

The recent corporate earnings & management commentaries showcased the visible difference between urban consumption growth across categories that have been robust (like convenience, leisure, jewellery, hotels & other luxury goods & services) and rural India, whose consumption growth has been sluggish. The volatile inflation and erratic weather conditions have played a part in disrupting rural consumption. Certainly, if inflation moderates it will support demand on two counts
a) lower costs will support incremental demand
b) Passing on the benefits of lower input costs will increase affordability for the consumer.

Which are the sectors likely to see earnings upgrade post December FY24 quarter numbers?

I think Capital Goods as a sector should continue to do well driven by the resurgence of a multi-year capex upcycle. The Gross Fixed Capital Formation (GFCF) as a proportion of GDP touched a multi-year high of 35.3 percent in 1HFY24, led by government Capex which rose 25 percent YoY.

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According to the latest RBI data, capacity utilisation has reached a threshold of 74 percent. Many companies in manufacturing are using reserves and surplus for investment. Given this backdrop & existing healthy order book, the setup looks quite optimistic for the companies in the Capital goods space.

Further, we maintain a positive view on the Indian Pharma sector on account of improved earnings outlook which is driven by performance improvement in the US generics market, decrease in raw material costs and market share gains for companies through new product launches.

Lastly, building materials as a sector look quite interesting, given the robust activity in the real estate space, especially housing.

Factors that are important to look at in the first half of current calendar year, concerning equity markets?

In our view besides the current earnings season, there are several other factors in the next few months which will set the course of global and Indian markets in H1CY24.

(a) The timing and magnitude of peak interest rates in the US and other developed economies will determine the strength of the global economy and investment sentiment in markets in CY’24.
(b) A likely revival in consumption in India may coincide with disruption becoming more visible in a few consumption sectors (autos, paints by way of entry of new players).
(c) India will be leading to general elections and more state elections in mid-2024 (In addition to 5 state elections in November last year).
Given the above, we suggest staggered investments over the next 6-8 months in a staggered manner.

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Do you expect any major announcements from the government in the interim budget?

If we look at the past interim budgets of 2004, 2014 and 2019, each of them included noteworthy policy announcements like the extension of the subsidized food scheme, Kisaan Credit Cards, One Rank-One Pension, a reprieve for the auto sector, and Kisaan Sammaan etc.

The recent state election results have shown that income transfer policies and other welfare schemes have been key to campaigns.

In this interim budget, while new large schemes may not be announced, some existing popular schemes could see expansion/extra resources to boost implementation rates. These may include Housing for all, health insurance etc. Farmer's cash transfer scheme may also see an increase. Overall, in our view, government social spending (ex subsidies) will rise.

Do you think the equity markets may not see major rally before general elections?

I think the market is already pricing in the general election outcomes. The Indian equity markets started CY’24 with extremely bullish sentiments, with top quartile valuations (~23x+ 12-month forward, Bloomberg consensus) and a record discount to debt yields. Nonetheless, with India’s exciting long-term growth story and the prospect of a 3rd term for popular PM Modi, this stretched starting point may weigh on returns this year.

While India’s EPS growth should be steady, the current valuation multiples indicate limited room on the upside. In our view, the equities are pricing in
a) optimal earnings & economic growth forecasts
b) a 3rd term for PM Modi
c) Interest rate cuts by RBI and other global central banks
d) soft landing for the global economy.

On the other hand, key risks to markets include
a) a sharp slowdown in the global economy
b) delayed interest rate cuts & sticky inflation
c) geopolitical risks
d) spike in commodity prices esp. oil
e) unexpected general election outcomes

Are the equity markets least bothered about fed funds rate cut now?

The US Federal Reserve in its December 2023 policy meeting projected interest rate cuts of 75bps over CY’24. The Fed chair expressed comfort with inflation and as such indicated returning to more normalized interest rates. I will prefer not to predict the Fed’s move given the sticky inflation reading, however, the current market rally indicates that consensus is expecting a more than 75bps rate cut.

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