Daily Voice: Shriram Life's Ajit Banerjee prefers largecaps versus midcaps in IT sector, remains cautious on auto

There has been a remarkable change in consumer demand preferences and patterns since Covid. Initially, we saw a sizeable demand in the EV (electric vehicle) segment for four-wheelers, which has off late tapered down, and preference for high-end passenger vehicles and two-wheelers over entry-level four-wheelers and two-wheelers, which still remains. There was a pent-up demand for automobiles over the last 3-4 years, which was driving the automobile sales largely.

However, with the pent-up demand drying up accompanied by the increased cost of automobiles and a slowdown in urban demand at this point in time, it would be prudent to remain cautious in the auto sector. There is an inventory pileup at the dealers' end and even though festive period sales have led to a draw down in the inventories, the concern remains.

Having said that, there are some silver linings as well. The rural sector demand is picking up so we can see pick up in two-wheelers and tractor sales going forward.

The bank & NBFC finance rate still remains high, which also acts as a deterrent for auto sales. So once the RBI starts repo rate cut, we can expect transmission of these reduced rates to the lending institution offering lower rates, so till such time it’s better to remain cautious.

Is it better to invest in the mid-cap IT segment compared to large-cap IT stocks?

The IT sector, overall, is looking favourable at this stage with early signs of growth emerging. The management commentaries and forward guidance are also sounding positive. New headcounts are being added after almost a two-year gap. The revival of the BFSI sector in the US has given much-needed positive signals to the IT sector.

With Trump 2.0 starting in January, a cut in the corporate tax rate is expected, giving US corporations more money for discretionary IT projects. That would benefit the IT sector in India.

In terms of our preference, we prefer large-cap IT versus midcap IT companies due to the better risk-reward available in the space.

Midcap IT companies have outperformed largecap ones in the past three years due to superior growth and improving margins, their valuations are high. They are currently trading at a higher premium than largecap IT companies as compared to historical averages, thus leaving little room for re-rating. While midcap IT companies are more specialized in terms of their offerings, most of them are exposed to concentrated clients and sectors unlike largecaps, which have a broader range of service offerings as well as client base. This leaves midcaps more vulnerable to the fortunes of any particular industry versus largecaps.

Largecaps have scaled, allowing them to win cost take-out deals, which is currently the flavour of the season. To sum up, while we like the medium-term outlook for the IT sector, we prefer largecap due to the better risk-reward available in the space.

After the Federal Reserve's outlook, do you think the RBI may not be aggressive in cutting interest rates in 2025?

The higher headline inflation number and the growth slowdown in the second quarter of FY25 have worsened the growth inflation balance. From the MPC minutes, we can see that most MPC members expressed worry about the lower-than-expected Q2FY25 real GDP growth, and external members noted the subsequent downward revision of RBI’s growth forecast for FY25. Hence, the case for the rate cut cycle to begin may arise from this.

However, after the December FOMC meeting and the hawkish tone of Jerome Powell, US 10-year yields moved up following the revised guidance on possible rate cuts in calendar year 2025 to 50 bps from 100 bps earlier. Additionally, the inflation forecast was raised by 25 bps. With rising pressure on the rupee and the growing cost of foreign exchange interventions, the RBI’s room for a rate cut is narrowing. The RBI may prioritise financial stability over inflation management at this point in time.

Some analysts opine that a rate cut could exacerbate currency pressures by reducing the rupees attractiveness. However, the RBI and the MPC need to consider external sector dynamics with growth and inflation trends before making a decision. Therefore, it is slightly premature at this stage to comment on their move.

Do you foresee any challenges to the economic growth forecast for FY25? Does this mean 6.6% growth is easily achievable?

The world is awaiting quiet eagerly on policy pronouncements after January 20, 2025, on trade, taxes, regulations, immigration, and energy amongst many others. India stands 10th in the list of countries with which the US has a trade deficit and is on the radar of Trump 2.0 policymakers. Therefore, India would have to certainly watch how the new US administration plans to steer the country and what the potential ramifications for India could be in supporting or derailing its growth. However, the new US government policies are likely to impact us from the next financial year. The recent wins in the state elections may provide some leeway to the central government to push reforms.

After disappointing Q2FY25 GDP data, high-frequency indicators released for the month of October and November show some improvement in economic activity. However, government capital expenditure is still tracking lower than last year as of October 2024. Recent high-frequency data show continued recovery in rural demand. Two-wheeler sales (an indicator of rural demand) have surged while passenger vehicle sales remained muted (an indicator of urban demand), signalling a muted festive season. Rural consumption growth rose by 6% in Q2 FY25 (up from 5.2% in Q1) whereas urban consumption rose by 2.8% in Q2 FY25 (vs. 2.1% in Q1).

Hiring intentions turned positive in October in the formal job market after a hiatus of two months. MGNREGA demand also moderated in October and November 2024 versus Q2 FY25. These are positive from the growth perspective. Manufacturing activity performance was mixed but services activity continues to hold up. Other services indicators, such as the Goods and Services Tax (GST) collections, e-way bills, and toll revenues, all recorded an increase. On the other hand, credit growth eased.

The government revenue expenditures have risen quite sharply from October onwards and are now almost tracking last year levels. Central government capex spending though continued to remain subdued with some early signs of picking up. However, there has been a sharp drawdown in the government’s cash balances in November, which indicates that spending has started and has picked up. If the government at the centre and states push the throttle on capex spending for the residual period of FY25, we can see growth recovery, but it may not match the level of last fiscal.

The cash reserve ratio (CRR) cut by 50 bps should ease growth headwinds due to the shortage of money. Tailwinds from back-ended fiscal spending in FY25 and further macro-prudential easing to support credit growth should help GDP growth catch up, and we should possibly hover around 6.4%-6.5%, ceteris paribus.

Which sectors are expected to be in the limelight in 2025?

We feel the following sectors would remain in the limelight in 2025:

Industrials: The next five years are likely to bring a major rise in corporate capex, leading to stronger order book for industrial companies. New investment areas such as mobility, defence, railways, electronics and semiconductors are indeed attractive. However, investments in conventional sectors such as coal-fired plants, steel and cement are expected to be an inch higher. Also, real estate – both commercial and residential – has headroom. Additionally, the materials sector could benefit in broad terms.

Consumption: Airlines, hotels, and retail including mass consumption are expected to take the lead (100 million middle-class homes are expected to form in the coming decade). Next could be luxury consumption and healthcare services. Lastly, various types of discretionary consumption, including autos and auto parts.

Financials: Within financials, large-cap banks and non-bank lenders remain in focus followed by insurance companies. The regulatory environment is likely to remain tight because the experience of the previous non-performing loan cycle has left scars that will take time to fade. In this context, larger lending entities could fare better than smaller ones.

Energy transition: India's energy consumption is rising, and the sources of its energy are also changing. Both present opportunities ranging from green hydrogen to gas to conventional power utilities, batteries, and other renewable businesses.

Do you expect an overall earnings recovery only from the last quarter of FY25?

Predominantly, the Q3 results in any normal year show good results as this period gets the benefit of higher revenue growth due to the festive season-related sales, wedding season spending, continuity in government revenue and capex spending, etc. This year, however, was marred with a slowdown since the beginning of the financial year, The slowdown has continued into the third quarter as well where market sources are hinting at slower consumption versus expectations as consumers are clearly impacted by rising costs and lower income.

The management commentaries across the sectors project sub-par growth projections accompanied by higher input costs, which is leading to a drop in earnings as well. If we look at the construction, infra and capex space, the economy is slowing, which is clearly evident in the GDP numbers, and these sectors have been impacted by reduced government spending and a delay in the pick-up of private capex. The pain is imminent from commentary across companies ranging from the FMCG to auto to capital goods sector to name a few. The increase in stress on micro-finance as well as unsecured lending and credit card side is also an indication of the stress on the ground. If we look at the commodity sectors, we will notice stress across GRMs (gross refining margins) for oil companies; steel prices are lower due to a demand-supply mismatch globally; cement price hikes have not been absorbed for most of the year. All these factors combined are certainly hinting at another muted quarter for corporates.

However, we are now seeing that government spending has picked up from Q3 onwards both in terms of capex and revenue, which can lead to economic growth being strengthened. The CRR cut will ensure core liquidity, aiding banks and NBFCs in disbursements and boosting consumer spending. Companies have indicated a stronger back-half of the year. Overall earnings recovery is, therefore, likely to fall into place, not before Q4 of FY25.

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.