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Daily Voice | Structurally bullish on defence, chemicals, API, Jitendra Gohil of Credit Suisse bets on realty, too

We have been very vocal for the past one year that India deserves a higher PE premium compared to global peers and despite spike in commodity prices, especially oil, India's relative valuation premium remains at historically high levels.

May 20, 2022 / 08:17 AM IST

Credit Suisse is structurally bullish on defence, chemical and the active pharmaceutical ingredient (API) stocks, and believes that investors with a medium to long term horizon should start looking at real estate companies as demand growth is expected to remain solid despite rate hikes by the RBI.

During an interaction with Moneycontrol, India equity research head at Credit Suisse Wealth Management, Jitendra Gohil, shares that he sees that the Indian market will remain choppy for the next few months. "Sector rotation and bottom-up stock picking is the best strategy now," he says.

Despite a slowing global growth and rising interest rates, oil prices have remained stubbornly high, and this is certainly a cause for concern for India, Gohil says. "If oil prices shoot up further, say another 10-15 percent, India may see one more round of selloff. Secondly, the Indian equity market is pricing in 15 percent per annum growth for FY 2023 and FY 2024."

Excerpts from the interaction:

With the fall of more than 15 percent from record highs, do you think the market has bottomed out for the time being and priced in all risk factors?

Close

There are a lot of moving parts, and it is difficult to say with conviction if this is a bottom or we can see another 5-10 percent correction or more. From valuation perspective, the Nifty index is trading at a rolling 12-month forward PE of 17.6 times versus the peak of over 22.5 times in October last year. This is also comparable versus 3- and 5-year pre-COVID average (from 2017-2019 and 2015-2019) of 17.5 and 17.0 times, respectively.

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Hence, from a valuation perspective, the Index is now trading closer to a reasonable level, in our view.

India's fundamentals are far superior compared to pre-COVID 3- and 5-year average. For example, BSE 500 net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) has improved materially from over three times to now close to 1.5 times, while the ROEs (return on equity) have jumped from high single digits to about 13 percent.

This fundamental shift, coupled with the fastest growth in EPS (earnings per share) compared to other large economies for the next two years, makes us comfortable on valuations for Indian equities as of now.

Due to these factors, we have been very vocal for the past one year that India deserves a higher PE premium compared to global peers and despite spike in commodity prices, especially oil, India's relative valuation premium remains at historically high levels.

What risk factors do you see that can bring in more correction for the market?

Markets can be irrational in the short-term and despite improved fundamentals of Indian corporates, we may see valuation may undershoot. During escalating geopolitical tensions, widespread fears of price hikes have resulted in hoarding of essential commodities such as food and oil globally. Over and above this, supply constraints, sanctions and stimulus-led demand has created shortages of several essential commodities.

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Despite slowing global growth and rising interest rates, oil prices have remained stubbornly high, and this is certainly concerning for India. If oil prices shoot up further, say another 10-15 percent, India may see one more round of selloff. Secondly, the Indian equity market is pricing in 15 percent per annum growth for FY 2023 and FY 2024.

If the RBI goes aggressive in controlling inflation, we expect some downgrades to Nifty EPS growth expectations. We are already 2-4 percent below consensus for the next two years and we may cut our expectations if growth dwindles further.

So far, we have been expecting some additional fiscal headroom for the government given robust tax collections, but given expectation of overall slowdown in GDP growth, the fiscal headroom is waning in my view.

Adani Group picked up Holcim's stake in ACC and Ambuja Cements. Do you expect more consolidation in the cement space?

From an industry perspective, this deal may lead to higher competition and margin pressure depending on the acquirer's strategy in the medium term with respect to expansion, pricing and target market share, in my view.

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Indian cement companies are already trading at a substantial premium to global averages and given the ESG (environmental, social, and governance) framework is gaining traction, foreign players may decide to exit. Moreover, domestically some small players are not expanding capacities and are thus losing market share.

We think that this is a good opportunity for larger players to expand via acquisitions. The deal has also capped valuations for existing players, in our view, as it was just above the current valuations, which is likely to pave the way for further consolidation in the sector.

From a long-term perspective, we remain positive on the infrastructure and housing sectors in India, which creates a promising demand outlook for the cement sector, further supported by the present urbanization trend and already low per-capita cement consumption.

We are near the end of March quarter earnings season. Have you seen more downgrades than upgrades due to inflation worries?

Surprisingly, Corporate India is withstanding the cost pressure very well so far. There are pockets of downgrades and upgrades but net-net earnings have been resilient so far. Up to a point, inflation is positive for earnings and this view has played out, but if it goes out of control earnings can take a knock, in our view.

According to our analysis, Corporate India can weather up to 7 percent CPI inflation, after which Indian equities might see deterioration in valuations. We are currently at this point, and the RBI, too, acted when retail inflation started to rise above 7 percent, which re-confirms our thesis.

Going forward, normal monsoon, salary hikes and private capex growth will determine the earnings trajectory for India, and it seems that we are on track so far.

On the positive side, slower growth will impact commodity prices as well and some of the companies that are facing unprecedented commodity cost inflation may see margin tailwind in the next 12 months, once the inflation starts to fall. Hence we have started recommending FMCG and some consumption oriented names.

On the basis of March quarter earnings and macro risks, what are your broad earnings expectations for the first quarter of FY 2023 and full year as well?

We are below consensus by about 4 percent for the next two years.

After recent broad-based correction, where do you see the value that can be picked for portfolio?

We have been expecting the Indian equity market to remain choppy for the next few months, and think sector rotation and bottom-up stock picking is the best strategy. We have advised our investors to exit or book profits in the IT sector few months ago, while we have started to become constructive on the FMCG sector where a lot of negatives are already priced in.

We also like selected discretionary companies now, including autos where we think supply constraints will abate and cost pressures will come down in the next few quarters.

We are structurally bullish on defence, chemical and the API (active pharmaceutical ingredient) sectors. We recommended investors to book profits in the real estate sector few months ago, but in this correction medium- to long-term investors should start looking at real estate companies as demand growth is expected to remain solid despite rate hikes by the RBI, in our view.

Lastly, some of the reopening plays such as multiplexes and staffing companies look attractive from a medium- to long-term perspective.

Do you expect inflation concerns to stay for long and is there any further major cut in global growth forecast for FY 2023?

Yes, inflation could remain elevated in India and globally for some more time, partly due to rising import bills and supply constraints globally. Until geopolitical tensions are fully abated, it will be difficult to say convincingly when inflation will come under control. However, the base effect will catch up and slowdown in economic activities will hopefully bring down inflation in the latter part of the year, in our view.

In terms of global growth, we always have been cautious as in my view this isn't a 2003-07 like scenario where the recovery was broad-based across the globe and despite the Federal Reserve hiking rates, the US dollar was falling. Post-pandemic recovery is fragile and uneven across the globe and within India as well. This time, Fed tightening is leading to strengthening of the USD, which is putting tremendous pressure on emerging economies like India that are import-dependent.

The consensus expectation of global growth is 3.3 percent, down from 4.4 percent at the beginning of the year. China, too, is slowing down materially as its key growth engine, real estate, is struggling. Surging inflation is forcing central banks to tighten policies faster, which may not immediately bring down inflation, which is supply led, while higher interest cost may derail economic growth for many countries.

In this challenging environment, India's position so far has been relatively better and our growth slowdown is much slower than other countries. On the flip side, if growth starts to dwindle dramatically, global central banks including India may have to go slow on hiking interest rates, but this isn’t our central scenario. Our House View is that growth will remain reasonably strong to withstand higher interest rates by the Fed.

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.
Sunil Shankar Matkar
first published: May 20, 2022 08:17 am
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