"The CPI inflation will likely fall under RBI’s upper tolerance band in FY24, so we expect a rate hike of 25 bps in April and a halt at the level for a while as the central bank gauges the impact before it cuts the rates by the end of FY24," Anil Rego of Right Horizons PMS says in an interview with Moneycontrol.
On the quarterly earnings growth season, which is going to start next week, Rego feels the FMCG sector is likely to see a muted quarter in Q4FY23, and sales growth in staples would be led by value growth and premiumisation.
The founder and fund manager at Right Horizons, a pioneer in the contrarian style of investing and a seasoned investor for over three decades, is bullish on the capital goods sector long-term due to sector tailwinds.
"The capex upcycle will witness infrastructure, power, renewable, petrochemicals and defence investments for the next few years. We are expecting strong revenue growth in Q4FY23 for companies with robust order bookings," he says.
Which are the sectors that will perform better and sectors that will disappoint in terms of their Q4FY23 earnings performance?
Banking
The banking space is witnessing robust credit growth momentum driven by the continued traction in the Retail and SME segments. On a segmental basis, home loans, Auto loans and Credit card outstanding continue to grow, and corporate loans are recovering gradually. However, deposit growth continues to lag credit growth, so focus on mobilising deposits is a key monitorable. In the third quarter of FY23, NIM expanded, and asset quality was benign.
Within the NBFC space, AUM growth, steady NIMs and improving asset quality were witnessed for key players. Growth across segments was upbeat, and traction in new business was driven by expanding distribution network. The disbursal momentum for housing financiers is likely to sustain, leading to healthy AUM growth. We expect in Q4FY23; systemic loan growth will continue to be strong, with solid credit growth being supported by ongoing growth in the retail and SME segments. The corporate segment is gradually recovering, and a pick-up in capex would be crucial to maintaining growth momentum. The margin trajectory will be influenced by the rise in the cost of deposits and further rate hikes. The asset quality should continue to improve in Q4FY23.
Auto
Though stable demand is expected in Q4FY23, volume growth will likely moderate in some segments, and exports will likely be weak for two-wheelers due to weak global sentiments. We expect operating margins to improve for OEMs led by the benefits of RM cost moderation, and operating leverage. We expect a recovery in exports in a couple of quarters down the line.
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Consumer
The slowdown in rural consumption and high input prices continued the impact on operating margins affecting the consumer goods companies’ earnings growth in Q3FY23. Post the recent correction, stable input prices of key raw materials are expected to improve margins consistently. Demand is likely to improve by the second or third quarter of FY24 as the slowdown in rural is expected to have bottomed, and urban demand has remained resilient and expected to remain strong.
FMCG is likely to see a muted quarter in Q4FY23, and sales growth in staples would be led by value growth and premiumisation. The disparity in prices was seen hence divergence in operating margins across companies is expected. We remain selective with a preference towards better growth prospects led by a strong portfolio of brands, cost-saving strategies and expansion of reach in the rural and urban markets.
Capital Goods
We are bullish on the sector long-term due to sector tailwinds. The capex upcycle will witness infrastructure, power, renewable, petrochemicals and defence investments for the next few years. Additionally, private capex is rising in pharmaceuticals, beverages, food processing and automation industries. We are expecting strong revenue growth in Q4FY23 for companies with robust order bookings.
We prefer companies with solid and diversified order books, the scope for margin expansion and healthy cash flow generation as the demand outlook remains buoyant. In addition, price hikes, operating leverage, and declining commodity prices will improve operating margins.
Do you expect better commentary by corporates on rural recovery after March FY23 quarter earnings?
Indicators suggest that economic activity has remained strong in Q3 and Q4 of FY23. Rabi acreage exceeded last year's area by 3.3 percent as on February 3, 2023. Improvements in agricultural and allied activities and farm loan waive off in certain regions will likely boost rural demand. We expect a gradual recovery in rural demand, and hence commentaries from corporates will reflect a gradual recovery.
Do you see interest rate cut possibility towards end of 2023?
We are noticing India's WPI rate has fallen to 3.85 percent in February 2023, its lowest reading since January 2021. CPI will likely follow as it is softening from elevated levels and is expected to fall below 6 percent the upper tolerance band of RBI in FY24. Since the effect of rate hikes typically take 3-4 quarters to affect the economy, we expect rate hikes to halt at peak levels and rate cuts at the end of the financial year.
Is it the right time to increase exposure to cement space given the strong infrastructure push?
The 3rd quarter performance for the companies under the sector reported health volumes and mixed pricing across regions. Fuel costs had increased till the 2nd quarter and decline post that this is expected to drive cost reduction in the fourth quarter. We expect margins to expand due to better realisation, lower fuel prices, and operating leverage in Q4FY23 and Q1FY24.
Channel checks reveal that pan-India cement prices have fallen month on month, led by a weak pricing environment in South India. A healthier environment for demand will absorb capacity additions as utilisation remains broadly similar.
Over the medium-term, growth prospects for the sector are intact due to the government’s focus on infrastructure development and sustainable momentum in the residential housing segment. Overall, we have a neutral outlook on the sector. We expect operating profit to improve if power & fuel costs decline and, provided the benefits are not passed on as lower costs.
Should one wait for some more time before taking fresh exposure to auto space?
The automobile sector is in a cyclical uptrend supported by a sharp recovery in urban demand and a shift in preference towards personal mobility. Numbers at the wholesale level are expected to be mixed with strong demand for PVs (passenger vehicle), and premium two-wheelers that may be offset by muted demand for entry and mid-level bikes and LCVs (light commercial vehicles).
Demand is strong in CV (commercial vehicles), led by pre-orders due to expected5 price hikes from April onwards. We prefer OEM companies with strong order books in the upper-end segments as valuation is attractive. We expect operating margins to improve for OEMs led by the benefits of raw material cost moderation, and operating leverage.
Do you think the banking crisis is over now?
Markets in the US, despite the banking turmoil, were defiant in March. The crisis stems from a rapidly rising interest rate environment that has made otherwise safe long-term investments lose value as banks were forced to realize losses due to a liquidity crunch induced by a faster pace of withdrawal. We expect the issue can be contained and Fed to calibrate rate hikes carefully from hereon.
Most experts feel this would be the last interest rate hike by RBI. Do you agree and why?
The annual CPI in India slowed to 6.44 percent in February of 2023 from 6.52 percent in the previous month and is coming off of elevated levels. It will likely fall under RBI’s upper tolerance band in FY24, so we expect a rate hike of 25 bps in April and a halt at the level for a while as the central bank gauges the impact before it cuts the rates by the end of FY24.
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