Daily Voice | Why this market veteran is overweight on domestic cyclicals but finds FMCG not attractive

We are positive on the power sector. Within that, we are also positive on green or renewable energy (RE).

India is facing a tight power demand-supply scenario. Thermal capacity takes 36-48 months to set up and renewable energy takes 12-24 months between land acquisition and equipment. Double-digit / high single digit power demand growth since July 2023 onwards has been a surprise and government machinery is gearing up to accelerate investments. Banks have been funding non-Power Purchase Agreement (PPA) capacity recently, which indicates a systemic belief that merchant prices would continue to be high.

Accelerating capacity expansion is essential to prevent recurrent deficit periods starting from FY26E and beyond. India should have at least 308 GW of renewable energy installed by 2030, according to the government's 450 GW RE capacity plan.

Also read: India’s Q2 GDP growth beyond expectations, RBI may opt a hawkish stance, say economists

Consensus estimates place power demand growth in FY23–30 at 7 percent CAGR as capital expenditures fuel GDP expansion, much like they did in FY04–10. To prevent a consistent power deficit, India's total power generation capacity must increase from 416 GW in FY23 to 665 GW by FY30. This increase should fuel thermal capital expenditures.

The sector's whole value chain is anticipated to profit from the capacity expansion, which is unavoidable and will especially benefit energy storage, towers, conductors, transformers, utilities (both thermal and renewable energy), transmission finance, towers, and total capital expenditures on generation and transmission.

Is it time to step up exposure to the FMCG space which has been in the consolidation mode since August?

We believe that the FMCG space is of high quality with no debt, high ROEs (return on equities) and high payout. However, they are facing low growth prospects – both in absolute and relative terms, but trade at rich valuations. With higher certainty of growth coming from domestic cyclicals and at much lower valuations, the risk reward, in our view, for FMCG space is not too attractive at the current point in time.

To put in numbers, Nifty FMCG Index is trading at 37x one-year forward EPS, which is almost 100 percent premium to Nifty versus a 10-year average of 84 percent premium. However, the next 2-year consensus EPS growth is expected in the low double digits for FMCG vs mid-teens for Nifty.

Also read: UltraTech to take over Kesoram Industries’ cement biz; sources peg enterprise value at Rs 7,600 cr

Themes that you are betting on in 2024...

We are overweight on domestic cyclicals, led by auto and manufacturing. The latter includes industrials, capital goods, power, defence, and railways among others.

After a long hiatus, we are already seeing strong earnings delivery by these sectors.

The government’s commitment to capex and the companies’ orders books provide further evidence of earnings visibility.

Nifty Auto Index is trading at 20x one year forward estimated EPS, with next 2 years earnings CAGR projected at 50 percent

BSE Utilities Index is trading at 15x one year forwards estimated EPS, with next 2 years earnings CAGR projected at 17 percent, with upside risks.

BSE Capital Goods Index is trading at 31x one year forwards estimated EPS, with next 2 years earnings CAGR projected at 26 percent

Do you think the market is pricing in zero interest rate hikes from here on? What do you broadly expect from the Federal Reserve and RBI policy meetings next month?

The yield on the United States Treasury (UST) 10-year Treasury Inflation-Protected Securities (TIPS) has dropped more than 35 basis points to less than 2.2 percent after peaking at more than 2.5 percent around the end of October 2023. The slim chance of a Fed rate hike in the near future has given way to an increasing likelihood of rate decrease in 2024.

Also read: Exit poll outcome: Five takeaways for national politics on road to 2024

The employment expansion, consumer spending, and the slowdown in inflation (9.1 percent in June 2022 to 3.2 percent now) all lend credence to the notion that the Fed has finished hiking rates for this cycle. However, the Fed is anticipated to wait to drop rates until mid-2024 and the relaxation of policy will be modest given that inflation is still high (3.2 percent currently versus aim of 2 percent) and will likely to decline just gradually. This fits very well with the US election season as well.

While increased government and consumer expenditure is expected to support the economy in the near term, private investment is expected to sharply decline, slowing growth until early 2025. Although the employment market is still generally solid, consumer spending has shown to be quite resilient. However, the demand for workers is gradually beginning to decline. Lower income groups are beginning to show signs of depleting their epidemic era reserves, as real household disposable incomes are beginning to decline.

The CPI in India has also somewhat decreased, from 7.8 percent on April 22 to 4.9 percent now. Nonetheless, the CPI has not fallen below the 4 percent RBI objective for more than 4 years. Furthermore, decreasing foreign direct investment and increasing imports point towards the expectation that the RBI may postpone rate decrease until the CPI sustains below 4 percent.

Do you expect an upward rally in equities before the elections next year or will there would be too much volatility?

We remain constructive on the markets in 2024, apart from being long term bullish.

The recent sharp upmove in FY24, has already seen some consolidation/correction in the month of October 2023. However, one must note that the rally has been on the back of strong earnings delivery. As a result, most frontline indices are trading at 20-30 percent lower valuation (in terms of 1-yr fwd PE) than the peak seen 2 years ago.

Over the next 12 months, India’s nominal GDP is expected to grow around 11 percent, with Nifty earnings growth projected to grow around 16 percent. India is a rare large country which offers double digit nominal GDP growth and earnings growth along with double digit ROE.

Historically, markets have seen some volatility around general elections. But, once that is out of the way, we expect markets to continue to focus on the strong earnings trajectory.

Do you expect big earnings support for the auto space in the coming quarters?

After overcoming numerous macro and sector-specific challenges, the auto industry experienced a healthy rebound in terms of demand, supply chains, and operational costs. In the last 1 year, the Nifty Auto index grew 33 percent year-on-year, outperforming the Nifty index, which grew by 8 percent, reflecting the sector's strong performance.

While PV (passenger vehicle) and tractor volumes reached new highs in FY23, CV/2W volumes have been slower to approach their earlier peaks, implying that the extent of recovery differ between categories.

Demand patterns are reversing, particularly in the 2W segment.

The majority of management statements suggest that although exports were still under pressure in the first quarter of FY24, they sequentially recovered in the Q2FY24. Now that headwinds have begun to lessen, exports should begin to gradually recover starting in 2HFY24.

Over FY23–26, the combined net income of Nifty Auto Index constituents is anticipated to increase by 36 percent CAGR, according to consensus estimates from Bloomberg.

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