Investors have expressed interest in an upswing in capital expenditure (capex), but according to Jefferies, there are few options to invest in this theme. The capital markets firm believes that as the investment cycle gains momentum, investors may be forced to purchase expensive stocks.
To explain why the capex cycle is likely to accelerate, the brokerage firm noted that the risk appetite of Indian corporations and banks has increased due to various government initiatives to promote capex and a potential upswing in the property sector.
"Order flows in industrial companies have also increased, with year-on-year growth of over 15 percent from the pre-pandemic lows of 5 percent. With capacity utilization at 73 percent, above the historical average, we are optimistic that we are entering a new phase of the capex cycle," Jefferies said.
Mahesh Nandurkar of Jefferies wrote in a note that the rising consumption share over the last decade has driven price-to-earnings multiples, and a similar trend is evident in the capex cycle.
"By applying a similar trend seen in the consumption cycle to the capex cycle, we believe that the revival of capex will result in the re-rating of industrial stocks, particularly as options are limited," Mahesh Nandurkar of Jefferies said in the note.
Read more | Receding fear of rate hikes, positive global cues create optimism zone for Indian equities
Since options for investment bets to play the capex cycle are limited and some companies are affected by ESG issues, Nandurkar stated in the note that he maintains an "overweight" position on the industrial sector, with preferred picks such as L&T, Thermax, Siemens, Polycab, KEI, and ABB India.
According to the note, some of these stocks have already been re-rated, but with an expected compounded annual growth rate of 25-30 percent in earnings from FY23-FY25, these stocks could outperform even if PEs remain stable.
Read more | Reliance Industries' capex benefits to flow in FY25, risk-reward attractive: JPMorgan
Rising consumption share driving PE multiples
Jefferies noted that over the past decade, as Private Final Consumption Expenditure (the consumption share in GDP) increased, there was a consistent re-rating of consumer stocks.
Private Final Consumption Expenditure as a percentage of GDP increased from 54.7 percent in FY11 to 61.3 percent in FY21 as the investment cycle weakened.
Jefferies pointed out that "the 1-yr forward PE of FMCG stocks, which was 20 times in 2011, is now 50 times, whereas consumer discretionary names (excluding autos) increased from 20 times to 70 times over the same period." The investment bank explained that the re-rating was also due to investors preferring to invest in the consumption theme rather than the weakening investment theme.
However, Private Final Consumption Expenditure as a share of GDP has begun to reverse in the last two years, indicating that consumption as a percentage of GDP has peaked.
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