Moneycontrol PRO
you are here: HomeNewsBusiness

Turned positive on autos for reasonable valuations, Motilal Oswal’s Duggad says

Duggad is overweight on the sector given its underperformance in the last five years. He is betting on stocks like Mahindra &Mahindra, Tata Motors and Maruti Suzuki

March 01, 2023 / 06:16 PM IST

Auto stocks have suddenly turned into a darling of investors and most securities firms are turning positive on the sector.

In an exclusive interview with Moneycontrol, Motilal Oswal’s Head of Research Gautam Duggad suggested his firm is overweight on the sector given its underperformance in the previous five years and reasonable valuations. Duggad is betting on stocks like Mahindra & Mahindra (M&M), Tata Motors and Maruti Suzuki.

Duggad also discussed the financial sector's performance in detail. “Despite the strong quarterly performance and five-fold increase in profitability in the last five years, the market capitalization of financial companies has not kept up with the profitability increase,” he said.

He attributes factors such as a potential increase in the cost of deposits, moderation of net interest margins, and slowing Gross Domestic Product (GDP) growth as the reasons.

Additionally, he notes that foreign institutional investors have been selling the shares in the last two to three months, which has affected the financial sector. Although valuations are attractive, the stock prices are not performing in line with underlying fundamentals, offering an opportunity to investors, he said.

Duggal also spoke about paint stocks being in a correction mode for the last one-and-a-half years, and the recent entry of Grasim into the category. With a consumption slowdown across the board and a big player entering the industry, one needs to be cautious in buying paint companies’ stocks, he said. Edited excerpts:

Let’s talk about the financial stocks. What do you make of them? Do you think they're oversold and the valuations look attractive and can lend support to somewhat falling markets right now?

Financials have had a very strong quarter for the last four or five years in a row now. However, the problem is something else. Right now, the macros have overwhelmed the micros on financials. If you look at the numbers, in the last four to five years, the profits of financials in Nifty 50, they were Rs. 45,000 crore in 2018, they will end with a profit of Rs. 2. lakh, 10,000 crore in 2023. So, almost a fivefold jump in five years in the profits of financial companies in Nifty.

However, the market cap of those similar 11 companies, they've not kept track with the underlying profitability increase. So, there has been a de-rating out there. In fact, instead of looking at five years, even if you look at say from a year-and-a-half back, you know, October-November 2021, the financials, their stock prices have been flat. However, between November 2021 and now, we have seen five very good quarters of underlying profitability, balance sheet and asset quality improvement.

So, the Street is concerned, I think, on multiple factors. One is the potential increase in cost of deposits, because deposit growth is still lagging loan growth. You've seen probably the peak of the net interest margins, you've seen about 50, 60, 100 basis point of NIM (Net Interest Margin) increase in the last one to one-and-a-half year.

So, possibly, this is the peak, and from here on, you would see some moderation in NIMs. And third, your credit growth, whether it can sustain 15 percent-16 percent when your GDP growth is slowing down, that is also a point of concern. So these are three fundamental factors. And then to add to that, we've seen good FIIs (foreign institutional investors) selling in the last two, three months.

And foreigners, specifically FII holdings, if you see their total portfolio in India, 35 percent to 40 percent are in financials. So whenever you see outflows on the FII side, you will see financials taking it on the chin. So while valuations are attractive, fundamentals are extremely strong, trade growth, asset quality, net NPAs (Non-Performing Assets), RoEs (Returns on Equity)– all of them are looking picture- perfect, the stock prices are not performing in line with the underlying fundamentals right now. So, somebody who has a long-term view, three-year view kind of horizon, I think this is as good a time as any to add to financials.

Let's quickly chat about paint company stocks. A cautious undertone due to the Grasim entry, which could spell bad news for everybody's profitability margins.

See, stocks have corrected. Paint stocks have been correcting for the last one-and-a half years now. If you look at Asian paints, I think the peak of Asian Paints was somewhere about Rs. 3,500. Nowadays, probably Rs. 2,700, Rs. 2,800. The last quarter’s performance was very muted. There were flat volumes. To add to it, as you mentioned, Grasim, JSW Steel, and there's one more player who's entering the paint category, and they're entering with deep pockets. So they are definitely word or words missing there to disrupt this industry, which has been functioning in a very nice, smooth, oligopolistic way, because there were four players who were controlling the market for the last two decades.

This is the first time a big entrant with deep pockets is coming with serious intentions. And they have some advantages given their distribution network. Birla White, you know the amount of money that they're putting to work on capacity building. So one needs to stay very cautious here because you're not buying the stocks at cheap valuations. They're still very inflated valuations, while they've corrected 20 percent. But the starting valuations were so expensive that even after a 20 percent price correction, you would still not get that comfort on a one-year, two-year (timeframe) for valuations. They're still upwards of 50, 60 P (this sentence needs to be checked and corrected). And at a time when growth is moderating -- you've seen how bad the consumption companíes’ results were this quarter.

Across the board, there is consumption slowdown. Yesterday, in the GDP (Gross Domestic Product) data which came out, the consumption data was extremely weak at an eight-quarter-low growth rate, government consumption, private consumption, whichever way you slice and dice the data, it's looking very weak right now.

So there can be some days where stocks move up 2 percent-3 percent because of the correction that that has (taken place), or maybe someday crude prices may fall $3-$4, and that will reflect in paint companies’ stock price moment, but beyond that, I wouldn't read too much into those price movements. Right now, from a medium-term point of view, there is a concern because a big player is entering, and it's being supplemented by two more guys who are entering that industry, especially at a time when demand is slowing down.

Your view on auto stocks. We've witnessed smart traction building in the opening deals for the last two consecutive sessions. There is hope that February numbers would be coming in higher, and probably price hikes will come through. How do you look at that basket and your top picks?

We've turned positive on autos of late. Autos, after going through a period of five years of underperformance on earnings -- the earnings in FY18 were, I would, say Rs. 28,000 crore in Nifty auto companies, they've fallen to Rs. 25,000 crore in FY23. Over a five-year period, there has been no growth. In fact, there has been a decline. Now this is the first quarter in the last 20 quarters where we've seen a meaningful earnings upgrading in auto names, right? So we've seen about 24 percent earnings upgrades and 5 out of 6 companies in Nifty have seen an earnings upgrade.

Second, demand is strong. Supply situation is easing because the chip shortage is easing out, and at the margin, you have seen commodity prices correcting. In fact, in FY23, the auto sector posted the best gross margin gains on a Year-on-Year basis. And the fact that they're coming out of five years of a downturn essentially means that valuations are still fairly reasonable. So what we like there is Mahindra & Mahindra on the OEM (original equipment manufacturer) side.

We also like Maruti and Tata Motors, and then on the ancillaries, we like Bharat Forge and Motherson Sumi, and Ashok Leyland. So it's a sector where I would be overweight now, given that you're seeing improvement in demand and supply, both complemented with the correction in commodity prices to an extent. And then you're coming out of a five years of down-cycles. So there are more legs to go in auto I think.

Themes at play as a harsh summer sets in. Especially, how does the long-term story of air-conditioner sales pan out for you? Do you think anything like Voltas appeal you?

It's very tempting to do this kind of seasonal trade summers due to this, winters due do this. I don't think you build compounding returns over a long period of time by getting swayed by what's happening for two months, three months. Somebody is a day trader and short term trader, they can obviously try their luck at some of these things. But by and large, I would steer clear of some of these kinds of concepts.

I think this is not the prudent way of investing. As far as your specific question on durables and ACs is concerned, I think there is a significant increase in competitive intensity there, which is coinciding with a demand slowdown for the last two years. You've seen some of the companies in the durable, I think names like Crompton and all, they have reported a topline decline? So things are going very tough, You have seen Whirlpools results for ‘the last three, four quarters. So it's not looking very hunky-dory out there. And we are in the midst of a fairly decent consumption slowdown. So I would wait before I try and take exposure them. And certainly I won't recommend getting into an out of the stock based on the seasonal volatility in the weather conditions.

Would you exercise caution due to El Nino for FMCGs (Fast-Moving Consumer Goods). Do you think that will have an impact on the stock price, as well as the fundamentals of the companies?

Yeah. So there you're already in the midst of a slowdown in staples. And if you analyze the results of consumer staple companies for the quarter, you would find that barring ITC and Hindustan Lever and I think maybe Britannia, most of the other consumer companies have posted a very muted set of numbers on volume growth, on margins, on profits. And on top of that, you are also just talking about the potential drought, El Nino, harsh weather conditions. Government also has not given any big push to consumption in its latest budget. So I think next two or three quarters are still going to be very muted.

But then somebody who has a three- to five-year view, this is a very good time to build a consumption portfolio of a set of stocks across the broad spectrum of consumer categories with good leadership in the underlying franchise, strong balance sheet and something which you wanted to buy for a long time, but couldn't buy because valuations were expensive and stocks were too popular and there was a euphoria around the consumption names still about a year back. Today, all of that has changed. These stock have time corrected for two, three years depending on which company you look at.

You know, Hindustan Lever's today's price is same as the price in February 2020, so three years of time correction, Nestle, four year of time correction. Other consumer companies haven't done much if you look at the last three, four years of performance. So there has been a time correction, there's been a price correction. And in general, the euphoria around the sector has moderated significantly. But somebody who has a very short-term view and expecting instant gratification, I don't think this is a sector for him or her. This is a time to build a portfolio of good quality consumption stocks for companies that are going through a period of lull.

Enough developments around Vedanta and concerns around fund-raising plan. But what do you make out of the sector between ferrous and non-ferrous, which do you like and what are your top picks there?

So we are underweight on the sector because the global environment on the growth is very, very fragile at the moment, and you're still talking about more rate hikes or global growth slowing down. In that kind of scenario, I could think the more rational thing to do is wait it out, you know. It's a very volatile sector. It's a very cyclical sector. It requires very special skill sets to get in and get out. We are underweight right now. We just have Tata Steel in our portfolio. On the non-ferrous site, historically, we've had a preference for Hindalco.

Nickey Mirchandani
Nickey Mirchandani NICKEY MIRCHANDANI Assistant Editor at Moneycontrol. She’s a presenter and a stock market enthusiast with over 12 years of experience who loves reading between the lines and scanning through numbers.