The quarterly earnings season for the October-December period will begin in January 2022. Nitin Sharma, Director, Research, and India Site Head at Fidelity International, believes names in banks, diversified financials, materials and pharmaceuticals will see earnings upgrades in the coming months.
India has been enjoying premium to most of emerging markets for several quarters now given the expected growth in coming years. “India’s premium is likely to sustain for now as it offers a better earnings growth profile at least over the next 2-3 years as compared to most other emerging markets,” said the seasoned analyst, portfolio manager, research team builder and leader in an interaction with Moneycontrol.
India is also trading at 20 percent-plus premium versus its average for the last five years as expectations around a lasting cyclical recovery after the pandemic take hold, he said. Excerpts from the interview:
Do you think India’s premium to global and emerging market equities will remain elevated in the coming years?
Any stock’s or market’s valuation premium or discount is primarily driven by the relative Return on Equity (RoE) and earnings growth. Historically, India commanded a premium to comparable emerging markets owing to higher real RoEs. This relative RoE advantage has visibly diminished off late, making the Indian markets appear expensive as against, say, China or ASEAN nations.
However, India’s premium is likely to sustain for now as it offers a better earnings growth profile at least over the next 2-3 years as compared to most other emerging markets.
What is your economic growth estimates for 2022 and what are the risk factors that can moderate or drive the economic growth momentum in 2022?
Macro, broad-based variables such as GDP is hard to forecast with a lot of reliability and that’s one reason why we believe in bottom-up investing. Having said that, we still expect India to well achieve the current consensus of 9 percent GDP growth rate in 2022 as we put COVID-19 behind us, embark on a cyclical recovery that had started gaining roots just when the pandemic broke out, and see a sustained capital spending cycle.
Structural factors such as rising formalisation of the economy leading to a higher tax base, increasing workforce productivity, stronger corporate balance sheets, and improving manufacturing economics in the country will support this recovery. A revival in consumption and in the services segments hit hard by COVID-19 will also be near-term triggers.
Total credit growth hovers at 7 percent and it will see a gradual revival back to the pre-pandemic rate of about 14 percent. The system has enough room to support this growth with the total Capital Adequacy Ratio (CAR) touching nearly 20 percent for top private banks and a comfortable 12 percent-plus for leading PSU banks.
The key risks are around the pandemic direction, continuation of supply chain issues impacting production and trade, and potential interest rate/liquidity shock once the Fed begins to taper the QE (quantitative easing). Higher energy prices are another risk – every 10 percent increase in oil prices pushes India’s growth lower by 0.2 percent and raises inflation by 0.3 percent.
Do you expect further corporate earnings upgrade in the coming quarters? What are those sectors that will drive upgrade in the Nifty EPS?
The pace of earnings upgrade is likely to slow down in 2022 after a strong show on this front over the last 12 months. High commodity prices, continuing supply chain bottlenecks and re-emergence of COVID-19 restrictions in various parts of the world will drag revenues or margins for various sectors and dent expectations of a uniformly fast recovery after the pandemic. However, some sectors still offer upside versus consensus expectations.
We believe names in banks, diversified financials, materials and pharmaceuticals will see upgrades in the coming months. Financials will generally benefit through a cyclical recovery with rising credit flow and comfortable asset quality. Materials sector should again benefit from a capex cycle and construction recovery along with better supply discipline.
What are your broad expectations from the Union Budget FY23?
This will be the third budget with the COVID-19 backdrop. Expect it to focus on reviving consumption while still creating room for continued infrastructure spending. The tax buoyancy seen over the current financial year should mean the finance minister has some flexibility in this regard.
The big-picture emphasis is likely to continue on boosting social and physical infra, supporting urbanisation, driving Make-in-India, further pushing asset monetisation and supporting farm incomes. Some ongoing themes such as boosting healthcare spend, guiding over public sector banks’ capital position and simplification of tax frameworks should continue to find space among budget priorities.
Over the years, the relevance of Budget has (rightly) come down for various economic and industrial activities where you now see more dynamic policy making approach. It is particularly visible in indirect taxation and offering a more viable ground for manufacturers through schemes such as PLI (production-linked incentive).
What are the risks and concerns that one should consider before taking a position? Do you think FII outflow is a major concern for India in the current environment?
From a global perspective, the first and the foremost risk continues to be the shape of the pandemic. The base case as per most market participants is that it will turn into a more benign endemic by the second half of 2022. Any negative surprise here will obviously curtain economic activities yet again.
A second significant risk will be around the Fed’s and other global central banks’ ability to neatly strike a delicate balance between taking decisive action on controlling inflation while not tightening the financial conditions too much that could kill the nascent economic recovery.
Lastly, the geopolitical situation remains volatile in many parts of the world with multiple flash points. Investors will need to be prepared for the uncertainty to spill over into the financial markets, which could be hit harder owing to such developments this year in the face of tightening liquidity.
On the domestic front, some large states are heading into elections in 2022 and will be watched over to assess the likely pace of coming reforms.
In terms of FII flows, the Indian markets have done well in 2021 despite FIIs having withdrawn about Rs 24,000 crore since April as this selling was more than matched by retail flows and domestic institutional buying. It should be noted that equities still form a very small proportion of the domestic savings portfolio and as such the local flows can absorb any FII outflow. Having said that, FII outflows are going to put pressure on the currency as the Fed steps up its taper.
What are the sectors to focus on in the year 2022?
Our investment approach as such is stock-specific. However, there are sectors with potential positive drivers in 2022. The sectors to focus first will be the ones offering a structural revenue growth opportunity. IT segment, for instance, looks at sustained demand driven by rising technology spend by companies globally and increased offshoring.
Similarly, the auto sector offers a combination of pent-up demand and a long penetration cycle for New Energy Vehicles (NEV). Then, there are sectors with a positive growth outlook off a cyclical recovery. Foremost here will be banks that can expect credit growth picking up even as the capital adequacy ratio are quite sufficient.
A rising capex cycle with infrastructure boost will also augur well for construction, engineering and industrials. Real estate should also see steady demand, driven by low interest rates and a reasonable affordability.
In many cases, the positives are partially built in the current valuations, so investors should tread with caution and look at individual stocks and valuations before investing.
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