‘Softening commodity prices to improve earnings trajectory in second half of FY23’

Valuations are elevated and several segments are reflecting “pockets of exuberance”, mainly backed by a strong visibility in earnings in the near term and a favourable macro, says Anoop Bhaskar, head – equities, IDFC AMC. In an interview with Ashley Coutinho, he says that given the uncertain global macros, sectors dependent on exports appear to be less favoured by investors. Edited excerpts:

What are the key triggers for Indian equities to watch out for in the year ahead?

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The MSCI India index has outperformed the MSCI EM index by a wide margin in the past year. Does this signal a decoupling from other emerging markets in some ways?

China is the largest component within MSCI EM, its key indices trade at levels lower than pre-Covid. India, on the other hand, post March 2020 has registered a sharp revival in the equity markets aided by strong retail flows, especially since CY21. India’s economic trajectory also appears to be more stable and is forecasted for steady growth going ahead. A combination of both these factors has resulted in this sharp outperformance over the last two years.

Indian equities seem to be richly valued at this point. What is your take on valuations?

Valuations are elevated and several segments are reflecting “pockets of exuberance”, mainly backed by a strong visibility in earnings in the near term and a favourable macro. Sectors with high visibility are capital goods; automobiles; hospitality and domestic consumer discretionary, especially quick service restaurants. Given the uncertain global macros, sectors dependent on exports appear to be less favoured by investors, a reversal from the mood a year ago. Improvements in global macro and reducing possibility of US economy sliding into a recession in CY23 could change this narrative.

The private capex cycle did not take off as expected in FY22 and has lagged government capex during FY20-22. How long before things turn around?

As per RBI’s quarterly bulletin, capacity utilisation is now at 75% at an aggregate level. There are pockets, where utilisation is reaching levels which are ensuring corporates commence brownfield expansion. In other segments, fresh cap-ex is being deferred. Greenfield capex is still conspicuous by its absence, given the cost and availability of land. This could be a factor, which reduces the impact of corporate sector capex, as brownfield expansion would be 0.4-0.6x of similar capacity of a greenfield expansion.

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What is your take on earnings growth for India Inc in the second half of CY22, given the global slowdown? Could you elaborate.

Earnings trajectory in H2FY23, is expected to be better than H1FY23 mainly on account of softening of industrial commodities. Steel, aluminium, lead are down from 15-30% from peak levels of CY22. However, equally important would be a decline of fossil fuels. Prices of coke, coal, pet coke and even crude oil have fallen but price volatility remains high. Overall, markets may have factored in a weak September quarter earnings season, more focused on management commentary which is expected to be positive for margin improvement during H2 FY23. In comparison, global valuations are more muted after a sharp decline from the start of the year.

According to a recent Spiva study, 90% of active large cap funds have underperformed the benchmarks for the period ended June. What do you make of this trend?

In such point-to-point comparisons, timing is clearly a critical input. A large portion of newly allocated equity monies has entered the markets post April 2020, a phase in which markets have registered shallow corrections. In a nearly one-sided upward trending market, active funds tend to underperform the benchmarks; however, during periods of heightened volatility active funds fare better. In the past, outperformance was driven by a few factors such as unclear fund description (in 2018, Sebi tightened fund classification); information advantage for institutional investors (today company’s earnings calls can be attended or listened to by all investors) and limited numbers of professional and institutional investors (today that number is extremely large and competitive intensity has increased manifold).