Markets underestimating growth recovery underway in India: Jitendra Gohil

India is a solid structural investment opportunity and the markets are likely underestimating the growth recovery underway in the economy, Jitendra Gohil said

It has been difficult for the markets to sustain at higher levels, given the multiple headwinds. JITENDRA GOHIL, head of India equity research at Credit Suisse Wealth Management, tells Puneet Wadhwa in an interview that based on their analysis, the markets in India can tolerate up to 7 per cent inflation. Once it overshoots that threshold, Indian equities could see a valuation deterioration. Edited excerpts:

Do you think the markets now lack the triggers to move up in the short to medium term?

India is a solid structural investment opportunity and the markets are likely underestimating the growth recovery underway in the economy. As the execution improves and there are firm signs of a pickup in private capital investment (capex), we expect a further improvement in buying interests among investors in the Indian equity market. In the near-term, though, the markets will be keenly watching the success of the upcoming LIC initial public offering and public sector disinvestment.

To what extent are the headwinds priced in?

While in the near-term, oil prices should remain elevated, we expect Brent crude oil to fall back to $75 per barrel in the next 12 months. Oil and other commodity prices going much higher than optimal levels is a major source of concern now, because they could lead to central banks tightening their monetary policies faster. The most significant event is the next US Federal Reserve (Fed) meeting in March, with the markets already pricing in a 100 per cent probability of a 25 basis point (bp) rate hike and close to a 50 per cent probability of a 50 bp hike. For the whole of 2022, the markets are pricing in a benchmark US interest rate of over 1.25 per cent.

How are the foreign institutional investors (FIIs) viewing Indian equities?

The government’s privatisation and disinvestment ambition last year were well received by foreign portfolio investors (FPIs); the execution, however, was a let-down. Moreover, the withdrawal of the three farm laws last year and the fact that there is no fresh guidance in privatising public sector banks so far are indicative of the government succumbing to pressure from various stakeholders. This is clearly disappointing for them.

While FPIs have taken note of various reforms the government has undertaken and the strength of corporate balance sheets in India, they are still worried about Indian equities’ high valuation premium relative to the peers, especially China.

FPIs do look at India as a structural growth story and we expect selling pressure to ease a bit in the coming months as economic activities gain momentum once the Omicron-related disruptions abate and corporate earnings catch up to justify India’s premium valuation.

Do you see higher inflation and the cost of capital impacting India Inc’s fortunes in FY23?

Based on our analysis, historically, the markets in India can tolerate up to 7 per cent inflation. Once inflation overshoots that threshold, we could start seeing valuation deterioration for Indian equities. The corporate capex pickup is at a nascent stage and we need a lower cost of capital for sure. However, demand is a more important driver than the cost of capital; this can be absorbed if the former is supportive. Companies have already deleveraged their balance sheets materially; hence, if economic growth remains solid — which we expect to be the case — a higher cost of capital should not be a big worry. We base our end-FY23 target of 19,000 for the Nifty based on FY24 EPS (earnings per share) of Rs 1,000, implying a lower valuation of 19x P/E (price-to-earnings) versus the current 12-month forward P/E of 20x.

Your sector preferences?

We believe the consensus is underestimating India’s medium-term growth potential and the growth assumptions should see upward revisions. Hence, our preference is for domestic cyclicals such as banks and cement companies. Tactically, metals look attractive to us and defensive sectors such as information technology (IT) and fast-moving consumer goods (FMCG) could lag. Among exporters, we are extremely positive on contract manufacturers in the pharma [active pharmaceutical ingredient (API)] and chemical sectors, especially after the recent correction.

Do you think public sector stocks could underperform as the divestment of large public sector undertakings gets pushed back?

In terms of specific public sector companies that are expected to be privatised, we believe the government’s commitment and execution capabilities might fall short of market expectations and, thus, some de-rating is warranted, as the response is not that great. We remain positive on the banking sector overall, and we have also been recommending a couple of public sector banks for a while now. With much improved fundamentals and inexpensive valuations, we would favour public sector banks on a tactical basis.