Price-value equation in large-caps favour, says Gautam Duggad

Expect markets to remain range bound given the challenging macros: Duggad

Indian equities are still trading at a substantial premium to Morgan Stanley Capital International (MSCI) emerging markets (EM) index despite the recent correction from highs, says Gautam Duggad, head of research, Motilal Oswal Institutional Equities. In an interview with Ashley Coutinho, he points out that supply chain challenges and rise in commodity prices can pose a risk to near-term growth and inflation dynamics. Edited excerpts:

The market has seen a fair bit of volatility of late. What is your equity outlook for the coming months?
 

Expect markets to remain range bound given the challenging macros amid the Russia-Ukraine conflict, rising rates, liquidity taper and higher input costs. In the near term, the situation pertaining to the Russia-Ukraine war and consequent reaction in commodity prices are key triggers. Valuations are now slightly more reasonable versus October 2021, but still at a substantial premium to MSCI -- EM as Nifty has corrected just 6-7 per cent from its recent highs.

Historically, equity markets have shrugged off the impact of wars in a few weeks or months. Will the Russia Ukraine conflict create a more lasting impact?
 

This will depend on the duration and magnitude of the war. If the war is prolonged and assumes greater proportion, the impact can be lasting. It will have implications on global supply chains, commodity price movements, portfolio flows, trade and eventually on global growth. As of now our team has adjusted the earnings downwards in sectors such as auto, consumer and cement and upwards in metals and oil & gas (O&G) to factor in the recent commodity price spike.

How much of a pain point will the surge in crude oil prices be for India?
 

Right now the prices are extremely volatile and in a matter of months crude prices have swung from $90 to $140 per barrel and are now back at around $100. If crude prices stay elevated for long, it certainly will have an impact on inflation, current account and growth. However, it is still a very uncertain situation and one needs to watch as to when and how the existing conflict will be settled. Supply chain challenges and rise in other commodity prices will also pose a risk to near term growth and inflation dynamics.
 

Foreign Portfolio Investors (FPI) have been on a selling spree since October last year. Do you expect the trend to accelerate going forward?
 

It is difficult to predict the direction and quantum of FPI flows in the near term. It will be a function of relative attractiveness of India on corporate earnings visibility, global and domestic macro backdrop on liquidity, rates, crude, inflation and relative valuations vis-à-vis other EMs. However, given the consistent and resilient domestic inflows in equity markets and robust systematic investment plan (SIP) flows, we believe the impact of FPI outflows have been counterbalanced and cushioned. Despite more than $20 billion of outflows in the last 5-6 months, Nifty has remained fairly resilient.

What is your view on mid-cap and small-cap stocks?

Relative price-value equation is more favourable for large-cap stocks in our view. Valuation gap between large-cap and mid and small-cap indices need to become more favourable for us to turn more constructive. Also, large-caps are better placed to withstand the impact of higher input cost inflation, rising rates and withdrawal of excess global liquidity. That said, mid-cap and small-cap investing is always a bottom-up game and one can always find good ideas in every market scenario.

What are your estimates for FY23 corporate earnings growth? And, will capex pick up this year?

We are expecting 20 per cent growth in Nifty earnings per share (EPS) for FY23, from Rs 738 in FY22 to Rs 880 in FY23, driven by banking, financial services and insurance (BFSI) (consistent loan growth and asset quality performance), information technology (IT) (strong demand visibility), commodities (higher prices) and auto (low base). Necessary conditions for capex revival are in place: corporate balance sheets are light and banks have cleaned up their balance sheets. However, we expect capex to pick-up gradually, given the underlying capacity utilisation across sectors which is still in early 70s. Also, sectors with appetite for large capex such as metals, cement, and O&G are still in a de-leveraging mode. So capex revival will still largely be driven by government and private capex will join the party selectively and gradually as the demand improves.

Which sectors are you betting on right now?

We like IT, BFSI, consumer discretionary, telecom and metals. We have a big overweight stance on IT since 2020 and are continuing with it given the strong demand visibility, robust deal pipeline and excellent cash flow (OCF, FCF conversion) and pay-out metrics. We are underweight on auto, infra and energy.

What is your view on banking and financial stocks?

We are positive on BFSI and have 300 basis points overweight on the sector in our model portfolio. BFSI has delivered consistent earnings growth despite the recent challenges pertaining to Covid-19, lockdowns and issues in medium and small enterprises (MSME). In fact, the profits of BFSI companies in Nifty has grown from Rs 440 billion in FY18 to an estimated Rs 1.5 trillion in FY22. We expect another year of robust 25 per cent growth in FY23 which could take it to Rs 1.9 trillion.