A sharp spike in Covid cases over the past few weeks, movement curbs imposed to in select cities to ‘break the chain’, elevated commodity prices that may stoke inflation coupled with the rich valuation of Indian markets has led Nomura to cut its Nifty50 target to 15,340 for March 2022 (earlier target: 14,680 by December 2021) – a modest rise of 2.7 per cent from the current levels.
Post the rally from mid October 2020, Nomura said, the market has re-rated and now trades at 21x one-year forward earnings, with valuations higher than the historical average.
“The expectation of favorable liquidity conditions (lower cost of capital) and an improvement in the corporate earnings cycle has driven the performance. A potential rise in yields could put pressure on valuation multiples unless expectation of corporate earnings growth surprises materially on the upside. Assigning 18.1x to the current FY23 consensus estimate, we arrive at a March 2022 Nifty target of 15,340,” wrote Saion Mukherjee, India equity strategist at Nomura in a note dated April 7, co-authored with Neelotpal Sahu.
Markets, Nomura believes, are dealing with three headwinds – the resurgence of Covid-19 cases; inflationary pressure with the rise in commodity prices; and rich valuations. Though the research and broking house has ruled out the possibility of a nation-wide lockdown for now, local restrictions, it said, could have a shorter and even potentially medium-term impact on growth.
It counts the policy on investment and manufacturing-led growth and the resilience of corporate earnings in the recent past driven by lower costs and market share gains from unorganised sector / smaller players as the two positives for the markets.
FII flows at risk
Going ahead, the strength in the US dollar, Mukherjee and Sahu believe, could adversely impact foreign institutional investor (FII) flows. Foreign holdings in the Indian equity market, the report said, have shot up to 27.6 per cent, much above the long-term average of 19.6 per cent.
Among key sectors, FII’s have increased their positioning in metals, cement, coal / utilities, consumer durables and industrials. They have reduced their positioning in media and real estate.
Corporate earnings in focus
Going ahead, the markets will focus more on corporate earnings rather than the broad economic growth. If the broader economic growth sustains above a threshold, corporate India, Nomura feels, can deliver on earnings through improvement in profitability.
“There is no tight correlation between GDP growth and corporate earnings; but on a CAGR basis, the capital base of corporates recorded 200 basis points (bps) higher growth than nominal GDP over FY06-20. It is the fall in return on capital or RoEs that led to corporate earnings as percentage of GDP declining. Factors like asset quality improvement for banks, lower cost, market share gain, positive commodity price cycle (for commodity companies) are likely to help improve RoE and drive earnings growth," Mukherjee and Sahu wrote.
As a strategy, Nomura has increased its weight on IT/Pharma and cut active weights on financials and cement sectors. “Overall, we are overweight on IT, Pharma, Metals, Financials and Infra. Underweight on Cement, Autos and consumers. Remove Ultratech, Voltas, and Just Dial from our model portfolio and add Marico, Dr. Reddy’s, Apollo Hospitals, AIA Engineering and PNC Infratech. Our top picks are Infosys, Sun Pharma, Mahindra & Mahindra (M&M), Reliance Industries (RIL) and Max Financial,” Nomura said.