India Inc faces capital allocation deadlock as demand softens, says Nuvama

In its third annual capital allocation study, Nuvama argued that a rare combination of slowing demand cycles and elevated valuations has left corporate India "all dressed up, but with nowhere to go."

Domestic brokerage Nuvama has warned that India Inc may be entering a prolonged capital-allocation deadlock, with companies boasting strong free cash flows (FCF) and peak margins but lacking meaningful avenues for growth. 

 

In its third annual capital allocation study, the brokerage argued that a rare combination of slowing demand cycles and elevated valuations has left corporate India “all dressed up, but with nowhere to go.”

 

According to Nuvama, India Inc’s post-pandemic improvement in I-CRoIC, the incremental cash return on incremental capital invested, was driven largely by restructuring rather than robust demand. The metric has now stabilised in the high-teen range, suggesting that the restructuring phase is largely complete. But demand remains soft, with sectoral toplines growing less than 10 per cent year-on-year (Y-o-Y) and the 10-year compound annual growth rate (CAGR) stuck around the same level. That is a stark contrast to the early 2000s, when demand surged at nearly 20 per cent annually.

 

 

The demand slowdown, Nuvama noted, stems primarily from weak exports and tepid wage growth, raising the risk of “endogenous hysteresis”, a drag that lowers the economy’s own potential growth trajectory.

With profitability at its peak and demand failing to pick up, Nuvama believes corporate managers face three suboptimal choices:

 

Reinvest and risk margin erosion – As seen in IT services, chemicals, durables and QSRs post-COVID, companies that expanded aggressively during a brief demand surge subsequently saw profitability erode. High valuations and a tepid demand cycle could lead to a repeat, the brokerage warns.

 

Protect margins but stagnate – FMCG and paint companies, facing technology-driven disruption of traditional moats, have maintained high margins but at the cost of growth. Their stocks, too, have delivered flat returns for four years.

 

Return cash, but at unattractive yields – With the median BSE500 stock trading at 35x earnings, implying a 3 per cent earnings yield, buybacks or large payouts become EPS-dilutive when cash itself earns 5-6 per cent.

 

This “capital allocation stalemate,” Nuvama argued, is likely contributing to rising insider selling across sectors.  ALSO READ | JM Financial flags broad-based promoter selling, thin buying in Q2FY26

Yet the brokerage also identified pockets of opportunity through its RRR framework:

 

Restructurers: Cyclicals with depressed margins and both micro (cost controls) and macro (policy support) tailwinds. Durables, helped by fiscal incentives, and chemicals, potentially benefiting from a weaker rupee, are key candidates.

 

Re-investors: Steady compounders with moderate but stable margins and the ability to expand their addressable markets. Companies such as Britannia, Blue Star, Uno Minda and SRF exemplify this bucket.

 

Rewarders: Cash-rich businesses with limited growth but meaningful free-cash-flow yields,  such as IT and telecom, that become attractive in deflationary or rate-easing environments.

 

The brokerage also flagged major reinvestment risks in sectors that have enjoyed a strong run but now face rising supply against weakening demand: power, industrials, hospitals, autos, and cables & wires. Besides, high valuations leave “little room for error,” raising the spectre of a repeat of 2021, when several sectors expanded supply just as demand faded.

 

For the stalemate to truly break, Nuvama believes a convincing demand revival is essential, and that would require an exports rebound supported by major rebalancing in China. In its absence, only a combination of domestic fiscal easing, monetary support and a weaker rupee may help. None of these outcomes appears imminent, analysts said.

 

Until then, Nuvama cautioned, investors should temper return expectations as India Inc navigates a rare and uncomfortable phase of strong balance sheets but shrinking growth opportunities.   

Disclaimer: The view/outlook has been suggested by Nuvama. Views expressed are their own