By S Hariharan
Indian stocks have outperformed both Asian and Emerging Markets peers this year – Nifty is up 23% against (-4%) for MSCI Asia Pacific Index and (-5.5%) for MSCI Emerging Markets index. There has been much commentary focused on how the valuation premium for India over peer markets is more than 1 standard deviation above its longer-term level. Nonetheless, over the last 12 months, consensus earnings upgrades to estimates for FY23 for Nifty components have also been around 20% (Data: Bloomberg).
What is, instead, noteworthy is that 1-year forward earnings projections for Nifty have more or less remained constant over the last 2-1/2 years (implying a period of lost growth), and currently impute 22% growth. There are currently factors contributing to uncertainty over both the revenue growth as well as operating margins that would be required in order to attain these earnings.
At the topline level, a meaningful pick up in credit growth as well as consumption are key factors, as private capex is still not a meaningful contributor to activity – private consumption is currently 15% below the pre-covid trend while GFCF is 10% below. It is vital that the government accelerate its thrust on fiscal spending, in order to aid rural consumption. There are seven states due to hold Assembly elections in 2022 and historically, the lead-up period has tended to witness a meaningful pick up in spends.
On account of differing policies to tackle spread of the latest wave of covid in different countries, supply chain bottlenecks are nearly certain to persist through the first half of 2022, and will continue to contribute to inflationary impulses through raw and intermediate goods. Central banks across developed countries have already committed to reducing monetary accommodation. While interest rates continue to be benign currently, it is quite likely that the coming year would see about 50-100 bps of benchmark rate rise globally and in India.
At the operating margin level, Nifty as well as NSE500 companies have enjoyed their best year in a decade – 16.3% for Nifty companies and 14.7% for NSE500 companies, which is nearly 250 bps higher than the median level for the last 9 years (Data: Bloomberg). While the benefit of cost rationalization may be retained in some part, the evidence of results from Sep 2021 quarter suggests that pricing power is much weaker and input cost inflation has not yet been passed on to consumers. Hence, it would almost certainly be the case that operating margins would contract meaningfully in FY23.
In this backdrop, where valuation has already priced in a supportive growth environment, it would be advisable to invest in sectors and stocks which face fewest headwinds in delivering earnings growth. Infrastructure construction plays have a high degree of visibility in terms of order book and government tendering activity. Listed real estate stocks stand to benefit from market share gains from unorganized players and a very conducive environment for new home-buyers. Auto stocks have favourable valuations and adequate pricing power to pick up earnings growth from a low base, once demand revival kicks in. Life as well as health insurance players stand to gain from deepening penetration levels and wide acceptance of a latent need.
At an index level, macro factors like investor flow stemming from global central bank policies as well as hardening interest rates, would serve to compress headline valuations and 2022 would likely be a year of significant divergence of performance among sectors. Mid and small-caps that have emerged with strong balance sheets post-pandemic have visibility of multiple years of strong revenue growth as well as margin expansion, after nearly 5 years.
(S Hariharan, Head – Sales Trading, Emkay Global Financial Services. Views expressed are the author’s own.)