Lockdown effect: Opportunity to accumulate good quality stocks for long-term investment perspective

April 03, 2020 4:21 PM

Tough conditions also provide an opportunity to accumulate good quality stocks for the long term. Historically, tough conditions have not lasted too long.

Sensex, NiftyThe market expects an 8 to 10% decline in the top line on account of the lockdown, which will have a trickle-down effect on the bottom line
  • By Ravi Singh

COVID 19 will hit the economy significantly, particularly in H1FY21 (spillover effect of lockdown to be visible in Q2FY21 coupled with the recovery time expected across the globe). The severe spread of the virus has halted trade activities across the world which has disrupted routine activities of multiple nations bringing the countries to halt thus distorting their economic growth. Though it is hard to give a timeline as to when things would normalize from the widespread economic slowdown caused due to this pandemic, we can be clear about one thing that the strength of the balance sheet will decide the intensity of the comeback. The earnings picture across the sectors has gone for a toss and the operating cost in the absence of revenue has to be funded by the balance sheet. Hence, moving forward, leverage will be a key deciding factor for selecting companies. As a result, India’s GDP estimates have been marked down to 2 to 3% for FY21. However, we expect another round of measures by both the government and RBI to prop up the revival.

The market expects an 8 to 10% decline in the top line on account of the lockdown, which will have a trickle-down effect on the bottom line. Given this, a sharp correction in the markets and valuations is not surprising. Significant downside risks to the markets include a sharp fall in FY21E Nifty earnings. Estimates suggest that a 21-day lockdown would result in an 8.5% drop in India Inc’s turnover. The lockdown would severely hurt the cash flows of households. Consumption is set to take a toll badly and will take a long time to recover. Now the onus for recovery lies in the hands of the government. Estimates suggest that India’s fiscal deficit is expected to shoot up to 6% from expected 3.5% for FY21. A large portion of this government spending is channeled into relief measures and not on productive spending. So it will be really a tough task for the government to support growth by spending.

Also, since the sectors with heavyweights in the indices are set to deliver bad numbers quarter after quarter during FY21, Index may continue to be volatile without a decisive bullish trend. With stocks from the BFSI sector having a weightage of nearly 42%, news from this sector will decide the direction of the market. Post this lockdown, the sector is expected to see a fresh wave of bad loans from retail, Agri and MSME sectors this time. Unless RBI announces some sort of temporary dispensation on NPA recognition norms, the sector has the potential to arrest the up move in the markets caused by technical factors like huge global liquidity, FPI flows and attractive valuations.

However, the above tough conditions also provide an opportunity to accumulate good quality stocks for the long term. Historically, tough conditions have not lasted too long. It is imperative to use this opportunity to build a portfolio of top quality companies available at attractive valuations. It is important to focus on large-cap as they are the ones to lead the market recovery and joined by quality mid caps at a later stage. Another approach would be to focus on quality names trading at premium valuations. The recovery in such stocks would be strong and fast. However, it is advisable to stay away from small and mid-caps which are facing balance sheet-related issues with high debt. Some of the factors to look for in mid-caps include extremely good balance sheet (focus on debt-free and higher cash will be an additional positive), a niche market with strong moats and good management track record will be advisable but the recovery in these stocks could take between 3 to 4 quarters from now.

Safe bets in the current period would be the defensive stocks i.e consumption (FMCG particularly consumer staples) and healthcare sector (hospitals and diagnostics included). Oil and gas refinery margins are set to improve on account of low crude prices and hence the sector remains a good bet. Metals and the automobile sector will see a significant lag and tourism, hospitality; real estate will be amongst the worst hit during this period. Sectors dependent on the global market for import of key raw material inputs should also be avoided due to disruption in the global supply chain and INR depreciation. Their recovery will depend on how quickly they can find the substitutes for their inputs indigenously (highly difficult) and integrate them with their supply chain.

(Ravi Singh is VP- Research Head, Karvy Stock Brokings. The views shared are the author’s own.)

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