D-Street Voice: Banking and Auto sectors can turn out to be Dark Horse in FY22: Siddharth Khemka of MOFSL

Siddharth Khemka, Head – Retail Research, Motilal Oswal Financial Services Limited, is of the view that banking and auto are two such sectors that have underperformed the market so far – but have the potential to turn out the dark horse in the rest of FY22.

Khemka has over 15 years of experience in the field of Equity Research. Prior to this, he was working with Centrum Wealth Management for more than 5 years as a Head of Research, Centrum Broking as Institutional research analyst and ICICI Securities as Mid Cap analyst.

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In an interview to Zeebiz's Kshitij Anand, Khemka said that the current valuations though not lucrative from a risk-reward perspective, but do offer bottom-up opportunities, given the gradual unlocking of the economy and an improved demand backdrop. Edited excerpts:

Q) We have seen a fast and furious rally in September as we move closer towards 18000 on the Nifty, and about 59000 on the Sensex. What are your views on markets? What is your view on markets?

A) The Nifty50 has rallied more than 4 per cent in September so far. The rally in the domestic market is being driven by positive global cues, strong institutional inflows, healthy corporate earnings, falling Covid-19 cases, upbeat corporate commentaries, and low cost of capital.

Amid this positive setup, rising commodity prices, higher inflation and potential interest rate hikes are key risks and may lead to some volatility in-between.

The Nifty valuations have reached elevated levels. We expect corporate earnings to recover along with the underlying economy and progressively higher vaccination trends.

Demand across sectors is coming back to normalcy faster than initially expected. Also balance sheets and cash flows have improved in FY21 as corporates tightened costs and deleveraged.

We are in the first phase of the economic growth upcycle which we believe can last for atleast the next 2-3 years.

Q) Telecom sector has been in the limelight in the week gone by. What is your view on the sector, the impact of the PLI scheme, and what should investors do?

A) The government announced a relief package for the Telecom sector, providing a near term liquidity solution, particularly helpful to VIL, and addressed multiple long-term issues of the sector.

These measures show a strong intent of the government to address the near-term liquidity of VIL. But, a tariff hike is a must and VIL investment in the business is a key monitorable.

Bharti Airtel and RJio should reap gains from VIL’s situation and the government’s cleanup of a few legacy issues. We see a strong opportunity for both tariff and market share gains for Bharti and RJio.

We do not see any significant risk of higher CAPEX intensity over the next 2-3 years as 5G is still some time away and 4G investments are peaking.

A steady increase in earnings and peaking CAPEX should drive a steady FCF yield. Incremental EBITDA could drive RoCE and FCF for Bharti and RJio.

Q) Most of the global markets have done well in 2021 -- where do you see India with respect to global peers? Is Indian market getting overheated or is there still value that could attract global investors?

A) Barring Brazil (-2% MoM) and Korea (-0%), Aug’21 saw all the key global markets – such as India (+9%), China (+4%), Japan (+3%), the US (+3%), Russia (+3%), MSCI EM (+2%), Taiwan (+1%), Indonesia (+1%), and the UK (+1%) – end higher in local currency terms.

In the last 12 months, MSCI India (+51%) has outperformed the MSCI EM (+19%). In the last 10 years, MSCI India has outperformed the MSCI EM by 181%.

India’s share in the world M-cap is currently around 2.8% marginally above its historical average of 2.4%. In the last 12 months, the global m-cap increased 31% (USD28.3t) while India’s m-cap rose 63%.

India’s Real GDP grew at a record 20.1% YoY in 1QFY22. The IMF has projected India’s GDP to grow at 9.5% in 2021 followed by 8.5% growth in 2022 – this would be the fastest growth among developed and emerging markets.

Compared to this, IMF expects the global economic growth at 6.0% in 2021 and 4.9% in 2022. Given this high growth and large domestic demand-driven economy, there is a strong interest among global investors to participate in the country’s long term growth prospects

Q) PLI scheme in the auto sector is likely to favour companies that are EV-focused. Is it a good time to accumulate auto companies and are there any stocks that are likely to benefit the most?

A) The Auto PLI scheme is consistent with the government's focus on clean energy vehicles. Coupled with the PLI for advanced chemistry cells (INR181b) and FAME-2 subsidies (INR100b), this provides a substantial incentive (total of INR~539b) to make the local manufacturing of advanced technology components and vehicles competitive.

We believe the eligibility criteria on both revenues and expected investments over five years are very reasonable, ensuring eligibility for most of the OEMs / component manufacturers.

While the incentives offered under the Auto PLI scheme are lower than the originally planned incentive of INR570b, we believe it is well-directed to improve competitiveness in the nascent segment.

Unlike the draft scheme, which focused on exports, this scheme is focused on the localization of advanced technologies. While this scheme seems to be straightforward from an OEM perspective, we believe it is difficult to judge possible winners among the auto component players as it aims to incentivize components that are not currently made in India.

In the OEM Universe, Bajaj Auto and TVS would benefit on their e-scooters and Tata Motors on its electric PVs. While details regarding approved products are awaited, players such as Bosch may benefit (for EV components).

Based on the current product portfolio, we do not see any other auto components under our coverage to be a major beneficiary of this scheme.

Q) Which sector could turn out to be a dark horse in FY22?

A) The market performance has been driven by select large sectors which have done well so far.  However, now with valuations at premium levels, there is a scope for some of the undervalued sectors which can see some recovery in business as well as market interest.

Banking and Auto are two such sectors that have underperformed the market so far – but have the potential to turn out the dark horse in the rest of FY22.

As a consequence of the second wave of COVID-19, most banks reported sluggish disbursements, resulting in muted trends in overall loan growth. However, banks have started reporting an uptick in disbursements since Jul’21.

We estimate business growth to pick up, supported by the upcoming festive season, and accelerate further in ensuing quarters.

Overall, we expect systemic loans to grow at 8%/12% over FY22E/FY23E. Collection efficiency improved steadily over Jun–Jul’21 and would enable moderation in the slippage run-rate from 2HFY22.

We expect banks to continue to strengthen their balance sheets – as they have already shored up their capital ratios – and estimate credit cost to normalize from FY22. Private banks currently trade at 2.9x one-year forward P/B.

We believe a pick-up in loan growth, along with moderation in slippage / credit cost, would drive earnings, resulting in the further re-rating of the stocks.

Overall, large banks appear to be well-placed to accelerate market share gains given their strong capital positions, robust balance sheets, and higher provisioning coverage. We prefer ICICI Bank, SBI and Axis bank among the large banks and Federal Bank in the midcap space.

Auto companies have lately been impacted by the semiconductor shortage. Apart from that there are several other factors such as commodity cost inflation and the increasing threat from EVs (particularly in 2Ws).

However, we believe that Demand momentum is building up gradually post the re-opening in Jun’21, with varied recovery across segments. Current valuations largely factor in sustained recovery, leaving a limited margin for safety for any negative surprises.

We prefer 4Ws over 2Ws, as PVs are the least impacted segment currently and offer a stable competitive environment. We expect the CV cycle to recover and gain momentum towards 2HFY22.

We prefer companies with - a) higher visibility in terms of demand recovery, b) a strong competitive positioning, c) margin drivers, and d) balance sheet strength. Maruti Suzuki and M&M are our top OEM picks.

Among the auto component stocks, we prefer Bharat Forge. We prefer Tata Motors as a play on global PVs and EVs.

Q) What is your investment philosophy? Has your holding in cash increased amid the recent run up to be deployed later?

A) Given the sharp run-up and premium valuations, we would suggest investors to gradually increase cash in portfolios to around 5-10%.

However, as we expect stock/sector-specific momentum to continue, hence we are not very aggressive in increasing cash in portfolios.

Rather, we are suggesting investors to shift a part of their portfolio to hitherto outperforming stocks to some of the under-valued stocks and sectors.

Investors should focus on asset allocation and build a diversified portfolio to navigate through any volatile or correction phase. The best strategy would be to accumulate good fundamental and quality stocks gradually, whenever market gives sharp correction.

The long-term fundamentals remain intact and thus one should adopt bottom-up strategy. One should keep on reviewing his portfolio from time to time and churn it from overheated stocks to more comfortable names as per his investment style.

Q) What is your call on small & midcaps? Do you see a rotation trade happening from broader markets to largecaps?

A) Post the sharp rally in midcaps and smallcaps the valuations have turned expensive. However, if we remove loss-making companies from the indices, then the Nifty Midcap/Nifty Smallcap indices are trading at a trailing P/E of 21x/23x FY21 earnings, at a marginal discount to the Nifty.

Thus, the current valuations though not lucrative from a risk-reward perspective, but do offer bottom-up opportunities, given the gradual unlocking of the economy and an improved demand backdrop.

The balance sheets and cash flows have also improved in FY21 as corporates tightened costs and deleveraged. Consistent earnings delivery v/s expectations is now critical for further outperformance.

Any risk-off owing to concerns over potential interest rate hikes may impact midcaps/smallcaps more in our view.

(Disclaimer: The views/suggestions/advices expressed here in this article are solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)