In conversation with Ajit Banerjee, Chief Investment Officer, Shriram Life Insurance

In this interview, Ajit Banerjee, Chief Investment Officer, Shriram Life Insurance, highlights the performance trend of the Indian corporates while taking a long-term view on how the markets will unfold in the coming quarters

What is your outlook on the equity markets in the short to medium term? Do you expect markets to consolidate from here onwards?

When we look at the markets as a whole, we find that there are multiple global macro factors at play along with higher interest rates and inflation which is likely to be sticky especially where the US and European geographies are concerned. We should be prepared that in the near term the markets could continue to see some degree of volatility. Domestic market-oriented companies are expected to perform better as compared to external market-oriented companies in the short term to medium term.

Global cues remain tough with volatility in crude prices and elevated yields given the hawkish stance of the central banks. The overall earnings growth for India Inc. except BFSI sector looks muted so far as observed from the results announced so far. In the medium term, given the growth outlook as well as corporate earnings trajectory, we think the equity market will remain fairly stable for India. Earnings growth is expected to be better in H2FY23 than H1FY23 mainly on account of softening of industrial commodities and the destocking witnessed in Q1 easing out and realisations getting better.

We believe that in the prevailing global scenario India’s positioning is quite advantageous from a domestic standpoint and that Indian markets are on the verge of a righteous new earnings growth cycle. The current macro backdrop aptly supported with resilient domestic GDP growth, prudent inflation management, significantly deleveraged corporate balance-sheets and well-armoured banking system balance-sheets with lower NPAs and robust credit offtake will help to build conviction about the fact that the strong momentum in India’s corporate earnings growth cycle is a reasonable certainty over a longer period of time.

How has the earnings’ season been so far?  Will margin pressures persist for select sectors due to rupee depreciation?

The initial set of results of companies in the July-September 2022 quarter suggest a slowdown in the corporate earnings and the end of the post-pandemic boom in the Indian corporate sectors’ margins and profits. The corporate revenues, however, continue to grow in high double digits predominantly due to the combined effects of higher inflation and high credit growth and currency depreciation (mostly applicable to export-oriented businesses). The pace of growth of net profits was up by a meagre ~6 per cent% year on year in Q2FY23 which is at the slowest pace in the last nine quarters. The same number in the previous quarter was up 27.4 per cent as per a report released recently.

Banks and finance companies were the top performers during the quarter and have accounted for most of the incremental growth in overall corporate earnings in Q2FY23 released so far. The combined profit of finance companies including insurance and asset management companies was up by 13.8 per cent for the set of the companies which have declared the results so far. Mining, metals, cement, oil and gas and consumer durable firms were the biggest laggards in the pack. Most firms in these sectors reported a fall in net profit and even net loss due a combination of lower sales realisation and high operating costs.

Therefore, we opine that domestic-focused sectors are performing relatively better than those having global exposure. Banks, industrials, and consumer-driven companies should deliver strong earnings performance while earnings for sectors like technology and commodities are expected to be relatively weaker in the near term. Till such time the Federal Reserve continues with its rate hikes accompanied with liquidity tightening measures, USD will continue to appreciate which will lead to higher import costs and thereby put margin pressure on the corporates having a higher component of imported raw material.

What are the pertinent risks facing equity markets in H2FY23?

Apart from the risks emanating from the geopolitical conditions prevailing in the world, volatility in crude oil prices with an upward bias poses a threat to the economic stability of the country. If the liquidity condition continues to tighten further accompanied by increase in interest rates, this would not only lead to an increase in the cost of capital that would have a bearing on the corporates profit and loss but will also refrain consumers from spending on discretionary items. Already we are seeing a deterioration in the interest coverage ratio of corporates with the increase in interest rates. Hence, these pose risk to the future earnings’ potential of the corporates.

However, the other significant risk to Indian equities is the present valuation. Indian equities today offer a relative low margin of safety. India’s premium to other markets is at an all-time high. India is approximately 15 per cent more expensive than the US on a price-to-earnings (PE) basis – the most expensive developed market, and almost twice as expensive as Taiwan. Historically, India has traded in line with both these markets. At a juncture when dislocation in global capital and currency markets remains very high, India is particularly exposed to a global risk-off event. Further, our balance of payment remains negative and though there isn’t any crisis due to this, it certainly creates an enduring risk to the currency and equity markets.

Which three sectors would you bet on for the long term? Also, which sectors seem attractive at current valuations?

At a broader level we see domestic-focused sectors performing relatively better than those having significant external exposure. Hence, sectors like BFSI and consumption facing sectors such as FMCG, automobile and infrastructure push beneficiaries – capital goods would be the preferred sector. Banks, industrials and consumer-driven companies should deliver strong earnings’ performance. Two other sectors which can be considered for a very long-term perspective are defence-linked manufacturing sector and the energy sector which is poised to grow in view of the tremendous diversification-led growth opportunities expected in the future. From a valuation perspective, the banking sector is available at an attractive level followed by IT and pharmaceutical sectors at present.