Market Outlook: Higher volatility, historically, has always led to durable bottoms

• Nifty declined ~2%  in tandem with global volatility triggered by concerns over financial stress in banks. European benchmarks corrected 3.5% while US indices are ~1% down for the week
• Historically, episodes of such high volatility globally and domestically has been painful to deal with in short term but always resulted in a durable bottom formation over medium term once anxiety surrounding events settles down
• In past two decades, there has been numerous intermediate corrections (excluding black swan events like 2008) measuring around 13% price wise and approx. four months time wise. To name the few, European crisis (PIIGS) in 2012, concerns around India’s CAD in 2013, US elections and Demon in 2016 and more recently NBFC crisis of 2018. Even Asian currency crisis of 1996-97 led to sharp fall over four months followed by markets going back to previous highs over next three-to-six-month period
• Key take away for investors has been that markets has tendency to bottom out amid bad news and investing in such times of high volatility has always been rewarding.

Current context and what to expect

• At present, Nifty has corrected 10.5% over past four months after recording life high in December 2022, discounting various negative news flow.
• From historical context, we believe that with index correction is approaching maturity of price/time correction and risk - reward is favourable for investors
• Large Caps, FMCG and Domestic Pharma could get preferred in flight towards safety

Short term view

• Volatility may persist over next few sessions wherein we expect buying demand to emerge around 16,600-16,800 zone and index to stage a technical pull back from oversold trajectory
• On the higher side, immediate key hurdle is placed around 200-day ema placed around 17,500 levels

FIIs action

The recent weakness caused by global financial crisis has triggered some sell-off from foreign investors in secondary markets last week. However for the month so far, FIIs have remained net buyers of more than Rs 15,500 crores due to couple of block deals (worth ~Rs 20k crores).

Sentimental Impact of global crisis on Indian banks, hard landing fears resurface in US

US banking outlook turns negative

Recent trouble started with collapse of US based Silicon Valley Bank (16th largest US bank), Silvergate Capital and Signature Bank. Run on deposits forced SVB Bank to book huge losses on their investment book to create liquidity which spooked investors. Further, higher interest rates have caused large unrealised losses for many US banks. In this backdrop, Moody’s have cut outlook for US banking system from ‘Stable’ to ‘Negative’. Further, concerns about Credit Suisse added to broader banking sector fears which got accentuated after its largest investor denied more financial assistance. However, recent announcement of borrowing $50 billion from Swiss central bank to shore up liquidity has provided some comfort.

The SVB Bank fiasco has relatively lower impact on Indian banks resulting in a correction of ~3% in Bank Nifty post the event. Though Indian banks foreign exposure stands at ~5% of outstanding advances; majority of these constitutes of exposure to foreign operations of Indian corporates. Thus, we expect near term sentimental impact of global crises on Indian banks which should be substantial.

In addition, Indian banks exposure in government securities is well managed with adequate provision in lieu of ~250 bps of rate hiked undertaken since March 2022. Thus, we do not expect any substantial MTM losses as seen in other geographies. Going ahead, faster decline in yields, on the contrary, may be beneficial for Indian banks.

The fear phycology globally is likely to put smaller banks in the capital conservation mode leading to tread more cautiously on credit growth which may in turn result in hard landing for the economy.

Preferred Stocks

SBI (CMP – Rs 527, Target – Rs 700, Buy)

Management maintained its credit growth guidance of ~14-16%, supported by steady margins, healthy deposit franchise and strong demand pipeline. Margin expected to remain resilient amid healthy. Expect earnings growth at 24% CAGR in FY23-25E and RoA at ~1% in FY25E.

Currently, stock is trading at ~0.8x FY25E standalone ABV which seems reasonably valuation; thus stock should see strong positive momentum ahead.

Axis Bank (CMP – Rs 832, Target – Rs 1,100, Buy)

Healthy credit growth (guidance of >5-6% compared to industry) and focus on risk adjusted exposure to aid operational performance. Expect advances to grow at ~17% CAGR in FY24-25E. Granular liabilities profile (CASA at ~45%), improving efficiency (cost to asset at ~2%) and steady provisioning to boost earnings momentum at ~29% CAGR in FY24-25E.

Axis Bank is trading at 1.6x FY25E ABV remains attractive level to enter the stock from long term horizon.

Crude saw decline of ~14% in the last fortnight, a welcome relief for some sectors 

Crude oil prices declined from highs of US$86 per barrel to ~US$74 in the last fortnight, a drop of nearly 14%. The sharp decline can be attributed to multiple factors such as a) higher US crude oil inventory data (+1.55 mil barrels vs expectation of +1.19 mil barrels) b) elevated recessionary fears. Lower crude oil prices are expected to have a near term positive impact on certain sectors like refineries, auto, consumer durables, FMCG among others

Marketing margins to improve for oil marketing companies

• OMCs remain a natural beneficiary due to decline in the crude oil prices, in the near term, largely led by improvement in marketing margins that form chunk of the profitability for HPCL, BPCL and IOC. Marketing vs Refining segment ratio remains highest for HPCL>BPCL>IOC
• Prior to the decline in crude oil prices, the marketing margins for Petrol and Diesel were at Rs 6 and Rs 3 respectively and with the decline, the profitability is expected to improve further

HPCL: We have a target of Rs 275 (upside of 15% from CMP Rs 239) at average of 1x P/B FY25 and 5x P/E. HPCL’s refining capacity is expected to increase in FY24 with expansion plans at its  Visakh refinery (from 8.3 MMTPA to 15 MMTPA) and a refinery cum petrochemical complex (9 MMTPA with a 74% stake) in Rajasthan.

BPCL: We have a target of Rs 380 (upside of 10% from CMP Rs 345) at average of 1x P/B FY25 and 6x P/E. BPCL has set a capital outlay of Rs 1.4 lakh crore for next 5 years to expand into Petchem, Renewable energy and CGD business

IOCL: We have a target of Rs 90 (upside of 13%% from CMP Rs 80) at average of 1x P/B FY25 and 6x P/E. IOC is expanding its overall refinery capacity by 30 MMT (currently at 81 MMT), which includes 14.3 MMT of Petchem Capacity

Further margin expansion expected in Auto OEMs

Q3FY23 results in the auto space were robust with margin recovery taking centre stage (namely metals, crude derivatives including plastics and rubber). Our coverage companies reported a gross margin expansion in the range of 50-300 bps on QoQ basis.

Non-ferrous metal prices are down ~5-7% in the past week. This bodes well for domestic auto space and could witness further gross margin expansion (in the range of~50-100 bps) leading to healthy P&L performance.

Key beneficiaries of the same could be Maruti Suzuki (Buy Rating, Target Price: Rs 11,200), Tata Motors (Buy Rating, Target Price: Rs 530) in the auto OEM space and Apollo Tyres (Buy Rating, Target Price: Rs 390) and Motherson Sumi Wiring (Buy rating, Target Price: Rs 75) in the auto ancillary space.

Decline in crude led input prices could revive volume growth for FMCG companies   

FMCG companies were riling from high commodity inflation & in turn muted demand conditions from last one year. We believe gross margin for most of the FMCG companies have bottomed out in Q2FY23. This decline would lead to price cuts or grammage increase, which in turn could revive volume growth in FY24.

Most of the FMCG companies are expected to benefit from the decline in crude prices. However crude based commodity’s proportion to total RM basket is higher for HUL & Jyothy Lab. We believe these companies would see recovery in volume growth in FY24 with the restoration of grammages for smaller SKUs. Further uptick in gross margins would give leverage to spend more towards advertisement & propel growth through new launches. We have a hold rating on HUL with a target price of Rs 2,800 /share

Paint companies expected to pass benefits to retain market share

We believe the paint companies will utilise the cooling raw material prices to maintain volume growth by passing it to the customer. The key raw material (crude derivative) ‘Titanium Di-Oxide’ has fallen by ~11% to Rs 300/kg as on date (from Q3FY23 average price of Rs 335/kg). We believe the fall in crude prices will keep TiO2 prices under check in the near term.

However, the upcoming supply (entry of big players Grasim, Astral, JK Cement etc) will weighs on margin expansion of Paint companies in the medium term. Hence, we see a limited 50-80 bps QoQ expansion in EBITDA margin of paint companies, tracking the decline in crude prices. On the demand font, we believe, paint companies to witness volume growth in the range of 7-10% YoY in Q4FY23 supported by inventory build up at dealers level and increased infra capex by government. (Asian Paints TP: Rs 3,180, Berger Paints TP: Rs 600)

Defence sector looks well placed in terms of increasing domestic procurement

Defence sector looks well placed in terms of increasing domestic procurements by government for our armed forces. With imports coming down, the risk of supply chain issues is also receding in this sector. We have been witnessing a structural shift in the defence budget with increased allocation for modernised indigenous platforms. Current government is looking very committed on this which is very clear from the recent announcement of increasing domestic procurement budget share to 75% for FY24 from 68% for FY23 which implies growth of about 19% as against 8% growth budgeted for total capital outlay.

The increase in domestic procurement will directly benefit domestic players including defence PSUs and private players in terms of more order inflows during the year for major platforms & sub-systems/components. As per the estimates, orders worth Rs 5-6 lakh crores will be placed with Indian defence players in the next 4-5 years. Defence PSUs like Hindustan Aeronautics, Bharat Electronics, Bharat Dynamics is poised to do well considering that they already have strong order backlog of 3-4x of TTM revenues and the healthy pipeline of orders.

Hindustan Aeronautic is our top pick in defence. The company has order backlog of about ~Rs 91,000 crore after receiving two recent contracts of transport and trainer aircrafts from Indian air force. This backlog is about 3.5x of TTM revenues and gives strong revenue visibility. Deliveries of Tejas MK1A from FY24E end will give a boost to earnings from FY25E onwards. Moreover, about Rs 55,000 crore worth of manufacturing contracts are expected in the next 1-1.5 years which includes large scale orders in aircrafts, helicopters, unmanned ariel vehicles and aircraft engines etc. Current valuation of 16x P/E on FY25E earnings looks attractive considering the future opportunities for HAL. Our target price on HAL is Rs 3,300.

Hidden Gem

Dabur India(Target Price: Rs 700)

Dabur India (DIL) is one of the biggest FMCG companies with a presence in Ayurveda based products across categories. The company has a substantial market share in health supplement, OTC & Ethical products, oral care, hair care, home care & juices

We believe the company has forayed into multiple new categories in the last two years leveraging its existing brands in under-penetrated categories. Further, Dabur has been able to maintain its operating margin closer to 20% level (long term average). We believe new products would start contributing to the volumes, going forward, which would offset the slower growth in the saturated hair oil category.

Dabur is likely to benefit from decline in crude & other commodity prices given it would help improve the rural demand scenario. The company would increase advertisement spend to support new products communication which in turn would aid volume growth. Moreover, extension of existing brands in fruit drinks, health food, baby products, health supplement variants has increased addressable market for Dabur. It would help in offsetting the slower growth in saturated hair oil category.  We remain positive on Dabur with Buy rating & target price of Rs 700 / share

Conclusion

The ongoing risk off environment has pushed the volatility higher ahead of crucial central bank meetings next week.  However, despite recent weakness, the current US VIX is significantly lower at just 26% compared to 32% seen in the month of October. We believe expectations of some sort of interventions from central banks is able to curb the volatility in US markets. The same pattern can be seen in Indian markets as well where despite making new lows, the volatility is comparatively lower from the last declines.

Source: ICICIdirect Research

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