Market outlook of the week: Consolidation in the offing with eyes on earnings

• Indian equity benchmarks underwent profit taking last week amid muted global cues and selling in heavyweight private bank amid earnings disappointment.
• Nifty declined 1% for the week led by 3% cut in Bank Nifty while Nifty Midcap and small cap indices managed to close marginally in green.
• On Global front, most developed market indices were in red amid push back in interest rate cut expectations.
• Nifty is expected to mark consolidation in coming week and undergo higher base. As we expect index to hold strong support at 21,000, adopt strategy to buy the dips with target of 22,000 in run up to budget.
• Sectors: In runup to Union Budget, we expect PSU, Infra, companies with rural exposure, HFC,s, Corporate lenders, Oil & gas to relatively outperform.

FPI Outflows

Equity markets saw one of the steepest outflows of Rs ~ Rs 20,000 crores in just 2 sessions after Covid.

Most of the outflow seems to be from HDFC Bank, but considering huge weight in headline index, Nifty has given away almost 900 points from highs.

Moreover, in F&O space we saw sharp liquidation of longs as the net longs turned net shorts within a span of 2 days.

India inflation continues to be benign

• CPI inflation for the month of December was 5.69% YoY vs. 5.55% in November and lower than market expectation of around 6.0%.
• Inflation was higher only in Vegetables while it declined in almost all other major items.
• Core inflation fell below 4% for the first time in almost 4-years printing at 3.9% YoY (vs. 4.1% in November). Most of the items in core are either trending below or within comfort zone. Lower crude oil and other commodity prices is helping it remain subdued.
• CPI at 5.4% in Q3 is lower than MPC estimate of 5.6%. Given inflation is projected at 5.2% during both Q1 and Q2 of CY24, inflation is likely a non-event in next few months.
• General consensus as of now is largely of 50-75 bps rate cut by RBI starting August while we believe that the rate cut could be of 75 bps. Yields could decline even more than 75 bps given impending FPI index inclusion inflows.

HDFC Bank (CMP - Rs 1,492, Mcap - Rs 11,33,102 crore)

• HDFC Bank reported weak performance wherein advances growth remained healthy, however, deposit accretion remaining lower than expectation.
• Advances growth remain strong at 4% QoQ with focus on retail and SME segment, however, deposit growth remained weak at 2.9% QoQ. This has led to elevated LDR (Loan to Deposit) ratio at ~110%. The bank seems to utilize excess liquidity to the tune of ~Rs 50,000 crore in Q3FY24.
• Despite utilizing excess liquidity and reversal of additional CRR requirement levied by RBI in the recent past, margin remained flat at 3.4% vs expectation of improvement of 5-7 bps.
• Growth in other income remained healthy with one-time inflow from stake sale in Bandhan.
• Earnings growth came at 2.5% QoQ at Rs 16,372 crore, partly supported by lower tax which might not be a recurring affair.
• Management maintains its strategy of increasing distribution capabilities (to add 900-1,000 branches in FY24E) and customer accretion. Accelerating liabilities accretion to sustain current growth momentum with faster traction in high yield segment to safeguard margins remains a challenge.
• At current price, the stock is trading at ~2.1x FY25E Standalone ABV which looks reasonable.
• Given regulator caution on unsecured credit (undertaken increase in risk weight on unsecured credit) and intense competition on liabilities, we remain selective in the lending space with focus on players with better liabilities franchise, lower CD ratio and strong distribution with the ability to disburse retail loans. With relatively lower CD ratio at 60-75%, healthy liabilities franchise and focus on retail segment in last 3 fiscals, we prefer PSU bank space - Bank of India, SBI which is still available at lower than historical valuations despite improvement in both business growth and RoA. Among private banks, we recommend smaller banking players - Karnataka Bank and South Indian Bank.

IndusInd Bank (CMP - Rs 1,573, Mcap - Rs 12,23,41 crore)

• IndusInd Bank reported healthy performance on business growth and earnings, however, higher than anticipated slippages came as a surprise.
• Advance growth continued at 20% YoY to Rs 3,27,057 crore, with traction in mid-corporate and retail segment.
• Margin remained steady at 4.29% resulting in 18% YoY in NII. While fee income grew 12% YoY, treasury gains led overall other income growth at 15% YoY.
• Continued investment kept opex elevated, credit cost remained in guided range at ~1.2% (annualised), post utilization from contingent reserves.
• Slippages remained higher than guidance at ~2.2% (annualised), however, GNPA ratio remained steady at 1.92%, owing to recovery and write-offs.
• Continued healthy business growth, focus on liabilities accretion and sustained margin remain positive. However, slippages and thus credit cost seems to remain higher than earlier guidance of ~110-130 bps. Given valuation at ~1.8x FY25E ABV, sustained growth and RoA should drive valuation gradually ahead.

Bank of Maharashtra (CMP - Rs 52.1, Mcap - Rs 36,873 crore)

• Bank of Maharashtra has reported healthy performance in Q3FY23 with 34% YoY growth in earnings coupled with continued improvement in asset quality.
• Continued robust traction at 20.2% YoY in advances and improvement in margin at 3.95% (+6 bps QoQ) has led to 24.5% YoY growth in NII.
• Provisions held for wage settlement has kept growth in opex higher. However, strong top-line momentum led 27% YoY growth in operating profit. While credit cost increased by 62% YoY, PAT grew 34% YoY to Rs 1,036 crore, aided by healthy top-line and lower tax.
• Asset quality remained steady with ~15 bps QoQ improvement in GNPA at 2.04%.
• Sustained healthy business growth at 18-20% coupled with healthy RoA at ~1.5%.

Federal Bank (CMP - Rs 147, Mcap - Rs 35,837 crore)

• Federal Bank has reported mixed performance in Q3FY24 with business growth remaining healthy, however, margin trajectory being muted.
• Advances growth came in healthy at 19% YoY to Rs 1,99,185 crore. Despite continued increase in proportion of high yielding book at 24.6%, NII growth remained muted at 9% YoY, owing to pressure on margins at 3.19% (-3 bps QoQ).
• Other income surged 62% YoY, primarily led by recovery of Rs 154 crore (including stake sale in subsidiary through IPO).
• While operating profit remained slower at 13% YoY, moderation in credit cost led earnings growth at 25% YoY to Rs 1,007 crore. Asset quality broadly remained steady with GNPA at 2.29% and NNPA at 0.64%.
• Growth trajectory is expected to remain healthy with focus on keeping RoA steady at ~1.3-1.4%. Given business growth at 18-20% and RoA of 1.3-1.4%, current multiple of ~1.2x FY25E ABV, makes the stock an opportunity on dips.

South Indian Bank (CMP - Rs 31.1, Mcap - Rs 6,500 crore)

• South Indian Bank reported healthy performance in Q3FY24 with focus on business growth as well as improvement in return ratios.
• Advance growth momentum sustained at 11% YoY to Rs 75,340 crore, led by focus on retail and MSME segment. Deposit accretion remained steady at 9% YoY.
• Margin contraction (-12 bps QoQ and 33 bps YoY at 3.19%) kept NII flat at Rs 819 crore. Treasury gains (compared to loss in Q3FY23) acted as safeguard offsetting elevated opex and resulting in 196% YoY growth in PAT at Rs 305 crore.
• Improvement trend continued in asset quality with GNPA declining 22 bps to 4.74% and PCR gradually increasing at ~78%.
• Excluding treasury, the bank has gradually inched up RoA at 0.85-0.95% with initial target to keep RoA at ~1%. Strategy to focus on digitization, diversified growth and increase granularity is expected to drive valuations further.

Sun Pharma – Taro’s acquisition

• Sun currently holds 78.5% stake in Taro. This deal values Taro at US$ 1.6 billion which is ~3x of Taro’s FY23 sales of US$ 570 million. Sun has proposed buying all the shares of Taro Pharma for US$ 43 per share amounting to US$ 348 million outgo. 
• Over the years Taro’s influence on Sun’s earnings has come down significantly- from 20% of sales in FY15 to 10% in FY23 and further reduction in profitability. This was due to pressure on Taro’s generic portfolio and other price related litigations. That said, Taro remains an important factor on account of ~US$ 1 billion of cash on its balance sheet.
• We believe the proposed 100% acquisition and subsequent delisting would streamline the focus and pave way for better cash utilisation. Sun’s specialty foray requires upfront investments and Taro’s cash is a key source for the same.
• Sun will also be in a better position to rationalise Taro’s US generics portfolio which is tilted towards dermatology, a segment which is facing severe pricing pressure.

LTIMindtree: outlook for Q4 remains weak; Recovery likely from H2FY25

• LTIM reported revenues grew 0.8% QoQ & 3.5% YoY due to higher-than-expected furloughs & higher pass-through income. Geography wise North America region (72.7% of mix) declined by 0.2% QoQ while Europe region (14.5% of mix) declined by 4.5% QoQ. Vertical wise the all-verticals’ baring Manufacturing & Healthcare declined sequentially.
• EBIT margin declined by 60 bps QoQ to 15.4% due to impact of the headwinds of higher-than-expected furloughs among others (-200 bps) mitigated by the tailwinds of lower SG&A expenses (+80 bps) & operating efficiency (+60 bps). The company’s utilization improved by 80 bps QoQ while attrition declined by 100 bps.
• We believe the company’s margins are expected to remain strained for some quarters till revenue growth picks up.
• The only solace is that the TCV wins remains strong as it won TCV of US$1.5 bn and also mentioned that the deal pipeline was healthy at US$ 4.6 bn.
• The company is expected to report weak result in Q4 also which has already pushed the company’s aspirations of 17-18% margins by couple of quarters. Nonetheless, we expect recovery both on revenues and margins from H2FY25 onwards.

Hidden Gem

Coal India (CMP: Rs 381, Target Price: Rs 500, potential upside: 30%)

• Coal India Ltd (CIL), is the largest coal producer domestically as well as globally.
• During FY23, CIL produced 703 MT coal contributing ~79% of India’s coal supply and dispatched 695 MT coal with ~84% supplied to power sector.
• The key investment rationale as to why we like Coal India is: Firstly, domestic coal based thermal power generation is here to stay (presently at 205 GW out of total power capacity of 416 GW). In fact, we are anticipating increase in capacity addition in this domain (by ~30 GW) amidst Government ambitious plans of 24x7 power supply to all by FY2025.
• Secondly, CIL has embarked upon an ambitious production target of 1,000 MT by FY26.
• Thirdly, rise in E-auction coal sales volume which is the most profitable segment for them. We expect e-auction volumes to grow at a CAGR of 26% over FY23-26E to 124 MT by FY26. CIL’s commentary suggests company’s aims for ~15% volume contribution from E-Auction space going forward (we built in ~13% share by FY26).
•  On the consolidated basis, Topline/EBITDA at Coal India is expected to grow at a CAGR of 9.7%, 11.7% over FY23-26E. EBITDA margins are seen improving from 28.8% levels in FY23 to 30.4% in FY26E. It has consistently maintained ROCE/ROE in ~40% range and expected to yield similar returns going forward. We have built in 11% volume CAGR at CIL over FY23-26E.
• We assign BUY rating to the stock and value it at Rs 500 i.e. 4.5x EV/EBITDA on FY26E.
• High dividend yield of ~7% provides healthy margin of safety to our investment thesis.