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Market Outlook of the Week: Global cues and inflation expectations to weigh in derivatives expiry week

ICICIdirect 17 Mins 22 Sep 2023
  • Key equity benchmarks declined >2% amid global volatility post FOMC outcome. Nifty Midcap and Nifty small cap indices declined in tandem (~2.3% each). Nifty traded at 19,750, down 2.2% for the week.
  • Key developed market indices declined 2.5% to 3% as US yields hit multi-year highs.
  • Nifty is expected to form a higher base around 19,500 in coming week followed by healthy consolidation in 19,500-20,000 band. Expect volatility to subside post monthly derivatives expiry.
  • Structurally, last week’s decline is a transitory shake out amid global volatility and should be viewed as a healthy retracement from overbought zone after three weeks 1,000 points rally.
  • We reiterate target of 20,700 by Diwali with key support at 18,900.
  • Sectors in focus: BFSI, Auto, IT, Power, consumption.

US fed maintaining hawkish bias

  • Data dependent FED flagged off possible rate hike in November.
  • While inflation has largely declined over the last few months but the recent surge in energy prices have triggered the speculation of increased inflation in coming months.
  • Resilient economy numbers have forced US Fed to revise the GSP numbers of US from 1% to 2.1% for 2023 along with decline in unemployment rate.
  • Fed is now expecting soft landing of economy and cooling off may take much higher time.
  • US Fed has hinted with overwhelming majority for another rate hike in November (12 out of 18) and higher rates for longer period next year.

India to be included in the JP Morgan Global Bond Indices – big structural positive for economy

  • India is expected to reach the maximum weight of 10% in the JP Morgan GBI-EM indices. Inclusion of the Indian Government Bonds will be staggered over a 10-month period starting June 28, 2024, through March 31, 2025 (i.e., inclusion of 1% weight per month).
  • Passive flows benchmarked to these indices stands at about USD 236 bn. A 10% weight could lead to a cumulative inflow of about USD 24bn in 10-month period from June 2024 to March 2025.
  • Indian Government borrows around USD 180 bn per year. Therefore, total inflows (while just 1 time as regular inflows will be lower post 2025) in 10-months could be around 13% of India’s annual borrowing.
  • Overall, there are currently 3 major EM bond indices:
    1. JP Morgan EM bond index
    2. FTSE EM bond index and
    3. Bloomberg Barclays EM bond index
    4. JP Morgan's EM bond index and Bloomberg Barclays' EM bond index both have around USD 230 billion in assets under management (AUM) tracking them. Therefore, if Bloomberg Barclays also include India in its bond index, similar flow of around USD 24bn could be witnessed.
  • Globally, active flows also closely mirror passive flows which could lead to additional flows in Indian debt market. 

Global bond index inclusion to benefit BFSI and economy in general

  • Softening of yields (on the back of increased flows in debt market) is expected to benefit in terms of treasury gains, especially PSU banks.
  • In the long term, any relaxation in reserve requirement could result in increased deployment towards relatively high yielding advances.
  • Gradual decline in interest rates is expected to boost consumption and thereby retail loan growth which is beneficial for banks as well as NBFCs.
  • Improved recognition of Indian bonds globally could enable NBFCs to diversify borrowing mix at competitive rates.
  • Indian Rupee has been one of the least volatile currency and with expected continued flows in coming months, we don’t see it to structurally depreciate much.
  • Inclusion in global bond index will attract foreign inflows which is likely to result in gradual decline in borrowing cost thereby lowering cost of capital – which remains beneficial for equities in general from a PE multiple expansion perspective, lowering even borrowing cost for corporates and thus economy in general.

Given structural long term growth opportunity, focus towards granular retail loan and improvement in operational performance and asset quality, we remain positive on banking sector. Among banks, we prefer banks with healthy business mix, steady asset quality and improvement in RoA available at relatively lower valuation. Thus, SBI (~1x FY25E ABV) and Bank of India (~0.7x FY25E ABV) remain our preferred picks in PSU banks and small private banks including South Indian Bank (~0.7x FY25E ABV), Karnataka Bank (~0.8x FY25E ABV) looks attractive.

HDFC Bank merged numbers shows near term pressure on margins

  • Opex and credit cost: Given leaner structure of HDFC Ltd, CI ratio on a merged basis declined from ~43% to ~40% while credit cost improved from ~70 bps to ~60 bps.
  • NIM: On merged basis, NIM are expected to decline from 4.1% to 3.7-3.8% which was been articulated earlier. However, impact of excess liquidity (raised in HDFC Ltd prior to merger) and ICRR is expected to compress margin by further 20-25 bps. Utilization of excess liquidity by way of deployment on lending side and repayments will result in regaining of margins in next 3-4 quarters.
  • Asset quality: GNPA/ NNPA on merged basis has increased 20/ 10 bps to 1.4%/ 0.4%, led by movement of some of HDFC Ltd’s non-individual exposure to Stage 3 and recognition of additional NPA as per banks policy. Credit cost has declined from ~70 bps to ~60 bps, though the bank expected the same to revert to long term mean of 80-90 bps ahead.
  • Focus on retail deposit: The bank aims to focus on accretion of granular retail deposits to enable improvement in margins and maintain LCR. Further, the bank does not intend to engage in any rate competition as it will result in higher cost of carrying liabilities. Replacement of borrowings with retail deposit is expected to gradually aid margins. 

While the bank has projected recovery in loan growth (17-18%) and improvement in RoA (1.8-1.9%) in FY25E, anticipated volatility in near term financial performance and challenge of accretion of liabilities at competitive price is expected to result in near term under-performance.

India - Canada: estranged relationship to have minimal economic impact

  • The trade with Canada is evenly balanced with imports equal to exports at ~Rs 33,000 crore (US$ 4 billion) as of FY23.
  • Key import items are Mineral Fuels (Rs 8,400 crore), Fertilizers (Rs 5,700 crore), Pulp of Wood (Rs 3,400 crore), among others.
  • While Key export items are pharmaceutical products (Rs 3,500 crore), Iron & Steel Products (Rs 2,500 crore), Capital Equipment’s (Rs 2,000 crore) among others.
  • Thus, estranged relationship between India and Canada has minimal economic impact domestically except Potash which is largely imported as a fertilizer and the only thing of strategic importance.
  • Potash is an important ingredient of domestically used NPK fertiliser.

Russia has banned export of diesel and petrol

  • The move has gained significance as it has happened right before winter season, where demand for gasoil, LPG is expected to pick up in Europe.
  • Current IEA expectation of 1 lakh bpd increase in diesel consumption in CY23 is moderate compared to an expected increase of 5 lakh bpd and 1 million bpd increase in gasoline and jet fuel and kerosine respectively.
  • The increase in diesel prices is on the back of supply tightness, which could exacerbate if China picks up or winters become harsher.
  • As per media sources, European refiners were unable to build inventories this summer due to unplanned outages, which has left to tight inventories ahead of winter.
  • Standalone refiners are expected to benefit the most, followed by Gas companies such as CGDs in the near term (however, they remain vulnerable to LNG volatility in winters). OMCs would remain a mixed bag as improvement in GRMs will be negated by losses on the marketing side.

Wipro top level exits may impact near term turnaround

  • Wipro’s Jatin Dalal, a veteran of 21 years, has resigned as CFO to pursue professional goals outside the organization. The company has elevated Aparna Iyer, CFO of Wipro’s FullStride cloud global business line, as CFO with immediate effect.
  • Quite a few senior management personnel have quit Wipro in the past 9-12 months (including COO, country head of Brazil, India Japan, and segment heads of Healthcare, Manufacturing etc.) and latest CFO exit adds to the list.
  • In Q1FY24, Wipro’s IT services revenue was down 2.8% QoQ in CC terms to $2,778.5 million. The EBIT margins at 16% was down 20 bps QoQ, given the negative operating leverage. Key segments such as BFSI, consumer and energy declined sequentially.
  • For Q2FY24, Wipro's has guided for a revenue growth of -2% to 1% in constant currency terms and similar margins band, reflecting near term challenges. The company sounded off on near term demand challenges due to reduction in discretionary spends including in key segments.
  • The loss of key leaders continuing into period of turnaround is a negative development. Wipro is struggling in its turnaround effort, has a weak mega deal pipeline and relatively weak growth outlook for FY24.

Hidden Gems

PNC Infratech (CMP: Rs 368, TP: Rs 460, 25% Upside)

  • PNC Infratech has established itself as a strong construction executor in roads and water infra segments (Jal Jeevan project). Additionally, superior execution capabilities via ownership of modern equipment and in-house teams enables PNC to deliver projects on-time.
  • Order book strong, provides healthy revenue visibility: Order Book strong at ~Rs 18,900 crore, 2.6x book to TTM revenues. Going ahead, the company has guided for inflows worth ~Rs 10,000 crore during FY24E driven by roads projects (70%+) while remaining is likely from non-roads segments like water, railway, etc.
  • Financial performance to stay strong: It has reported 30.6% revenue CAGR in FY18-23; operating margin has largely been in the range of 13-14% and reported robust return ratios (RoCE: ~20%). Given the orderbook visibility, we expect healthy revenue CAGR of ~13.5% over FY23-25E to Rs 9,097 crore.
  • We value PNC at Rs 460 per share, valuing its construction business at Rs 373/share (at 12x FY25 EPS) and HAM at 1x equity invested.
  • Well-placed to fund road HAM projects: Going forward, it has balance equity requirement of Rs 1,228 crore to be infused over the next three to four years. Given the healthy operating cash flow generation (generates annual EBITDA of ~1,000 crore and has net capex requirement of 100 crore), we expect the equity to be funded from the internal accruals.
  • Asset monetisation on the anvil: PNC is currently in discussions with potential investors to monetise its assets. Eleven HAM and one BOT project (Bareilly Almora) are under block to monetise having debt of ~Rs 6,900 crore and equity of ~Rs 1,700 crore (seven operational; rest likely to be operational by next three to four months). The management expects the process of monetisation (including receipt of money) to conclude by FY24-end with receipt of amount. With monetisation fructification, company’s scalability would improve drastically, going ahead.
Source: ICICIdirect Research

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