Market Outlook of the week: Midcaps to outperform, even as Nifty looks set for new high in June 2023

• Indian equities outperformed global peers, despite concerns around global economic slowdown and concerns around US debt ceiling deal.
• Nifty gained 1.6% to trade at 18,494. Broader markets outperformed with Nifty Midcap100 index registering new highs.
• Globally, barring Nasdaq (1%) and Nikkei (0.6%), all major markets were down between 2%-3%.
• Nifty eyeing new highs in June: We expect Nifty to eventually break past 18,500 and head towards life highs of 18,887 in June 2023 backed by strong improvement in market breadth indicating broad based participation. Key support placed at 18,000, which is lows for May 2023.
• Nifty Midcap 100 at new highs: Index has given a breakout from 18 long months of consolidation indicating resumption of structural bull market. We expect index to gain 15%-20% over next one year and relatively outperform. NBFCs, Liquor, IT, capital goods themes are expected to lead.
• Lower industrial commodities: Key commodities like Copper, Aluminium, Brent oil, all are down on one and three month time frame. Copper and Brent are down 9% each on 3 month basis. This could act as tailwind on margins of respective industries.

Fund flow: FII continued their buying spree in May with 25,700 Cr inflows

• May month so far has been witnessing continued flows and FIIs have been net buyers in almost every session of the month.
• FII have bought over $3.5 billion (Rs 25,700 Crores) so far.
• India is likely to receive $1.1 billion during MSCI rebalancing exercise on 31^st May.
• MSCI has announced few changes and we are likely to witness volatile move ahead of the effective dates of these changes (1^st June). Hence on Wednesday (May 31^st), large moves are likely to be seen in some of the heavyweights.
• The new additions in MSCI India index like Max Healthcare, Sona BLW and HAL have seen significant price performance recently. Also Kotak Bank, ONGC, Maruti and Ultratech Cement have seen increase in weights while heavyweights like Infy, TCS and HDFC have seen weight reduction.
• On a net basis, India is expected to receive some $1.1 billion flows into market out of which a major pie of nearly $700 million may be seen in Kotak Bank only. The recent outperformance seen in some of the above names can be attributed to the same.

Adani group back in limelight

Post the rally, Adani Ports has become the first Adani Group company to recoup its market cap losses post the Hindenburg saga. It has crossed 1.5 lakh crore MCap

• Adani Ports (CMP: Rs 728, Target: Rs 800, Upside: 10%) lowered its organic capex for FY24 (Rs 4,000-4,500 crore), the bulk of the capex (organic and inorganic) already happened in FY22 and FY23.
• On the volumes front, FY24 started for Adani Ports with record volumes of 32.3 MMT (13% YoY), a respite as monthly volumes in FY23 largely stayed in 25-26 MMT range.
• The company will focus on utilizing the existing assets and will use the higher FCF (EBITDA expected at Rs 14,500 crore and Capex of Rs 4,500 crore) in FY24 to pre-pay loans (Rs 5,000 crore). This will result its net debt to EBITDA in 2.5x range.

ACC-Ambuja Cement: Efficiency to enrich profitability pool with market share gains (Ambuja TP: Rs 470, Upside 13%, ACC: TP: Rs 2,130, Upside: 20%).

• Adani group Cement companies (ACC & Ambuja) reported one of their best quarters in terms of volumes with both companies operating at 95%+ utilization levels in Q4FY23.
• Synergies with Adani group have already started kicking in through groups exposure into energy and logistics which is helping them to improve cost dynamics and supply chain efficiencies. Overall cost of production for the quarter for Ambuja declined by Rs 270/t, while ACC reported a decline of Rs 312/t. We build in cost savings initiatives of Rs 345/t during FY23-25E and expect Ambuja to clock EBITDA/t of Rs 1,240 by FY25E.
• Aggressive capacity expansion plans of Rs 46,000 crore, doubling the capacity to 140 MT at 15% CAGR (ACC + Ambuja) by FY28E. Company would fund the entire capex requirements through internal accruals (cash & investment as on FY23: Rs 11,530 crore).
• We remain positive on both the stocks. We find the risk reward favourable at the CMP for ACC as it trades at reasonable valuations of EV/t of US$85/t (~8x EV/EBITDA), which is ~25% lower than the replacement cost. We value ACC at 10x FY25E EV/EBITDA with TP of Rs 2130. For Ambuja, given dual levers of long-term growth prospects and enhanced efficiency we value the stock at ~15x FY25E EV/EBITDA with a TP of Rs 470.

Liquor companies have been facing significant pressure in margins in FY23 on all fronts

• Bigger liquor companies such as USL and Radico are facing significant pressure on major raw material ENA (Extra Neutral Alcohol), Glass, Paper and PET.
• USL YoY EBITDA contraction of 800 bps to 9.4%, Radico saw 30 bps contraction to 9.5% and Globus saw 400 bps contraction to 13.5%.
• Companies are seeing softness in few commodities such as paper and PET and also expect prices of glass to turn soft (due to recent correction in gas prices); the prices of ENA is still expected to remain high.
• While the companies are witnessing price hikes in several states, however, on a bigger picture input price inflation continues to run ahead of output price.
• United Spirits (CMP: Rs 840, Target: Rs 1,000, Upside: 19%; 54x PE FY25E) remains our top pick. The management expects to hit 15% margins in FY24 and then progress towards higher margins due to a mix of better product mix towards premiumization led by Luxury and Premium categories (31% revenue mix, 37% growth) besides cost efficiencies. The company is now debt-free and the management could look at dividends in FY24.

Chinese recovery disappoints; Metal sector narrative shifts from demand uptick to production curtailment

• While lot of hope on was built in Chinese demand recovery during the start of CY 2023, the ground realties have left lot to be desired . Most of the data points released over the last few months has indicated muted Chinese demand recovery, which has played a spoil sport for global metal sector.
• On the back of subdued demand recovery in China, Chinese steel exports over the last couple of months have witnessed a sharp uptick. Both for the months March 2023 and April 2023 , Chinese monthly steel exports have stayed elevated levels at ~7.9 Million tonnes each which has put downward pressure of global steel prices.
• In China, there has been a shift in narrative from demand uptick to production curtailments. China has indicated that they would like to limit their steel production at CY 2022 level. Hence Going forward, the quantum of curtailment in Chinese steel output and likely decline in Chinese steel exports remains a key monitorable.
• The recent softening trend of coking coal prices has been the only ray of hope for domestic steel players. However as steel players carry couple of months of coking coal inventory, the benefit of the recent fall in coking coal prices to the tune of ~ US$25/tonne is expected to flow in Q2FY24.
• Tata Steel (Target – Rs 130, Rating – Buy) is preferred as it is currently trading at 4.5x FY25E EV/EBITDA compared to 5.8x FY25E EV/EBITDA for JSW.

Tile Manufacturers experiencing turnaround

• Overall tiles industry size is at ~Rs 60,000 cr (domestic: export - 70:30). Volume growth in domestic segment was 6% in FY23 for Somany and ~11% for Kajaria.
• The domestic industry volume is expected to grow at 6- 8% in FY24 (branded players to expand market share with 12-13% volume growth), while Morbi players will focus on Exports diverting their volumes, which are likely to grow ~20-25% in FY24.
• Gas price impact: The industry faced margins pressure as gas prices had doubled in last 5-6 quarters and margins had come off sharply. For Kajaria, the margins had come down to 12% (from 16% normalized and peak of 20% attained in H2FY21). Similarly, for Somany, margins had come down to 6.5% (from 10.5-11% normalized and peak of 13.5% attained in H2FY21).
• Recovery in Q4 and outlook ahead: With Gas prices declining by 30-35%. A good part of the benefit was visible in Q4 as Kajaria resultant margins were at 14.6%, was up 241 bps QoQ while Somany margins were at 9%, was up 247 bps QoQ.
• Going ahead, we expect both Kajaria and Somany to revert to normalised margins of 16% and 11%, respectively.
• We expect both players will report 14% revenues CAGR with 12% volume CAGR. This will drive ~32% and ~58%, earnings CAGR, respectively over FY23-25.
• We are constructive on both Kajaria (Target Price 1350, upside 8%) and Somany (Target Price 765, upside 23%) and have a BUY rating.

Defence PSU disappoint in Q4, bullish outlook intact

• Since defence sector PSUs had already reported provisional numbers for FY23, there was no major surprise in terms of their top-line numbers. Margins were the key monitorable for the quarter and full year which have been a mixed bag.
• For Q4, Hindustan Aeronautics (HAL) reported 8.1% revenue growth with 435 bps EBIDTA margin improvement, Bharat Electronics (BEL) 2.1% revenue growth with 347 bps margin increase while Bharat Dynamics (BDL) revenue was down by 42% with over 900 bpd margin.
• It would be better to look at their full year numbers rather than quarterly as the execution varies substantially quarter to quarter.
• For FY23, revenue for HAL and BEL are up by 9.4% and 15.4% as the execution remained better in their contracts. These two companies have fared better than BDL which saw 12% revenue de-growth on account of some supply delays & design changes.
• In terms of margins also, HAL & BEL have managed to improve their EBITDA margins by about 280 bps and 130 bps but BDL’s EBITDA margin has contracted by 940 bps YoY due to muted execution in 2HFY23.
• Going forward, the outlook for these three companies looks strong as the current order backlog position remains healthy at 3-3.5x of FY23 sales for HAL and BEL and about 10x for BDL.
• We remain positive on HAL (Target price: Rs 3,610) and BEL (Target price: Rs 135)

Hidden Gem

L&T Finance Holding (CMP – Rs 102, Mcap – Rs 25,298 crore, Target Price – Rs 125)

Retailisation story at attractive valuation

• L&T Finance Holding is a leading NBFC engaged in retail and wholesale lending (real estate and infrastructure segment). Backed by strong parentage, LTFH has been assigned “AAA” rating and has strong distribution network with 2,500+ dealer tie up in farm equipment and 5,500+ tie-ups in 2 wheeler segment.
• In April 2022, LTFH has announced plan to undertake business restructuring with target towards retailisation and product based approach. As per the plan, downsizing of wholesale has been undertaken resulting in share of wholesale loans declining from 49% to 25% (at Rs 19,840 crore) and increase in proportion of retail book from 51% to 75% in last 12 months.
• Going ahead, AUM growth is expected to be driven by the retail segment – newer segments seen driving faster traction (consumer loans, home loans, LAP and SME loans) while existing mature segments (farm equipment, rural group loans (MFI) and two wheeler finance) are expected to witness steady growth with a gradual gain in market share.
• Expect retail book to grow at 31% YoY in FY24E and 24% YoY in FY25E; gaining share to more than 90% in outstanding AUM. Such increase in retail assets is expected to aid yields and thus margins trajectory. Further, asset quality is seen to be contained with GNPA and NNPA guidance at
• With retail loan book gaining traction to almost >90% of outstanding AUM by FY24E, RoA and RoE are expected to improve to reach ~2.1% and ~10% in FY23-25. Thus, at current valuation of ~1x ABV, LTFH remains an attractive opportunity.