Market Outlook of the week: Nifty poised for a move to challenge life highs with state elections verdict to weigh on sentiments

• Indian equity indices consolidated in a lacklustre trading week as Nifty inched up 0.4% while Nifty midcap and small cap indices closed flat.
• Globally, most major equity indices gained 1% with volatility subsiding.
• Nifty poised for a breakout: Nifty has undergone notable price/time correction over past two months with many negatives priced in the process. We expect Nifty to take-out short-term hurdle of 19,850 and challenge life highs of 20,222 in December 2023. Any transitory volatility amid monthly expiry or state election outcome would provide incremental buying opportunity with strong support at 19,400.
• Key catalysts: Declining brent prices, yields along with positive global setup and strong breadth internals support the bullish chart setup.
• Global markets looking up: Post recent decline in bond yields and inflation, positive global setup would also help domestic indices.
• Sector rotation: IT, PSU, Pharma, Auto are expected to outperform while BFSI and metals provide favourable risk-reward setup.

Corporate Earnings Q2FY24: Growth Momentum Accelerates!

• Corporate earnings in Q2FY24 came in robust with PAT growing 33% on YoY basis at the Nifty Index level (excluding the BFSI space). It was largely led by expansion in gross margins (up 540 bps YoY). EBITDA margins in Q2FY24 came in at 19%, up 426 bps YoY basis.
• Topline growth for the quarter came in muted (2% YoY) largely led by decline in commodity prices in metals and Oil & Gas space.

• YoY muted topline performance especially at the consumer facing companies was also a function of shift in key festive seasons of Diwali from October last year to November this year wherein most of the consumption guys built their festive inventory more in the month of October this time vs. September last year.
• Automobile space witnessed healthy rural demand recovery during the festive season while the same for FMCG space was below expectations. Corporates continue to be enthused by robust infrastructure spend by government thereby stimulating core economic activity.
• In Q2FY24, topline growth was led by Auto and Capital goods domain with both segments growing ~20% on YoY basis. In the auto space, domestic volume growth was flattish on YoY basis while growth for the quarter was led by Tata Motors amidst out-performance at its key overseas subsidiary i.e., JLR. In the Capital goods domain both execution as well as order book built up has been robust.
• On the negative side, IT companies had cautious outlook as large cap companies maintained that near term demand challenges remain.
• For Mid-Cap and Small-Cap domain, the broader trend of low single digit topline growth and 25%+ of profit growth on YoY basis persists. In fact, small cap universe was the only space which witnessed healthy double digit PAT growth on sequential basis (QoQ) as well which was largely flat for the rest of universe.

• With present EBITDA margin profile of ~19% and EBITDA margins at ~17% in H2FY23, we expect corporate earnings growth to sustain in H2FY24 (however moderate tracking base effect).
• We have a positive outlook on markets supported by health double digit earnings growth. Incorporating revised earnings our broader Nifty EPS doesn’t undergo any meaningful change. We expect Nifty EPS to grow at a CAGR of 16.5% over FY23-25E with our fair value for Nifty pegged at 21,500 i.e., 20x P/E on FY25E EPS of ₹1080. From a sectoral perspective we have a positive view on banks, capital goods/infrastructure, power, while would advise avoiding sectors having more global exposure like IT, oil & gas etc.

RBI applies on unsecured retail credit; lenders to witness impact basis unsecured exposure

• Recent increase of 25% in risk weight on unsecured retail loans (excluding home loans, vehicle loans, education loans) came in-line with expectation as RBI has been cautious on faster growth in unsecured lending.
• However, the move to increase risk weight by 25% on banks lending to NBFCs (excluding HFC, CIC and priority sector loans) came as unexpected surprise.
• Impact on banks is seen to remain in-sync with proportion of unsecured retail book with impact on CaR ratio at 20-80 bps. For most of the banks, margin is expected to witness marginal decline resulting in steady RoEs. Growth in unsecured credit is to moderate, though we expect it to remain higher than system credit growth.
• NBFCs (excluding HFC) are expected to witness double whammy impact owing to higher cost of funds (given increased risk weight on bank borrowing) and higher capital consumption on unsecured lending. Thus, margins are expected to witness moderation in coming quarters, thereby lowering return ratios.
• Higher bond issuance expected as NBFCs aim to reduce dependence on bank borrowing. Banks to engage in issuance of tier II and III bonds to shore up capital adequacy.
• Among NBFCs, Bajaj Finance is expected to witness moderation on margins and business growth.
• SBI Cards, given 100% book being unsecured, is expected to witness highest impact due to new regulation.

Defence Sector: Prelim approval for three big defence projects is expected next week

• As per the reports, three mega defence projects worth Rs 1.4 lakh crore is expected to get preliminary approvals next week. The three projects include manufacturing of another aircraft carrier with an estimated cost of Rs 40,000 crore, 97 more Tejas MK1A fighters with an estimated cost of Rs 55,000 crore and 156 Prachand light combat helicopters with an estimated cost of Rs 45,000 crore.
• Though these projects were already in discussions from the last couple of months, we believe that prelim approvals from government will be a big development as the official procurement process will start after this.
• Hindustan Aeronautics (HAL) will be the primary beneficiary for Tejas MK1A fighters & light combat helicopters while Cochin Shipyard (CSL) will be the beneficiary of aircraft carrier contract.
• Bharat Electronics (BEL) will also play a key role in supplying electronic systems like Uttam radars, electronic warfare, communication systems etc. Private players like Data Patterns and Astra Microwave would also benefit in terms of supplying electronic sub-systems for these radars & electronic warfare.
• Midhani will benefit in terms of supplying superalloys and titanium alloys for these platforms. Bharat Dynamics (BDL) will also benefit from additional requirements of Astra air-to-air missiles and Helina missiles which are planned to be used from Tejas aircrafts and combat helicopters.
• We also believe that execution period for these orders will be meaningfully lesser than the previous orders of these same platforms, as the indigenization level is expected to be relatively higher led by induction of engine components, electronic systems like radars, electronic warfare etc.

Softer crude to bring oil companies in focus

• Brent crude oil prices have remained volatile and largely depressed at US$81 per barrel levels from earlier US$85+ price.
• The depressed prices are due to combination of factors such as OPEC rescheduling its meeting from 26^th Nov to 30^th Dec (leaving the market cautious about future supply cuts), lower processing in Crude by Chinese refining companies (3% down from Sept highs of 15.5 mil bpd) and rise in US crude oil inventory.
• At the current Brent crude oil prices, the blended marketing margins for OMCs will drastically improve to Rs 3-4 per litre (breakeven at US$85 levels) and would further improve as crude cools down. However, the impact on OMCs stock would not be as aggressive, mainly due to risks associated with incoming General elections. Lower crude oil price with higher discounts would provide a double thrust to fortunes of OMCs (better GRMs and Marketing margins).
• On the flip side, lower crude oil prices (esp in winter season) would prove to be a dampener for spot gas players such as Gujarat Gas (which directly competes with LPG).
• Standalone refiners and petrochemicals players (Reliance and MRPL) would largely see a healthy operating growth due to a combination of decent EBITDA on the refining side and possibility of revival in Petchem demand due to lower prices (while maintaining margins).
• Upstream companies would be largely neutral as prices are capped at ~US$75 per bbl levels (but would start seeing de-growth if crude oil prices fall further.
• Stocks: OMCs: Our preference on falling crude Oil prices remain (HPCL>BPCL>IOC) based on higher marketing capacity vs refining capacity.
• HPCL: BPCL: IOC marketing volumes in FY23 (in MMT) were 43.5: 50.3: 72.3 and refining throughput were 19.1: 40.3: 72.4

Hidden Gem

Gateway Distriparks (CMP: Rs 108, Target: Rs 125, Upside: 16%)

• Gateway Distriparks (GDL) has a diversified presence in logistics verticals like container train operators (CTO), cold chain logistics, container freight stations.
• Rail segment comprises 78%+ of consolidated revenues, with the rest being contributed by CFS. Has five intermodal terminals, built on owned land at key areas along WDFC.
• The company expects Jaipur ICD to commence operations from Q1FY25 and initially began with 1,000-1,500 TeUs per month in H1 and then proceed towards 3,000-4,000 TeUs in H2. The management also expects to add two new ICDs in the near term (Rs 200 cr capex) and is adding 3 more rakes to service the volumes.
• Kashipur ICD volumes too could see an improvement to 4,000-5,000 TeUs per month from current 3000 run-rate, based on improvement in EXIM volumes in medium term.
• Western DFC has been 70% commissioned (800 kms in usage, ~550 kms left), and its entire route commissioning would get shifted to FY25. The WDFC electrified route connectivity is expected to gradually shift 1-2% road market share to railways each year (better turnaround times, double stacking, IR haulage charges could lower etc).
• In FY23, Rail volumes stood at 3.3 lakh TeUs and are expected to clock 18% growth in FY24 (nearing 4 lakh TeUs mark), while rail revenues stood at Rs 1,081 crore and expected to reach Rs 1,250 crore mark (up 15%). Overall, Revenues are expected to grow 11% YoY to Rs 1,572 crore (non- core segment CFS expected to largely stay flattish at Rs 322 crore).
• The management has targeted EBITDA per TeU improvement to Rs 10,000 per TeUs in the long term (from current Rs 9,000) and at the same time improve existing monthly volumes run-rate from newer markets. This would translate into strong FCF generation (~6% yield in FY25E).
• Assigning a PE multiple of 24x FY25E, we ascribe target of Rs 125 per share and a BUY rating.