Nifty likely to head towards 18,200 levels after reclaimed 20-day average during last week

Nifty reclaimed 20-day average during last week, which has been acting as a hurdle on four instances over past ten week’s corrective phase. Going forward we expect Nifty to overcome this hurdle and head towards 18,300 in February 2023. Buy the dips with key support at 17,400 (52-week average)

 Key Observations that support bullish stance:

• Price/time wise correction approaching maturity: Since COVID lows, intermediate corrective phases have matured after approx. 9% price wise and 10 weeks of time wise correction. In current context with 8% correction from highs over 10 weeks, we expect current consolidation to mature and Nifty to resume its uptrend in coming week. In each of previous instances, post correction index gained at least 7% over next one month from lows
• Midcap and small cap indices (+1.5%) relatively outperformed last week. This along with cash turnover in February improving to approx. 55k Cr (Jan: 48k Cr) indicate improving sentiment and retail participation
• Global markets have been in good shape with all major indices trading above their 20-day average. UK index registered new five year high while Dax is just 5% away from highs
• India VIX corrected further 10% back to Dec-Jan lows signifying low risk perception of the market participants 

IT, BFSI, Capital goods/Infra and Auto are expected to outperform

Global and domestic fund flows turning favorable

Portfolio rebalancing is visible where underperforming countries are getting FPI flows. Taiwan for example has witnessed inflows of more than $9 billion and South Korea saw inflows of more than $7 billion in current year while India saw outflow of nearly $4.5 billion.  However, it includes outflows due to Adani group but India has witnessed outflows towards the end of January and in February when the volatility was in peak, net outflow was just 5k crores till date only.

Domestic inflows came back strong after moderate festive period

The domestic flows which have been the mainstay of Indian equity markets in last few years came back stronger in last 2 months after being soft during festive season (August to November 2022). Net inflows averaged lower at around Rs 4,400 crore during Aug to Nov 2022 as investors withdraw (gross redemption higher during this period) money during festive season. However, in last two months, inflows have again picked up to Rs 5,300 crore in December 2022 and Rs 11,300 crore in January. SIP reach new high of 13,800 crores

Expect long pause post currently coined “Insurance” hike

• RBI hiked Repo rate by 25 bps to 6.5% meeting market expectation, while it continued its “withdrawal of accommodation” stance. The current hike is seen more about front loading and staying cautious considering the global scenario.
• The RBI has raised growth estimates to 6.4% and inflation is expected at 5.3% for FY24.
• RBI allowed lending and borrowing in G-Secs, the same is seen to be beneficial  for major domestic players as also overseas investors, subject to norms. At present Govt Securities are borrowed/lent through CROMS platform. G-Sec held by insurance companies and duration mutual fund are not available for short sellers to cover shorts (since lending stock in repo means borrowing by them which is not permitted). The proposed development will allow G-sec holders to deploy idle G-sec to generate higher returns.
• RBI MPC said calibrated monetary policy action is warranted to keep inflation expectations anchored, break core inflation persistence and thereby strengthen medium-term growth prospects.
• The RBI comment indicates that in all likelihood, the rate hike cycle in now behind us. We expect a long pause over the next few policy meetings, particularly in calendar year 2023.

Nifty earnings till date at marginal ahead of estimates 

• Among Nifty results declared so far (~94% of index), Q3FY23 results were broadly ahead of our estimates (~3% outperformance). Positive surprises were witnessed in Auto (gross margins expansion across OEM’s and outperformance at Tata Motors), Capital Goods, Pharma & FMCG space while Oil & Gas and Metals largely underperformed. Nifty EPS in Q3FY23 is expected at Rs 195/share (up 5.4% QoQ)

• Incorporating the revised forward earnings, as on date, our aggregate Nifty earnings largely remain unchanged. It is primarily driven by lower single digit uptick in forward earnings estimates across the major sectors expect FMCG

• We await the result season to conclude before freezing our estimates.

• Retaining our earlier numbers (i.e., FY22-25E earnings CAGR at 14.8%), released at the time of market strategy report 2023, we continue to value Nifty at 21,500 i.e. 21x PE on FY24-25E average EPS of Rs 1,020.

Pharma CRAMs have witnessed 20-40% correction over the last three months and the sentiment continues to remain cautious

Pharma CRAMs have witnessed significant correction over the last 12 months and the sentiment continues to remain cautious. Companies like Divi’s and Laurus have corrected 35% and 40% respectively during the last 12 months.

Valuation multiples contracting

We believe significant PE multiple contraction as one of the reasons as most of the players enjoyed significant premium as they rode on industry-beating fundamentals over the last 8-10 years, be it Gross block addition, strong EBITDA margins, healthy ROCE and 12-15% sales CAGR on a consistent basis. Divi’s Labs for instance has witnessed significant EBITDA margins contraction from 35-40% during the last few years to ~24% in Q3FY23.

During Covid these players executed Covid opportunities at the behest of the innovators with almost 50% of their resources getting deployed for Covid work and witnessed significant jump in earnings in FY21 and FY22 as major global players diverted their R&D towards Covid and outsourced significant materials from players such as Divi’s, Laurus, Suven among others.

As things stand today, there has been a significant shrinkage in Covid execution as the Innovators have started moving on from Covid work which is visible in the CRAMs revenues of companies such as Divi’s which witnessed ~55% YoY decline in CRAMs during Q3FY23.

Way ahead

Global innovators are now going back to the pre-Covid R&D projects besides devising new molecules. It is expected to take at least 3-4 quarters to turn their work into opportunities for Indian players. As such, we expect J curve recovery in the CRAMs revenues as the order inquiries are expected to turn into revenue stream with a lag.

Our view

Global CRAMs space remains a sticky business with high entry barriers and long-lasting customer relationship. It is difficult to change a CRAMs vendor due to data integrity issues. Which is why there are handful of global players including few Indian companies. We also notice that global R&D activity has regained momentum post Covid and so too the outsourcing opportunities. (one global estimate pegs global pharma CRAMs growth at a CAGR of ~7% from US$160 billion in 2020 to US$237 billion by 2026).

We have HOLD rating on Divi’s with a TP of Rs 2,945 and on Syngene with a TP of Rs 610. We have BUY rating on Laurus with a TP of Rs 400.

Defence: Marginal increase in capital outlay not to impair the outlook 

• Defence capital outlay of Rs 1.62 lakh crore budgeted for FY24E was lower than expectations as it implies just 8.4% YoY increase as against the general expectation of 15-20% increase. However, we believe that there has been a gradual increase in capital outlay in defence every year and shows 5 year CAGR of about 10%.

• Moreover, though the percentage of domestic procurement is kept unchanged at 68%, we see govt’s strong focus on reducing imports and pushing more for indigenization of defence equipments as this has also increased gradually from 50% to 68% in the last 5 years.

• One important thing to notice was that the total R&D budget allocation of Rs 23,264 crore for FY24 implies 10% growth and 4% of total defense budget which has also increased considerably over the past couple of years. This also shows govt’s focus on spending more towards designing and developing more indigenised platforms.

• If we look at the cumulative order backlog of defence PSUs, it is about Rs 2.2 lakh crore which implies strong revenue visibility for the next 3-4 years for these companies. Overall we believe that the defence budget for FY24E may not be a great in terms of % increase but the sector has been witnessing structural change and going in the right direction

Preferred Pick – HAL

Hindustan Aeronautics (CMP: 2425, TP: 3300; Potential Upside: 35%)

Order backlog at ~Rs 84,000 crore (3.2x TTM revenues) gives strong revenue visibility. Deliveries of Tejas MK1A will start from FY24E end which will give a major boost to earnings from FY25E onwards. Moreover, about Rs 55,000 crore worth of contracts are in pipeline as per the management, which are expected in the next 1-1.5 years. This include large scale orders in Helicopters (LCH, LUH and ALH), transport aircrafts, unmanned ariel vehicles, aircraft engines etc. Tejas MK2 prototype is also expected this year which will also be a large scale contract for HAL considering the IAF’s requirement of 6 squadrons in medium weight fighters. Overall, HAL looks well placed in terms of rising indigenisation, pick-up in execution and strong visibility of order inflows.

NBFCs better placed amid robust business growth and bottoming up of margins

• NBFCs have been reporting robust pick up in advance growth on the back of recovery in credit demand and higher focus on retail segment. HFCs and auto financer have reported continued strong momentum (Advance growth at 11.8% for HDFC Ltd, 26% for MMFS) coupled with healthy growth for diversified peers (AUM growth at 27.4% for Bajaj Finance, and 24% for IIFL Finance). However, gold financier witnessed moderation in growth (Muthoot at 6%) while wholesale lenders reported downsizing.
• Lag in repricing of assets, amid rising interest rate cycle, have led to margin pressure for few NBFCs (HDFC Ltd report margins remaining range bound at 3.5% while MMFS witnessed 10 bps QoQ decline in NIM). With rate cycle nearing peak and gradual passing on higher rates to customers, NBFCs are set to witness improvement in margins profile ahead; the same is expected to boost earnings further.   
• Asset quality remains robust across NBFCs with gradual improvement in coverage ratio. Hence, earlier concerns on asset quality remain on back burner.
• Among NBFCs, prefer HDFC Ltd (Buy rating with target price at Rs 3,150, valuing the stock using SOTP valuation with standalone business valued at 1.8x FY25E ABV) and Bajaj Finance (Buy rating with target price at Rs 7,250, valuing at 5.7x FY25E ABV). Among non-coverage, L&T Finance (currently valued at 1.2x FY23 BV) and IIFL Finance (valued at 2.1x FY23 BV).

Stocks Witnessing earnings Upgrade

Tata Motors: Buoyant margin expansion amidst rising contours at JLR front!

(CMP: Rs 433; Market Cap: Rs 1.6 lakh crore; Rating: BUY; Target Price: Rs 530; Potential Upside: 22%)

During the quarter the company witnessed healthy margin recovery across its key verticals namely Indian CV, PV as well as JLR amid higher than anticipated wholesales volumes at JLR. Overall it posted a profit of Rs 2,958 crore vs. our loss estimate of Rs 981 crore. Tracking present upbeat performance and ramp up at JLR along with additional capacities post acquisition of fords plant we have built in 13.8% volume CAGR & 18.2% sales CAGR over FYFY22-25E, with consequent margins at 13.7% on consolidated basis. We value stock at Rs 5,30 per share (i.e. 10x, 2.5x FY24E EV/EBITDA on India, JLR; Rs 158 value to Indian EV business). With focus on profitability and FCF generation, company is seen reaching double digit ratios (i.e. 15%+) from FY24E onwards.

Trent Ltd (CMP: Rs 1,330, TP: Rs 1,730, upside: 30%). Zudio: A game changer for Trent 

• Trent reported superlative sales number with a strong beat on the revenue front. On a favourable base, revenue grew by 61% YoY to Rs 2171 crore (I-direct estimate: Rs 1,886.9 crore). On a three-year CAGR basis, revenue growth stood at an impressive 36%, which is the highest amongst other lifestyle retailers.  

• The industry leading revenue growth is mainly owing to sustained robust trajectory of store addition pace. Company during YTDFY23 added 91 new Zudio stores taking the total count to 326. Inflationary stress has been more acute at the lower end of the fashion value chain (ASP’S < Rs 1,000) as demand remains weak. However, Zudio continues to defy all odds with sustained robust growth. Back of the envelope calculation suggest Zudio format to have grown ~2.5x in Q3FY23 with share in revenue increasing significantly from ~30% to 40%+ (share of Zudio format in FY20 stood at ~ 16%).

Industry leading performance and consistent revenue growth will enable Trent to sustain its premium valuations going forward (TP: Rs 1,730 based on SOTP valuation, 6x EV/Sales for Standalone business).  

Stocks witnessing earnings downgrade

Escorts Kubota Ltd: Margin under-perform bigtime amidst ambitious FY28E targets!

(CMP: Rs 2,033; Rating: HOLD; Target Price: Rs 2,165; Potential Upside: 8%)

Escorts Kubota Q3FY23 results were disappointing with gross margin contracting by ~210 bps sequentially (with rest players reposting healthy GM expansion) and consequent EBITDA margins coming at 8.4% with management commentary indicative of similar reading for coming 1-2 quarters. Amidst industry tailwinds of positive sentiments, we have built 11.3% sales volume CAGR over FY22-25E, with consequent margins seen at 10.5% in FY25E. We value stock at SOTP-based TP of Rs 2,165 (25x P/E on average FY24-25E EPS). Assign HOLD rating.

Page Industries (CMP: Rs 39,300 , TP: Rs 37,550 , downside: 4%). Margins dip to a six quarter low

• Page Industries Q3FY23 result print was below our estimates owing to lower than expected volumes. Volume de-grew 11% YoY to 52.8 million pieces owing to subdued demand in athleisure segment. Also, implementation of Automatic Replenishment System (ARS) across the organisation impacted the primary sales of the company.  

• Owing to lower absorption of fixed cost and increased advertisement spends EBITDA margin contracted by 532 bps YoY to 15.8% (lowest margin in last 6 quarters). The margins have been lower than the normal range of 21-22%.

Hidden Gems

Indian Hotels - CMP Rs 322   TP Rs 390 (Upside 21%)

• Post sharp rebound in CY22, we expect performance of Indian Hotel Industry to continue to stay healthy in CY23 as well. 
• Domestic air traffic now inching towards pre-Covid levels with average daily traffic surpassing 4lakh mark. Hotel booking data also suggests continuation of strong buoyancy in the demand led by wedding & holiday season along with healthy corporate demand.  
• Further, India’s G20 presidency in 2023, ICC world cup and easing of E-visa rules would lead to sharp rebound in the foreign tourist arrivals in CY23. 
• The government is also targeting to make India one of the top five tourism destinations in the world by 2030 under the new tourism policy. This would provide growth visibility from long-term perspective. 
• The current inventory growth is significantly lower than the growth witnessed during FY09-13 post global financial crisis. The hotel supply pipeline is expected to grow only at 5 year CAGR of 3.5-4%, adding approximately 18,400 rooms to the current pan India premium inventory of 90,974 rooms across 10 key cities. 
• This will facilitate the up-cycle as demand improves over the medium term while supply will lag demand with cautious expansion approach by hoteliers. The significant part of the recent inventory is coming mainly through management contracts and operating leases. 
• IHCL reported strong growth in revenues in Q3. Revenue grew 51.7% YoY to Rs 1,685 crore. The same was up 22.8% vs. preCovid levels led by strong performance from the domestic segment. EBITDA margin also expanded 441 bps from pre-Covid levels to 35.4% on a consolidated basis. This led to a sharp rebound in net profit that was up 88% from pre-Covid levels to Rs 382.7 crore
• We expect revenues in FY24 to double from FY22 levels to Rs 6,521 crore, EBIDTA 5x to Rs 2,177 crores  CAGR of 41.8% and ROEs to be in double digits; margins seen at over 33% in FY24E, which has the potential to further expand by ~100 bps thereafter
• We value IHCL at Rs 390 i.e. 23x FY25E EV/EBITDA

Conclusion

We expect Nifty to move higher towards 18,200 levels in the coming week due to expected short covering among heavyweights primarily among banking names. Despite negative global cues, Nifty is holding 17,800 levels and we believe short term bias to remain positive.

Source: ICICIdirect Reasearch

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