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Equity Outlook - September 2023
The S&P BSE Sensex declined by 2.3% in the
month of August. Weak monsoon, spike in inflation and US yields hardening led
to the marginal correction. S&P BSE Midcap Index & S&P BSE Small
cap Index increased by 2.7% and 6.3% respectively. The divergence in
performance is also a reflection of institutional flows into respective
categories. Small and mid cap biased domestic funds has been receiving higher
inflows on the back of recent superior performance of these categories.
IT, consumer durable, telecom and capital
goods sectoral indices recorded positive returns. Likely revival in private
capex along with the current momentum of infra spends benefited capital goods
sector. Relatively attractive valuations and potential improvement in operating
parameters led to gains in the IT Sector. Hopes of a demand revival with the
advent of festive season translated to gains in consumer durables sectors. Oil
& Gas, Banks, FMCG and Auto sectoral indices recorded negative returns. Market
is cautious about a probable burden on OMCs (Oil Marketing Companies) to absorb
some portion of potential fuel subsidies ahead of upcoming elections. Banks have
seen a moderation in spreads as the cost of funds is recalibrated to the
prevailing rates. We remain positive on the banking sector due to reasonable
credit growth and favourable asset quality trends. Sectors linked to rural
consumption have seen some pressure, triggered by spike in inflation and sub-par
monsoon season.
Most of the economic activity indicators
remained reasonable for the recent period. Spike in CPI inflation and shortfall
in monsoon is worrying investors. While shortfall and uneven distribution of
rains could have a bearing on spike in food price inflation, part of it could
be speculative. The speculative part of the inflation can see a quick
moderation. The average reservoir level across the country is 9% lower than the
average of last 10 years. In case the monsoon doesn’t revive in the next few
months, this could have an implication on sowing and food production.
In terms of flows, FPI flows were positive for
the sixth successive month with inflows of USD 1.5bn. Domestic institutional
investors were buyers to the tune of USD 1.3 bn. Valuation within the large cap
bucket remain marginally higher than long term average whereas valuation within
mid/small caps remains elevated given the sharp rally in the past few months. The
domestic flows have been particularly strong in the Mid/Small category for the
past several months. Hence, caution is warranted within this bucket.
Quantum Long Term Equity Value Fund (QLTEVF)
saw a decline of 0.9% in its NAV in the month of August 2023; Tier-I benchmark
S&P BSE 500 and Tier-II Benchmark S&P BSE 200 declined by 0.6% and 1.3%
respectively. QLTEVF performance is reflective of the performance trend
observed in large cap stocks which has a share of more than 80% in its
portfolio. Financials, Consumer Discretionary and Industrials negatively contributed to the performance. Health
care, Energy and IT positively contributed to the performance. The portfolio is
valued at 13.5x consensus earnings vs. the S&P BSE Sensex valuations of 17.6x
based on FY25E consensus earnings. While the valuation is at a discount of
23%, annual earnings growth over the next two years based on consensus
estimates is at discount of only 8% compared to Sensex. These characteristics are
indicative of the value style. Cash in the scheme stood at 5.5% as of month
end.
Pockets of
Earnings Resilience Remain Amid Range Bound Markets
Though
there are excesses in certain pockets of markets, few names with potential of
earnings resilience are available at attractive valuations. The fund has
recently added a position in a cement name. The player has certain
cost improvement levers compared to peers, which could lead to superior
earnings growth compared to the sector. The balance sheet strength is likely to
improve as the earnings recovery gains steam. Though sector utilisation doesn’t
point to a case of high pricing growth, a consolidated market could limit the
chances of a deterioration in the pricing environment.
Another sector which is likely to see an improvement in operating metrics is two wheelers where the fund has an overweight position. The following table shows change in key metrics of prominent two-wheeler companies over FY19-FY23. Most companies have passed on the cost inflation which is evident in high growth of unit realization. Unit profitability (Refer EBITDA Per Vehicle column) has improved albeit at a slower pace, despite a decline in utilization. Sales volume has understandably declined for most names barring the premium segment where sensitivity to price hikes is relatively lower.
There are couple of
factors which could support companies to harness operating leverage in the
medium term:
·
Input cost inflation is likely to be contained in the
medium term leading to limited price hikes and an improvement in affordability.
·
An improvement in utilization, as volume growth comes
back , can aid operating leverage (Growth in profitability to be higher than
revenue growth).
Key Metrics of
Two-Wheeler Companies- Good chance for a pick-up in operating leverage
|
Change
(FY23/FY19): % |
Realization
Per Vehicle |
EBITDA
Per Vehicle |
Sales
Volume |
Decline
in Utilization (Percentage
Points) |
Production Capacity |
|
Company
A |
53.2% |
61.0% |
-21.7% |
(20) |
5.0% |
|
Company
B |
47.4% |
18.7% |
-31.9% |
(26) |
-1.6% |
|
Company
C |
42.1% |
14.0% |
1.1% |
(22) |
33.3% |
|
Company
D |
69.1% |
98.4% |
-5.9% |
(4) |
0.0% |
Source: Annual reports
Though factors mentioned in the initial part could keep the markets range bound in the near term, a reasonable earnings growth trajectory is likely to prevent a material correction. Investors with a long-term horizon may consider investing in a staggered manner to benefit from persistence of the current earnings upcycle.
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