Weak Earnings Cycle To Test New Retail Investors, Says Nirmal Bang's Rahul Arora

The fundamental earnings growth was never supporting where the valuations were in the first place, Arora said.

The Nifty corrected by 8.8% from the recent peak. NSE building in Mumbai (Photo: Vijay Sartape/NDTV Profit) 

The Indian stock market is currently witnessing a long-overdue correction amid probably the worst earnings cycle going into Diwali that will test the strong flows of new investors, according to Nirmal Bang's Rahul Arora.

"I think this was long overdue; there was a certain reality check that was required in the market," the chief executive officer of Nirmal Bang Institutional Equities told NDTV Profit in a televised interview on Monday.

The fundamental earnings growth was never supporting where the valuations were in the first place, Arora said. "This is probably the worst earnings cycle that we have seen going into Diwali in a long, long time."

"What is very evident is that the rural economy is in a mess." Hindustan Unilever Ltd. coming with 2–3% volume growth, a low number from two-wheeler manufacturers, and even certain consumer discretionary companies are taking a bit of a knock, he said.

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The biggest earnings growth over the last 10 years has come in because of margin expansion and, over the last five years, balance sheet deleveraging. From this point forward, the focus is entirely on topline growth, but he noted that there appears to be a lack of visibility in this area. "The market is now adjusting to the new reality."

Arora still doesn't think that the markets are going to fall off a cliff. "Somewhere around 22,000, we will find a floor on the Nifty 50," he said. However, the move to 26,000 will "be a very challenging one".

A lot of investors who have come in for the first time post-Covid have not seen a correction, Arora said. New retail investors have just seen the Nifty go from 7,500 to 26,500, and this (correction) will be new for them, he said. "Flows will certainly be tested."

A lot of defence, infrastructure, and PSU stocks were bought by retail and high-net-worth investors. It will be interesting to see how they move hereon as all of these results are stacked up in the second half of the earnings season, Arora said.

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Markets are cutting in line with earnings cuts, and there is a "method to the madness", Arora said. "People who are pricing in extrapolated growth thinking that it will keep getting better. But the reality check has hit."

If the three major pillars—banks, FMCG, and information technology—don't push the benchmarks higher, it will be difficult to present a compelling argument for the Nifty to rise, he stated.

Global funds have sold stocks worth over Rs 1.25 lakh crore since Sept. 27, according to provisional data from the National Stock Exchange. Domestic institutions have been net buyers of shares worth Rs 1.20 lakh crore during the same period.

The Nifty corrected by 8.8% from the recent peak, while the mid- and small-cap indices corrected by 7.3% and 4.5%, respectively, from their recent peaks.

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Also Read: India Manufacturing PMI Expands In October Amid Strong Demand

Here Are The Excerpts

Rahul Arora, CEO of Nirmal Bang Institutional Equities is with us as well. Rahul, thank you so much, for agreeing to this request, because I know it was a bit of a last minute for you. So appreciate you accommodating this. But it's kind of playing out as per script for you, the Indian cricket team and the markets, both of them are not quite faring as per what people would want.

Rahul Arora: So, I think you probably heard it enough, and you probably get bored with my answer, but I think this was long overdue. I think there was a certain reality check that was required in the market. Fundamental earnings growth was never supporting where the valuations were in the first case and, you know, we saw that, beginning with the defence sector about four months back. It went on to the EMS side, consumer durables, electricals. It slowly moved into IT services, then consumer staples, again, after the results and now it's, you know, percolating into autos.

So, I think you're sort of seeing, as we were discussing the other day on Muhurat Trading as well. This is probably the worst earning cycle that we have seen going into a Diwali in a long, long time. What is very evident is that the rural economy is in a mess. I think when you have Hindustan Unilever coming out with 2-3% kind of volume growth, two-wheeler manufacturers, giving you the kind of numbers that they are. Dmart, just about getting into teens in terms of top-line growth and even certain consumer discretionary plays like PVR. I mean, I mean, you look at the stock of PVR today, I think that's also, you know, taking a bit of a knock on the chin despite, you know, a big-ticket Diwali release.

So, I think the problem here is that the biggest earnings growth in India over the last 10 years has come in because of margin expansion, and over the last five years because of balance sheet deleveraging. So you had debt come down, interest costs come down, and therefore profitability growing. From here, I think the entire onus is going to be on top line growth, and the visibility of that seems to be lacking. I think the market is now adjusting to that new order reality. I still don't think we're going to fall off a cliff. I still think that, you know, somewhere around 22,000 we will find a floor on the Nifty but I think the move to 26,000 now from where we began this fall could be a very challenging one.

22000 is 2000 points away. So that is actually a worry, because we've cracked 8% in a matter of a month and some days. So that's been as much as people who like to say that it's been a sideways move now. We had a very swift pullback, because not too many people anticipated this. In some fashion, even if the valuations were high, because the domestic flows kept on, keeping the market afoot, you reckon that that pillar and those numbers will come out in a matter of a few days, would be a very important gauge of what the markets do, because if the retail investor blinks and those SIP flows get impacted, that could be an even bigger problem, if you will?

Rahul Arora: So, I think you've raised a very important issue. I think the point is, a lot of investors who've come in for the first time in the market post-Covid haven't really seen a correction. So, I think you've raised a very critical point as to how they react in the face of a correction, because they've just seen the Nifty go from 7,500 to 26,500. So this is something new for a lot of first-time investors as well, and flows will certainly be tested.

But I think the fact that you use the word retail, I think you know, if you look at the defence, Infra, a lot of PSU stocks. A lot of these were bought by retail and HNIs. There was not a very large institutional holding that, you know, propped up these stocks. Now the interesting part is, all of these results are stacked up in the second half of the result season, starting now up to the 15th. So it'd be very interesting to see what kind of results they declare, and the reaction of the retail side of the market to that, because that is where the maximum ownership is.

That being said, I think you know, while you're saying that, okay, we're down about 10% but look at the earnings cuts that have happened. I think in some cases, the earnings cuts are at 10%, in some cases 15%, in some cases even 20% so I don't think the market is not doing anything that is not paying sense. It's cutting in line with the earnings cuts. So let me give you a classic example: IndusInd Bank, we cut our own estimates by about 17% for the current year, and the stock was down 20% and most brokers cut between 15 and 20%. So I don't think what's happening is senseless, for lack of a better term. I think there's a method to the madness. People who are pricing in extrapolated growth, thinking that it will keep getting better. But I think the reality check is it.

So, I think the one thing also that happened is, you know, as you went into the general elections earlier this year, in May, I'm guessing the rural spending to the bottom of the pyramid would have begun in March, April. That effect has waned off. Now, you know, there was a fund manager who recently told me, but V-Mart’s results were good. But you know, the counter argument was that V-Mart’s results were good on such depressingly bad numbers that they should actually have been growing 40-50%. So, I think if you have a situation where consumer discretionary plays are only going to be giving you the kind of earnings growth that we've been talking about. It goes back to the point you were making earlier, a couple of days back that, you know, maybe money will keep chasing those and expensive will keep getting expensive.

But, you know, I think just look at the Banking data that came out over the weekend. The sectoral deployment data that came out over the weekend, Credit growth is down to 13%, Housing growth is down to 12.5%. Services, credit growth is down to 13%. So you're having a situation where credit growth in the banking system is also struggling to just about hold on to teens. The only thing that grew well in the sectoral deployment credit growth was the loan against gold, which grew by 50% and gold has been a hot topic of discussion across the board over the last one month. That's the only thing that actually probably held up the 13% growth.

So, if banks are not going to contribute, if FMCG is not going to contribute, IT valuations are starting to look expensive. Large caps are now trading at 30 or north and mid-caps are trading at between 40 to 50. You're pretty much down to Reliance having to hold the market, because that's 75% of the market. So, if three major pillars of a market don't take it higher, it's very hard to make a challenging case for the Nifty to go up.

Again, like I said, I don't think the market is going to fall over a cliff. I think flows will continue to come but I think if the Nifty was to head down to 22,000 and I'm not saying it will, I said it could find a floor there. It would become a fairly more attractive entry point for retail and institutional investors.

To play the Devil's Advocate, just trying to understand, I wonder, government spending has trended lower in the first six months, arguably the first seven months of the current calendar. Maybe because of various factors, including for whatever reason, but it's way lower than what the averages should have been based on the Capex spend target at the start of the year. If that picks up, and even goes back to trend from the 50-50, or 1,000 number that they have right now to the 90,000 number that should have been the trend number. Does that help Capex spend and therefore earnings recover? Trying to understand if what you've seen in the results thus far is a trend which will go into quarter three or quarter four, or is it difficult to say if the government spending comes back? 

Rahul Arora: No. So I think the finance minister has been very clear in her last two or three presentations to the country that she expects the private sector to pick up the baton. I think if you see the rate of growth that she has projected for capital expenditure, it's, you know, sort of been just about in line with what they have actually been doing in the past. She's actually made no bones about the fact that she wants the private sector to pick it up now.

As you rightly pointed out, I think there are political compulsions, and I think some allocations have been made to align states like Andhra Pradesh and Bihar, but I think even if government spending was to revive in a material way, these are you're talking about these projects coming on stream with a long, dated timeline, right? So let's say a chemical company or a cement company announces a Rs 200 or Rs 500 or Rs 1,000 crore capex. Chances are this capex is going to come on stream only 18-24 months down the line. So, you're going to be looking at, you know, revenue contributions only post FY 27-28. So I don't know whether the market in this environment is ready to digest earnings that far out, you know.

So I'll tell you, before this correction started, the entire street was on FY27 valuations. Now, the point is, they have moved literally a year forward, saying, okay, these are the kind of upsides we have on FY 26. So it all depends on your starting point, but I don't see a very major revival in Capex from the government. I think the finance minister has made no bones about it and even if you do have that. It's slightly long dated. But I think that the point here being, if you take a look at Railways or Defence or Capital goods companies that are government driven, these have healthy order books even today. It's not like they don't have healthy order books.

The question is, will the execution timelines be met once they are met, will the government offtake those things that they have booked, and how will working capital and inventory be managed? So all of this, you know, sort of feeds into your ROE/ROC and therefore into your evaluation. So it's a great long-term theme to play, but I wouldn't be too immediately excited, you know, with it as a short-term theme.

Okay, a 60 second answer, if we can. Are you disappointed with the FMCG names, is there lunch? Are other companies, including Ecom companies, New Age companies, coming to eat their lunch? 60 seconds. 

Rahul Arora: Extremely disappointed. I think there is something structurally changing in the consumer sector. I think Gillette has been a spectacular set of results. PNG was not too bad. But I think if you're looking at Consumer as a basket, I would still be aligned towards Consumer Discretionary.

Staples, is underweight for me and we could potentially look at names like Gillette and PNG, which have come up with good results, and the stocks have been rewarded accordingly.  

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WRITTEN BY
Sai Aravindh
Sai Aravindh is a desk writer at NDTV Profit, where he covers business and ... more
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