Nifty Earnings Growth May Average 11–13% In Next Two Years, Says Citi's Surendra Goyal

Surendra Goyal: See Q1 earnings season, two, three things to highlight. Firstly, the numbers have come in above our expectation, particularly if you exclude the oil marketing companies. So the Ebitda numbers are in high single-digit growth year over year, earnings low double digit, but both the numbers are slightly above our expectations.

Having said that, on the earnings revision side, the consensus earnings revisions which have been trending positive for some time now, have slipped back into a flattish kind of trajectory. So, no revisions, no upgrades, no downgrades. So that's where earnings are and that's in the context of consensus expecting a single-digit kind of earnings growth this year for Nifty. So that is where we are. So not from a view perspective. It's not really changed as much.

Earnings came in slightly higher, but as I said, more importantly, the earnings revisions are still on a flattish trajectory. The next couple of years. Citi analysts, as well as consensus, the expectation is that Nifty earnings should grow between 11-13% CAGR, somewhere in that range, and for that, the market trades at roughly 22 times earnings. So I think that's where we are. So if you look at the valuations on absolute basis or relative basis, they are on the higher side, particularly if you look at relative to EM, the valuations are greater than two standard deviations above 10-year mean.

So given that backdrop and the fact that earnings growth is 11-13% is what we expect, we think that one should be kind of buying the dips. We still like the top-down story. The macro still looks quite good. Earnings compounding has been pretty impressive, so we like it. But again, given the kind of runup we have seen over the past one year, I think it's better to kind of buy any kind of dips.

Surendra Goyal: So, two points there. Firstly, like, as you said, from a Fed perspective, the narrative has only improved in the last few months. But was India really pricing in any kind of risk, because the market has been doing well for years now. So typically, if there is a pricing of risk, then you could argue that the risk has been priced in, and now potentially there is upside. So that was not the case.

In this backdrop, valuations were already kind of going up, inching up, of course, it's been accompanied by a good macro and strong earnings growth. I think the only variable which has been very strong and is difficult to call is domestic flows. So in a recent note, we highlighted that if you look at the flows this year or the money coming into the market, Domestic institutional investors have deployed around $32 billion, FIIs around just about $2 billion and that domestic, institutional investor flow has been very strong. It's actually accelerated compared to last year and if that remains supportive, yes, you could get more upside.

Saurabh Handa: So, if you look at the last quarter, Q1 it was quite subdued for the oil marketing companies, primarily because oil prices were a bit on the higher side. Refining margins were quite weak and if you recall, there was a fuel price cut that had happened in March, so that hurt the marketing margins for these companies.

Now, all these factors seem to be reversing. So you have a situation where crude prices are range bound with a downward bias. In fact, overnight, you've seen them again below $80 which is positive for these companies, on the marketing side. On the refining side, we have seen a little bit of an uptick. So when you add the two together, refining plus marketing, which is your integrated margin, those are trending better, quarter on quarter.

In fact, on a spot basis, they are actually trending even higher. So if the current situation sustains, then you could see a situation where Q2 is better than Q1 and then Q3 is even better than Q2 and the other potential catalyst could be on the LPG side. So these companies have been losing money on LPG, typically, because it's a controlled product, the government compensates them.

There was nothing which was announced in the budget, but there is a possibility it happens towards the supplementary demand for grants, which could again say happen by the third quarter. So all in all, things seem to be sort of falling into place for the oil marketing companies for a bit of a rally from here, and which is what is driving our positive catalyst watch.

Now on crude prices, CITI as a house, has been neutral to bearish. I would say our view is sort of a range bound oil price. Yes, there are geopolitical risks, but the fundamentals are not very supportive. So our view is, after the ongoing summer period, you might actually see, you know, crude potentially struggling at even $80 which is kind of the situation where we are at now.

If fuel prices stay stable, then that works for the oil and gas, at least the downstream companies. To your point, upstream. So currently, the government has been allowing upstream companies to realise $75 on a net basis. So as long as crude is around 75 or above that, then, you know, from an earnings perspective, I would say the upstream companies are fairly okay.

The risk could happen if crude, say, starts breaching that. So can we see a situation where crude goes to 70-65 etc? That's when you might actually start re-looking at earnings for the upstream companies. But we are not there yet, but at least in the short term, I would say the OMCs look okay. BPCL as you said, we have a positive catalyst watch.  

Saurabh Handa: At least in the short term, yes, and that's how we are positioning ourselves as well. So that's why the catalyst watch on BPCL, and I mean, you could see, you know, pretty supportive earnings for this quarter and maybe next quarter as well. So yes, for now, we would go with the OMCs. 

Kunal Shah: Since the last one and a half years, we have been highlighting that credit growth in India, maybe over the next couple of years, should range between 13 and 14-odd percent and I think what's really driving down the credit growth was the industry credit, or the corporate credit, and that's still growing somewhere in mid-single digit to maybe a high single digit kind of a number.

It's moving towards a high single digit, but still much below the overall average credit growth. Retail has been something which has driven credit growth. Of late, we have seen moderation on the unsecured lending post the increase in the risk weights which have been there. If you look at this quarter's earnings, everyone has moderated the pace of unsecured, so that's something which is cooling off.

Another segment which was growing at a much faster pace, which was banks lending to the NBFCs, is now growing at maybe almost 5-7 percentage points lower than what the average has been. So, all of this is really pulling down the credit growth, and that's where, if we look at the latest numbers, now it's come down to 13-to-14-odd percent and if we adjust for HDFC Ltd., then it's closer to 15-odd percent compared to maybe 16-17-odd percent, which has been there all through.

So, what can actually drive again is the corporate credit. We still need to see the investment activity picking up. Still when we look at it on the corporate side, it's largely working capital which has driven the demand. It's not more of the investment activity which has maybe driven the corporate credit as such and the other constraint is on the resources front. So deposit growth has been lagging, and now we are seeing most of the lenders, they are anchoring their credit growth targets in terms of how they are able to mobilise the resource and it's not only about the availability of the resource, but the cost at which they are able to raise.

Since there is a clear focus with respect to margin management, I think somewhere we have seen many of the lenders going relatively slow on the credit side and more looking at high building high ROA kind of opportunities, rather than getting into the segments which are relatively low ROA, creative.

Surendra Goyal: See, there were a couple of things there. We did put out a couple of notes on this topic. So firstly, private capex is not really as slow as some people suggest. There are pockets where it's doing well, however, it's not as broad based as and then what happens particularly in this segment, is people tend to compare it to the prior cycle, which was like very, kind of prolonged and very strong.

So, this is definitely not like that. This is narrower in certain pockets and at overall pace. It's consistent and decent, but it's slower than what say 2006 to 2010-11 was. So that's, I would characterise It's been there. Last year was also decent. But again, it's there in certain segments, rather than being very broad based in nature.

Kunal Shah: So when we look at it, private banks have continued to outpace the overall industry credit growth, and we had seen them gaining the market share at the cost of PSU banks, but incrementally, when we look at it against the expectation, which would have been there say 12-15 months back. We have cut down the growth estimates for few of the leading private banks. If you look at it in terms of the consistent performers.

It's like ICICI, which has been relatively more consistent, and that continues to be our top pick. In terms of the preference, we still believe, like ICICI can do well, on the growth relatively better, and in terms of the preferences we have HDFC and IndusInd Bank as well, not from the growth perspective, but overall, with respect to where the valuations are.

Kunal Shah: Yes, sticking to the large banks.

Arvind Sharma: So, in the first quarter, the numbers, most of them, were pretty strong, and margins were better than expected, slightly better, but better so. But what's happened after the first quarter, especially in July, is clearly the demand has moderated. It's manifested in the inventory increase in some of the price cuts that have happened. So we believe that over the course of the next six to eight months, we could see a bit of a moderation in demand.

We are building in almost three to three and a half percent growth for the industry, and clearly, it's much lower than what it was last year. Last year was very strong growth. I think it's a combination of a bit of pent-up demand happening.

Secondly, you know, progressively as your order backlog kind of subsides, your wholesale numbers tend to go down. Though what we've seen also in July is companies are also cognisant of this fact. So suddenly in July, you see that retail dispatches are better than wholesale. So there is an intent to correct inventory. Has it happened fully? Probably not, probably maybe a couple of more months of that inventory destocking are still expected to happen over the next couple of months. But clearly the kind of very strong demand that we saw in FY 24 has definitely come off. 

Arvind Sharma: I think that's why they have started early on for the inventory part. Also, what was very interesting to see is that the festive season is also very important for small cars and that has been very weak for almost the past four or five years. The last festive season we saw was probably four-five years back. So one could see that mix shift slightly in favour of small cars.

It's too early to call out for that right now, still 40 days remaining for the monsoons. But we could see that segment getting slightly better than what we've seen over the past four years. 

Arvind Sharma: Maruti is our top pick. For Mahindra, you know, SUVs, we are slightly more cautious, but on tractors, again, because it's more lever to rural, more lever to monsoons, we are fairly positive.

Surendra Goyal: So, not since January. Like we have been cautious on this space, I think, since the fourth quarter of calendar 2021. So, it's been a while since we have been cautious about this space. Now, what has happened this year so far, if you look at the performance till, I would say May, sometime around May, the sector was underperforming quite significantly, and after that, it's really caught on where it is today.

It's broadly in line with the market, maybe slightly ahead of the market after the last couple of days move. I think it's part of it is related to the point you made earlier around the U.S. macro narrative. Rate cuts, things will possibly be a soft landing, which has gotten priced in and then that also got aided by commentary from select players around green shoots, particularly in U.S. banking. So I think that's been the big driver for the sector so far.

Now, if I kind of go back and see what's happening, versus the view, which we had put out in January, like when we had put out the year ahead, note, it's kind of very similar, right? What we were expecting is that FY25 will be a little ahead of FY24 in terms of growth rates. If you look at FY24, the sector growth was, give or take, 3%. This year, we are expecting it to improve by a couple of percentage points. So, it's playing out exactly in line with that.

However, the narrative has changed, and there is more optimism. I think the domestic flow situation which we discussed has been very buoyant and to that extent, I think once the sector started going up, people were underweight, both institutions, both domestic and foreign. So there was a bit of a catch-up trade. Now, as we go forward from here, I think the pace of recovery is very important, because now I think about what the stocks are pricing in, like irrespective of people have pencilled in those estimates or not, but stocks are pricing in a very decent recovery from here and if you really don't get visibility on that, then I think stocks could really cool off.

Our key concerns still remain around the pace of recovery driven by multiple factors. One is, it's still not a great environment for clients’ decision making, decision making is still challenged. Secondly, some of the more medium-term concerns around global capability centres. Those trends still continue to be pretty buoyant. Global capability centres are growing at a pretty fast pace. So in that context, we still think it's a sector where growth is going to be moderate and, in that context, the sectoral evaluations are at a 40% premium to the broader market, do look high to us.

Surendra Goyal: We do have a relative bias towards large-cap I.T., there we have a couple of stocks which are rated neutral, not sells, which is Infosys and HCL Tech. So that's the relative positioning within the sector.

Surendra Goyal: Nothing in E&RD, a lot of it is to do with the growth valuation. So valuations are much higher, and growth is kind of starting to cool off and the biggest driver for the E &RD stocks in the last three, four years has been the auto segment of the EV segment, where globally you see things starting to cool off, moderate a little bit.

I think as that reflects in growth rates, there is a risk to valuations, because these stocks are the most pricey in our I.T. coverage universe.

Saurabh Handa: So, we're optimistic on the sector. So yes, the tariff hike, you know, played out only from July. So, you'll start seeing the benefit from Q2 and Q3. So, in some senses, Q1 was sort of a backward-looking quarter. So, you should start seeing sequential revenue and Ebitda improvement in this quarter, Bharti has remained a key buy for us, and it's also been amongst our top large-cap picks in India.

In fact, recently, just to mention Surendra and his strategy note, has also added Indus Towers to his preferred large-cap picks. So Indus is another stock that we have been quite positive on, we continue to remain positive. I would say in the overall sector, the one big trigger on tariff hikes has played out.

Another positive which has played out was monetisation of 5G has commenced, something which I think the Street was not very clear how that would happen. So, these are two clear positives.

Now going ahead, I think the focus will be a bit besides the benefit of tariff hikes on Vodafone Idea, you know, recommencing its capex, and how they managed to execute in this sort of a three-player market. Can they stem their subscriber losses? You know, start maybe gaining subscriber share and this has obvious implications for Indus as well, because as they start expanding their coverage on 4G, it essentially means more business for Indus, because it means more tenancies for Indus.

I think one important event also to follow would be on the AGR side. So there is a pending curative petition in the Supreme Court. It hasn't yet been listed by the Supreme Court for hearing, so we are awaiting developments on that. But that can be quite meaningful, because if there is room for the government to reduce some liability on the AGR side and recompute the dues, then you know the Vodafone idea as a clear beneficiary, it does, again, become an indirect beneficiary. So overall, we are still quite optimistic on the space, and we have decent upside on most of our stocks.

Kunal Shah: So NBFCs is what we can talk about.

Kunal Shah: So, it will be bottoms up, I would say, because many of them have been able to hold on to the growth, in particular, when we look at it, at least there was no moderation on the growth side, and it was pretty much in line or better than the expectations for few of the leading players.

There are some pockets of emerging stress, I would say, like unsecured but secure lending is holding on to relatively well. In fact, margins also, many of the players have been able to hold on and if there is a narrative which is setting with respect to the rate cuts, or at least the easing of the wholesale rates, that would tend to benefit NBFCs much earlier compared to that of the repricing on the deposit side.

So, we have seen NBFCs outperforming to an extent there has been rerating, which has happened in many of the names. But we believe that if they continue to hold on to the asset quality performance, there is still scope, if growth and margins are largely maintained. 

Kunal Shah: So, we like Shriram, Chola and LTF.

Arvind Sharma: I think two-wheeler demand, per se this year, we are putting almost 7-8% kind of a growth YoY. One thing to note is that in passenger vehicles, while we've already crossed the pre-Covid peaks in FY24 itself, in two years, we are yet to reach it. So there's a bit of pent-up demand.

But again, the competition is very, very high, and there's a strong crowding that happens in segments. Like last year, we saw in the premium segment, everybody launching bikes there. Now we see the 125 cc segment, everybody is launching bikes there or upgrading their variants. So because of this competition, despite a very strong demand the pricing has always been constrained.

So that's why we believe that the volume growth would be high and we have a pecking order in terms of stocks that we will prefer. We still like Hero a lot, valuations obviously help. They're also levered more to rural areas. So, if that uptick happens, again positive for them.

The other part where two-wheeler say some of them have a very strong export exposure, and their things have not been as great as we were expecting them to be. Commentary by OEMs, by part makers, every commentary suggests that you know the expectations of resurgence and exports haven't really been fulfilled. So, we are more positive on domestic, rural themes. So, we like Hero. We also like Eicher, but Hero would be our preferred pick in the two-wheeler space.