Citi Research: Nifty Expected To See 14% Earnings Growth For Couple Of Years

Surendra Goyal: So, to begin with, see, more than the earnings, we look at the upgrade-to-downgrade ratio, which again, was positive both for FY24 and FY25 within our coverage. So that kind of tells you that things are progressing in the right direction. And if you look at the consensus Nifty earnings forecast, it has pretty much remained unchanged through the year. If you go back historically, we have started off high and then there have been downgrades, for most years, if you take the last decade, barring one or two years. That's been the usual trend. So in that context also, the earnings are holding up pretty well and it's a fairly good level of earnings also.

So as we go forward from here, there is generally an expectation that we still have around a 14% earnings CAGR for Nifty over the next couple of years. So to that extent, I would say that yes, sentiment has been pretty upbeat, but this quarter's earnings kind of supported that. And even the upgrade-downgrade ratio which I spoke about, everything is kind of pointing to things trending in the right direction.

Surendra Goyal: So if you look at sectors like autos, that is where a significant upgrade came in, and again, a lot of it is driven by margins. The mix and then in turn margins, that was one. We have Saurabh Handa, who can talk about energy. Those numbers have come in fairly strong. Industrials is the other one, where again, certain stocks, etc, have done well. So these are sectors where there have been fairly good upgrades.

In terms of downgrades, I think financials are definitely at the margin, things have been a little soft. Kunal here can talk about it. So there, I think we have seen some softness. Some select materials, I would say, not broad-based, have seen some downgrades.

Other larger sectors, I would say, pretty much have the same trajectory. No big changes.

Surendra Goyal: So, for example, if you look at financials and again banks, specifically within financials, if you look at the valuations in the context of history, the valuations are already pricing in some of this weakness. So if you look at versus five years or versus 10 years, banks are at a discount to those means and averages, which is not true for the broader market. So I would say there I think some of the weakness is priced in.

I think the question, which people are debating, is how much of this is like a 2-3 quarter thing, or is it kind of longer drawn out? So that's one sector where I think a lot is kind of priced in. In terms of some of the sectors like industrials and again, select pockets within industrials, for example, numbers are strong, but then the multiples are also quite elevated. So to that extent, I think there is a fair bit of optimism already priced in.

In general, I would say I think when we talk to investors also valuations is something that comes up in almost every discussion, because the market at 20-21 times is definitely higher than where it is historically traded and the premium to other emerging markets is also significant. So to that extent, that's something which is there, like front and centre in every investor conversation. And that is something that people are also monitoring quite carefully.

Kunal Shah: So when we look at it, may be in terms of how they actually performed with respect to Q3 as well as the nine months, headline earnings were better. But still, if we look at qualitatively, few of the trends which are worth highlighting, one is with respect to deposit growth, and that was underwhelming this quarter, and some moderation out there even on the loan growth side compared to what we had seen in Q2.

Secondly, when you look at it, some inch up on the retail slippages, not for all the banks, but in some pockets, we have started to see increase in the delinquency levels, and that was reflected in the slippage run rate for this particular quarter. So, may be on qualitative aspects, it didn't go that well and that's the reason there were some downgrades which have happened within the sector. If you look at it, there is definitely a supply side constraint, when you look at it even from a bank's balance sheet perspective. Now, many of the banks are setting their narrative and entering the growth towards the deposit growth. There is a tightness in the liquidity and now there are challenges in terms of deposit mobilisation and if you are trying to anchor the entire asset group towards the liability growth, some banks are definitely facing the problem on the growth side.

But still, in terms of the earnings management, the focus still continues to be there. There was not too much of a disappointment on the margin, I would say, even in the last quarter, even though outlook we need to see as to how it pans out. There are limited levers for margin improvement from here on. So that is the risk which is there.

Kunal Shah: I would say, may be, obviously the levers are not there at all for the improvement. In fact, there is a downside, but that's baked into the estimates. I don't think there will be too much of a disappointment which will come in. So that's where we are saying with respect to the margins. And there are I would say, operating leverage delta which is still available, which can support the earnings growth getting into FY25 and FY26.

Kunal Shah: Interesting question and that's what is there in everyone's mind. Private versus PSUs. PSUs are generally cyclical, private would always be more structural. When you look at it, PSUs, why they are doing well. In fact, in terms of the entire corporate asset quality stress that is behind them, they are seeing a lot of benefit on the recovery side, which is helping the overall earnings growth and that's where when we look at it in terms of the ROE profile, coming from the lows, we are definitely seeing an improving ROE profile.

Compared to that, if you look at private banks, they peaked out in terms of the margins, in terms of ROE in Q4 of last year. Since then, we have just been seeing the moderation in the ROE profile compared to the improving profile for PSU banks. And with respect to growth, given that there are constraints on the deposits for the private banks, there may be apprehensions with respect to sustaining similar kind of growth even though it's higher than the industry average. While PSU banks coming from a low base—they were much lower than the industry average—and given that there are no constraints on the CD (cash deposit) ratio for PSU banks, because they were getting deposits at a much better rate compared to their loan growth, there is still a delta which is available to take some kind of a market share from private banks in the interim or in the very near term.

So looking at both the aspects in terms of the improvement in the ROE profile, along with growth being slightly better compared to what they have done in the very recent history, there may be, I would say positive sentiments towards PSU banks. But given where they are trading today, in terms of the ROA and ROE profile, which they can generate and the valuations which I've got re-rated, we still believe like private banks over the next 12-18 months should do better compared to that of PSUs.

Kunal Shah: We like ICICI, IndusInd and HDFC.

Atul Tiwari: See, the Q3, you know, across the board, big or small companies generally had good to very good order inflow growth and that continues to reflect the strength of capex recovery in India. So I think that trend we can see across different companies, big and small.

Obviously, within that, some of the more niche MNC names tend to be much more dominant in their space. As a result, when ordering happens in that space, their order inflows get impacted much more disproportionately. I think some of that is playing out and some of it is obviously the scarcity factor that you know, if you have technology and you're dominant in a particular space and your orders are very strong then stocks can react quite strongly.

So I think, the way most investors are looking at is that yes, in some pockets valuations are quite punchy, but as long as orders are growing at 20-25% plus and ROCs are high and the cash flows are coming through, these valuations probably can sustain.

Atul Tiwari: We don't cover ABB. So, we can't comment on that. In the MNC industry, we cover Cummins India, which had an equally strong revenue and order and inflow growth and we have a buy rating on that one, despite substantial rating in P/E multiples, because, it's a question of where you are in the cycle.

So, if you know, market senses that the cycle is peeking out and then probably these valuations will become prohibitive, but at this point of time when you can see you know, that you're probably still in the first half of the capex cycle and with probably a few years of recovery ahead of us, I really doubt that, you know, people are kind of going to bother too much about valuations at this point of time. So for example, on Cummins, we have been quite positive and it has re-rated and we remain positive.

Saurabh Handa: So if you look at the downstream companies, which are the oil-marketing companies, I would say all of them by and large have been reporting pretty strong numbers through the year, and there have been consistent earnings upgrades by us as well as the street.

So I would say, may be around 6-12 months back, in general, people were fairly conservative and negative on the stocks because fiscal 2023 was quite weak for them. They were making losses. There were concerns around pricing and government intervention. The whole thing has now flipped. So we've seen a massive spate of earnings upgrades, especially in that space. The stocks have obviously reflected that. There's been a massive re-rating. But we believe still there is room for the stocks to, you know, go up further from here. So we are still positive on a couple of these names. Stocks like BPCL, HPCL—we still have buys on them. If you look at fiscal 2025 earnings, the outlook for now seems fairly okay. Crude is range bound. It's gone up a bit—close to $80-85. But our general view is it stays in the 70s, 80s which is pretty okay for the marketing side of the business, for these companies.

On refining our view is positive. We believe refining margins stay at mid to peak cycle levels, at least for this year. So the earnings outlook even for FY25 is fairly alright and it opens up room even for upside risks. So I would think it makes sense to still remain, you know, positivity inclined in these names. From a stock market perspective, obviously they've run up a lot in a very short space of time. So it's quite natural to may be see some profit-taking. We wouldn't be surprised by you know, we would be looking to buy into any dips that happen.

Saurabh Handa: In that, you can look at, may be the upstream names and say the gas names. So on upstream, ONGC is one stock which on an absolute basis has gone up but it has relatively underperformed compared to the downstream names. So we are positive there.

Now in ONGC, you don't see too many earnings upgrades because the realisations tend to be broadly fixed at $75 oil or 6.5 gas. But in ONGC, it could be at an inflection point as far as its production trajectory is concerned. So in ONGC, in the last 10-12 years, its production has been declining at like a 2% CAGR. That's at the cusp of turning around. And in fact, we might see that this quarter as well. So even though earnings are broadly in line, because production growth could start being positive for ONGC, we remain buyers on that stock. It's still one of the cheaper stocks on a price-to-book basis. It is still at only one time. So it should give you 13-14% ROE.

On the gas side, we have slightly stock-specific views. So we are positive on names like GAIL, MGL, IGL. GAIL again, the stock has done well, but a lot of the segments are now performing pretty well and on the transmission side there has been regulatory re-rating, tariffs have moved higher and volumes are picking up because gas consumption is picking up in India. Trading, which used to be a concern for them in the past, has been doing fairly okay. On the petrochemical side as well, they've been reporting losses. That seems to be turning around. So, a lot of things are falling into place for a lot of these companies across the value chain. But like in the gas space, we are also slightly cautious on other stocks such as Petronet LNG or Gujarat Gas, where we believe valuations are probably on the higher side.

Surendra Goyal: So two parts to your question. Firstly, why have the stocks done relatively well? I think it's a combination of valuations in the India context being okay at the start of the year, last year. And then sometime towards the end of the year, people started getting more positive because of the Fed’s change in stance. And it was also a time when banks—the other large part of the index—started to struggle a little bit. So obviously, that's important from a flow perspective. So when you put it all together, I think that is the reason why IT stocks have held up relatively better than what most people thought.

Now, from here on, I think the key is going to be the slope of the recovery because I think among most people, at least everybody I speak to in general, the expectation is that FY25 will be better than FY24. But how much better, that is the key question. And there, there is a big assumption being made in the second half. So people who are positive are kind of building in that there is a fairly sharp recovery, particularly may be in discretionary spending in the second half of the year.

People who are cautious like me, we really don't see any evidence of that at this point of time. So we are taking a view and there is enough macro uncertainty. If you look at some of the recent events in the U.S. also, the direction of rates, when the rate cuts will happen, I think there is a fair bit of uncertainty. If you look at uncertainty, it's generally been a negative for people kind of releasing the budgets. With that backdrop, it's very difficult today to build in a case for a strong second half recovery. So people like me are modelling a more moderate, more gradual kind of recovery and when you do that, then valuations look pretty full for the sector. That is where our cautious view comes from. In our India strategy, we are still running underweight on IT services.

Kunal Shah: So again, NBFCs we have to look at it with respect to the product segments, because I think the dynamics in different product segments vary. When you look at it, in fact, like say for players, housing finance companies, now they are relatively better-positioned, given that there has been interest in the risk weights on the unsecured side, plus may be there has been increasing the risk weights for bank lending to NBFCs which is not the case for HFCs as such. So they are relatively better-positioned at this juncture. If there is anything to do with the secured lending, they would be relatively better-positioned. And, may be some of the diversified players have also corrected, in terms of the valuations to like the decadal lows, both in terms of price-to-earnings as well as price-to-book, while still continuing a similar kind of growth profile as well as return profile. So those names are looking quite attractive given the valuations wherein they are and what is the outlook getting into FY25 and FY26.

Kunal Shah: We recently upgraded Bajaj and Chola. So Bajaj, at this valuation, is at the decadal low I would say. Chola, any which way, is at a relatively high valuation but Bajaj is looking again attractive within the space.

Atul Tiwari: So far, whatever numbers have come till Q3, demand remains very strong. And especially at the premium end, it is very strong. The mass, or so called affordable, is not doing that well. But the premium housing is doing quite well and we have seen price rise as well.

Our sense is that, because there are no signs of weakness immediately, it is difficult to say that weakness will happen very shortly. But at the same time, stock prices have run up quite a bit. And market is extrapolating in our view—15-20% kind of growth for next few years from the developers. So we need to be a little cautious on the valuation front, but as far as underlying business is concerned, there is no reason to complain as of now.

Atul Tiwari: So we have very few buy-rated stocks in the sector. So we are cautious and our contention here is that historically through the cycles, we have seen, you know, the residential developers kind of struggling with ROEs and cash flows as well. So while on the capex side that we just discussed, there also the valuations are quite punchy. But if you look at industrial companies, you get pristine balance sheets, very high ROEs, very consistent cash flows. At least that comfort is there. Here on this side of my coverage, the comfort on these aspects is not there. So we are slightly more cautious here.

Saurabh Handa: In terms of the telecom operators, we like Bharti Airtel, which is kind of the main player out there, a standalone entity. Execution has been very strong. Their premiumisation strategy has been working well. They have been delivering on market share gains. And from next year you should start seeing a decline in capex intensity, which then translates into better free cash flow generation, deleveraging. So Bharti, we would be buyers, even at these levels, even though the stock has done well.

In an ancillary space, we do like Indus Towers. It's a contrarian buy call. We've highlighted it even in our strategy picks for the year. We had upgraded it last year because we felt the risk-reward is quite okay. Now there are still a few things that need to fall into place. But at current valuations, the stock is still looking fairly attractive to us.

Vodafone Idea has started paying down some of its past dues. With Bharti’s capex intensity coming down next year, even Indus Towers’ should come down. So there is a possibility of free cash flow generation and dividends being reinstated. So that's a little bit of non-consensus tactical call that we have. But overall among the telecom operators Bharti remains our buy call.

Surendra Goyal: See, our numbers have not really changed that much. Let me put it that way. I spoke about 14% CAGR in earnings. Again, the numbers if you look at last quarter, or the quarter before that, it's not very different. So I think, the good thing is that at an elevated level, the earnings momentum is sustaining and the visibility is there and you feel more comfortable as time goes by that okay, we can get to that kind of a number.

From a risk perspective, I think there are still certain pockets where like, for example, if you look at consumption, in general, there are obviously a few outlets, but that still remains quite challenged as a space. And it's a large enough space. So I think there are still pockets where you worry about, but in general from an earnings trajectory perspective, things are looking pretty healthy.