‘We’re in the sell on a rise camp due to weak growth outlook’

Developments in the global markets and a steady rise in Covid-19 cases kept the Indian indices choppy last week. SAION MUKHERJEE, India Equity Strategist at Nomura, tells Puneet Wadhwa that despite adverse macro, there are stock-specific opportunities across market-caps that investors should consider. Edited excerpts:

The markets have been unable to sustain at higher levels. Do you see lower levels ahead?

After an intense foreign institutional investor (FII) sell-off in March 2020, some sanity is back. The recent rally has not been supported by fundamentals and earnings. The earnings cut has been intense, as analysts have reduced FY21/FY22 earnings by 24 per cent/14 per cent since the start of the financial year 2020-21 (FY21). At this point, we don’t expect the market to retest the March 2020 lows. The assessment is based on the assumption that liquidity support is likely to sustain and (there will be an) eco - nomic recovery. An unbridled spread of Covid-19 infection and a significant deviation from the current expectations of economic recovery remain as risks. Despite adverse macro, there are stock-specific opportunities across market- caps that investors should consider.

How do you see India perform vis-à-vis other emerging markets (EMS) over the next one year?

From a regional perspective, we have a ‘neutral’ rating on India. We like Japan, South Korea, and China in the region. The key concern regarding India is still the rising number of Covid-19 cases and its impact on the broader economy. It is likely that on the back of fewer Covid19 cases and huge fiscal and monetary stimuli, other economies recover faster than India.

Are your institutional clients worried about the geopolitical development between India and China?

We haven’t seen much of a concern yet on the geopolitical development. At this stage, we don’t see an escalation. On the positive side, the event can increase commitment towards local manufacturing. Not so much due to the geopolitical concerns, but due to a weaker growth outlook, we are in the ‘sell on rise’ camp.

What’s the feedback you are getting from companies regarding Unlock 1.0? Are green shoots of recovery visible?

Companies have started talking about a revival, but that is inevitable after a hard lockdown. Most companies are talking about 70-80 per cent normalcy in terms of operations and sales. Sales are boosted by pent-up demand of the past two months. Hence, even if sales are recovering to 70-80 per cent levels on products that were hardly sold during the lockdown, it is not a positive outcome. There should be a sense of demand recovery in the next one-two months. If Covid-19 cases continue to rise and the growth outlook remains weak, steady demand to come back to pre- Covid-19 levels in the near term won't be possible.

What are your estimates for corporate earnings for FY21?

For FY21, the consensus estimate is around 14 per cent growth. Earnings growth for FY21 is likely to be low single-digit at best, or even lower. The markets are looking beyond the current disruptions because of Covid-19 and expect normalcy to return sometime in FY21; FY22 shall largely be a normal year. The consensus Nifty earnings estimate suggests an earnings compound annual growth (CAGR) of 24 per cent between FY20 and FY22. Over the past four years (FY15-19), earnings growth has been just 9.8 per cent. Therefore, expectations of earnings growth are high and there is a scope for disappointment, given the uncertainty around the spread of Covid-19 in India, significant disruption to the economy which can have a lingering impact in FY22.

Which are your overweight and underweight sectors?

We are biased towards exporters and companies that can sustain the downturn and are likely to emerge stronger in their sectors over time. We are overweight on oil and gas, telecom, health care, and IT services. We are underweight on consumers, and infrastructure/construction. We estimate real GDP to contract 6 per cent in FY21. The propensity to spend will reduce in general. Stocks haven’t corrected adequately to factor in this possible weak demand scenario. We remain selectively positive on the rural consumption theme.

What about financials?

The recent commentary from corporates suggests that a number of retail accounts on moratorium has come down, thereby reducing concerns on asset quality issues to an extent. We have factored in an increase in credit costs in our estimates, which is adequate at this stage. Consensus Nifty earnings for FY21 have been cut by 24 per cent since April 2020, and a large part of it (-33 per cent in FY21) is driven by financials.

Have agri, telecom and pharma stocks run ahead of fundamentals?

We still like the telecom and pharma sectors. The sectors have outperformed in the recent past, but have been underperformers over the past five years because of significant structural headwinds. At the margin, the market environment appears to be improving. Also, companies have disciplined themselves through tough times. These sectors, therefore, have the scope to surprise on the upside over the next one-two years.

EXPECTATIONS OF EARNINGS GROWTH ARE HIGH, AND THERE IS A SCOPE FOR DISAPPOINTMENT GIVEN THE UNCERTAINTY AROUND THE SPREAD OF COVID-19 IN INDIA AND SIGNIFICANT DISRUPTION TO THE ECONOMY WHICH CAN HAVE A LINGERING IMPACT IN FY22