Mr. Manish Chowdhury – Head of Research – Stoxbox

Capital Goods: We believe that India is on the cusp of a large-scale capex which was difficult to come since the peak of the investment cycle in 2011. Strong order backlog coupled with robust order inflows for the capital goods companies from diverse sectors such as railways, road, power T&D, digital automation, renewable sector, cement, oil & gas, etc. definitely suggests an uptick in the sector and reduces the risk of sector concentration. We expect a pick-up in execution to help capital goods companies to post healthy growth in topline going forward. Moreover, with the private balance sheet looking better (the low-interest rate regime of the past two-odd years helped corporates to reduce their debt), input cost pressures waning, corporate sales remaining buoyant, and easy availability of financial resources, we expect the contribution of private capex to improve going forward which was earlier led by more public-intensive projects. Going forward, capital goods companies would benefit as the manufacturing theme plays out in India due to the government’s PLI schemes and policies, various domestic initiatives (Gati Shakti, NIP, and NMP), global players’ preference for the China+1 strategy, and now Europe+1 on the back of rising energy costs and supply chain hurdles. We believe that the current investment cycle to be larger and more sustainable as it would be driven by other multiple sector-specific factors (renewable energy, defense, logistics, EV transport, urban infrastructure, etc.), thereby adding breadth to the capex cycle. With India going for general elections in 2024, infrastructure will be the focal point for government spending. We expect companies with better working capital cycle management and strong execution capabilities to be the larger beneficiaries of the revival in capex cycle.

FMCG: 2022 was a difficult year for FMCG companies as they took corrective actions to tackle inflationary pressure which included average price hikes of about 7-8%, thereby impacting volume growth considerably. However, we believe that the FMCG sector is in a sweet spot to weather the storm in 2023. A large part of the outperformance is expected to come from margin expansion due to easing inflationary pressures, evidenced by the fact that consumer price inflation eased to an 11-month low of 5.88% in November 2022. With the agriculture index down ~25% from recent highs and the Rabi outlook supportive of higher acreage and yield, we believe that FMCG companies would not resort to aggressive price hikes going forward. The companies with a higher footprint in rural areas (rural population constitutes ~ 65% of the total population) would be better placed as there could be a gradual recovery in volumes on the back of good harvest, higher minimum support prices (MSP), and an increase in fertilizer subsidy. Urban consumption is also likely to remain steady due to premiumization, an increase in the working-class population, and upward mobility in incomes, thereby reflecting on the performance of the modern trade segment. For the long to mid-term, there are many structural drivers in place for the FMCG sector including higher disposable incomes leading to a shift to branded products, a large opportunity to increase penetration in key categories in rural India, the emergence of new sales channels such as e-commerce/quick commerce/D2C, etc. With the competition in the FMCG sector expected to brew up with the entry of Reliance through the “Independence” brand, we feel that it would be prudent to stick with companies having large market shares in key categories and strong coverage of both urban and rural markets.

Pharmaceuticals: Despite the challenging macro environment including weak global economic growth and significant costs escalation during the year., we remain positive about the growth outlook of Indian pharmaceutical companies. The domestic-focused companies are expected to generate stable growth amid a focus on new product launches and improved demand for both generics and branded products. We believe that the domestic pharma business would be on the radar as the US market faces price erosion. To take advantage, pharma companies (Torrent Pharma, Alkem Lab, Eris Lifesciences, and J B Chemicals among others) have increased their R&D expenses and are focused on new product launches and entry into new therapies. We expect pharma companies (Sun Pharma, Lupin, Aurobindo, and Dr. Reddy’s), with a focus on US business, to witness normalcy in demand and higher new product launches, despite pricing challenges, intense competition, and stricter regulatory compliance requirements. The APIs-focused companies (Divis, Laurus Labs, and Aarti Drugs among others) witnessed a temporary slowdown in order flow from developed markets, However, the China+1 strategy is a long-term growth driver for API companies and the outlook remains robust. The EU market outlook remains cautious, given the inflationary pressure and uncertain macro environment. However, expansion in product offering, market share gains, and entry into new geographies in Europe would cushion the adverse effects for pharma companies.

Banking: After the hiccups of the COVID-19 pandemic, the Indian banking sector has emerged stronger and the outlook for 2023 remains positive. Currently, the credit growth of ~18% is at a decadal high, while the deposit growth of ~10% is also picking up pace. With a rising interest rate scenario and strong demand for loans due to a revival in the economy, the banking sector is likely to benefit from expanding margins as it passes on rate hikes through the floating rate loans while simultaneously delaying the rate hikes for deposits. Moreover, retail-funded balance sheets, benign credit costs, and a higher share of repo-linked loans place the banking sector in a sweet spot to further enhance its profitability. We expect banks to maintain strong advances growth going forward, supported by urban growth with household leverage remaining moderate along with an acceleration in the capex cycle. Another factor to aid the performance of the banking sector is the improving asset quality due to lower new NPL along with the benefits of higher provisioning during COVID. The private sector space is likely to remain the most sought amongst investors due to strong underwriting standards, favorable sector tailwinds, and little room for surprises both on the earnings and execution side. Though there has been a run-up on the PSB side, we continue to prefer banks with strong deposit franchises, scale, and lower operation costs, as the pace of consolidation gathers steam.

Automobiles: Several positive factors are at play at the same time which makes the automobile sector an ideal candidate for consideration in the upcoming year. With the sector looking largely bottomed out following a cycle of muted demand, we feel that PVs, CVs, and tractor segments look relatively better placed compared to the two-wheeler market. The PV segment is set for record sales in 2022, with an expected sale of 38 lakhs units which is almost 12% higher than the previous best of 33.8 lakh units in 2018. With the semiconductor supply issues moderating and industrial commodities weakening, the strong order book of PV companies (estimated at over 10 lakh units) would start translating into business performance. Moreover, new product launches by OEMs, expected strong demand in the replacement category of CVs, and robust capex plans by companies bode well for the overall auto sector. The EV segment could play a dark horse for companies having exposure to this fast-growing segment. We believe that the two-wheeler segment could witness muted growth as the rural economy is still not firing on all cylinders. Going into 2023, the cost of financing vehicles, raw material prices, and new emission and safety norms (implementation of the second phase of BS VI emission norms from April 2023) would be the key monitorable which could further set the tone for the auto sector.