Sharekhan Special August 31, 2021 Index Q1FY2022 Results Review Automobiles • Capital Goods • Consumer Discretionary • Consumer Goods • Infrastructure/Cement/Logistics/Building Material • IT • Oil & Gas • Pharmaceuticals • Agri Inputs and Speciality Chemical • Miscellaneous • Visit us at www.sharekhan.com For Private Circulation only Q1FY2022 Results Review In-line quarter, healthy outlook Results Review Results Summary: After ending FY2021 on a strong note, Q1FY2022 earnings of broader indices showed a promising start (Nifty/ Sensex companies’ PAT rose 100%/66% y-o-y) in the new fiscal with strong growth momentum on low base. Management commentaries on earnings outlook remained positive, on improving economic activity post second COVID-19 wave and anticipation of strong demand revival. Demand recovery and ramp-up of vaccinations look encouraging. We expect economic activity to increase in the upcoming festive season. Nifty trades at 23x and 20x EPS based on FY2022E/FY2023E EPS, at a premium to mean average. Valuation gap between large and mid-caps has shrunk, we advise investors to focus on stocks with strong earnings growth potential with reasonable valuation. High-conviction investment ideas: o Large-caps: Infosys, ICICI Bank, M&M, L&T, UltraTech, SBI, HDFC Ltd, Godrej Consumer Products, Divis Labs and Titan. o Mid-caps: NAM India, BEL, Gland Pharma, Dalmia Bharat, Laurus Labs, Max Financial Services, LTI. o Small-caps: TCI Express, Kirloskar Oil, Suprajit Engineering, Repco Home Finance, PNC Infratech, Mahindra Lifespaces, Birlasoft. After ending FY2021 on a strong note, Q1FY2022 corporate earnings of broader indices showed a promising start with continued strong growth momentum on the low base of Q1FY2021, though it was along the expected lines. Unlike the last two quarters, Q1FY22 saw divergence in growth across sectors due to the impact of the second wave of COVID-19, contraction in margins in some sectors due to higher commodity prices and supply-side challenges, while strong growth momentum in certain sectors was led by higher adoption of technology and rising commodity prices. Corporate earnings of both Nifty and Sensex companies grew by 100% y-o-y and 66% y-o-y respectively, while on a q-o-q basis it declined 6.6% and 5% respectively. Metals, oil & gas, cement, specialty chemicals and pharmaceuticals reported strong performance in Q1FY2022, while sectors such as autos, NBFCs, capital goods reported weak performance. Most management commentaries on earnings outlook remained positive given improving economic activity post second COVID-19 wave and an anticipation of strong revival in demand. Further, there were no major miss in earnings estimate of the sectors that have higher weightage in broader indices. Effectively, earnings estimates for the Nifty and Sensex were marginally revised upward for FY2022E/FY2023E in the earnings season after modest cut in estimates prior to the results season. Within the Sharekhan coverage universe, Q1FY2022 earnings performance was broadly in line with our estimates on the operational front given a lower impact of the second wave of COVID-19 as compared to the first wave of COVID-19. Notably, earnings upgrades were limited to sectors such as metals, oil & gas, cement and infrastructure during the quarter. On the flipside, the automobiles, capital goods, NBFC sectors missed estimates. IT companies continued to report strong growth on the back of higher adoption of digital transformation and rising offshoring by large customers, while the earnings recovery for auto companies was halted owing to impact on demand and supply issues. Earnings growth of banks moderated owing to higher credit costs and fresh slippages in retail segments, while metal and oil & gas companies reported strong earnings growth aided by strong price realisations. Margins of companies remained under pressure owing to increase in input costs, wage revision and increase in discretionary expenses. Outlook Outlook improves, but uncertainty persists: Smart recovery after the deleterious impact of the second wave of COVID-19, a sharp drop in the COVID-19 cases, stability in industrial indicators and ramping up of vaccination coverage look encouraging. We expect economic activity to further improve during the upcoming festive season. Further, a broad-based pick-up in core exports (ex- gems & jewellery and petroleum products), improving GST collections, government’s pro-growth policies and the RBI’s accommodative policy for driving growth and a revival in private capex over the medium term would drive strong growth in net profits across the sectors in FY2022E and FY2023E. However, rising commodity prices, cost inflation, patchy monsoons, higher crude oil prices and a potential increase in interest rate pose risks for earnings. Valuation Strong earnings visibility, but time to focus on quality with reasonable valuation: Nifty earnings would deliver a 28% CAGR over FY2021-2023E and importantly, BSE 500 earnings expected to clock a 31% CAGR over the same period, which reflect broad-based earnings recovery over the next two years. The Nifty is trading at 23x and 20x EPS based on FY2022/ FY2023E, at a premium to long-term average led by strong earnings growth trajectory and global equity re-rating. The market has shown maturity to digest earlier-than-anticipated tapering off talks by the US Federal Reserve, however volatility may intensify after recent outperformance. Further, valuation gap between large caps and midcaps has shrunk, so investors should focus on companies with quality earnings compounders with a reasonable valuation. High Conviction Investment Ideas Large-caps: Infosys, ICICI Bank, M&M, L&T, UltraTech, SBI, HDFC Ltd, Godrej Consumer Products, Divis Labs and Titan. Mid-caps: NAM India, BEL, Gland Pharma, Dalmia Bharat, Laurus Labs, Max Financial Services, LTI. Small-caps: TCI Express, Kirloskar Oil, Suprajit Engineering, Repco Home Finance, PNC Infratech, Mahindra Lifespaces, Birlasoft. August 31, 2021 2 Results Review Results Sector wise Q1FY2022 review snapshot Automobile Sector view: Positive Automotive companies witnessed tough Q1FY2022 due to COVID-19 induced lockdown restrictions. Revenue was broadly in line with expectations, but margins were severely impacted due to negative operating leverage and increased raw-material prices. Companies having exposure to exports performed better as compared to companies having high domestic exposure. We remain positive on automobile demand despite weak Q1FY2022. We expect strong uptick in automobile volumes across segments post normalisation of the economy, led by pent-up demand from rural, semi-urban, and urban demand along with favourable macro outlook. Preferred picks: M&M, Bosch, Sundram Fasteners, Suprajit Engineering, Gabriel India, Greaves Cotton and Apollo Tyres. Agri Inputs & Specialty Chemicals Sector view: Positive Agri-input companies witnessed soft Q1 on account of margin pressure owing to elevated export freight cost, though gross margins remained stable as a large portion of the raw material price rise was passed on to end-customers. Fertiliser companies reported strong numbers due to improved DAP margins on the back of sharp hike in fertiliser subsidy on DAP and inventory gains despite a decline in total phosphatic fertiliser sales volumes. Specialty chemical companies saw contraction in margins due to high logistic cost and RM cost. Strong export demand offset weakness in domestic market given second wave of Covid-19. Preferred picks: Coromandel International, PI Industries, SRF, Atul Limited, Sumitomo Chemical India and Aarti Industries. BFSI Sector view: Private Banks - Positive; PSU Banks – Neutral, NBFCs - Positive Banks saw high slippages in Q1, especially in retail, agriculture or MSME due to the second wave of Covid-19. NII growth was weak and NIMs were under pressure due to sluggish disbursement and muted loan growth. Second wave of covid-19 also impacted asset quality of NBFCs and led to loan degrowth. Performance of home finance remained resilient as Govt.’s efforts for affordable housing bode well for the sector. Life Insurance sector saw revenue momentum on the back of resurgence of ULIP demand. Margins impacted due to higher claims. Preferred Picks: ICICI Bank, Axis Bank, HDFC Bank, SBI, HDFC Ltd, LIC Housing, NAM India, HDFC Life, ICICI Lombard Capital Goods Sector view: Positive In Q1FY2022, many companies in the capital goods sector reported strong y-o-y performance, although on a favourable base. However, margin was impacted due to increased raw-material prices, decline in availability of manpower, and logistical issues. In the consumer durables segment, the sector saw decent top-line growth in Q1, the same was largely led by low base with cyclical exposure adding to better earnings comfort versus pure consumer segments. In the capital goods segment, margins were steady on a y-o-y basis but witnessed a decline on a sustainable basis, given higher overhead expenses and commodity headwinds. In terms of end markets, exports witnessed better pick in demand momentum as compared to the domestic market, albeit some challenges from the logistics side. Preferred Picks: L&T, ISGEC Heavy Engineering, Carborundum Universal, Cummins India, Polycab India, Dixon Technologies and KEI Industries. Cement/Infra/Building Materials/Logistics Sector view: Positive For Q1FY2022, the cement sector’s net earnings outperformance was driven by better realisation and lower opex. We expect demand and realisations to improve from Q3FY2022.