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Improved earnings to lift Sensex, Nifty higher; private banks, IT space attractive for investors

Financial Express - Business News, Stock Market News

stock marketBanking and NBFC space, earrings performance for many players has been lacking in the last couple of year due to provisioning requirements.
(Image: REUTERS)

Sensex and Nifty have scaled fresh highs and since then seen some minor corrections. The rally in stock markets is despite the suppressed earnings for the last couple of year and especially amid the pandemic. As the economy picks up, earnings are estimate to improve and this momentum in earnings may take stock markets higher, said  Sachin Trivedi, SVP, Head of Research & Fund Manager  – Equity of UTI AMC. Further looking at pockets of opportunities, Sachin Trivedi highlighted private banking space as a potential opportunity and discussed emerging themes in the auto space.

Sensex and Nifty have scaled fresh highs, what is the next market trigger that might propel indices higher or force a correction?

It is right that broader indices like Nifty and Sensex are trading at valuation (in price to earnings), which are above longer term averages. However, we should also note that these earnings are suppressed, especially post pandemic. When we look at corporate earnings performance in the last couple of year, it has been weak. Corporate profit as a percentage of GDP which was at around 7% in 2007 has declined to just around 2.6% in 2021. With improvement in the economy, these earnings should improve. When we look at consensus earnings estimates (Bloomberg), they are expected to grow at a healthy double digit rate for the next few years. Among various other factors, it was earnings surprise post Q2 FY21, which excited the markets and helped the market inch up. My sense is continued earnings momentum should take markets to a higher level.

US Fed has said that it will look at rolling back some measures introduced during the pandemic, could just that indication force a market correction?

Strong growth, widespread vaccination, and upside inflation risk have pushed the Federal Open Market Committee to begin to consider withdrawing monetary accommodation. The policy is not tightening yet, but the extreme patient stance the Fed adopted during the pandemic appears to be coming to an end. Therefore in light of improved growth outlook, gradual withdrawal of measures taken during extreme times like pandemic may not have a material impact on markets. Equity markets will continue to focus on earnings improvement. Yes, couple of asset classes, including highly levered companies or companies with the weak business case may face pressure, but in general it may not hamper markets as long as earning are expected to be on improving trajectory.  

What sectors are you keeping a close watch on?

Generally, portfolio construction for us is bottom up stock selection. In our research universe, we closely track a large number of stocks across sectors. However, portfolio construction takes place keeping in mind the fund mandate and style of the fund manager. At the sector level, we find pockets of opportunity in sectors where business is migrating from small unorganized players to organized players. We also like large private sector banks, where they enjoy good franchise on the liability side and can use this leverage on the lending side using technology. We also like IT services companies, where the medium term growth path accelerated post pandemic as digital adoption at the client level got preponed. We also like Auto space, where volumes are down by more than 20% in last two years, however medium to long term growth potential remain intact as penetration level is much below potential.

Are financial stocks attractive right now?

Banking and NBFC space, earrings performance for many players has been lacking in the last couple of year due to provisioning requirements. With the second wave of Covid -19, one should expect some more provision in the near term. But as things normalize in the economy, investor can expect a revival of earning momentum, and therefore return ratios should also improve. This has created pockets of opportunity in the space. In the lending space, we like large private sector banks where they have strong liability side franchises. These banks with strong practices should able to generate value for investors over time. Emerging digital platforms are posing challenges, but the proper focus and timely investment in technology may help these banks to create value. With the increasing financialization of savings, there are longer term opportunities with players which offer services like distribution of financial products, insurance, mutual funds, exchanges, and broking.

Automobile makers are a big part of your transportation and logistics fund, how has the fund performed and do you see the auto sector growing strongly for the next few years?

 UTI T&L fund, being sector fund, has exposure to Auto OEM and Auto ancillary sector of close to 85%. Fund has generated a return of close to 60% in the last year (as of 26th June 2021). However, when we look at volume performance for players in the sector, it has been weak for the last two years. In the passenger vehicle segment volumes declined by ~20%, in Two wheelers segment volumes declined by ~28%, and M&HCV volumes fell by ~56% in the last two years on base of FY19. This decline in volume has been primarily due to increased cost of vehicle but at the same time individual income growth has not kept pace with this increase. We understand a large part of cost increases are behind, and as economic activity improves, per capita income will also improve, which will take demand back to a longer term growth trajectory. We expect new product launches will also improve from Auto OEM in the next few years, attracting buyers and improving volumes in the market. We expect, operating leverage and better pricing will also support earning performance in the sector.

What are the key emerging themes in the auto sector, is it the need for personal mobility or EVs?

In the last couple of years, we have seen buyers have been upgrading vehicle types and upgrading on features. In two wheel space, the preference has increased for higher powered motorcycle. Especially 200 cc and above category of motorcycles, the share has risen from 0.7% in FY10 to ~7.2% in FY21. We expect this trend to continue. Scooter being a unisex product, its share has increased from ~15% in FY10 to ~30% in FY21. In cars, consumers are upgrading on the engine’s power, and they are also upgrading on body style and features. SUV (especially compact SUV) share in a passenger vehicle has increased from ~14% in FY10 to ~39% in FY21. We expected this trend to continue as Auto OEM are looking to introduce more products in this category.

We expect lithium based electric vehicle adoption to improve with a fall in the price of a battery pack. An increase in localization of battery cells will further bring down costs, making it affordable for the mass segment. Adoption could be faster in the scooter segment and three wheel passenger vehicle side. However, range anxiety, lack of charging infrastructure, and steep pricing compared to petrol/ diesel cars would push out adoption in passenger cars. Central and state government policies and incentives would also play a key role in improving electric vehicle adoption.

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