Feb 23, 2023
Pockets of optimism
January proved challenging for the markets, which declined 2-3% across the board. However, the fall in mid and small caps was consistent with the fall in headline indices, which is a refreshing change given their high beta nature. The earnings season, which began this month, thus far has been in line with expectations apart from a few sectors like Pharma and Chemicals, which saw both pricing and demand contraction.
As illustrated below, input price pressures continued to impact year-on-year profit growth for Nifty 200 companies and Sanctum Indian Titans (Titans) portfolio companies. However, there is a silver lining in the quarter-on-quarter growth, which suggests a sequential improvement in input price pressures. Price hikes and cooled-down input prices have led to robust improvement in margins. YoY net profit growth (excluding financials) is still in the negative territory, but there was robust QoQ growth.
Source: Ace Equity, Sanctum Wealth Research
Data Till 12 th February 2023
While earnings growth in the quarter was slightly tepid, it does not warrant a major downgrade. We are optimistic that the worst of the margin pressures are behind us and that a recovery is underway, as previously communicated. Furthermore, some of the key mid and small-cap holdings in our Titans portfolio, like Kei Industries, Schaeffler India, and APL Apollo, have demonstrated earnings resilience during uncertain times. This gives us the confidence to continue backing manufacturing and capital goods themes.
Suspense and a thriller
The previous month was filled with suspense, particularly with elevated expectations from the Union budget, and what was delivered carried some clear and consistent messages.
Infrastructure investments continued to receive attention in the budget. The capital investment outlay increased 33% YoY to Rs. 10 lakh crores ($122 billion), equaling 3.3% of GDP and almost three times the outlay in 2019-2020. The continued investment in railways, power, roads, and housing will result in significant asset and job creation. This will be positive for the capital goods sector, which has already been a big beneficiary of increased infrastructure investments of late.
Apart from an increased focus on infrastructure, it was mostly a business-as-usual budget for most sectors while being a cause of concern for some. The government specifically targeted certain tax-beneficial investment avenues for the wealthy and implemented changes to squeeze out more tax revenue for itself.
One major change in this regard was in the life insurance sector, where the government proposed to tax the proceeds (other than the death benefit) received from life insurance policies (excluding ULIPs) with an aggregate premium of greater than Rs 5 lakhs a year. If life insurance companies cannot convince the government to increase the Rs 5 lakh limit, this tax advantage will be gone from the next financial year.
The removal of the tax break on high-ticket insurance-plus-savings businesses will impact all the life insurers in the short run, especially HDFC Life having the highest exposure of 10-12% to high ticket non- ULIP > Rs 0.5mn of Annual Premium Equivalent. Next year’s growth will be specifically affected, and these companies may end up posting mid-to-high single-digit growth as compared to mid-to-high teens growth currently. However, beyond next year, growth is expected to normalize.
Our exposure to the life insurance sector in Titans and Olympians flagship schemes is < 2.5%. As a result, we believe the budget changes don’t pose a significant risk to the overall portfolio, while Finedge has ~8% exposure which shall have some short-term impact.
The nail-biting thriller of the month was Hindenburg’s scathing report on the Adani group. The report and its aftermath have soured market sentiment, and investors are rushing to determine the systemic impact of the group’s failure on the banks, which have lent heavily to the group.
All these events raise an important question: what comes next for the market?
Like other countries, India has had its share of corporate failures in the past. However, the impact of these events on the stock market and index levels has been typically short-lived and followed by a sharp recovery as investors refocus on earnings growth.
For example, when IL&FS collapsed, the entire NBFC sector was hit hard, causing entities like DHFL and Reliance Capital to collapse. The markets corrected 15% in two months but recovered half of it the next month and surpassed the previous peak four months later.
Currently, Indian banks’ exposure to the Adani group (Rs. 80k crore) is less than IL&FS’s (Rs. 1 Lakh Crore), and foreign lenders and other parties have the remaining exposure, which don’t pose a direct systemic risk to the Indian banking system. So, while it is a stock market rout for the group for now, the underlying businesses don’t appear to be in immediate trouble, and Indian banks are well positioned to absorb the pain, should it come.
Once Adani’s troubles are out of the way, the focus will be back on the macroeconomic outlook, which will have a more profound impact on market performance.
Though India doesn’t have major macroeconomic troubles right now, there are signs of a slowdown in consumer spending because of inflation. However, the investment and capex demand is firing on all cylinders, as is evident from the government spending numbers and the results of major capital goods companies. We believe this will continue in the near term due to the government’s continued impetus on infrastructure creation.
The Indian stock market briefly surpassed its previous highs in December but has since returned to a range due to its relative overvaluation compared to other markets trading at better valuations. The chart shows that Indian markets are still relatively rich compared to other emerging markets, even though the valuations have moderated a little.
In our previous notes, we have mentioned that the current market correction hasn’t been as severe as during past global/local economic troubles, but the consolidation period has been longer than the median, reflecting the grinding nature of the current market. A table from our previous notes reproduced below highlights this point.
Source: NSE, Sanctum Wealth Research
In the pre-GFC era, long periods of range-bound activity were common due to little or no cheap money to support the markets. This trend became rare as central banks always gave in to market tantrums post- GFC. However, with money being expensive again and central banks unwilling to budge, we believe that much of 2023 will be a stock-pickers market rather than a broad-based bull or bear market.
Our theme-based investing style has proved successful in the last year, driven by earnings growth. To continue this success, our strategy going forward will be to trim laggards on the earnings front. With flab- cutting in the last 1.5 years, newer opportunities will emerge, and we will analyze and bet on themes and stocks that fit our objective of delivering stable returns with low volatility.
Here is how our flagships strategies have performed over time.
Performance is calculated using Time Weighted Returns, net of fees and expenses. Returns over one year are compounded annually; returns for less than one year are absolute. Please note that SEBI does not verify the performance information provided above. Please note that past performance is not a guarantee of future performance