How are you looking at the overall markets? We are holding out by a solid 1% and in fact breaching some crucial levels on the upside. What do you think is driving this optimism?
Clearly the volatility that we have seen in the markets has been associated with the rise in the Covid cases. Let us look at it from three perspectives: 1)What is happening on the vaccination front? 2) What is happening on the earnings front; and 3) in terms of valuations.
On the Covid front, the rise in cases is a big concern. However, our belief is over the next few months, the vaccination coverage especially in the 45 plus age group should improve and that should arrest both the case fatality rate as well as also ease some of the stress that we are seeing on the medical infrastructure. So far, a nationwide lockdown has not yet been announced and lockdowns have been more localised in nature.
The second part is on the earnings front. Over the last two quarters we have seen earnings upgrades. However, our belief is that while this quarter may not be really a representative of the Covid related stress in the economy, incrementally the earnings upgrades may not be as visible. However, on a base case scenario, what we are really building in is that there is no nationwide lockdown and therefore as things start to improve over the next few months, FY22 numbers would be largely achievable and in that context valuations have also seen some degree of moderation.
We have seen the markets come off a bit and so valuations have also moderated somewhat. We would look at opportunities in this sort of a market and be more stock specific and build on those positions. We could see near-term volatility but as we get into the second and third quarter, things should start to improve especially with the economy getting back on track.
Given the high input cost pressures, do you see the margin pressure continuing for Maruti?
I would refrain from commenting on Maruti since it is stock specific in nature but let me talk about the margin pressure that you are alluding to because of the higher commodity costs. Clearly, there will be some degree of margin pressure and while a lot of the automakers have passed on some of the cost increases, it has not been completely passed on. There is very high likelihood of some degree of margin pressure. As I was alluding to earlier, in the last two quarters, across the board we saw earnings upgrades. Looking at the very low base of last year, the expectations are anywhere between 60-65% earnings growth for Nifty companies. However, our belief is this time around, the earnings upgrades cycle may not be as visible as it was last year. One has to contend with that at least for this quarter. The next quarter also, some of the impact of Covid related shutdowns will be visible.
However, unlike last year, when we had a nationwide lockdown, this time the impact was broad-based across services and manufacturing. This time around, the impact on manufacturing could be lesser but yes, in the near term we would have to contend with some degree of disruptions and margin pressure because of commodity cost inflation.
Faced with the increase in commodity costs along with the Covid-19 second wave, are we bracing for a hit in the Q1 performance of FY22?
Clearly this quarter will not be a true reflection of all the Covid related slowdown. This quarter, we would possibly look at some improvement on a sequential basis but Q1 would be the most reflective in terms of the impact that we have seen because of the Covid related hit.
In some of the high frequency indicators, there has been a moderation and therefore the pace of improvement has come off and all of that will possibly get reflected in Q1. However, the base case seems to be that a full nationwide lockdown would be averted and therefore maybe by Q1 end, opening ups will start because of the vaccination.
If that is the case, then by the second half of the year, one can possibly return to some degree of growth and at this point in time, we are not really cutting our estimates for FY22 in terms of earnings. We will still wait and watch. The management commentary is extremely cautious from whatever we have seen at this point because there is a fair degree of uncertainty. But we will see how things unfold over the next few quarters.
We did see a huge migration towards commodities, especially steel. Do you think it is a matter of time that somebody would say that steel is too expensive?
Our belief is that for some time the commodity prices will stay elevated. Two things are taking place. Globally, demand has started improving. On the supply side, there are certain constraints which are also supporting prices. Where Indian prices are concerned, they are still at a discount to global prices and therefore there could be some catch up there.
There has been improvement in profitability for most of the steel players. Steel sector had earlier seen a significant amount of balance sheet stress, but of late. companies have been deleveraging and improving their balance sheet as well.
Our belief is that for some time, the commodity cycle continues to remain strong and our preference for ferrous players continues.
What explains the optimism in stocks like Indian Hotels, PVR, Lemon Tree?
We have been staying away from these segments especially hotels and multiplexes as these have faced the brunt of the Covid pandemic. These are segments which will take a considerable amount of time to come back to a normalised run rate. There were things that were improving at the margin prior to March, but now with the Covid second wave, for these sectors to return a normalcy in terms of growth and profitability is going to take some time.
We are looking for opportunities in segments like industrials for instance or domestic cyclicals where as and when the economy gets back on track and the case curve flattens out, we will start seeing activity levels picking up.
