The market may be getting in a bit of a sideways move now. Bulk of the earnings are over and the market is looking overseas for triggers. What does your experience from the last cycle tell you regarding the possible return of inflation and the rate hike scenario in a growth rebound? Will the equity markets both in India and abroad be able to take it in their stride?
What we have been thinking over the last couple of months and especially looking at this quarter’s numbers, we need to talk in detail about wage inflation, commodity inflation and input price inflation which have been quite substantial and started to weigh down on the margins for most of the companies across sectors.
On the headline basis, corporate India reported the best ever quarterly profits but a deep dive shows there are four or five trends. The first one is that the top line growth across sectors has seen a strong rebound which suggests that the demand recovery is real and the pent up talk which people or the market has been little bit careful about, is behind us and actual demand recovery is happening in the economy which is an encouraging sign.
The second part is that across results, we have seen inflation pressures. We have seen commodity input price pressure that has weighed down on margins and the commentary by the management has been that the next couple of quarters could be challenging because there could be a lead lag between passing on the cost pressures to the end consumer.
The third important point which not too many people have been talking about is that the cash flow generation has been very subdued. In the last four quarters, the cash flow generation was very strong. Companies worked on their working capital and improved their cash flow generation. But in this first half, a large part of cash flows have gone into working capital management and the working capital cycle has actually shifted across companies, something which needs to be corrected over the next two quarters.
We firmly believe that top line is vanity, bottom line is vanity and finally cash in the bank is reality. Cash flow is an important driver for rerating of the stocks. We need to be careful about that.
The fourth important point is that the loan growth has started to pick up and that is a very encouraging sign among private sector banks which saw a decent loan growth recovery even on the asset quality. We have seen decent recovery and upgradation by most of the banks on asset quality and it looks like the worst is behind us on both the corporate side as well as the retail side.
In a nutshell, the quarterly earnings have been in line but the earnings upgrade cycle which we have been seeing for the last four quarters have taken a pause. Our sense is that in the next two quarters, there could be a marginal decline in the earnings estimate for FY22 or FY23 because of the input price and the commodity price cost which will be on the margin. The last two quarters of FY21 saw the highest margin for corporate India. Looking at this trend, we believe that the market should take a pause and there is a very high possibility that we should see an intermediate correction and the market should start becoming very selective.
Over the last few days, during the earning season, we have seen that even though the headline markets have not corrected, but stocks in the broader markets have corrected by 20-30% starting from October. That trend is likely to continue over the next few months. Do not forget that in the last cycle, though 2003-2009 was a mega bull cycle, we saw a few 10% corrections and a couple of 30% corrections as well. But in the last 18 months, it has been a one-way rally. There is hardly any 10% correction and our sense is that valuations are elevated and more expensive than the regional market and global markets now.
FII flows continue to be negative. However, the HNI and the retail flow continues to support the market but our sense is that one needs to navigate this market more cautiously now and we need to be careful that the earnings upgrade cycle is taking a pause.
Can you help us understand the category of banks where different changes are happening — the PSU pocket, the largecap private sector and even for that matter, some large type of lenders?
Banking had two problems; one was the asset quality which was across the sector both on the corporate side and the retail side and the second was the loan growth. As we saw over the last three-four years, a large part of corporate India focussed on deleveraging, making sure that they reduce the debt burden from their balance sheet and despite strong earnings growth, banking sector did not see a very strong pick up on the loan growth side as corporate India was in a deleveraging mode.
What is changing now is that working capital requirements have started to move up. As I alluded to in my cash flow analysis, that clearly shows that most of the corporates have now started to borrow from banks for the short term and that is the first sign of loan growth pickup which is starting to happen.
The second part is that on the retail side, we have seen very strong mortgage demand and the largest mortgage lender of the country, the housing finance company has also alluded that the real estate market demand seems to be very strong. That is also helping most of the banks and NBFCs in that space to spur their loan growth.
The third part is on asset quality. We have seen a sharp improvement in asset quality over the last couple of quarters, both on the corporate as well as on the retail side. Post Covid second wave, we have seen an impact on retail. Delinquency levels had moved up across the NBFCs and banking retail space but that has started to correct. Efficiency has started to improve again and so those are encouraging signs even in this quarter.
Please complete your point.
The point I am trying to make is that asset quality has started to improve in the banking space both on the corporate banking as well as on the retail side. Loan growth has started to pick up and we saw clear evidence of that in the last quarter results for most of the private sector banks. We continue to prefer large private sector banks because on a structural basis, in the last 20 years, this space has compounded and there is enough space from a market share gain perspective for private bankers or private lending. We like large private sector banks more on a structural basis and our sense is that they are not as high on valuation as most of the other consumer discretionary names or some of the new-age businesses.
We believe there is an opportunity in the private lending space to invest your incremental capital. We are positive on the space from the next 12 to 18 months’ perspective.
