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Daily Voice | Shibani Kurian of Kotak AMC sees further downside risk of 6-7% for IT earnings growth if global banking issues escalate

Kotak Mahindra AMC remains positive on sectors deriving demand from domestic sources. These include large banks, capital goods, manufacturing and automobiles.

March 27, 2023 / 07:19 AM IST
Shibani Kurian

Shibani Kurian

"With global macro uncertainties, the current consensus estimates on IT sector revenue growth (5.8 percent-8.2 percent YoY, constant currency) and margins for FY24 appear to bake in much of these concerns," Shibani Kurian, Senior Executive Vice President & Head - Equity Research at Kotak Mahindra Asset Management Company said in an interview with Moneycontrol.

However, she said if the global banking issues escalate further, there can be a further downside risk to the street estimates (6 percent-7 percent). The downgrades will be more growth than margin-led.

With over 20 years of experience in the Indian equity markets, Shibani remains positive on sectors deriving demand from domestic sources including large banks, capital goods, manufacturing and automobiles.

With global markets likely to remain volatile in the near term on the back of macro uncertainties, the volatility is also expected to continue for Indian markets in the near term even, says Shibani who manages the Kotak Focused Equity Fund, Kotak EQ Contra Fund and KIGF-7.

Do you see downside risks to IT revenue and margin estimates?

The Indian IT sector is navigating through an uncertain phase in the near term with global macro headwinds at play. However, structurally the demand for Indian IT services remains intact as the digital transformation journey of corporates the world over is likely to continue. Post Covid, we saw a sudden rise in demand for IT services as companies sought to accelerate their digital journey. This led to a bump up in revenues for Indian services players and the same is now normalising.

With global macro uncertainties, there appears to be some delay in the current decision-making cycle. However, the current consensus estimates on revenue growth (5.8 percent-8.2 percent YoY, constant currency) and margins for FY24 appear to bake in much of these concerns. However, if the global banking issues escalate further, there can be a further downside risk to the street estimates (6 percent-7 percent). The downgrades will be more growth than margin-led. Margin expectations of the street are more benign with a potential upside risk as attrition rates fall and supply-side pressure ease.

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Which are the sectors that perfectly fit into the DCF today (discounted cash flow method) and can they be bought?

We believe that FY24 would likely see wide dispersion between sectors and stocks in terms of earnings. Our focus today is on companies where we believe that there is visibility of earnings, strong cash flows and balance sheet and those which are trading at reasonable valuations. In this construct, we remain positive on sectors deriving demand from domestic sources. These include large banks, capital goods, manufacturing and automobiles.

Do you think the banking crisis taken place in US and Europe is just the beginning of concerns? Any kind of similar concerns in the Indian banking system?

The current turmoil in the global financial markets can be attributed to the steep increase in interest rates seen in past year resulting in MTM impact on bond portfolios. This along with some banks running asset-liability mismatches on their balance sheets and concentration of deposits has largely led to the current situation.

Over the past 12 months, US Fed has increased interest rates by an unprecedented amount to tackle the inflation problem and this has caused some dislocations in the global financial markets. While it is difficult to predict any contagion at this juncture, regulators and central bankers globally are exercising caution and have acted swiftly so far to stem contagion and that is a welcome relief.

Against this backdrop, the impact on Indian banks appears to be limited at present. While Indian banks are not completely immune to global volatility, the balance sheets of banks in India are strong. Banks in India follow stringent norms based on BASEL 3 regulations on capital and liquidity and there is a cap on the amount of investments banks can make in their HTM (Held To Maturity) portfolio.

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Further, the liability franchises of Indian banks are largely retail and granular with households contributing more than 63 percent of total deposits. The operating profitability of Indian banks and their capital position remains strong enough to absorb any potential hits on their investment portfolios, which provides comfort during current uncertain times.

Do you expect further downside in global equity markets given the banking crisis, and if yes, then will it drag Indian equities to June 2022 lows?

Indian equity markets which were the best-performing markets in CY22 have been under pressure in CTYD 2023 and have underperformed in the emerging market pack. With this, valuations of Indian equity markets have corrected back to long-term averages on an absolute basis.

On a relative basis too, India’s premium to emerging markets has come off to more reasonable levels. While valuations have corrected, one needs to keep a close watch on earnings estimates for FY24 where consensus is building in mid-teens earnings growth.

With global markets likely to remain volatile in the near term on the back macro uncertainties, we do expect volatility to continue for Indian markets too in the near term even as valuations provide downside support. In the medium term we remain positive on Indian equities on the back of growth, improvement in corporate earnings and improvement in balance sheet quality.

Do you think the weak rural demand is the only concern for auto space?

Auto sector has over the last few years faced multiple headwinds, primarily emanating from rise in cost of ownership led by regulatory changes, higher commodity costs, higher fuel cost as well as weak rural demand. In addition, technology disruption (electric vehicles being given subsidy/tax benefits) is further posing growth challenge for ICE category of vehicles, more so in 2-wheeler space. This has led to volume growth getting impacted for lower end of vehicles both in 2-wheeler and 4-wheeler category even as the premium segment has shown growth/resilience.

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However, now we see signs of demand reviving within the auto space spurred by a strong festive season demand, improving affordability, model launches, replacement demand, and some signs of improvement in rural wages. We expect to see normalisation of long-term growth rates post a multi-decadal low over the last few years.

Strong execution abilities and supply chain management will be the key differentiators to determine volume growth as demand picks up in select pockets. Softer commodity prices and improving chip availability bode well for the sector too.

What is your take on the staples segment?

Staples are expected to show acceleration in earnings growth in FY24 led by margin expansion. After 2 years of severe margin pressure, inflation is ebbing in input materials as in the last six months, prices of most key inputs have declined up to 30 percent, led by vegetable oils and crude oil.

Demand is expected to improve albeit gradually with rural wages likely bottoming out. Rural markets should improve gradually with increased government spending, higher realisations for crops & increase in disposable income as inflation recedes. The premiumisation trend continues to play out. El Nino impacting the monsoon is a concern, although stock performance does not seem to be correlated to a weak monsoon. Valuations of the FMCG pack are reasonable as it is trading at close to 5-year average forward P/E multiples.

What is your reading on the commentary by Federal Reserve?

The Fed hiked interest rates by 25bps bringing the target fed funds rate to 4.75-5 percent much in line with expectations. The commentary seems to suggest that the central bank is trying to walk the tightrope between managing inflation and bringing financial stability to the banking system.

The statement modified the guidance for future rate hikes, replacing a reference to "ongoing rate hikes" with guidance that "some additional policy firming may be appropriate". This reflects the expectation that the Fed is nearly done with the rate hike cycle, but the door remains open for more hikes if they are warranted.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

Sunil Shankar Matkar
first published: Mar 27, 2023 07:19 am