Bet your bucks on private banks, consumer sector

It has been a year since the IL&FS crisis erupted and its repercussions are still being felt, especially in the financial sector. Besides the shadow banks, banks too have started facing asset quality concerns now.

Underlying economic momentum has decelerated sharply, as reflected in 1QFY20 real GDP growth of 5% and the Reserve Bank of India’s (RBI) latest downward revision in the FY20 GDP growth forecast to 6.1% (from existing 6.9%). Thus, earnings downgrades have remained a key feature of corporate India.

The government and the RBI have been taking steps to revive growth.

The central bank has cut the repo rate by 135 basis points (bps) since February 2019, although the transmission is still very limited. On the other hand, the government has taken the historic step of a big corporate tax rate cut and also other measures for specific sectors.

Fiscal and monetary stimulus are trying to work in tandem to boost growth, the impact of which will be visible only with a lag.

High-frequency data and interactions with management spanning sectors suggest that the 2019 corporate earnings will be a washout and any normalcy will only return in 2020.

Underlying demand slowdown in the domestic economy and weak global commodities prices are expected to take a toll on earnings with very few bright spots if any.

Our FY20 Nifty earnings per share (EPS) estimate has been cut by 3.8% to Rs 539. Prior to this, it stood at Rs 560.

Markets have remained weak in 2QFY20, despite the sharp bounce back post-tax cut.

Nifty’s divergence with the broader markets has expanded significantly.

Earnings risks continue to be tilted to the downside on account of the underlying weak demand scenario in the domestic economy.

The uneven asset quality trends in financials and the deflationary trends in commodity prices are other pain points.

At this point, tax rate cuts will largely limit the downgrades rather than driving big upgrades on the earnings front.

In these times we are focused on the sectors where there is visibility of growth and momentum of earnings.

In such situations, valuations take back seat and get premium for re-rating in price-earnings (PE).

In the current situation, we remain bullish on the financial sector, primarily corporate banks, owing to expectations of asset quality normalisation for the next two years.

Also, we feel the bad loan cycle has peaked out and post-corporate tax cuts we believe the CapEx cycle to get revived and these bankers are going to be the biggest beneficiary. With good corporate governance, we expect good returns to be made in this sector.

Secondly, for private banks, which have outperformed since the last few quarters, we expect them to report healthy numbers and maintained asset quality in a turbulent time.

We believe the recent crisis in the NBFC sector will add opportunity for some of the large private banks with a focus on building the retail assets in their portfolio and get bigger.

Thirdly, we expect the consumer sector should continue to do well, with good monsoon across India and strong visibility of growth.

We have seen these companies have given eight quarters of double-digit profits. Some of the few names have been at their all-time high prices and also peak valuations.

Lastly, quality management and growth will continue to be pricey. Happy investing!!