Mr. Varun Lohchab, Head Institutional Research, HDFC securities
Q3FY21 was another strong quarter, beating expectations across most sectors, led by margin surprises and even slight beat on revenues. Sales continue to rebound at a faster pace than costs post the lockdown, resulting in earnings beat. Key highlights of the quarter: (1) Q3 margins beat estimates across multiple sectors such as Cement, IT, Chemicals, Paints, Durables due to (a) cost efficiencies leading to lower SG&As (A&P, travel expenses, etc.), (b) improved pricing power in the wake of lower competition; (2) Festive season and unlock led sharp demand rebound; (3) larger companies gained market share; (4) collection trends improved for lenders; (5) commodity costs rising sharply helped oil and metals sectors while gross margin pressures were visible in autos/durables etc.
Like Q2, ~70% of our coverage universe of ˜160 stocks beat Q3 earnings and ˜65% of them saw earning upgrades for FY21/FY22, which is quite commendable. Q3FY21 saw aggregate PAT beat of ˜10% resulting in ˜7.1/4.2%% PAT upgrade for FY21/FY22. While the extent of earnings beat was lower in Q3 vs Q2, FY22/FY23 upgrades were higher than Q2 due to increased confidence in economic recovery.
Given the positive base effect from Q4, markets would focus more on QoQ trends in revenues and costs compared to Q2/Q3 levels, which has become a benchmark. Given the sharp rally in markets and Nifty valuations at ˜22x FY22 PE, absolute upsides look capped at index level. However, we still see a positive risk-reward on the economy facing sectors and spot bottom-up investment ideas across most sectors for the next 12 months.
Our preferred sectors continue to be IT, Chemicals, large Banks, Cement, Consumer Durables, Gas, and Insurance while we remain underweight on Consumption (Staples, Discretionary and Autos). Our large-cap picks in the model portfolio include Infosys, ITC, SBI, SBI Life, ICICI Bank, Axis Bank, L&T, Bharti. Within mid-caps, we like Persistent, Max Life, Gujarat Gas, Radico, Crompton Consumer, Alkyl Amines, Galaxy Surfactants, JK Cement, and KNR Construction.
Q3FY21 results: Consumer Discretionary, Cement, IT, Banks were the standout performers, Consumer staples/Pharma/Infra/Real Estate were below par. Significant and broad-based earnings beat were visible in Cement, Chemicals, IT, Consumer discretionary, leading to further EPS upgrades for FY22/FY23. Earning misses were more prevalent in Consumer Staples, Pharma, and Infra/Real Estate.
So, what happens to FY21/FY22/FY23 earnings?: Given Q3 trends and management commentaries for our coverage universe, we have seen aggregate PAT upgrades by +7.1%/+4.2% for FY22/FY23 (FY21 PAT upgrades largely due to earnings normalisation of oil& gas sector, ex oil at ~5%). We are now building in 28%/21%/17% YoY growth for aggregate PAT for FY21/FY22/FY23 respectively. Nifty consensus EPS for FY22 has also increased by ˜10% in the past six months. Consensus Nifty EPS growth is now pegged at 33%/18% for FY22/FY23, which makes further upgrades less likely.
Our view: Index absolute upsides capped; bottom-up opportunities still visible across sectors as economic recovery plays out in FY22/FY23. While our sector preference has remained largely unchanged in past six months, post the sharp rally of ˜100% from March lows and valuations at ˜22x FY22 PE, index upsides look capped for the next 6-9 months. However, we still see select bottom-up investment ideas across most sectors. The economy-facing ones like Banks, Cement, Infrastructure, Real Estate, Utilities, and Gas still have room for re-rating while IT and Pharma look fairly valued with earnings driven upsides. Consumer Staples and Discretionary face PE derating risks, given stretched valuations.
Model portfolio: Maintain bias towards economy-facing and value sectors. We add weights in L&T, GAIL India, Birla Corp, Dabur, Teamlease, ICICI Sec, Maruti and Alkem Labs while we fund the same from high quality but very expensive large caps, where we remain underweight.