Markets priced to perfection; don't factor in third Covid wave: Jigar Shah

The markets are priced to perfection and do not take into account a third wave., says Shah

As the economic recovery gathers steam and the frontline indices hit record highs, JIGAR SHAH, chief executive officer, Kimeng Securities India, tells Puneet Wadhwa in an interview that June quarter earnings will be mixed, with the export-oriented, telecom, and consumer staples sectors doing well. He expects auto and cement firms and banks to show a bit of weakness. Edited excerpts:

With the Sensex at a fresh all-time high, can the markets now consolidate and wait for corporate earnings to catch up?

The financial year 2020-21 (FY21) was one of the best years in terms of corporate earnings in a decade. We are sceptical if this can repeat, given that a) the valuation comfort is low at 22x one-year forward P/E on the Nifty; b) the breakdown of economy and earnings momentum in Q1FY22; c) continued threat from Covid-19 as the vaccination pace is slower th­an desired; d) a pick-up in in­fl­ation/interest rates. Our lat­est target for the Nifty is 13,000, at 17.8x one-year forward P/E — which is still 17 per cent below the current levels.

Are the markets factoring in a third Covid wave of the pandemic hitting India?

The markets are priced to perfection and do not take into account a third wave. Given that complete lockdowns are unlikely, the markets and to some extent businesses are less worried about a third wave. However, given the uncertain nature of this virus and its impact, it cannot be taken lightly. That said, the ability to give any more fiscal stimulus is depleted now.

Will the secondary market liquidity suffer at the cost of the primary market, given the number of IPOs lined up?

There are approximately $10-billion worth of IPOs and a larger number of placements lined up in this financial year. Whether all of these go through would depend on the overall market sentiment and if the interest rates are not raised too soon. In the event of overcrowding of primary market offers in a short period, the secondary market flows may suffer. But yes, the appetite for good quality paper remains from the institutional segment. A critical factor would be retail participation, pricing of the IPOs and placements, and the opportunity for investors to gain from these new papers. If some highly priced, big names tank after the IPO, it would impact the appetite.

Can the hike in dearness allowance of government employees help spur consumption in a meaningful way?

This is good but more like a drop in the ocean. To spur consumption in a meaningful way, we need a cut in GST rates or some other direct measures on tax, whi­ch are not feasible in the middle of the year. Investors should still look at consumption-based stocks favourably because consumption has remained resilient in both urban and rural areas. Consumer staple stocks are still gaining share in the rural and semi-urban markets. The only headwind in the near term is the rising cost of commodity prices and fuel.

What are your expectations from Q1FY22 earnings and overall FY22 numbers?

The consensus expectation for CY21 earnings for Nifty stocks is a YoY rise of 40 per cent. This is on the back of a poor year in FY21, which was hit by the pandemic. Even though the economy may expand by 10 per cent or so, to achieve 40 per cent earnings growth, another profit margin expansion has to happen. That is doubtful given the second wave hurting the overall economic output in Q1 and high commodity prices.

What about the June quarter numbers?

The June quarter earnings would be mixed, with export-oriented sectors doing well, and telecom and consumer staples also doing well. Auto and cement firms, and banks may show a bit of weakness. We are overweight on software, telecom, and tractors, neutral on cement, and negative on cars, trucks, media, and state-owned banks.

What's drawing investors to the cement, sugar, paper, and specialty chemicals sectors?

This is directly a result of the high valuation for the Nifty/Sensex. Investors turned to small- and mid-caps, which were cheap but have now risen sharply and gained well above large-caps in 2021. This broad-basing of the bull run was the reason for sugar, paper, specialty chemicals, and other side stocks moving up. There was indeed some fundamental merit, as well; in those sectors/stocks where earnings are sustainable with rising free cash flows, there will still be a headroom. We are now in a bottom-up stock picking market and where there is strong fundamental merit, investors are still keen to allocate.

Do you see the shortage of semiconduc­tors as a big problem for the entire auto industry in the months ahead?

The chip issue is here to stay for nine-12 months, as mentioned by the Tata Motors management and several other auto/electronics makers. It will have an impact on auto stocks, especially four-wheelers. Hence, we continue to like tractors within the auto space (they outperformed in FY21, as well). We are also constructive on two-wheelers.