A Key Sector May See Earnings Upgrades Amid Macro Headwinds, Says Avendus Spark's Jayaraman

Macroeconomic headwinds await as markets enter a new year, but stable margins could aid banks with earnings upgrades, according to Ganeshram Jayaraman of Avendus Spark Institutional Equities.

Banks are witnessing a "very unique margin environment" as compared to previous interest rate cycles, and can see some earnings upgrades, Jayaraman, the managing director and head at the investment firm, told BQ Prime.

Earlier, a rise in interest rates used to impact the margins immediately. But currently, Jayaraman is seeing a different asset liability structure for banks this cycle because 40% of the banking sector's loans are linked to external benchmarks. So, the repricing is almost immediate as the repo rate goes up, which was not the case earlier, he said.

Another 40% of the loans are marginal cost of funds-based landing rate or MCLR loans, which will rise as deposit rates rise, he said.

According to him, between the September, December and March quarters, the entire repo rate-linked loans will reprice a little ahead of liabilities.

Over the next six quarters, 80% of banking sector loans may get repriced, Jayaraman said. Only about 20-25% of the liabilities will get repriced during this period as CASA does not get repriced. Current Account Savings Accounts are a type of non-term deposit account.

Incremental deposits will reprice. Hence, the margins will not be at risk and should be quite stable, he said.

2023 could be a difficult year in terms of macroeconomic headwinds, Jayaraman said.

Avendus Spark has been been recommending cyclicals over the past two years. However, given the macro situation, it might have to tilt the portfolio towards defensive stocks, he said.

It includes stocks in sectors such as staples, hospitals, telecom, or any stock with less leverage demand.

The macro risk is interest rates could rise in India, he said. He highlights factors such as the reasonably high current account deficit that the country is currently facing, along with the pressure to repay debt amid close to zero liquidity in the Indian banking system.

Stressing on the origin of the macro uncertainty, Jayaraman said in the next 12 months, interest rates could rise in India, which could be detrimental to the leverage demand category.

According to him, corporate balance sheets have enough cash and a cycle of fresh equity capital raise will begin from the middle of 2024, after the general elections.

Corporates are expected to see operating cash flows coming in, in 2023 and early 2024, he said.

Jayaraman expects credit growth of 12-13% next year.

Around 70% of companies could see resilient earnings in 2023, Jayaraman said.

If macroeconomic concerns weaken, earnings could be stable whereas operating leverage potential is high, he said.

"Given the uncertain macro, we continue to recommend investors to retain a cyclicals-biased portfolio for now. Defensives constitute a low proportion of our recommended top picks," according to a report by Spark Capital, which was recently acquired by Avendus Capital.

It will monitor the incremental data over the next three months.

The brokerage is 'underweight' on pharmaceutical sector, given the stocks' outperformance amid continued headwinds, it said.

According to the brokerage note issued on Dec. 5, banks, cement and steel companies score the highest on margin of safety on earnings growth expectations as well as valuation comfort.

IT services, life insurance, internet and specialty chemicals rank the lowest.

The oil and gas sector also has the lowest margin on safety on earnings expectations and maximum valuation comfort, the note said.

The highest potential for earnings upgrades and lowest comfort on valuations lie in sectors such as automobiles, industrials, realty, consumer, utilities, and NBFCs, it said.