Limited room for Nifty expansion: Gautam Duggad

Gautam Duggad, Head Of Research, Director – Institutional Equities, Motilal Oswal, says if in the next three-four months, Nifty does not go anywhere and consolidates in this range, it will provide some cushion for valuation to move up in the next 24 months. However, Nifty has been very subdued. Coming to trailing three-year returns – October ‘24 or November ‘24 versus November ‘21, Nifty has given 11% three-year compounding, whereas mid and smallcap has given 21% and 23% compounding on a three-year basis. From here, room for valuation expansion is extremely limited and it will be a function of how much earnings growth you are able to derive from any index.

The earning season has been subpar. What is your key takeaway of the earning season and going forward which are the sectors that you think are poised for further upgrades or earning surprise if at all?
Gautam Duggad: Yes, the earning season has been very soft and after a very long time we have seen downgrades being much higher than upgrades. So, if you look at it in absolute terms, so far this quarter for the coverage universe which has posted numbers upwards of 225 companies. So far, the earnings are down 4% versus expectations of a 1.5% decline. Of course, it is heavily influenced by the drag from commodities.

If you exclude just the three OMC companies, the earnings are up 6% versus expectation of around 5%, so broadly in line. And if you go a step further and exclude all metals and oil and gas, which is basically all commodity companies, then for about 205 companies that we track out of the 226 that I mentioned at the beginning, if you exclude those 21 commodity companies, earnings are up close to 10% which is in line.

So, while earnings are soft and we have seen a very distinct moderation across the board, the picture looks slightly better if you account for the big drag from a few of the commodity-oriented sectors. For Nifty also the earnings are flat, but more importantly the internals of the earnings are very weak. As you mentioned, we have got earnings of about 100 companies by more than 3% for FY25 and we have upgraded only about 36-37 companies, so that is close to 3:1 in favour of downgrades.

Secondly, we have cut the earnings for Nifty and also, the EPS, by close to another percent in the interim review that we did. This comes on top of the 3% or 3.5% earnings cut that we did at the time of preview. So, net-net, from April to November now, our EPS estimate for Nifty are down close to 8%, from Rs 1,140 to now about Rs 1,060, which basically means that FY25 is going to be just a 5% earnings growth year.

We are not used to single-digit earnings growth for the last five years now. Between FY20 and FY24, every single year was a double-digit earnings growth year and we have had a 21% earnings compounding between FY20 to FY24. Clearly FY25 is occurring as a bit of an outlier in a five-year, six-year trend where things are slowing down a bit, there is moderation, there is a breather, and of course it is also a reflection of the government spending being down.

In the First half, the government spending is flat. The capex spending is down 17%. So, let us hope that in the second half, the government spending and capex spending pick up. There has been a good monsoon. Consumption, which has been the weakest point in this earnings season, also revives a little bit because the kharif crop should be good. These are things as we stand here. As regards to your question on sectors, so in this quarter, we have seen very strong performance from PSU banks.

In fact, they are the only component of our coverage universe where we have seen six out of the six PSU banks that we tracked have beaten our expectations. Apart from PSU banks, healthcare has been good, they have also met expectations, real estate has been very good, and then IT has been in line and you can say even consumers were in line, but it was very soft. We were expecting 3% growth, we got zero. So very few happy pickings in this broad spectrum of sectors that we cover. Apart from PSU banks, healthcare, and real estate, very few sectors have posted a double-digit growth.

What is your take on how you are looking at the entire pickup in capex and how are you reading into numbers from some of the engineering companies within that space? How are you looking at the overall order pickup? What would you have liked to see in the earnings that perhaps was a miss this time around?
Gautam Duggad: In the capital goods and industrials universe that we cover, the numbers have been better than expectations, that is because of few of the heavyweights like L&T, where the expectations were very low and they have managed to beat those expectations. We have seen good numbers from Cummins. The only miss was I think ABB. So, overall, in an otherwise very soft scenario and top-down also capex being down, at least this quarter, the impact is not so clearly visible, that is why I mentioned if October onwards the government machinery starts spending, capex spending starts reviving, because look at the numbers.

The government has budgeted for Rs 11.1 lakh crore of capex spending this year. In the first half, which is April to September, the total capex spending was down 15% to 17%, whereas the full year expectation is that as for the budgeted number, it should grow 17%, which essentially implies that for the second half of FY25 the capex spending has to go up 52% YoY which is very difficult in my view.

Even if it goes up 30-40%, it will provide very strong legs to the execution and order book. So, on any correction, we are very positive on industrials. We are very overweight there. We have L&T. We have ABB in our model portfolios. Any correction there because of this quarter or two quarter of weak earnings, should be bought into, provided one has at least a three-year horizon because this government has been very clear in the last seven-eight years, they have been very pro-capex, pro-manufacturing, pro-infrastructure creation. So, any blip that you get on a quarterly basis in earning, I would think it is a buying opportunity.

You said you have cut the Nifty EPS estimates, 2060 thereabouts versus 1140. That means we are still trading at 22-23 times forward earnings. Is there any scope of a valuation expansion because earnings are getting de-rated? What will provide the leg up to the Nifty because right now we are at 22-23 already?
Gautam Duggad: I do not think there is room for valuation re-rating or PE multiple expansion because in the last six months, earnings have got cut by 8% from 1140 to 1060 and Nifty has also seen 8% downtick. The 52-week high was somewhere about 26,200. Right now, we are in the 24,200 -24,300 range. So, earnings have been cut by 8%. Nifty has also seen an 8% cut, which essentially means that your PE ratio has not seen any de-rating in the last six months.

The index has come down, driven by the earnings cut. In fact, your midcap, smallcap, broader markets are still trading at very expensive valuations. If you look at the midcap index PE, the NSE 100, which two-three months back was trading at 35 PE, is now down to 30 but it is still at a 25-30% premium to Nifty. This premium was obviously 60%, which is purely unsustainable in our view because it has never traded at that kind of a premium for any long period of time in the past two decades.

Even now, after the correction, at an index level, the midcap index is still trading at 30% premium to Nifty. So, yes, the growth or rather the returns from here even if you talk about largecap will entirely be a function of how much earnings growth we get over the next two years. We are expecting about 15-16% earnings growth in FY26. FY25 is 5%. FY25 ex-commodity is 10%. So that 10%, we are expecting to move towards 15-16%. In fact, I would say that if in the next three-four months, Nifty does not go anywhere and consolidates in this range, at least it will provide some cushion for valuation to move up in the next 24 months because we have had a phenomenal last two-three years in the broader markets.

Of course, Nifty has been very subdued. Coming to Nifty’s trailing three-year returns – October ‘24 or November ‘24 versus November ‘21, Nifty has given 11% three-year compounding, whereas mid and smallcap has given 21% and 23% compounding on a three-year basis. So, from here, room for valuation expansion is extremely limited and it will be a function of how much earnings growth you are able to derive from any index.