4 themes to bet on in midcap space: Jitendra Gohil

"In midcaps we like companies that are in the hiring businesses. We also like some of the structural themes like chemicals or pharma or API names which have corrected a lot. We also like multiplexes and the export theme," says Jitendra Gohil, Director - Head of Equity Research, Credit Suisse.

What is your market hypothesis for this year? With two-three years of good returns under the belt, should the return expectations be moderated?
In terms of FY23, we think it is better to look at H1 versus H2. In the first half, there are some positive catalysts for the equity market. The second half will probably depend on what happens with the China slowdown or whether they come out with a huge stimulus or what the Fed does with their interest rate hikes.

But in the first half, equity will see more upside going forward. The key concern as of now for consensus or market participants is that last year India saw a phenomenal rally and was in fact one of the top five performing markets in the world. Now the valuation premium of India is at around 78% versus emerging markets for MSCI ex-Asia Japan. We think this PE premium will sustain.

We are not in the camp which believes that India may see more de-rating. Already, the Nifty index has derated from 22.8 in October to around 20 times currently. But even if Fed starts to hike rates or try to temper their QE programme, India’s valuation may not dramatically fall and that is why we wrote this report where we did analysis of different parameters and found that India stands out on a few parameters. That gives us more confidence that India’s PE premium may not de-rate.

First of all, India is not just the fastest growing economy but is the fastest accelerating economy. If we average pre-Covid three-year GDP growth versus next two years GDP growth, India is the only economy in the world, compared to our peers, which is going to see more than 110 bps acceleration. If you are stock specific, almost 38 of the Nifty 50 companies are going to see faster ROE expansion in the next two years compared to their average three-year period.

Even on ROAs, India has one of the best ROAs among peers and that is going to accelerate further while other economies are going to see tapering of ROAs or probably falling. There are a few parameters that gave this confidence that relative to other markets, India’s fundamentals have improved a lot and that gives us more confidence that the valuations may not deteriorate significantly. Hence in the first half, India’s equity market can remain buoyant and resilient.

What are the themes which you like for this year?
We are recommending some of the multiplexes. It is the most hated sector in the lockdowns and the kind of environment that we are seeing . But I feel the best time for OTTs to gain market share from multiplexes was during the lockdown period when big budget movies were not released on OTT platform.

Once we are out of this constraint driven by Omicron, multiplexes will bounce back pretty sharply over the next two-three years. I feel there is potential to see some kind of re-rating compared to pre-Covid levels for these multiplexes. So that sector remains pretty exciting for us. We think there is good money to be made in multiplexes if one is investing for the next two-three years.

The second sector that is coming out very sharp is that the hiring outlook is improving in India. There is formalisation of labour and some of the hiring companies or companies which are providing contract labourers – that segment is looking pretty good for us. So these are the two midcap oriented sectors that we like a lot.

The last part is the banking and domestic cyclicals. I feel that India’s GDP growth might accelerate faster than what consensus is expecting over the next three years. So the medium term outlook for India is going to get revised upwards based on our models, our analysis and we feel that the large private banks which did not participate much last year are in a better position. Also, some of the domestic cyclicals such as capital goods companies can do pretty good over the next few quarters or so.

If you take into account some of the triggers which lie ahead – a lot of state elections, tapering and Budget – all will provide some volatility in the market?
We think that economic growth will be pretty divergent going ahead. If one looks at global growth, while the Fed is talking about tightening their monetary policies, China is actually loosening and they need more monetary as well as fiscal support in our view.

So while the largest economy is going to tighten, the second largest economy is going to loosen. It will also depend on how the inflation behaves. From March to June, the commodity prices will start to see some kind of a base impact but one cannot firmly say whether that is going to remain under control.

So while inflation is going to remain elevated and the 10-year yield is still hovering around 1.6-1.7%, the market is probably pricing it at 1.8% to 2%, not more than that. I feel the overall backdrop for the equity market is still very positive. So, comparing the 10-year average PE ratio and then looking at today’s PE ratio and say that it is 1.5 or 2 standard deviation higher than historical average – that argument does not hold true when inflation is so high and the interest rates are so low.

The negative interest rate environment is going to continue even if the Fed starts to hike rates. The market is pricing in three hikes. So the interest rate environment is going to remain lower for longer and that might support equity markets.

On the other hand, the risk is that if US inflation shoots up to say 8-10% and Fed has to put emergency brakes or they have to increase interest rate faster than what market is pricing in, we might see a kind of a selloff. But that will be in the second half of the year where we will reassess our thesis on the equity market. But for the first half, in case of any selloff or small correction over the next few weeks, we will be the buyers in the market.

What about midcaps and smallcaps? How do you see the valuation picture there? What kind of themes have you studied and researched in broader markets?
As I mentioned, in midcaps we like companies that are in hiring businesses. We also like some of the structural themes like chemicals or pharma or API names which have corrected a lot. We feel that there is a lot of opportunity in the midcap space. The stocks have corrected and that could offer good buying opportunities.

We are going pocket by pocket in the midcap space and our preference is midcaps over large caps at least in the next three to six months, given the kinds of corrections we have seen in the midcap. Last month we went mild overweight on midcaps in this kind of correction. We are actually buying midcaps into multiplexes as I mentioned and some of the recovery plays that can come back very sharply. Also we feel that the export sector is going to see a very sharp revival going ahead. I feel there is a lot of opportunity in the midcap space and one has to be positioned accordingly based on their risk appetite.