Stocks to track, Budget and earning cues for investors: Chola Securities’ Dharmesh Kant breaks it down

Broader markets continued to outperform the benchmark equity index during the first half of 2024. Where the BSE Sensex advanced nearly 10% on a year-to-date basis until June 27, the BSE MidCap and BSE SmallCap indices rallied 25% and 21%, respectively, during the same period. So, will the ongoing rally in mid- and small-cap stocks be sustained in the second half? What should investors do now? In an interaction with Business Today, Dharmesh Kant, Head of Equity and Derivative Research, Chola Securities, shared his views on the domestic equity markets. Edited excerpts:

Mid- and small-caps delivered superlative returns to investors during the first half of 2024. What can we expect from the markets now?

Kant: This outperformance was largely on the index front for mid- and small-caps. The breadth of both segments was not secular and polarised. The reason being that few stocks from banking, financials, auto and auto-ancillary, real estate, EMS, and textiles led the price and earnings action.

At the recent all-time high (Nifty at 24,000 plus), only around 30% of the top 500 stocks by market capitalisation are trading at or around their all-time highs. The scenario is more dismal if one looks at the Nifty 50 basket, where only 10 stocks are at or above their all-time highs.

Caution comes from the narrowness of market breadth, be it earnings or price action. If one looks at earnings aggregates, clarity emerges regarding the reason for such narrow market breadth. Our proprietary grouping of NSE-listed top 500 companies by market capitalisation shows large-caps (top 50 companies ex-BFSI) delivered 25.50% net profit growth in FY24 over FY23, while mid-caps (next 150 ex-BFSI) delivered around 47.80% and small-caps (next 300 ex-BFSI) only 6.20% net profit growth, respectively. While BFSI in the top 500 market cap basket registered 31.80% net profit growth in FY24 over FY23.

We expect challenges to be steeper for markets in the rest of FY25, as price appreciation has run ahead of time. Companies’ P&L for FY24 was marked by low single-digit top-line growth and a high bottom line, aided by better operating margins.

Maintaining operating margins will be a tall task as input and commodity prices are on an upswing so far this fiscal year. Companies will be hard-pressed to maintain a balance between volume growth and price hikes, as both parameters have been difficult thus far. Sideways consolidation and time correction look likely. 

How much upside do you see in Sensex and Nifty during the second half of 2024?

Kant: In our annual outlook report for CY24, we pencilled Nifty at 24,000 in the calendar year 2024, which has been done. We have taken into account an estimated FY25 Nifty EPS of Rs 1,200 and valued Nifty at a price-to-earnings ratio of 20xFY25e, which works out to an earnings growth of 15% over FY24. Given the recent surge in commodity prices and the inability of companies to take price hikes, it will be quite a task. Having regard for the liquidity ‘Tsunami’ infused by retail investors both through direct equity and indirectly through the mutual fund route, another 5% up move on headline indices seems likely by year end.

Suggest 3–4 stocks that may deliver robust returns to investors over the next 2–3 years

Kant: We believe the same themes will continue in FY25 with a few additions. From the next 2-3 years’ perspective, a mix of railway infrastructure, defence, and public sector undertakings should bode well for investors. Investors should add RVNL, HAL, and LIC to their portfolios on a SIP basis over the next year to reap benefits over a holding period in excess of 3 years.

RVNL is a niche player in the railway infrastructure space. The space has been buzzing and flooded with orders about the government’s renewed focus. The company boasts strong financials. ROE of 20%, sustainable operating margin of 6% to 7%, over the last 5 years profit has compounded in excess of 20%, and revenue at around 22%.

The order book is in excess of Rs 70,000 and has a book-to-bill ratio of three times. The company is confident in its ability to execute projects and maintain positive growth, targeting an order book of Rs 75,000 crore to Rs 1 lakh crore.

In light of ever-increasing budgetary allocation to railways, the laying of bullet train tracks, going for 4-lane railway tracks from the existing 2 in most parts of the country, and the overhauling of existing bridges, we believe the stock is cheap at the current price.

On the other hand, Hindustan Aeronautics is a pure play on defence made in India. The company has a strong order book of around 94,000 crore plus pipelines. Book-to-bill ratio in excess of three times.

Life Insurance Corporation of India has a strong distribution network of 13.47 lakh agents and a market share of 51.26% as of March 2023. It's available at 1/4th the valuation of its private sector peers.

What do you expect from the forthcoming quarterly results season?

Kant: We are expecting a muted earnings season for Q1FY25. Key highlights likely to occur are slippage in operating margins due to higher input prices, low single-digit volume growth, and a lack of pricing power in general. However, companies aided by government spending like railway infrastructure, defence, and infrastructure will continue to do well along with EMS. 

What are the major announcements you expect from the Union Budget?

Kant: It is difficult to assess at this juncture. Much will depend on monsoon progress and the quantum of rainfall. IMD is maintaining its prediction of above-normal monsoons this season, which must translate into reality. Having regard to the aforementioned caveat, we believe there won’t be any departure from prior policy rollouts. The focus will remain on boosting infrastructure, defence, railways, and EMS through PLI schemes. Sectors that can be added to the above list are textiles and chemicals. An emphasis on better governance, higher tax collections, and incentives for faster execution are expected. 

How can an investor deploy Rs 10 lakh in this market?

Kant: Go SIP mode, be it the direct equity or mutual fund route.

Which themes do you think will outperform from here onwards? Why?

Kant: Sector-wise, defence, railways, banks, capital goods, and EMS look attractive. Key factors are government spending, China plus one playing out, better visibility and consistency as to order book, revenue, and profitability in this highly heated market, driven by the huge liquidity boost of retail investors.