Kotak report sounds a warning for the ‘nonchalant’ Indian market investor

Kotak report sounds a warning for the ‘nonchalant’ Indian market investor
Source: Pixabay
  • The market is too nonchalant about severe disruption challenges across sectors, finds the report.
  • Auto and construction materials sectors will see hiccups in the medium-term.
  • Consumer staples, oil, gas & consumable fuels sectors will take minor hits as well.
India has been on the road to transformation and Dalal Street has been a reflection of that with benchmark indices like the Nifty and Sensex beating global peers at large in the past year. However, transformation inherently brings a certain amount of disruption and according to a report by Kotak Institutional Equities, the markets are failing to price that in.

The research firm expects large disruption across sectors in the next 2-3 years. “We believe the market is too nonchalant about the severe disruption challenges in the case of certain sectors that will affect both growth and profitability of the incumbents. The rich valuations of stocks would suggest that they are clearly not factoring in any medium-term disruption-related risks or that they will stand to benefit from any disruption,” the report reads.

Where will disruption rise?

Kotak identifies auto and construction materials as sectors that will see medium-term disruption. The auto sector has been pivoting towards electric vehicles but the ‘new’ sector has seen new players entering like Ather, Ola and more which have also made a name for themselves. And, as the technology evolves and new players enter, it will make it difficult for the existing large players.

“Incumbents in the two-wheeler and four-wheeler segments enjoy very high profitability and returns and are thus vulnerable to destruction to current large profit pools as EVs become more competitive versus internal combustion engine vehicles or ICEVs over time. They are already fairly competitive, with ICEVs on a full-cost basis,” Kotak believes.

It is expected that a change in the mode of distribution will affect building and construction materials sectors as well. The business-to-consumer or the retail model will shift, and the business-to-business or B2B or institutional model will capture a higher share.

“India will see an increasingly larger portion of real estate development in the form of multi-apartment, multi-building developments at the expense of single-home developments. Incumbents enjoy high profitability and returns which may not sustain as the sales mix shifts progressively to bulk or institutional sales versus retail sales,” the report says.

Disruption is also expected in consumer staples and oil, gas and consumable fuels sectors — but will take longer to disrupt. However, they will see disruption nonetheless.

“We believe that most consumption sectors and stocks will see a large disruption in the next 3-5 years; the process has already started in a few. The market is focused on the current recovery in profitability from a moderation in raw material prices, but is oblivious to the risks to profitability in the medium term arising from changes to market and product dynamics, which will result in the traditional moats of companies being eroded and even breached,” the report warns.

The ‘selective bias’

The report authors are pessimistic about the high profitability and returns of consumption sectors and companies sustaining at current high levels — in the medium term, given the increasing disruption risks.

“We find the market’s selective attitude toward disruption risks as rather puzzling; investors understand the disruption issue in general but many prefer not to see disruption risks in their preferred sectors and stocks,” Kotak says.

The fourth quarter earnings reports have only played up to the market’s ‘convenient’ expectations and disregarding negative developments, it adds. The surprise GDP growth of FY23 at 7.2% has enthused investors, yet the weak micro outlook is failing to dampen enthusiasm enough.

The net profits in 4QFY23 of the Nifty-50 Index increased 19% YoY, which is 7.4% above Kotak’s expectations. It expects net profits of the Nifty-50 Index to grow 12.6% in FY24 and 15.2% in FY25.

“Inflation declining from peak levels and interest rates most likely peaking in the current rate cycle and current account deficit (CAD) and balance of payments (BoP) looking comfortable. However, consumption demand continues to be sluggish, while investment demand is showing some signs of weakness,” the report reads.

Corporates vs Investors

A recent Jeffries report had also said that corporate India sentiments have been much more positive than investors expectations. Cyclicals have been seeing strong demand conditions across industrial, property, autos, chemical sectors. Moreover, it says that financials are seeing moderation in topline but asset quality trends are strong. However, the IT and high-frequency discretionary are weak.

“Broadly, investors remain positive on India’s growth outlook; and expect political / policy continuity in 2024. The foreign investor positioning appeared closer to neutral to slight OWT (overweight) on India and the long consolidation in benchmark indices, alongside earnings growth, has made valuations attractive,” Jefferies says.

With funds on a light footing, and a large-scale disruption at front, analyst models might have to price in a lot of uncertainty in the horizon, including any climate change surprises that might land on the economy.


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