In its latest note, brokerage firm ICICI Securities said that the RoE of the Nifty 50 index is rising above the 15% mark after a decade, and it expects it to expand to 17% by FY25E, thereby clearly entering the value-creation zone.
The RoE of Nifty 50 dropped below 14% in FY14 for the first time after FY03 and continued till FY22 before rising in FY23. The RoE hit a peak of 26% in FY05.
According to the brokerage, stocks that are likely to improve their RoEs over FY23 to FY25E and transition into value-creation zone include capital-intensive and cyclical sectors such as auto, capital goods & infrastructure, utilities, telecom, commodities and financials.
The brokerage points out that the RoE trajectory provides a sense of ‘déjà vu’ of what happened in the pre-GFC era between 2003 and 2007. It said the stocks within capital-intensive and cyclical sectors like L&T, BHEL, Bharti, NTPC, Hindalco, M&M, ACC, Reliance, and DLF were transitioned from a sub-14% level of RoE to a value-creation zone of RoE >15%.
Many of these stocks further reached the high-quality zone, boasting RoEs exceeding 25% at the peak of the investment and credit cycle.
As capital-intensive and cyclical sectors expanded their RoEs above the 20% range in the pre-GFC era, their P/B ratio was also boosted, and by the peak of the profit cycle, the P/B ratio had expanded well above 5x. A similar behavior cannot be ruled out going ahead, it said.
Conversely, sectors with lower capital intensity, such as FMCG, IT, and pharmaceuticals, are already largely in the value-creation zone (RoE > 15–20%) and are not expected to be significant drivers of RoE growth from current levels, it noted.
Capacity utilisation improved to 76% in the economy, as per the RBI’s OBICUS survey, and high-frequency indicators like PMI, GST collections, infra orders, and real estate construction indicate demand remains robust, driven by the investment side of the economy.
However, the brokerage highlights certain potential risks. Firstly, it says the severe weather conditions could pose threats to agricultural output and income growth, affecting the rural economy, which relies on agriculture and involves 46% of the working population.
Additionally, the brokerage notes that IT hiring has been sluggish, coupled with a weak outlook.
Given its substantial 42% share in the private corporate sector wage bill, this slowdown in the IT sector presents a significant risk, it said.
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