As stretched valuations could create volatility in the near term, be cautious about stocks facing headwinds

Up to 32% downside in one year: Stay away from these 5 stocks to avoid losses

Buoyant optimism is fuelling the Indian equity markets to record highs in the current financial year. The benchmark Nifty 50 index has delivered 10.5% returns since 1 April, and has outperformed the equity indices of several countries, including China, Mexico, Brazil, France, Canada, South Korea, Australia, Germany, the UK and Hong Kong. The benchmark indices of these countries have delivered returns between -8.2% and 2.9%.

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Domestic markets have seen a broadbased rally in 2024-25, with 77.2% of over 2,801 listed stocks (or 2,163 stocks) with market caps of more than Rs.100 crore, delivering positive returns. Of the 2,163 stocks, 1,457 (or 52% of total) generated more than 15% returns during the period. The data on indices and stocks is based on the closing values between 1 April and 26 July this year.

However, the substantial jump in prices, coupled with stretched market valuations, is making experts anxious about the sustainability of the rally. A recent Emkay report considers the risk of an imminent 5-10% correction in the headline indices, with bigger drawdowns in SMID (small- and midcap) stocks. The report sees no positive catalysts and expects tepid June quarter earnings, delay in interest rate cuts, frothy valuations, and the recent stock price rally as reasons for correction.

The June quarter earnings are expected to be hit by the base effect. A Motilal Oswal preview report for June quarter earnings expects the growth to be weighed down by sectors like oil and gas, cement and speciality chemicals. It expects EBITDA margins for the Nifty 50 index to contract by 80 basis points.

The valuation issues are seen across market segments—large, mid and small cap. The Nifty 50 index is trading at a one-year forward PE of 21.4 times, which is 10% higher than its five-year average. Valuations for the NSE Midcap 150 (42 times trailing PE) and NSE Smallcap 250 (31 times trailing PE) are also 52.5% and 35.5% higher, respectively, than their respective five-year averages.

Meanwhile, inflation continues to remain a concern due to rising food prices. India’s June CPI combined inflation jumped to 5.08%, significantly higher than the market expectations. The Reuters poll had forecast inflation at 4.8% for June. On the other hand, India’s WPI inflation surged to a 16-month high of 3.4% year-on-year in June this year.

The higher inflation rate could delay the RBI rate cut and may dampen the sentiments. “Despite growing expectations of a Federal Reserve rate cut in September, the RBI is unlikely to cut rates within this calendar year,” states a Prabhudas Lilladher Ecoflash report.

The concerns of experts are also visible in the distribution of ‘buy’, ‘hold’ and ‘sell’ ratings, compiled by Reuters-Refinitiv since the start of 2024-25. The ratings (buy, hold, sell) for 732 stocks with market caps greater than Rs.500 crore have gone up since April 2024 from 7,055 to 7,245. However, the proportion of ‘buy’ ratings (in total ratings) has declined from 62.1% to 61.9%, whereas the proportion of ‘sell’ ratings has increased from 18.2% to 18.5%. On the other hand, the proportion of ‘hold’ ratings have remained stable at 19.6%.

Looking at the jump in the number of ‘buy’, ‘hold’ and ‘sell’ ratings since April, the number of ‘buy’ ratings has increased by 2.4%, ‘hold’ ratings have gone up by 2.6%, while ‘sell’ ratings have jumped by 4%. The increase in ‘sell’ ratings (in both proportional terms and growth terms) indicates that analysts are recognising the growing possibility of a correction.

As the valuation concerns and rate cut uncertainties could aggravate risks, we have identified five stocks where investors should refrain from investing to avoid losses. These are stocks with a higher number of ‘sell’ ratings compared to their combined ‘buy’ and ‘hold’ ratings. Among these, the stocks that are currently offering a downside were included. Only stocks that have seen a decent run-up in their prices (more than 5%) since the Lok Sabha election day crash (4 June 2024) were considered.

The five stocks listed here have been selected after analysing various brokerage reports to understand the reasons for high ‘sell’ ratings. Factors such as demand weakness, higher costs, rising competitive intensity and sector headwinds are some of the reasons that are weighing on their performance. A recovery in the overall demand environment, fall in inflation rate and improvement in global economic growth will help these stocks improve performance. Currently, however, they are facing headwinds and investors should be cautious.

L&T Technology Services
THE TECHNOLOGY COMPANY reported muted performance in June quarter, with a 3.1% quarter-over-quarter (q-o-q) decline in revenue in constant currency terms. Weak seasonality in SWC (smart world & communication) business dragged the revenue growth. In terms of segment-wise performance, both sustainability and hi-tech declined by 3% and 11.6%, respectively, on a sequential basis, whereas mobility grew by 11.6% q-o-q.

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The management remains confident of achieving 2024-25 revenue growth guidance of 8-10%, but analysts believe meeting this target will be difficult due to near-term uncertainties. These include geopolitical tensions and macroeconomic issues, which are resulting in muted discretionary tech spending by clients.

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Analysts list an uncertain demand environment, potential threat of recession in developed economies, rising sub-contracting costs and cross-currency headwinds as key factors that could negatively affect the performance. Brokerage reports from Emkay and Centrum, released after the June quarter results, have given a ‘reduce’ rating, while Asian Securities have rated it as ‘sell’, and Antique Broking and Axis Securities have rated it as ‘hold’. The Axis Securities report is positive on long-term growth, but concerns over the prospects of large economies and supplyside constraints pose uncertainties about short-term growth rates.

Berger Paints India
THE PAINT COMPANY’S March quarter performance was impacted by negative operating leverage and adverse product mix. The performance in the June quarter is likely to remain muted amid subdued demand for paints due to election impact. It’s expecting a 3.4% yearon-year growth in revenue. Both EBITDA and PAT are expected to fall by 2.7% and 3.1%, respectively, as per the estimates of analysts compiled by Reuters-Refinitiv.

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The company is expected to see lower value growth, compared to volume growth in 2024-25, due to the impact of price cuts and higher sales of low-value products. The strong competitive pressure from new and existing players will also affect its performance in the current financial year. However, the company’s recent investments in brand building and distribution expansion are expected to support volume growth in the long run.

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The company’s industrial business continues to do well and the ongoing investments in the infrastructure sector are expected to drive the segment in the future. Despite the positives, analysts believe that it will be difficult for the company to gain market share over the next two years. This is due to the increased competitive intensity after Grasim’s entry into the paint business, and the likelihood of volatility in the commodity prices.

MRF
THE TYRE MANUFACTURER reported a weak performance in the March quarter due to higher costs. The continuing volatility in raw material costs and moderate demand is expected to impact its performance in the June quarter. It is likely to report a 12.7% and 26.2% decline in EBITDA and PAT, respectively, on a year-on-year basis, according to the consensus estimates of analysts compiled by Reuters-Refinitiv.

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In the June quarter, the prices of key commodities like aluminium, copper and rubber jumped by 15%, 16% and 5%, respectively, on a q-o-q basis. The increase in costs will lead to a 100 basis point contraction in EBITDA margin, states a Motilal Oswal automobile sector preview report (June quarter). The major impact of commodity price increase will be reflected from September quarter onwards. The company is losing its competitive positioning and pricing power in the sector, particularly in TBR (truck, bus, radial) and PCR (passenger car radial) segments. The EPR (extended producer responsibilities) provision created in the past due to Environment Ministry’s regulation for waste tyres, could dent profitability, if such costs turn out to be recurring. The expansion in return ratios will be limited in future due to the impact of the planned capex, and there’s a likelihood of dilution in RoE over the next two years.

Tata Chemicals
THE CHEMICAL COMPANY is facing challenges due to the demand-supply skew in soda ash prices, which is impacting its realisations. The subdued demand was seen across geographies (India, US, UK, Kenya) in the March quarter, with a 54% year-on-year decline in EBITDA. The performance is unlikely to improve in the June quarter as EBITDA is expected to fall by 51% y-o-y, according to Reuters-Refinitiv estimates.

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A delay in expected recovery in China’s construction sector and weakness in flat glass demand from Europe is denting soda ash prices. The management expects stable demand for soda ash in 2024-25, with the emergence of new applications, such as solar glass and lithium-ion batteries. However, there are concerns due to the ongoing geopolitical challenges, weak demand scenario in China, high interest rates and increase in global capacity.

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A report from Nirmal Bang (June 2024) states that despite management’s indication of a gradual recovery in the soda ash industry towards a balanced demandsupply situation, it could take 12-24 months due to the increase in new capacity. The report believes the current concerns over margins will persist till there is a closure of old synthetic capacities in the EU and China. It expects performance to improve once the US cuts interest rates.

YES Bank
THE PRIVATE SECTOR bank reported good performance in the June quarter, with a 47% year-on-year jump in net profit. While the deposits grew by 21%, loans registered a 15% growth rate in y-o-y terms. Moreover, the bank reported stable net interest margins (NIMs) and an improvement in slippages on a sequential basis. Despite these positives, analysts have maintained a bearish tone.

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The profitability is expected to remain subdued in the future due to challenges arising from competition in deposit mobilisation, weak margins and high operating expenditure. Moreover, its RoA remains burdened by the bulky RIDF (rural infrastructure development fund) investment, which is approximately 11% of its total assets.

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A recent ICICI Securities report states that the bank is making concerted efforts in organic PSL (priority sector lending) origination, which should ease the incremental RIDF burden, aiding yields and RoAs. This, coupled with easing credit costs, could improve RoA over the next two years. However, the report maintains a ‘sell’ rating as the current valuations adequately capture the turnaround. Another report from AnandRathi estimates RoA to remain lower than 1% through 2024-25 and 2025-26 as the cost-to-income ratio is likely to remain elevated due to weak NIMs and higher operating expenses. In the June quarter, the cost-to-income ratio stood at 74%.
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This story originally appeared on: India Times - Author:Faqs of Insurances