Best companies to buy: Stocks with bullet-proof balance sheets will command a premium

Covid-19 has dashed hopes of the long-awaited economic recovery in India. The national lockdown has been extended until May 3, 2020, and early data like power consumption and fuel demand paint a worrisome picture.

Further, the roadmap for lifting the lockdown remains unclear for now, and it would depend on the progress made in containing the epidemic.

The lockdown has shut down non-essential businesses for weeks and most likely result in GDP contraction in Q1FY21. Unemployment levels have soared, as small businesses struggle to survive the lockdown. Unless the government intervenes to support the economy, FY21 growth could sink below 3 per cent year on year. Consensus estimate for Nifty EPS has been downgraded by just ~6 per cent in last one month and current estimates still imply double-digit growth in earnings. This scenario is unlikely to materialise and FY21 estimates will see sharp cuts as clarity emerges on the extent of damage to the economy.

The government has announced some measures like distribution of cereals and cash transfers to the poor as immediate relief measures. However, more steps like higher spending on healthcare, cash transfers and loan guarantees for small businesses may be needed to revive the economy. RBI has announced a series of measures twice, including policy rate cuts, liquidity infusion, moratorium on loan payments and support to smaller NBFCs and MFIs to tide over the crisis.

While these measures are helpful, continued availability of liquidity may require active intervention by RBI. Government borrowings for FY21 are likely to exceed the budgeted amount by a wide margin, as tax collections are likely to fall short of estimates even as the government would have to step up expenditure to revive the economy. Sovereign bond yields have been hardening over the past few weeks despite a sharp 75 bps policy rate cut on concerns of fiscal slippage. RBI will have to step in to ensure that the government’s borrowing costs do not rise due to higher borrowings.

Worries about the economy and corporate earnings have dragged the equity markets. The benchmark Nifty fell ~38% from peak level in a span of one month and several stocks have corrected more than 50%. As a result, valuation multiples have contracted and Nifty now trades at ~17 times on a trailing PE basis compared with ~25 times in February. That said, both Indian and global equity markets have rallied since the last week of March even as a cure or vaccination for coronavirus eludes us and the epidemic continues to spread.

Although the equity markets have recovered from the lows of March, the outlook for the economy remains uncertain. The lockdown would strain balance sheets of corporates as companies try to manage fixed costs with near zero sales. In such an environment, resilient companies with strong cash flows and bullet-proof balance sheets will command a premium. The names the come to mind would be Bharti, Kotak Bank, ICICI Lombard, L&T, Maruti, SBI Life and Torrent Pharma among largecaps and Ashok Leyland, Deepak Nitrite, Kansai Nerolac and Navin Fluorine among midcaps.